Comments on: Maximizing The Stimulus http://www.citizeneconomists.com/blogs/2009/01/29/maximizing-the-stimulus/ Citizen Economists is an online economics magazine written by citizen journalists. These ordinary citizens provide reports and commentary on the current events affecting the economics of the fields they work in. Wed, 08 Feb 2012 04:44:52 -0500 http://wordpress.org/?v=2.8.4 hourly 1 By: Dan McLaughlin http://www.citizeneconomists.com/blogs/2009/01/29/maximizing-the-stimulus/comment-page-1/#comment-5990 Dan McLaughlin Sat, 07 Feb 2009 18:01:14 +0000 http://citizeneconomists.com/blogs/?p=440#comment-5990 Hi Dirk, For some reason my original response and a few other entries from other articles disappeared. So, here it is again. The figure I used was from the St. Louise Fed statistics regarding bank borrowing of reserves from the Fed. (http://research.stlouisfed.org/fred2/series/BORROW) When a bank borrows reserves, it does so to add to its own reserves. It’s reserves are used to support its lending, which is the source of fractional reserve money creation. Borrowing in November, 2007 was .366 (1/3) billion and in November 2008 it was 698 billion. Granted, a lot of that is probably not going to be used in the short term for new loans, but rather to prevent bankruptcy or the forced sale of their assets because the reserve ratio is too low. However, when you couple that with the fact that the fed is buying up assets, likely to be in the trillions of dollars, with fake money, there can be little doubt that all of that money made from nothing will dilute the value of existing money, devalue the dollar further than the 97% it has already been devalued since 1913 and destroy the dollar as reserve currency. The entire bailout plan is using counterfeited money to add to what was already there. The only saving grace is that most foreign governments have been at least as stupid as ours and will likely destroy their currencies nearly as much. The countries that will likely come out of this whole episode in a relatively stronger position are the ones who have been less irresponsible, buying the debt of other countries, rather than the ones who were selling the debt and spending like there’s no tomorrow. The next few years should be quite interesting to watch. You talk about market confidence. Why is it that people lose confidence? They recognize that the costs that they built their business on cannot possibly be sustained at the seemingly low levels which gave the illusion of long term profitability. The inflation inevitable in an artificially low interest rate, monetary expansionist economy raises their costs as more and more people crowd into market. Costs don’t go up because the fed raises interest rates. They are forced to raise rates because the rising price pressures threaten to spike consumer prices, which are the holy grail of central bankers. The bubble economy results from entrepreneurs being fooled by non-market signals into investing in business ventures that cannot possibly make it in the long term when competing with so many new market entrants for the limited supply of real things, like steel, human labor, wood, carbide, etc ….. There is only so much of real resources to go around, no matter how low interest rates are or how much money is pumped into the system. Money is not things. Entrepreneurs don’t fail because the Fed suddenly pulled the rug out from under them. They fail because costs inevitably rise due to limited supply and unlimited demand. The low interest rate policies deceive investors into believing that their dream world is the long term future reality. Loss of confidence comes from the true reality, that there never was a chance for their business to make it right from the very start. Loss of confidence comes from people trying to get their money from fractional reserve banks and being repudiated because the banks defaulted on their absolute obligation to have the money there on demand. Loss of confidence comes from employees of failed businesses having to find work, probably at lower rates than they could command when people lived in the fairyland. In short, loss of confidence is the adjustment from the fairyland to reality. The quicker it is accomplished, the better off everyone will be. The longer it is forestalled, the more pain and the longer the adjustment. I wanted to mention one other thing. Real capital was not destroyed in the downturn. All of the factories, machines, vehicles and other items of real, physical capital are still there. All that has evaporated is the over-inflated monetery price of the capital. As the prices of that real capital come down to presently existing market levels, entrepreneurs will purchase them, including loan assets of failing banks, if they have any value. That is a very good thing for the economy. The new owners will be able to be much more profitable, more productive, create jobs and get the economy rolling again. If the prices of that real capital are maintained far above market prices, they will remain unused and unproductive and the economy will suffer. It is, again, a matter of supply and demand after a shift in both. The faster those productive resources are made productive, the better for everyone. Hi Dirk,
For some reason my original response and a few other entries from other articles disappeared. So, here it is again.
The figure I used was from the St. Louise Fed statistics regarding bank borrowing of reserves from the Fed. (http://research.stlouisfed.org/fred2/series/BORROW) When a bank borrows reserves, it does so to add to its own reserves. It’s reserves are used to support its lending, which is the source of fractional reserve money creation. Borrowing in November, 2007 was .366 (1/3) billion and in November 2008 it was 698 billion. Granted, a lot of that is probably not going to be used in the short term for new loans, but rather to prevent bankruptcy or the forced sale of their assets because the reserve ratio is too low.
However, when you couple that with the fact that the fed is buying up assets, likely to be in the trillions of dollars, with fake money, there can be little doubt that all of that money made from nothing will dilute the value of existing money, devalue the dollar further than the 97% it has already been devalued since 1913 and destroy the dollar as reserve currency. The entire bailout plan is using counterfeited money to add to what was already there. The only saving grace is that most foreign governments have been at least as stupid as ours and will likely destroy their currencies nearly as much.
The countries that will likely come out of this whole episode in a relatively stronger position are the ones who have been less irresponsible, buying the debt of other countries, rather than the ones who were selling the debt and spending like there’s no tomorrow. The next few years should be quite interesting to watch.
You talk about market confidence. Why is it that people lose confidence? They recognize that the costs that they built their business on cannot possibly be sustained at the seemingly low levels which gave the illusion of long term profitability. The inflation inevitable in an artificially low interest rate, monetary expansionist economy raises their costs as more and more people crowd into market. Costs don’t go up because the fed raises interest rates. They are forced to raise rates because the rising price pressures threaten to spike consumer prices, which are the holy grail of central bankers.
The bubble economy results from entrepreneurs being fooled by non-market signals into investing in business ventures that cannot possibly make it in the long term when competing with so many new market entrants for the limited supply of real things, like steel, human labor, wood, carbide, etc ….. There is only so much of real resources to go around, no matter how low interest rates are or how much money is pumped into the system. Money is not things. Entrepreneurs don’t fail because the Fed suddenly pulled the rug out from under them. They fail because costs inevitably rise due to limited supply and unlimited demand. The low interest rate policies deceive investors into believing that their dream world is the long term future reality. Loss of confidence comes from the true reality, that there never was a chance for their business to make it right from the very start.
Loss of confidence comes from people trying to get their money from fractional reserve banks and being repudiated because the banks defaulted on their absolute obligation to have the money there on demand. Loss of confidence comes from employees of failed businesses having to find work, probably at lower rates than they could command when people lived in the fairyland.
In short, loss of confidence is the adjustment from the fairyland to reality. The quicker it is accomplished, the better off everyone will be. The longer it is forestalled, the more pain and the longer the adjustment.
I wanted to mention one other thing. Real capital was not destroyed in the downturn. All of the factories, machines, vehicles and other items of real, physical capital are still there. All that has evaporated is the over-inflated monetery price of the capital.
As the prices of that real capital come down to presently existing market levels, entrepreneurs will purchase them, including loan assets of failing banks, if they have any value. That is a very good thing for the economy. The new owners will be able to be much more profitable, more productive, create jobs and get the economy rolling again.
If the prices of that real capital are maintained far above market prices, they will remain unused and unproductive and the economy will suffer. It is, again, a matter of supply and demand after a shift in both.
The faster those productive resources are made productive, the better for everyone.

