Macro-Economic Reality

There is a misperception about the money supply. Whenever a loan is approved by any bank, the money for the loan does not come directly from the bank’s reserves or deposits, otherwise, the bank would run out of actual cash. Instead, the bank keeps a record of loans and deposits which must meet certain limits according to the Basel rules. Car loans and House loans and Business loan all require a different leveraging percentage of the bank’s reserves, along with liens, mortgages, etc.
When a loan is approved, the Fed authorizes the Treasury to print the money for the loan so that when the loan check is cashed, there are funds available. The ratio of loans (debits) to assets (savings) is largely an accounting procedure.
The statement: “the banks simply do not lend out reserves” is credulous. Banks have leverage limits on how much they may have as outstanding debt-loans in relation to assets-savings. Therefore, banks do simply lend out reserves but not in the concrete sense. Banks keep their deposits and issue loans, under approval by the regional Fed, up to the leverage limits set by the Basel agreement which is 10% for certain loans and up to 50% for other loans – it depends on the kind if loan. Thus, a bank must hold in reserve appr. 35% for mortgages and a variable amount for all other loans depending on the credit rating of the agency/person requesting the loan.
Bonds are instruments for raising revenue. Several levels of govt issue bonds from the US Treasury, to states to municipalities, even corporations issue bonds. The conditions for pay-out vary however at maturity. For example, US Treasury bonds may be bought back before maturity, as Bernancke did, to reduce the US debt which was politically embarrassing.
The relation between the interbank transfer rate, which is really a transaction fee can be as high as 10% for example as between banks from different nations or even between BOA and CHASE, but the Federal Funds Rate is only .5% and was established to help banks comply with the requirement to hold a certain amount of liquid reserves to match deposits. US Treasury Bond interest rates are quite low today, around 2%. But, in the context of inflation which is today quite low also, the bond value could rise and cause more government debt. So, low inflation is a good thing for the government and the Fed chair will ensure that by keeping any factors which contribute to inflation, like a higher interbank transfer fee, as low as possible. On the downside, a low inflation rate means that prices and wages, and hence profits are also low, so some inflation is a good thing. One way to increase inflation ‘just a little bit’ is to increase the Federal Funds or overnight rate by a .25 rate, which is nothing unless you factor in scale which for large banks could become significant. A .25% change on a US T-Bill would be significant and might encounter massive trading, perhaps selling.
As for the multiplier effect which confuses everyone. The more transactions there are, the greater the velocity of the dollar which is the multiplier. Whatever increases velocity, or rate of transaction, is a multiplier which varies for each market. When income s earned and a person receives income, the person may simply deposit and not spend it. If the person spends it completely, there is a higher velocity of money. Agencies receiving those dollars may in turn spend it again instead of depositing it, and so on. The larger the number of total transactions, the greater the velocity – the multiplier effect.
Why are interest rates on savings so low? The obvious answer is because savings on deposit are so high, the bank does not need more on deposit and does not want to pay so much in interest given the high amount on deposit. To analyze the problem from the perspective of the Fed and so neglect the attitude of the bank executive is too confusing. When banks need to increase their deposits, they will increase interest rates. The Fed wants to increase GDP – it is not concerned with bankruptcy which is the concern of the corporate executives and property owners. One intervening variable is credit card expenditures which permit individuals and other agencies to maintain their savings while still consuming at a high rate while paying debt maintenance on the credit card. Even very large corporations do this, like Ford Motor Company which has formed an investment bank which it has separated from its production end. It accumulates debt on one end while saving profits on the other. This kind of individual, corporate strategy or Federal-National strategy is metaphorically called “Buying Time” by Wolfgang Streeck in his latest book by the same name.
Political reasons are often involved in economic decision and should be included in any analysis – the key point is of the primacy of the political. Cui bono is an effective factor for analyzing policy initiatives!
