My parents and their investments...maybe there is a money supply shortage

[Dueller]

My parents are probably some of the least sophisticated investors in the country. They're approaching 80 and have only rarely invested in anything other than CD's in local banks. They have had a few mutual funds in retirement accounts and rental/farm property by default or inheritance, but on the whole they have been ultra-conservative. However, as a result of living well within their means, disciplined savings, a frugal lifestyle, a few tax breaks, military and teachers retirement plans and the elements of time/compunding interest, they've acculumated substantial assets (middle seven figures).

They had a few CD's mature tuesday so off they went a shopping armed with the reassurance the FDIC limits had been increased. Long story short, they had a few local banks in a bidding war of sorts and ended up getting 1 year CD's at rates 1 1/2% above anything I've seen advertised anywhere....even on the 'net.

They're tickled with themselves.

[red911sc]

Originally Posted by Dueller

They're tickled with themselves.

They should be - good for them!

[widgeon13]

Sounds like they live on their retirement incomes, still save some as well, have no (or minimal) debt and are home free and going to leave you a nice nest egg. The only thing that could possibly bite them would be estate taxes.

Probably a good recipe for others as well.

[competentone]

Originally Posted by Dueller

They're tickled with themselves.

Henry Paulson and Ben Bernanke are "tickled" with them too -- since they are the ones who will now be paying to cover up the losses the a**holes like Paulson have created while mismanaging other people's money on Wall Street.

This week, the money supply has been effectively increased by over $1.5 trillion. Expect the inflation rate to be in the double digits within a year. (The real inflation rate, not the lie the government tells with the CPI.) Your parents will be losing purchasing power on their money as soon as the price inflation rate exceeds their interest rate.

The Wall Street investment bankers will be getting their hands directly on $700 billion of the new dollars; these criminals will line their pockets with it as they "cover up" their previous losses transferring the crappy loans they made off their balance sheets and onto the governments.

Today is not a day anyone who has lived their life conservatively, carefully saving and investing, should be celebrating. Today marks the day the biggest heist in human history occurred. The victims are the savers; the thieves are the crooks on Wall Street and their "partners in crime" -- all those living recklessly, using the loose credit made available to them by the criminals to consume more than they have produced.

[jyl]

There is money supply and then there is money velocity.

If $1TR of money is injected into the economy, but it is not spent (i.e. has zero velocity), then it doesn't impact prices and hence doesn't impact inflation.

To illustrate: suppose an economy has $1,000 of total money circulating and the only asset in the economy that anyone buys or sells with that $1,000 is 100 identical Porsches. So each Porsche costs $10. Now suppose the govt suddenly prints an additional $1,000 of currency and puts it in circulation. Now there is $2,000 of money chasing the same 100 Porsches. The price of each Porsche becomes $20. Porsche prices have just inflated by 100%. But suppose that additional $1,000 is simply buried in a hole in the ground. It has zero velocity. There is no increase in the amount of money actually chasing the 100 Porsches. Porsche prices don't rise. There is no inflation, despite the increased money supply.

Recently, the Fed has injected several hundred billion $ into the banking system in the form of short-term loans to banks who are unable to borrow cash from other banks. Are those banks turning around and using those dollars to increase lending consumers and businesses, who are then using those dollars to buy things, driving up prices of those things? No, they are not. Banks are hoarding cash, their lending is actually contracting. Those dollars may as well be buried in a hole in the ground.

In the medium-term (next year or so) I suspect US inflation will actually decrease, and deflation will be a bigger problem than inflation. Commodity prices are declining (oil, metals, corn, etc). End demand is very weak. Employment is weak and getting weaker, so wages are not increasing. Banks are hoarding cash and trying to repair their balance sheets, so credit is not increasing. Consumer confidence is extremely low. The end purchaser, whether consumer or business, thus has less money available to buy things and is also hoarding cash. The gross margins of companies in the supply chain (the manufacturer of the product, the distributor, the retailer) are under pressure, in some cases already declining. This is not a recipe for rising inflation.

You can see this in the TIPS yield. It is falling fast. Investors are no longer expecting rising inflation, they are expecting declining inflation. http://www.clevelandfed.org/research/data/tips/index.cfm And stocks usually bought as inflation hedges (e.g. energy sector) are going down, hard.

