A Wayward Economics Professor's Email

Economics Economics Questions
1

I am a student at Montana State University and was forwarded this email from a professor of economics here on campus. To any layman, the explanations appear sound. I think it would be great if we could piece together a rebuttal.

______,

I wanted to help summarize some of our discussion so that you can think about it a little more clearly (as we went over a lot of topics).Is the Federal Reserve monetizing the ‘debt’? No. I will tell you that the ‘Debt’ is not being monetized. We pay tons of interest (glen beck had it at $500 billion per year). Is the ‘deficit’ for new spending being partly monetized? Yes. The finance of the current gov’t spending is coming from the Fed. Reserve buying bonds issued by the Treasury through some third party. If there wasn’t a ‘global recession’, the Fed. Reserve wouldn’t be buying the debt, the world would do that for us. I’m happy to be in this country!Is this a problem? Not yet. The biggest issue with monetizing is monetary inflation. Because these new dollars will become a part of the high-powered money, the money multiplier increases the money supply by a larger amount then the bonds face value. Is this a problem right now? No, we have had deflation (look at core-cpi and not just from oil prices). Buying some $50 billion per month in bonds will not cause inflation to go through the roof. Remember the amount of money TARP was (almost $700 billion)Will this be a problem in the future? Probably not. Why? Simple. Right now we need to finance things like extended unemployment insurance, Medicaid, food stamps, TANF, mortgage assistance, and other gov’t aid to help individuals who have no job and are one step away from being homeless. As the economy comes out of the recession, these assistances will not be required on a large scale as required right now. Instead of taking money from the gov’t, these individuals will pay taxes again. Remember the 90s when we had surpluses. We paid back a lot of debt. Too bad Bush didn’t do the same during his expansionary times. I guess he wasn’t as fiscally conservative. He had a war to finance anyways.A stable money supply adjusts to the economic condition. Mainly, during recession, we need to finance more debt and during expansions, if we choose, we can pay it back. Now, will the Fed Reserve step in and shrink the money supply if required. Of course. When inflation occurs (remember the early 80s), I assure you that the money supply is reined in. Do we rein it in during expansions? If inflation and expected inflation is okay, then for the most part, we ride high until the expansion is over without reducing the debt. Gov’t and people act many times in the same way. Do people care about the amount of debt they have? Not really. If they can afford to finance it, then they really don’t care. Why do we think that more gov’t debt means devaluation is automatic? Just because I double my person debt, does that mean I am going to default and become bankrupt? No. Just because the gov’t increases debt, as long as inflation is not a problem, then we are okay. The U.S. is not going to default on its debt and since we are still paying interest, we can all relax!There is another aspect that hasn’t been addressed: the exchange rate. All these dollars floating around causes our dollar to be worth less (increasing the money supply may not cause inflation but it may cause the exchange rate to adjust instead, or both). Think of it as inflation/deflation when buying other countries’ goods. Is monetizing ‘deficits’ a problem on the exchange rate? Yes and no. Our goods become cheaper so other countries will want to buy our goods (expanding our economy). Other countries goods become more expensive so we will buy less of theirs. Is that bad for us? Maybe, if you want other countries’ products. But then again, we have been blowing the ‘buy American’ horn for quite some time. Maybe a little devaluation will help the cause. Countries like Canada devalued their dollar on purpose to increase their exports. They allowed their dollar to go from around 1 CDN = 87 cents USD to 52 cents USD in 2000-2003 to help them with their problems. Only recently have they been forced to adjust their dollar upper wards.On to the second question: should we trust the Fed. Reserve to run the money supply? Yes. The Fed. Reserve assets are the most liquid of any bank. They primarily have treasury bonds which is almost as liquid as cash in terms of an investment. Can other banks say the same? What would happen if small banks were in charge of the regional money supply and needed to adjust the money supply. How liquid are they? Can they buying/sell assets as quickly? Would you ‘trust’ their money? More importantly, would other country want the money? What is the demand for this currency? No thanks, I’d rather use FRB IUOs then some small banks IOUs.Last note: Times change. Policies changes. Just because the founding fathers didn’t think it was right in their time doesn’t mean that it is right in our time. Technological progress assures that times change.If people are opposed to the greenback, they should start carrying gold or, better yet, barter.