Each bank manager/owner, like a CEO, has a delimited set of responsibilities. The Federal Funds overnight rate like Interbank Transfer Rate, an interest rate, is simply tacked on to other fees, which eventually gets tacked on to the increased cost of doing business, or pricing. If these costs do not decrease sales revenues, wage income, or loan applications nor increase the cost of accounting and issuing checks to employees/government tax agencies significantly, then changing the Fed Transfer Rate or Interbank Transfer Fee, when only aggregate or totalized bank deposits/reserves are affected, makes sense, at best, from a regional Fed perspective because at scale the Fed benefits but does not affect transaction in the local sense.
The reason for the target rate on the Fed Funds overnight loans (think gold shipments in the 19th century for balance of payments!) is because that rate is added onto bank fees to the entrepreneurs doing business with the bank and who passes that onto consumers. A .25 increase, or a 1% increase is like adding a point to any loan transaction. Small increments to inflation permit an expanding economy in terms of higher wages and more jobs.
How does the Fed control the money supply? The assumption is that the larger the money supply, the greater the number of transactions and therefore higher the rate of consumption of goods and employment – productivity increases. The Fed is the top set of regional banks. The Fed has to cope with the markets, with the aggregate of consumers/employees, and with the large number of small banks across the nation; consider international capital flows as well. The Fed is not simply concerned about the size of the money supply, but of the quality of the loans – this is called SOLVENCY. The Fed could, like a Greenspan, just do whatever the Pentagon and the White House want it to, which it has had a tendency to do, and permits all loan applications through for approval, leading to wild speculation and poor investments which occurred after the repeal of Glass-Steagal. The control of the economy is only given a brake by the Fed who enforces loan application policies BECAUSE loan approvals increase the money supply! So, today it is more difficult to get a loan of any kind due to procedural checks on the process – loan rates dependent on credit ratings – the lower the rating the higher interest rate AND the greater the percentage the bank must hold in reserves!
The only legitimate way to print new money is from approved loans. Bonds do not increase the money supply, they decrease the money supply because they rake in investment capital to balance the Fed expenditures. When the bonds are up for maturity, they pay out, then the money is “printed up.” Recently, much more money has been infused into the economy than has been taken out by bonds, because Bernancke was buying back bonds at a clip of 700M/month to reduce the debt and he accomplished a shift from 80T to 20T in US debt during his watch!!!!! The mature cost of the bonds would have dwarfed the price he paid. By paying out, he infused all of those bondholders with cash NOW to reinvest! Thank you for the 1.5% productivity increase!
Loans are not related to taxes. If however, I purchase a car or house with a bank loan, I will pay taxes on the car, on the house when purchased and property taxes to the state, but the loan is not taxed. There is no necessary reason to peg the loan to the dollar. All loans work the same way except that the monetary system YOU are in when you are applying for the loan will pay the loan money in the currency you live under – YOU then buy the currency you want, unless you arrange for a particular currency with the bank, but whatever the currency transaction rate difference is, the Interbank Transfer Currency Rate, you will pay, just as you pay for all taxes and bank fees when you get the loan, so a loan of 30K will be somewhat less for this reason.
But, to be disabused of misinformation – when a loan is approved and a deposit shows up in the loan applicant’s account, you can be dead certain that the Fed has accommodated for this change at the other end by printing up new money to cover that loan. Otherwise the money supply, all the cash in all the banks would get sucked out by a few days of transactions because people would be spending that newly loaned money. Now, to the extent that everything goes digital, this will be a moot point, but on the balance sheets, the loans of each small bank must equal the loans at the Fed Regional Bank, if you care to know what is going on quantitatively at all! There are processes known as Bank audits! Maybe someday there will be a Fed audit, haven’t heard of one yet, but I have no doubt they would pass.
Is it a FACT that the progressives do not understand the money printing process – does anyone? Of course money is printed when loans are approved, that is not contentious – that is the way it has always been. What is contentious is when the Federal Government cuts checks for all of its employees and the Pentagon contracts with ‘not quite’ the equivalent incoming tax and bond revenue! The trick has been to keep the interest rate so low that debt maintenance, the interest on bonds or payout upon maturity, is next to nothing. Since no one can enforce debt repayment, or a balanced budget, except the Federal Govt, it is a circular argument. The Republicans are pathetically ridiculous about this fact: they whine and grumble about fiscal conservatism and then turn around when they get into office and bleed the nation dry into debt and war. Where is their fiscal responsibility now?