You will also be able to see this in daily life. What do most people spend most of their dollars on? The NYT published a nice pie chart back in May. That was back when inflation was a worry, so the price increase data is out of date, but just look at the categories of spending. http://www.nytimes.com/interactive/2008/05/03/business/20080403_SPENDING_GRAPHIC.html You can mouse over or zoom in to see the smaller segments. The large majority of families' spending is on shelter (houses, rent), then transportation (new and used cars, gasoline), then food (about half dining out and half groceries), and so on. House prices are falling. Rent is not rising much, indeed is falling in places. Car prices are falling. Gasoline has stopped rising, in most states. Dining out prices are not rising much, grocery prices are rising but now commodity prices have peaked, and so on. Go through the segments and you'll see that, for the majority of the pie, prices are falling and/or rising at a decelerating pace. Again, I'm talking about price trends now, not back in May when the chart was prepared.

If you want to read more about this, here is a start. http://www.marketoracle.co.uk/Article5359.html Click the "deflation" link for more articles. There is one article, April 2008 I think, in which he discusses the money velocity concept.

[jyl]

The other thing to think about, is what direction is the amount of wealth in the US going?

Here I'm talking about wealth broadly, i.e. all assets, not necessarily "money supply" as economists measure it.

Household net worth had fallen $2TR in recent quarters, as of Jun 08. Here in Oct 08, the decline has surely become substantially larger, what with most peoples' houses and investments falling.

All other things equal, declining wealth should tend to drive declining prices.

[onewhippedpuppy]

Originally Posted by Dueller

My parents are probably some of the least sophisticated investors in the country. They're approaching 80 and have only rarely invested in anything other than CD's in local banks. They have had a few mutual funds in retirement accounts and rental/farm property by default or inheritance, but on the whole they have been ultra-conservative. However, as a result of living well within their means, disciplined savings, a frugal lifestyle, a few tax breaks, military and teachers retirement plans and the elements of time/compunding interest, they've acculumated substantial assets (middle seven figures).

They had a few CD's mature tuesday so off they went a shopping armed with the reassurance the FDIC limits had been increased. Long story short, they had a few local banks in a bidding war of sorts and ended up getting 1 year CD's at rates 1 1/2% above anything I've seen advertised anywhere....even on the 'net.

They're tickled with themselves.

That's the kind of investing they should teach in school. They should be very proud of themselves.

[competentone]

Originally Posted by jyl

There is money supply and then there is money velocity.

If $1TR of money is injected into the economy, but it is not spent (i.e. has zero velocity), then it doesn't impact prices and hence doesn't impact inflation.

To illustrate: suppose an economy has $1,000 of total money circulating and the only asset in the economy that anyone buys or sells with that $1,000 is 100 identical Porsches. So each Porsche costs $10. Now suppose the govt suddenly prints an additional $1,000 of currency and puts it in circulation. Now there is $2,000 of money chasing the same 100 Porsches. The price of each Porsche becomes $20. Porsche prices have just inflated by 100%. But suppose that additional $1,000 is simply buried in a hole in the ground. It has zero velocity. There is no increase in the amount of money actually chasing the 100 Porsches. Porsche prices don't rise. There is no inflation, despite the increased money supply.

Recently, the Fed has injected several hundred billion $ into the banking system in the form of short-term loans to banks who are unable to borrow cash from other banks. Are those banks turning around and using those dollars to increase lending consumers and businesses, who are then using those dollars to buy things, driving up prices of those things? No, they are not. Banks are hoarding cash, their lending is actually contracting. Those dollars may as well be buried in a hole in the ground.

In the medium-term (next year or so) I suspect US inflation will actually decrease, and deflation will be a bigger problem than inflation. Commodity prices are declining (oil, metals, corn, etc). End demand is very weak. Employment is weak and getting weaker, so wages are not increasing. Banks are hoarding cash and trying to repair their balance sheets, so credit is not increasing. Consumer confidence is extremely low. The end purchaser, whether consumer or business, thus has less money available to buy things and is also hoarding cash. The gross margins of companies in the supply chain (the manufacturer of the product, the distributor, the retailer) are under pressure, in some cases already declining. This is not a recipe for rising inflation.