]]> By: Dirk http://www.citizeneconomists.com/blogs/2009/01/29/maximizing-the-stimulus/comment-page-1/#comment-5745 Dirk Fri, 30 Jan 2009 18:09:56 +0000 http://citizeneconomists.com/blogs/?p=440#comment-5745 Hi Dan, Thanks for the response. I agree that central banks cause more problems than they cure. I will also not argue regarding the Fed leaving interest rates low too long in 2003. What I will argue is that the vast majority of loans that were made during the bubble were originally good loans, but the Fed's efforts to deflate the bubble backfired, creating an economic downdraft that has now pulled down trillions in loans. If you're saying the trillions the Fed has added to its balance sheet will become tens of trillions, then I agree inflation will emerge- but you're the first person I've heard with that kind of calculation. If you have a citation explaining the effects of these actions on money supply, let me know- but I've heard M2 has only increased 70%, which is a drop in the bucket compared to the capital destroyed in this downturn. And that's not addressing the (very real) wealth effect. We should agree the solution to this problem is work, not retrenchment. To pay our debt, to build real wealth, to create a better standard of living for our children and the rest of the world, we need more production, not less. Perhaps it needs to be moved around the world, yes, but pulling in the horns will not move humanity forward. And this will not happen in this deflationary environment, as it didn't in the 1930s and has not so far. I don't confuse wealth and money. But I also don't confuse calling price illusion, wealth effect, real bills, etc. theories with the reality that these are real forces acting on confidence. Ultimately, it is human productivity, which is derived from confidence, that produces wealth. And recovery in stock, housing, and even oil and food prices, would build some confidence. The sooner we're worried about adding new sources of supply to counter inflation, the better off we'll all be- unless you support Obama's crisis-fed socialist politics. Hi Dan,