Do taxes fund Federal spending? Where do taxes dollars go? It is irrational to assert that the Federal Govt does not use tax revenue to fund its budget and that banks do not use reserves to fund their loans. Both notions are inaccurate. The Federal Govt does not deficit spend its entire budget otherwise you be left explaining where the tax revenue goes. Also, you will need to explain the federal Budget at some point, it is not unrelated to monetary policy: the control of the money supply. All that is occurring is that a portion of the tax revenue funds the bond market which increases due to deficit spending – the Federal Govt issues bonds to cover its deficit. Bank reserves do fund the loans on each bank’s books because those banks may not spend it – they must keep those reserves in their vaults, on their books. Although Solvency is a strict requirement for all agencies under the Federal Govt, the Federal Govt may deficit spend under political fire. The recent past has seen massive social spending cuts as well as large subsidization of corporations to keep the deficit under control and maintain productivity in terms of consumer spending and employment.
There is the dilemma public deficits and debt. Questions should arise like: “Is debt an imaginary fear?” or “why doesn’t each government that prints its own money just have a free for all and spend in deficit to its heart content?” And the reason is because it would create a devaluation of the values of solvency and fiduciary responsibility and smack of corruption. This is exactly what has happened in several nations. The EU was formed to prevent this problem. Namely, government heads would spend as much as they like, they would pay themselves and their cronies as much as they like, with no accountability. Some nations would extort large interbank currency transfer rates or impose tariffs, like China. This infuriates the people and other heads of state. It leads to inequality. So, there must be some control on deficit spending. One way the US institutes a control on deficit spending is by issuing bonds in addition to tax revenue. The bond’s interest rate is the debt maintenance. Although deficit spending is somewhat controversial, it has its defenders, for example, Keynes.
Ironically, the CSA (Confederate States of America) collapsed because no one paid their taxes, which is also the case for Greece. But, Greece got itself into debt when it took on the 2004 Olympics which is could not afford. In tandem with tax evasion (a problem that stalks the US) and a huge social services debt, Greece could not meet its fiscal budget. BUT THE KICKER IS THAT THE 1968 GREEK CONSTITUTION STIPULATES THAT THE GREEK SHIPOWNERS, THE LARGEST SHIP-TRANSPORTERS ON EARTH, ARE NOT REQUIRED TO PAY ANY TAX. This constitutional stipulation has put Greece under IMF austerity and no amount of German loans will save it because while Germany loans Greek banks money as a bailout, that money comes right back to Germany who exports large commodities to Greece. The solution is for Greece to tax its ship-owners and to recover the expected back taxes. But, all of Europe is in this situation where subsidies and special conditions protect the filthy rich and the people must cower under continuous drawing down of social services and income. The analogon in the US are those states whose property taxes are so high, and whose property values are also high, that the foreclosure rate and hence the geographical mobility of its citizens is also quite high.
In the US and most of the West, there is a strong value orientation that everyone go to work – rejecting the social institutions of education and work is considered to be a rejection of the primary social values. So, it would be politically irresponsible to simply deficit spend (not to mention to eventual collapse from inflation) to pay people a basic income for doing nothing. Although, the US has significant social services’ budgetary expenses, the objection is that it is something for nothing on the backs of hard-working Americans.
MONETARY THEORY, MONEY SUPPLY AND PRICING
There is no necessary connection between the size of the money supply and prices. Prices are set partly on the basis of costs, and partly on the basis of profit expectations, and also partly on the fear of bankruptcy. Pricing is political! Wages are somewhat related to subsistence needs, so there is usually recognized a lower limit, but this too is political. On the high end, wages and salaries are related to status more than to need. CEO’s never make less than VP’s!
Having more money in circulation is a tricky notion. What is circulation? All the money in print? All the money that is in print and on loan? Or, all the money in print and on loan MINUS savings? This gets into a morass. One problem Keynes addressed related to consumer decisions over whether to spend or save; he points out that this is based on confidence or future considerations. A lack of confidence is equivalent to thrift. Now think Panama Papers! All that money socked away in offshore accounts is money that was circulating that is now in stasis. If this factor of savings, like the factor of potential credit is ellipted from the notion of money supply, a more accurate sense of its size is possible. But before we say that a constricted M causes higher V or greater competition as a function of M size, we must control for all political “propensities” to spend and save. Since this is speculative or probabilistic, we must consider not just interest rates but loan (and tax) authorization principles practiced in each nation/state/corporation/household – see end on last post!