Bests,
Dr. ______

2

I’m not in the mood to read all of that, but here’s why we’re fucked:

The FED has engaged in “revolutionary” counter-cyclical policies since last year, i.e., they bought a lot of bonds/securities on the market, increasing the supply of money by a multiple of 15-20. Now, that may seem odd considering the price of goods and services has not increased nearly that much, but that’s because the banks are holding onto most of it (due to uncertainty). The FED, though, bought the bonds when their prices were high, that is, when interest rates were low, and bonds/securities continue to be over-valued due to perpetual FED purchases. Now, if the banks get off of their massive reserves, inflation will be exponential–the dollar would be in serious trouble, which is why the FED is paying the banks to sit on their reserves. That’s right, the banks are getting paid not to lend. Now the original exist strategy was to “unwind” this process by selling the bonds back on the market and reducing the money supply. Unfortunately, as soon as the FED stops buying bonds, their values will collapse, and when they go to sell bonds, the value will collapse some more, and interest rates will rise, a lot. This means that the FED cannot pull out nearly as much money as it put in (inflation), and will face soaring interest rates which kill the malinvestments we’re so dependent on (stagflation).

  1. For example, the FED bought 10 bonds at a market price of $10–putting $100 into the economy.
  2. When it goes to buy them back, the price is at $2 each, meaning it pulls back only $20, leaving $80 in circulation.

So the FED’s not going to do that; instead, they’re going to continue to pay the banks more and more interest in order to prevent most of that liquidity from reaching the market. The long-term consequences of this should be obvious.

3

Hate to be a douche but that post may be a slightly less daunting read if you could break it into paragraphs for us.

4

May I just say that despite my lack of true expertise in economics, I must say that there are some glaring assumptions and somewhat silent implications in this letter.

“If there wasn’t a ‘global recession’, the Fed. Reserve wouldn’t be buying the debt, the world would do that for us. I’m happy to be in this country!Is this a problem? Not yet.”

China has already gotten cautious on us once, I’m sure all our other creditor nations are worried too. Assumption

“Is the Federal Reserve monetizing the ‘debt’? No. I will tell you that the ‘Debt’ is not being monetized.”

Not yet.

“The biggest issue with monetizing is monetary inflation. Because these new dollars will become a part of the high-powered money, the money multiplier increases the money supply by a larger amount then the bonds face value. Is this a problem right now? No, we have had deflation (look at core-cpi and not just from oil prices). Buying some $50 billion per month in bonds will not cause inflation to go through the roof. Remember the amount of money TARP was (almost $700 billion)Will this be a problem in the future? Probably not.”

Massive assumption.

“Right now we need to finance things like extended unemployment insurance, Medicaid, food stamps, TANF, mortgage assistance, and other gov’t aid to help individuals who have no job and are one step away from being homeless.”

Typical leftist nonsense. Oversells the intervention through pathos rhetoric.

“As the economy comes out of the recession, these assistances will not be required on a large scale as required right now. Instead of taking money from the gov’t, these individuals will pay taxes again.”

And what of all the people grown dependent on the gov’t? What about entitlements? Assumption.

“Why do we think that more gov’t debt means devaluation is automatic? Just because I double my person debt, does that mean I am going to default and become bankrupt? No. Just because the gov’t increases debt, as long as inflation is not a problem, then we are okay.”

We’re not talking 20k here, we’re talking trillions of dollars. It’s a silly analogy.

“The U.S. is not going to default on its debt and since we are still paying interest, we can all relax!”

O good, and here I was all worried.

“Is monetizing ‘deficits’ a problem on the exchange rate? Yes and no. Our goods become cheaper so other countries will want to buy our goods (expanding our economy). Other countries goods become more expensive so we will buy less of theirs. Is that bad for us? Maybe, if you want other countries’ products. But then again, we have been blowing the ‘buy American’ horn for quite some time.”

Strong dollar BAD!! Weak dollar GOOD!! It’s little things like this that make me understand exactly where this guy is coming from.

“Maybe a little devaluation will help the cause.”

Don’t really have to read between the lines on this one.

The problem is that real wages go down and so do real savings because people holding dollars get fleeced just by holding dollars. It’s the ultimate silent crime.

“Should we trust the Fed. Reserve to run the money supply? Yes. The Fed. Reserve assets are the most liquid of any bank. They primarily have treasury bonds which is almost as liquid as cash in terms of an investment.”

So does the Social Security trust fund. They’re only liquid if we assume there’s a market for them outside of the Fed. Am I right here, economics experts?

“What would happen if small banks were in charge of the regional money supply and needed to adjust the money supply. How liquid are they? Can they buying/sell assets as quickly? Would you ‘trust’ their money? More importantly, would other country want the money? What is the demand for this currency?”

I don’t actually have a good answer for this but something seems wrong here, I just can’t put my finger on it.

“Just because the founding fathers didn’t think it was right in their time doesn’t mean that it is right in our time. Technological progress assures that times change.If people are opposed to the greenback, they should start carrying gold or, better yet, barter.”

False dichotomy. Either you’re for the dollar or you’re for carrying gold and/or barter. Perhaps I just want my dollars to be worth a damn?