You can see this in the TIPS yield. It is falling fast. Investors are no longer expecting rising inflation, they are expecting declining inflation. http://www.clevelandfed.org/research/data/tips/index.cfm And stocks usually bought as inflation hedges (e.g. energy sector) are going down, hard.

You will also be able to see this in daily life. What do most people spend most of their dollars on? The NYT published a nice pie chart back in May. That was back when inflation was a worry, so the price increase data is out of date, but just look at the categories of spending. http://www.nytimes.com/interactive/2008/05/03/business/20080403_SPENDING_GRAPHIC.html You can mouse over or zoom in to see the smaller segments. The large majority of families' spending is on shelter (houses, rent), then transportation (new and used cars, gasoline), then food (about half dining out and half groceries), and so on. House prices are falling. Rent is not rising much, indeed is falling in places. Car prices are falling. Gasoline has stopped rising, in most states. Dining out prices are not rising much, grocery prices are rising but now commodity prices have peaked, and so on. Go through the segments and you'll see that, for the majority of the pie, prices are falling and/or rising at a decelerating pace. Again, I'm talking about price trends now, not back in May when the chart was prepared.

If you want to read more about this, here is a start. http://www.marketoracle.co.uk/Article5359.html Click the "deflation" link for more articles. There is one article, April 2008 I think, in which he discusses the money velocity concept.

You are making a few errors in your thinking on this matter.

You raise a good point about the velocity of money but fail to understand that when new money is created, it goes to certain people first. Those who receive the money first have the potential to use the money before it loses its value in the economy (due to the inflationary effects). This creates imbalances in the economy, allowing certain businesses -- those receiving the money first -- to profit from the inflation at the expense of those who receive the money last. The growth of the financial sector over the past decades is largely the result of the fact that banking institutions receive the new dollars, constantly being created by the Fed, first.

Money certainly can end up "in a hole in the ground" and not affect prices of goods and services, because it is not being used in the effective "bidding" process for those goods and services. However, nobody puts money in "a hole in the ground" forever. The whole reason for saving money is that the money will be used eventually in the purchase of goods and services.

Right now, one of the "holes in the ground" I have been warning about is the dollar reserves held outside the United States. The government has been inflating the money supply dramatically for decades, but we have not experienced the full price inflation effects in our economy from that money supply inflation. This is because foreign entities have been willing to ship us goods, accept our dollars in return, and hold those dollars with the intention of spending them at some later point. If the trillions of dollars being held internationally were spent on goods and services and returned to our domestic economy, we would see immediate and severe price inflation.

You are really missing the point when you state that the banks are "hoarding cash."

First, one needs to understand that banks have no money. If Mr. Smith opens a bank -- aside from any capital from the investors/shareholders -- all funds the bank has comes from depositors.

If Mary, Jane, and Bob each deposit $1000 in Mr. Smith's bank, the bank holds a percentage (required by law) as a reserve to meet withdrawal demands and lends the rest of the money out.

If the bank holds 10% in reserve and lends the deposits from Mary, Jane, and Bob, $2700 will circulate into the economy while $300 remain in the bank.

If Mary, Jane, and Bob all decide at the same time that they want their $1000, the banker needs to either call in the $2700 he lent, sell the paper on the $2700 he lent to raise cash, or borrow the $2700 from another bank.

Since most of what banks lend is not callable, calling in loans to meet depositors' demands is not a real option. That leaves selling assets (the paper on the loans) or borrowing.

Right now, with all the toxic (bad) loans in the system, it is extremely difficult for banks to sell loans. Additionally, banks are extremely reluctant to lend against what may be questionable loans on another banker's books. This situation leaves the banker with no choice but to borrow from the "lender of last resort," the Federal Reserve.

But the Federal Reserve doesn't actually have any money; the Fed makes the money it lends "out of thin air."

The Fed lends the new money, and the depositors withdraw the funds. This is how the money supply grows. There is now both the original depositors' money (which was lent out by the banker) circulating in the economy along with the new money the Fed has put into the system.

Right now banks are not "hoarding cash" as you claim. They are borrowing from the Fed and giving depositors their money. There are effective "runs on banks" taking place thoughout our economy. (You've relayed some extreme examples in an earlier thread.)

If the depositors withdrawing their money from banks end up just sticking the money "in a hole in the ground," then you may be right that we will not see significant price inflation as the money will not end up chasing goods and services in our economy at this point in time. Remember, the money is being held to be spent at some later point in time.