Loans given for speculative purposes where loan-to-value is inaccurate results in bankruptcy – the significant problem, also called insolvency!
When you say “naturally raised by competition” you assert a causal relation which is questionable. Competition is based on scarcity, so logically, the money supply shrinks because of oversavings or restrictions on appropriate loans, e.g. business maintaining not speculation driving. The main purpose of the Fed is to maintain a sufficient money supply to avoid competition, that is, banks should have enough money to loan, and secondarily the mission of the Fed is to decrease unemployment. Unemployment is not simply a matter of improving entry into jobs but also reducing layoffs which amount to around 75k/day in the US as we write!!
The four main debt instruments that loans provide are: mortgages, cars, college, and credit cards and then business loans. The easier credit is, the easier it is to maintain the money supply so business and households can consume and produce. Therefore, interest rates are low. This is modernity.
Remember that govt debt is a misnomer. The govt does not owe anyone even after deficit spending. It is a political category related to solvency, corruption and ethics. If the US Govt simply prints money so that people can make money off of the government without any valid exchange, it is considered a violation of our key value of equality. Inequality is a motivation for resistance and protest, for social instability.
The govt issues checks to its employees and to its contractors – that is it. Govt spending is covered by taxes and bonds. The debt is a function of outstanding bonds, that is, it is a paper debt until it is due. This is the difference between deficit and debt: the only debt the govt has is to repay its bonds! Read what I said about Bernancke
Bonds are revenue and covers deficit spending. New money is printed when the Fed authorizes the Treasury to print on the basis of approved loans or its checks to employees and contractors. Bonds are not renewed: bonds are issued and revenue gained and paid out at maturity or whenever the govt decides before that. Subsidies and so-called hand-outs (some people need help!!) are part of the budget paid for by tax and bond revenue. The govt is not exactly a corporation, it is like one however. But when you say invest, the way our govt acquires investors in through getting people to pay their taxes and buy bonds!
You have to understand how the money supply is increased or decreased and how the Fed manages the money supply.
The money supply increases when loans are taken or when people earn income by working. If income is not spent on consuming goods and instead saved, then money supply does not increase. The key factor is VELOCITY of transactions – how many times and how quickly is the dollar used for transactions of exchange.
The Fed manages the savings problem by reducing interests rates on savings, as you should be aware. To increase the money supply, the Fed also keeps interest rates on loans low where a decrease in the interest rates increases the money supply and an increase will reduce the money supply.
The money supply itself is not a causal factor in competition, the conditions for increasing it or decreasing it are causal, that is, credit, loan approval, investment in production processes and consumer behaviors. We use the money supply as a nominal to understand whether money is dear or loose – is it hard to get a good paying job, is it hard to get a loan, are prices high, can you find a deal? I do not think anyone can quantify the money supply and disambiguate savings from circulation – the dynamic is far too complex.
For example, your credit rating is based on the amount of credit that you currently have in contrast to your debt – all of those credit cards have a maximum amount, total that up and that is the amount of credit you have available. How much of that are you spending? Is that part of the money supply? Yes. Do you spend it all, NO, because of the interest rate. But, if the interest rate on credit cards was say 4%, you could go hog wild, max out your cards and pay out the maintenance on those loans for the rest of your life. The kicker is MANY PEOPLE DO JUST THAT! So, summing up the money supply is complex.
If prices rise ask why? Are production costs increasing, or wage increases? Competition means that there is scarcity and therefore inflation occurs, (price increase). Why is there scarcity? On the other hand, and much more likely to occur, is that there is plenty of supply but not enough capital to consume because wages are too low, loans are too expensive or difficult to get, think credit rating! People make bad decisions: there are layoffs, there are bankruptcies, there are foreclosures, there are repossessions, there are Marshall’s auctions – these are the results of too much competition.