Thanks for the response. I agree that central banks cause more problems than they cure. I will also not argue regarding the Fed leaving interest rates low too long in 2003. What I will argue is that the vast majority of loans that were made during the bubble were originally good loans, but the Fed’s efforts to deflate the bubble backfired, creating an economic downdraft that has now pulled down trillions in loans. If you’re saying the trillions the Fed has added to its balance sheet will become tens of trillions, then I agree inflation will emerge- but you’re the first person I’ve heard with that kind of calculation. If you have a citation explaining the effects of these actions on money supply, let me know- but I’ve heard M2 has only increased 70%, which is a drop in the bucket compared to the capital destroyed in this downturn. And that’s not addressing the (very real) wealth effect.

We should agree the solution to this problem is work, not retrenchment. To pay our debt, to build real wealth, to create a better standard of living for our children and the rest of the world, we need more production, not less. Perhaps it needs to be moved around the world, yes, but pulling in the horns will not move humanity forward. And this will not happen in this deflationary environment, as it didn’t in the 1930s and has not so far.

I don’t confuse wealth and money. But I also don’t confuse calling price illusion, wealth effect, real bills, etc. theories with the reality that these are real forces acting on confidence. Ultimately, it is human productivity, which is derived from confidence, that produces wealth. And recovery in stock, housing, and even oil and food prices, would build some confidence. The sooner we’re worried about adding new sources of supply to counter inflation, the better off we’ll all be- unless you support Obama’s crisis-fed socialist politics.

]]> By: Dan McLaughlin http://www.citizeneconomists.com/blogs/2009/01/29/maximizing-the-stimulus/comment-page-1/#comment-5728 Dan McLaughlin Fri, 30 Jan 2009 05:10:23 +0000 http://citizeneconomists.com/blogs/?p=440#comment-5728 Hi Dirk, You are right that the moral hazard inherent in the incentives of the stimulus package is a very large problem. You are not right that inflation is not a problem with it, however. Inflation is not immediately apparent so, out of sight, out of mind. When the Fed pumps over 600 billion dollars in new reserves over the course of a few months, that translates to potentially more than $6 trillion after the multiplication by the fractional reserve banking system. The trillions of dollars that will ultimately flow from the federal government in the form of various fiscal actions will further prop up prices that need to come down in order for the markets to adjust. It is inevitable that all of the inflationary pressures will lead to a massive inflationary bubble which could easily dwarf this last one. If the inflation does not show up in consumer prices, it will show up elsewhere, just as the last inflationary bubble emerged in real estate. Real estate in many markets was, beyond the shadow of a doubt, overpriced in the extreme. It is irresponsible to prop up prices so that normal, responsible people can’t afford them. The idea that inflation will solve all problems is what brought about the problem to begin with. Just because there was no hyper inflation in the consumer markets does not mean that it did not occur. Hyper-inflation in non-consumer markets was just swept under the rug. As long as consumer prices don’t increase too rapidly, everything is hunky dory with inflationists. The problem is that money is not wealth. Wealth comes only from production. I know that you believe that the inflation process through fractional reserves comes about by loaning money, and that that money may be productive. The concept of declining marginal productivity applies to debt as well as anything else, however. The more that inflation is used to stimulate the economy, the more marginally unproductive debt is created. An increase in the money supply creates the illusion that investments will be profitable and many entrepreneurs are fooled. There always comes a time to pay the piper, however. Those marginally unproductive loans cannot pay back, because they were, in reality, unprofitable before they started. There was not enough of real productive resources to supply all of the demand for them. When prices are bid up, only then does it become apparent that a marginal business and it’s debt was built on an inflationary house of cards. Those marginally unprofitable businesses will fold and their loans will go bad. That should present an opportunity to productive businesses and responsible entrepreneurs. You can’t fool mother nature. Inflating to cure the effects of inflationary bubbles is like prescribing arsenic to aid in the recovery from arsenic poisoning. Those loans that were marginally unproductive debt must be written off. Prices must be allowed to fall in order for the market to adjust to reality. In the Depression of the 1930’s, the core problem was not deflation, but rather the distortion created by the wildly inflationary 1920’s. Inflation showed up at that time in the stock and financial markets and in real estate, not surprisingly. Deflation was the obvious and necessary result when it became obvious just how much unproductive debt there was. In all prior depressions, the market was allowed to adjust and in a matter of a year or two, the economy was recovering. It was only after central planning social engineers decided they needed to “fix” things that the depression became the Great Depression. I remember seeing pictures of the tsunami of a few years ago. The wave was not an immediate problem for the people on the beach. The water had actually receded. When the wave reached the shore, it was too late. Our government is setting us up for another financial tsunami just a few short years down the road, just as they set us up for this one, and the one before that. Monetary manipulation is the source of all financial tsunamis. Yet, our central bankers are portrayed as knights in shining armor. Some things never change. Hi Dirk,