I think that "later point in time" may come much sooner than people expect, especially if we see sudden increases in price inflation. Price inflation will feed on itself; people will want to get rid of their money that is losing value and convert it into something that will hold its value. For a good explanation of this I'd recommend that you spend a few minutes and read this article, which explains what happened during the inflation in pre-WW2 Germany. This was actually written in the 1970s:
http://www.usagold.com/germannightmare.html

If everything somehow goes perfectly in the economy, and the depositors who withdrew their money don't spend it, and the bank receives all the payments on the loans it made and then pays the Fed back the money it borrowed, and the Fed contracts the money supply as it dissolves the "new money" loans it made to the banks, then we might see no price inflation in the economy from the Fed's current lending actions.

But if one starts looking at the numbers in this credit crisis, I don't see how one can conclude that "everything will work out fine." There is simply too much debt out that will never be paid back. The banks will never repay the loans they are taking from the Fed. The Fed's "new money" lending will become a permanent inflation of the money supply -- which will affect prices in the economy dramatically.

[jyl]

My main point is that predicting inflation from a "monetary" standpoint is not as simple as saying the govt is putting additional money into the economy. You have to think through the money's velocity. And if the money is not being spent, but instead buried in the ground, then so long as it stays buried with no velocity, it doesn't create inflation.

In the near to medium term, I do think the money (call it $1.5TR) that the Fed and Treasury has injected and will inject into the economy is essentially "buried in the ground". Here's why:

When banks are getting these emergency loans from the Fed, the banks are not putting that cash into the economy via loans. They are holding on to it, because they want/need more liquidity - more of their balance sheet assets to be "cash and equivalents". As you point out, some of that cash is being withdrawn by fearful depositors, but do you think those depositors are going out and spending that cash? Of course not - they are depositing it in banks that seem safer, or splitting it up into multiple FDIC-insured accounts at different banks, or in some cases hiding it under their mattresses. They aren't going out and buying cars with the life savings that they are terrified of losing. This injected money is being hoarded, it has zero velocity.

When Treasury begins buying assets from banks, which will start in a month or so and go on for over a year, what is the velocity of that money? Well, on the bank's balance sheet, all the purchase does is swap $1.00 book value of troubled assets (mortgages and MBS, mostly) for, let's say, $0.85 of cash and equivalents. The assets on the balance sheet have not increased (in my example, assets have decreased by the $0.15). No increase in assets means no increase in lending capacity. So this injected money, too, is likely to have low velocity.

Thus I don't think the Fed and Treasury's actions will increase inflation in the near to medium term. Yeah, its $1.5TR, but it isn't circulating in the economy, chasing goods and services.

Now, at some point, suppose the banking industry gets out of the current crisis, consolidates, stabilizes, raises capital and increases its lending activity again. At that point, does this $1.5TR become unburied, gain velocity, and get effectively "added" to the economy? What happens then?

Well, I have some thoughts about that. I'll type them tomorrow since it is past midnight. Basically, the issues are (a) how big is $1.5TR relative to the US economy anyway, (b) is there money being "subtracted" from the economy that might offset, and (c) what else affects inflation, besides a country's money supply and velocity?

[competentone]

Originally Posted by jyl

At that point, does this $1.5TR become unburied, gain velocity, and get effectively "added" to the economy? What happens then?

Well, I have some thoughts about that. I'll type them tomorrow since it is past midnight. Basically, the issues are (a) how big is $1.5TR relative to the US economy anyway, (b) is there money being "subtracted" from the economy that might offset, and (c) what else affects inflation, besides a country's money supply and velocity?

Before giving your thoughts -- which I suspect will be largely based upon some of the mistaken concepts behind Keynesian economics (based upon the previous arguments you have made), I would suggest that you try to gain a better understanding of some of the basic concepts of economics (without a Keynesian slant) by taking a little time reading this (you can probably skim over the first sections quickly; the end of the article, discussing "Money and Overall Prices" is the most relevant to our discussion) :

http://mises.org/story/3122

I'd then suggest you also read my previous suggestion explaining some of the aspects of inflation in pre-WW2 Germany:

http://www.usagold.com/germannightmare.html

[jyl]

Weimar Germany was a defeated and occupied state, crushed by war reparation obligations that the weak economy could not meet. As dictated in 1919, reparations were $132 billion marks, the interest payments alone exceeded Germany's entire GDP, and these crushing payments were supposed to extend to 1984.