It is important to understand that economics is a control on politics, the primacy of the political!
INFLATION
Inflation is caused when costs increase. But, as one firm increases their price, other firms may undercut them unless their costs also increase. Pricing that is too high will cause low sales, pricing that is too low will not earn enough revenue to pay debts and result in BANKRUPTCY!
For any product or service, there are a series of transactions during the production process, or execution of the service, from raw materials to unfinished partial product, to transport and assembly of partial unfinished products, to sales, and then back to the next series of production. All kinds of decisions are relevant concerning how much of this and that, employees – hiring and laying off, getting the product to the market and selling it for the cost+total profits.
This does not always work out, and each step along the way requires capital to make the process work which requires loans at reasonable interests and easily acquired, AND the problem to avoid is bankruptcy. Bad decisions along the way lead to bankruptcy. One decision is pricing which must be competitive, the same as others or lower in order to move product. If all firms of the same product (or different production runs by the same firm but using older or newer equipment – at different expenses) experience cost increases due to employees demanding higher wages, problems getting raw materials (finding the oil, growing the crops), tax increases, or higher interest rates from banks, then prices must go up. Basic supply-demand: if supply is short, demand increases and prices rise because firms must be solvent and pay their bills.
All of this obviates CEO pay raises, legislators pay raises, and the minimum wage.
So, costs cause price increases, that is, inflation.
One way to keep costs down is to get capital, loans, at a low interest rate. More loans, more money, greater velocity if everyone cooperates and consumes rather than acts thrifty and saves up their money which decreases the money supply but more seriously, does not consume the available goods on the market. This is the case, where firms have to lower their price down to cost, or perhaps even lower just to move the product and get something back – to pay their bills including interest rates on loans. Consider wholesale!
One way that firms do this is to vary the price across markets: markets that can pay more will pay the higher price, markets that cannot pay more will get the lower price but may have to sacrifice services like quality of product or timeliness with respect to when the product is available to be purchased – richer consumers get first dibs, so to speak. So, for every production run, or service provision, the top half of the product goes immediately to one market at a higher price and then later at a lower price to other markets in a graduated way. If you want your product cheaper, you wait longer and travel further and accept the cheaper quality, for example.
In order for wages to increase and the “”quality of life”” to improve for EVERYONE, some inflation is necessary to accommodate wage increases – a cost. Of course another way to do this is when the government lowers taxes by cutting government expenditures, services, or the banks keep the interest rates low. This reduces the costs to the firm, keeps prices low and supply high, and inflation low while slightly improving wages for some – note minimum wages are very sticky and do not move much over the years.
Inflation is not due to the fact of printing money, inflation is the increase in prices and wages from price-setting and wage-demanding political processes. When one group of workers in a production chain demand more wages, the price of the product must increase, or the profit gained by the owners must decrease. The interest rate on a loan to begin/maintain production can also increase prices because this cost will be added to the price of goods.
Now, as I have said, measuring the money supply is impossible because aggregating savings, loans, credit levels, and actual cash in pockets ready to be spent, like credit cards, can only be estimated with other indices like employment or people requesting unemployment insurance, or strikes and workers protesting their wages, or crime where too many people are in poverty and therefore acting out. But, ONE GREAT WAY to understand the money supply is through INTEREST RATES – if interests rates are low 1). people have less incentive to save and more incentive to spend because money sitting in banks is losing value due to inflation!, and 2). if interest rates are low people have an incentive to take out loans and spend by buying houses, cars, clothes, food, etc. and doing things that cost money! It is all about the velocity of the transaction when money is cheap. Money is Modernity: buy, consume, spend, etc.
For people with too much money who want more capital from their money, they can invest their money in other firms, to help those firms grow. They can buy stocks and reap the dividends. Mutual funds and Index funds are mostly low risk with around 5-10% interest (Hedge funds make 30%+ if you have that kind of money) But, if you don’t like the risk, you can help the government and buy their bonds at a lower interest rate but still, it is better than nothing or a savings account interest. Remember, investors are the owners of the firms and determine pricing, alright, the owner-investor determines the price!!!
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