You are right that the moral hazard inherent in the incentives of the stimulus package is a very large problem. You are not right that inflation is not a problem with it, however. Inflation is not immediately apparent so, out of sight, out of mind. When the Fed pumps over 600 billion dollars in new reserves over the course of a few months, that translates to potentially more than $6 trillion after the multiplication by the fractional reserve banking system. The trillions of dollars that will ultimately flow from the federal government in the form of various fiscal actions will further prop up prices that need to come down in order for the markets to adjust.

It is inevitable that all of the inflationary pressures will lead to a massive inflationary bubble which could easily dwarf this last one. If the inflation does not show up in consumer prices, it will show up elsewhere, just as the last inflationary bubble emerged in real estate. Real estate in many markets was, beyond the shadow of a doubt, overpriced in the extreme. It is irresponsible to prop up prices so that normal, responsible people can’t afford them.

The idea that inflation will solve all problems is what brought about the problem to begin with. Just because there was no hyper inflation in the consumer markets does not mean that it did not occur. Hyper-inflation in non-consumer markets was just swept under the rug. As long as consumer prices don’t increase too rapidly, everything is hunky dory with inflationists.

The problem is that money is not wealth. Wealth comes only from production. I know that you believe that the inflation process through fractional reserves comes about by loaning money, and that that money may be productive. The concept of declining marginal productivity applies to debt as well as anything else, however. The more that inflation is used to stimulate the economy, the more marginally unproductive debt is created. An increase in the money supply creates the illusion that investments will be profitable and many entrepreneurs are fooled.

There always comes a time to pay the piper, however. Those marginally unproductive loans cannot pay back, because they were, in reality, unprofitable before they started. There was not enough of real productive resources to supply all of the demand for them. When prices are bid up, only then does it become apparent that a marginal business and it’s debt was built on an inflationary house of cards. Those marginally unprofitable businesses will fold and their loans will go bad. That should present an opportunity to productive businesses and responsible entrepreneurs.

You can’t fool mother nature. Inflating to cure the effects of inflationary bubbles is like prescribing arsenic to aid in the recovery from arsenic poisoning. Those loans that were marginally unproductive debt must be written off. Prices must be allowed to fall in order for the market to adjust to reality.

In the Depression of the 1930’s, the core problem was not deflation, but rather the distortion created by the wildly inflationary 1920’s. Inflation showed up at that time in the stock and financial markets and in real estate, not surprisingly. Deflation was the obvious and necessary result when it became obvious just how much unproductive debt there was. In all prior depressions, the market was allowed to adjust and in a matter of a year or two, the economy was recovering. It was only after central planning social engineers decided they needed to “fix” things that the depression became the Great Depression.