When Germany missed reparation payments in 1922, the Allies forcibly occupied the vital Ruhr. Deprived of earnings from the country's economic engine, the government resorted to printing currency. Big business and some in government actually sought massive currency devaluation in order to eliminate war debt. During the hyperinflation period, the govt printed so much money that the German money supply rose by a factor of 7.3 billion over appx 4 years (i.e. 730,000,000,000 %.)

The situation in Weimar Germany and the US are very, very different. The money supply in the US is not rising by a factor of 7.3 billion, or anything even remotely comparable. The Fed's emergency bank loans may be 4-5% of the total money supply, and as noted that added money has low/no velocity. 5% is quite different from 730,000,000,000%.

I realize that lots of alarmist blogs out there are full of this US Weimar Republic stuff. I grant that if the situation of the US became similar to the situation in post-WW1 Germany, there's no reason we'd fare any better. But we are very, very far from there.

[Vintage Racer]

My parents are also retired. They own two homes that have more than quadrupled in value since they bought them. They have very few bank deposits, but they own a diversified portfolio of stocks and Treasuries. Many of their stocks pay dividends each year in excess of the price originally paid for the stock. Many of the Treasury bonds were purchased when bonds paid 8%.

They have always lived below their economic means and taught me this good lesson.

Originally Posted by competentone

Henry Paulson and Ben Bernanke are "tickled" with them too -- since they are the ones who will now be paying to cover up the losses the a**holes like Paulson have created while mismanaging other people's money on Wall Street.

Many people mismanaged their money. The borrowers were stupid to borrow money that you could not repay. The lenders were stupid to loan money to deadbeats. The investors were fools to buy the securitized products from the banks.

Many smart investors avoided this whole disaster. We are not mad at anyone.

Paulson, however, made a fortune at Goldman before he went to the Treasury Department.

[competentone]

Originally Posted by Vintage Racer

Many smart investors avoided this whole disaster. We are not mad at anyone.

You should be.

The bailout (and current "liquidating" actions by the Fed) means that everyone will be paying for the disaster -- whether they participated in creating it or not.

Higher taxes -- and particularly, price inflation throughout the economy -- is the way we will all be paying for the irresponsibility of some.

It is sort of like hurricanes. Some get to live the beach-front lifestyle, but when a hurricane comes and destroys the beach-front homes allowing that lifestyle, we all end up paying for it when the government bails out the beach communities with "disaster relief."

[competentone]

Originally Posted by Dueller

My parents are probably some of the least sophisticated investors in the country.

This is an excerpt from an article (which is actually an excerpt from a book) on the von Mises Institute's web site. Everyone with savings should read and understand what "money" is. Even "unsophisticated" investors can understand this:

2. How Money Begins

Before examining what money is, we must deal with the importance of money, and, before we can do that, we have to understand how money arose. As Ludwig von Mises conclusively demonstrated in 1912, money does not and cannot originate by order of the State or by some sort of social contract agreed upon by all citizens; it must always originate in the processes of the free market.

Before coinage, there was barter. Goods were produced by those who were good at it, and their surpluses were exchanged for the products of others. Every product had its barter price in terms of all other products, and every person gained by exchanging something he needed less for a product he needed more. The voluntary market economy became a latticework of mutually beneficial exchanges.

In barter, there were severe limitations on the scope of exchange and therefore on production. In the first place, in order to buy something he wanted, each person had to find a seller who wanted precisely what he had available in exchange. In short, if an egg dealer wanted to buy a pair of shoes, he had to find a shoemaker who wanted, at that very moment, to buy eggs. Yet suppose that the shoemaker was sated with eggs. How was the egg dealer going to buy a pair of shoes? How could he be sure that he could find a shoemaker who liked eggs?

Or, to put the question in its starkest terms, I make a living as a professor of economics. If I wanted to buy a newspaper in a world of barter, I would have to wander around and find a newsdealer who wanted to hear, say, a 10-minute economics lecture from me in exchange. Knowing economists, how likely would I be to find an interested newsdealer?

This crucial element in barter is what is called the double coincidence of wants. A second problem is one of indivisibilities. We can see clearly how exchangers could adjust their supplies and sales of butter, or eggs, or fish, fairly precisely. But suppose that Jones owns a house, and would like to sell it and instead, purchase a car, a washing machine, or some horses? How could he do so? He could not chop his house into 20 different segments and exchange each one for other products. Clearly, since houses are indivisible and lose all of their value if they get chopped up, we face an insoluble problem. The same would be true of tractors, machines, and other large-sized products. If houses could not easily be bartered, not many would be produced in the first place.

continued online here:
http://mises.org/story/3122


$

[vash]

dueller, i dont know what the heck the guys are typing about. but be really nice to your parents...........nicer than your siblings.

[Vintage Racer]

Originally Posted by competentone

You should be.

The bailout (and current "liquidating" actions by the Fed) means that everyone will be paying for the disaster -- whether they participated in creating it or not.

Competentone,
Believe or not, many people own their two homes and have significant wealth.

We own and sell businesses, and we are not one bit worried by this economy. If fact, we relish it because we may be able to pick up good assets at low distressed prices.

Please preach your doomsday prophecy on another website (try the SpOrT TunEr CRoWd).

Doc

[competentone]

Originally Posted by Vintage Racer

Competentone,
Believe or not, many people own their two homes and have significant wealth.

We own and sell businesses, and we are not one bit worried by this economy. If fact, we relish it because we may be able to pick up good assets at low distressed prices.

Please preach your doomsday prophecy on another website (try the SpOrT TunEr CRoWd).

I have never said that there will not be continued opportunity in this economy; I have never said that some people will not do well.

My "doomsday prophecy" is based upon years of study. Money is such an important tool in a technologically advanced society such as ours, that when criminals and incompetent fools (like Paulson and Bernanke -- in that order) take dramatic actions to destroy the tool of money, it has severe negative effects throughout the economy.

Pretend the risks are not there if you like.

Believe the a**holes in government telling you "Everything is 'safe.'"

I prefer to live with my eyes wide open, seeing both the good and the bad.

[competentone]

Originally Posted by Vintage Racer

Competentone,
Believe or not, many people own their two homes and have significant wealth.

We own and sell businesses, and we are not one bit worried by this economy. If fact, we relish it because we may be able to pick up good assets at low distressed prices.

Please preach your doomsday prophecy on another website (try the SpOrT TunEr CRoWd).

Additionally, if you have the least bit of empathy for others living on this planet, you will understand that theft and manipulation, by the government and the "elite" with government connections, of certain markets in the economy can be harmful to those who may not be in a position of having achieved "significant wealth."

Simple "basic concern" for others should cause even those who will be "comfortable" in any economic downturn, to still be concerned about government actions which harm the markets/economy.

[Vintage Racer]

Originally Posted by competentone

My "doomsday prophecy" is based upon years of study. Money is such an important tool in a technologically advanced society such as ours, that when criminals and incompetent fools (like Paulson and Bernanke -- in that order) take dramatic actions to destroy the tool of money, it has severe negative effects throughout the economy.

You just keep studying, and I'll keep running a real business.

It is convenient to blame Washington. By blaming those people, you are able to ignore the foolish actions of the people that started this whole thing by borrowing beyond their means. Or did Paulson hold a gun to the head of these people and make them sign contracts?

Did Bernanke threaten death to everyone that did not borrow heavily?

[competentone]

Originally Posted by Vintage Racer

You just keep studying, and I'll keep running a real business.

It is convenient to blame Washington. By blaming those people, you are able to ignore the foolish actions of the people that started this whole thing by borrowing beyond their means. Or did Paulson hold a gun to the head of these people and make them sign contracts?

Did Bernanke threaten death to everyone that did not borrow heavily?

Huh?

Over and over again, I've been blaming all the irresponsible people "living beyond their means."

Of course, the irresponsible people need "enablers" in order for the lending to get so massive that defaults in the debt threatens to topple the entire financial system.

As for the government holding "a gun" to force bad lending -- you really need to look at some of the recent court cases where lenders were sued for not doing enough lending in the sub-prime market!

And you really need to understand our fiat money system and how it is a government-backed system used to redistribute massive amounts of wealth.