I remember seeing pictures of the tsunami of a few years ago. The wave was not an immediate problem for the people on the beach. The water had actually receded. When the wave reached the shore, it was too late. Our government is setting us up for another financial tsunami just a few short years down the road, just as they set us up for this one, and the one before that. Monetary manipulation is the source of all financial tsunamis. Yet, our central bankers are portrayed as knights in shining armor. Some things never change.

]]> By: Raymond http://www.citizeneconomists.com/blogs/2009/01/29/maximizing-the-stimulus/comment-page-1/#comment-5727 Raymond Fri, 30 Jan 2009 03:50:35 +0000 http://citizeneconomists.com/blogs/?p=440#comment-5727 Inflation will raise long term interest rates. The interest paid on bonds loses purchasing power when prices of goods and services are rising. So as the CPI rises, bond buyers demand a higher rate of interest payment to compensate. So we will have high taxes, inflation, and a higher cost of borrowing for business and individuals. FDR spent billions for make work projects and to "stimulate" the economy during the great depression. The net gain in employment by the time he was out of office was practically zero. The nature of employment simply changed from private to government jobs. The government tax or borrow to bail or put some to work ---from the same economy. Inflation will raise long term interest rates. The interest paid on bonds loses purchasing power when prices of goods and services are rising. So as the CPI rises, bond buyers demand a higher rate of interest payment to compensate.

So we will have high taxes, inflation, and a higher cost of borrowing for business and individuals.

FDR spent billions for make work projects and to “stimulate” the economy during the great depression. The net gain in employment by the time he was out of office was practically zero. The nature of employment simply changed from private to government jobs. The government tax or borrow to bail or put some to work —from the same economy.

]]> By: Dirk http://www.citizeneconomists.com/blogs/2009/01/29/maximizing-the-stimulus/comment-page-1/#comment-5721 Dirk Fri, 30 Jan 2009 00:24:57 +0000 http://citizeneconomists.com/blogs/?p=440#comment-5721 The problem with the stimulus package is not the inflation. The government will raise taxes at some point to recover much of it, and any inflation is hedged by government ownership of bank. Based on bankruptcies and mass credit destruction, more money creation is probably warranted in order to create some inflation and lower interest rates (by purchasing mortage-backed securities and Treasuries). The bigger problem are the incentives this stimulus bill presents. Are you a US steel company who has been marginally competitive worldwide? Hurrah, give yourselves raises and add US capacity (hmmm?), Uncle Sam is requiring US steel. Have you contracted an STD? Hurrah, Uncle Sam is providing free care- should we mitigate the effects of wife-beaters, graffiti-artists, and unlucky gamblers too? Do you run a theater that presents shows that don't attract enough customers to make a profit and don't want to get a job as a nurse in a nursing home or as solar energy installer? Hurrah, Uncle Sam is sending a check. If we would just inflate the money supply and create inflation, money would have incentive to come off the sideline and either buy goods and services (theater tickets if they want) or invest in alternative supply (maybe nursing homes or solar energy). But giving these choices to Washington is the consequence for "free marketers" letting this deflationary period ride- because if Peter can't find a way to give Paul opportunity, Paul will take it. The problem with the stimulus package is not the inflation. The government will raise taxes at some point to recover much of it, and any inflation is hedged by government ownership of bank. Based on bankruptcies and mass credit destruction, more money creation is probably warranted in order to create some inflation and lower interest rates (by purchasing mortage-backed securities and Treasuries).

The bigger problem are the incentives this stimulus bill presents. Are you a US steel company who has been marginally competitive worldwide? Hurrah, give yourselves raises and add US capacity (hmmm?), Uncle Sam is requiring US steel. Have you contracted an STD? Hurrah, Uncle Sam is providing free care- should we mitigate the effects of wife-beaters, graffiti-artists, and unlucky gamblers too? Do you run a theater that presents shows that don’t attract enough customers to make a profit and don’t want to get a job as a nurse in a nursing home or as solar energy installer? Hurrah, Uncle Sam is sending a check.

If we would just inflate the money supply and create inflation, money would have incentive to come off the sideline and either buy goods and services (theater tickets if they want) or invest in alternative supply (maybe nursing homes or solar energy). But giving these choices to Washington is the consequence for “free marketers” letting this deflationary period ride- because if Peter can’t find a way to give Paul opportunity, Paul will take it.

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