Wednesday, March 25, 2009

Taxpayer Risk is Uncontained

It strikes me from watching a small amount of TV, that few people on either side of the microphone understand the magnitude of losses we are talking about with forced taypayer assumption of distressed paper. Most people seem to be under the impression that companies like AIG and other dead financials have lost almost everything they own. That is totally wrong. They’ve lost much more than they had, have, ever will have, and more than we could ever pay them.

I expect politicians to be clueless. I expect bankers to be clueless. I hope reporters eventually figure it out. I know citizens figured it out long ago. With the hope of bringing around groups that still need help, I offer this simple analogy to help illustrate potential losses if we buy this sludge:

I have a computer model that tells me no baseball team has ever lost more than 80% of its games in a single season. It crunches all the historical data that we had time to enter, and it tells me than such an event is "impossible" in MLB. Convinced that I am a new age technical genius, I start placing bets that no team in baseball will lose more than 130 games in any given season.

I can't place the bet I want in Vegas, so I create my own derivatives. That is, I derive my own bet structure with third parties, based on outcomes in the established market, and we write up a legal contract to seal the deal.

My bet is likely to win, so the market forces me to accept discounted winnings relative to what I lay down. The market determines that I will win 4.6 cents for every dollar I place at risk. Yay! I don't care. That's 5% per year GUARANTEED.

Best of all, there is an incredible appetite for my contracts. Who is doing the betting? Oddly, it is the people who know the game best: the players, the owners, and the fans. I'm ok with that, because they don't want to win, they actually want to lose. They are using my paper as insurance against a really bad season, which they do not expect, but they throw a few cents at it, just in case.

So I form a company. Cash floods the 94th floor, we have to take the fire escape to get home at night. There are so many crazy losers out there, I hardly have time to drive my Gallardo between contracts. We're making billions, a nickel at a time. It's brilliant.

Pause - The astute reader already recognizes a disconnect. The market has discounted my odds differently than the computer model. Specifically: "Impossible" vs. 20:1. But the data can't lie right? So the market odds are wrong, right?

The players deeply understand the game, they know what can happen even if it has never happened, the computer only knows what has happened. Anyone with an ounce of trading experience at the companies making these bets should have screamed stop! Look at the volume of bets against us. High transaction volume = the CORRECT price. Something is wrong.

But no one, no one, at Bear, Lehman, Goldman Sachs, AIG, and on and on, was good enough to know what any country farmer would have told them for free: there is no such thing as a free lunch. There is no return without commensurate risk, whether you are capable of deciphering that risk or not. That unbelievably simple fact was lost on every key employee at every one of these sham firms. Mind-blowing incompetence, from top to bottom.

So after I borrow my usual $290B from the two other firms doing the same in the NFL and NHL, I lay down my usual levered-up $500B for the 2007 season. I'm off to northern Ireland to kill partridge.

But then something strange happens. The Cubs start to stink. Not the usual stink, I mean they really stink. Halfway through the season, and they've only won 14% of their games! The market can't even figure the value of my paper, no one really knows how to price it, but they all agree it is bad. Really bad. We know we can't lose, but for some reason, our stock price drops 80%. Huh? At this rate, we are going to have to find more collateral to back our loans. This can't be happening.

We hold a company meeting. The old heads laugh, they know how this all turns out, the Cubs pull through. Our computer model proves it happens every single time. Besides, we have 10 leading 25-30 year old sports writers who all agree that nothing bad ever happens to the Cubs, so far as they can remember. So instead of selling our distressed paper for 70 cents on the dollar, a huge and embarrassing loss, we decide to let it blow over.

The season grinds on. Wouldn't you know it, the Cubs actually get worse. Panic descends upon the board room. The Cubs have an 11% record and now there are hardly enough games left to break 20% W's. We decide we have to sell some paper, but even at 20 cents on the dollar, a loss of over $300B for the firm, we get no bids. After all, who wants to buy a high probability loser with liability measured in the many trillions? Who wants to take it on for free?

It becomes obvious that only the Government is dumb enough to save us. If they don't, we'll collapse over night, and that will collapse the NFL firms depending on our money, and the NHL too. The sports world is in peril. But we have a great idea. We will cut the taxpayer a phenomenal deal to take illiquid paper off our books for 50 cents on the dollar. We are talking about paper that, historically speaking, never loses. Taxpayers stand to make great money on this thing.

Uncle Sam is thrilled, at first, but then expresses some consternation. Aren't you financial gurus forgetting about something? Hello?? Is anybody home? Oh, plus and we'll make almost twenty $4,000 campaign contributions, and buy you and your staffs dinner in our rotating tower.


Substitute betting against real estate declines of 20% for baseball wins, and you get the picture. It isn't that the free market won't price these "assets" above zero because they are worthless, it is because they will saddle us with untold trillions in future losses. For a few hundred billion in "great deals" up front, taxpayers will lose trillions upon trillions upon trillions upon trillions of dollars.


  1. OutAndIn:

    Good luck on your gold shorts

    At least I can bet against ya on something :)

  2. Congressman Kent Conrad was interviewed on NPR this morning. As Chairman of the Congressional Budget Committee he heads the Democratic budget under Obama. While fiscally conservative himself, he admits openly that the proposed 3.6 trillion dollar budget will likely be hard to trim.

    Asked by the NPR interviewer if Republican lawmakers concerns that federal bankruptcy could occur, his response was this was not possible, since the US government could always create more currency, and inflate its way out of insolvency.

    From everything I've heard you post over the last year and a half, you emphatically deny that this can happen, since our debt-based economy REQUIRES that borrowing be linked to an adequate supply of LENDERS. (Sorry if I've oversimplified)

    Who is right?

    Appreciate your blog.

  3. Nice post FDR. For the interested reader, check out Nassim Taleb's book, The Black Swan, or his other one called Fooled by Randomness.

    As to the post above concerning Kent Conrad's comments, it's been tried before and it has NEVER worked in the context of the question.

  4. FDR,
    Please check out blog entry from yesterday in the link below....scroll down to the section called "The End Game Approaches". Posters on blogs like MW (and perhaps even some of comments by readers here) usually talk about a future in which China no longer purchases Treasuries as a time of hyperinflation. I don't get that. Would that mean there is even less money in the system, hence greater deflation? I think Denniger is touching on this in the link below, but he doesn't explicitly say what the financial impacts would be, only that its getting ready to hit the fan big time.

  5. 7900 is here. I guess we are just going straight up, lol.

    Hard to imagine that we wouldn't have at least a 0.382 retracement even we are indeed in primary counter 2.

  6. the tone has changed dramatically since we originally discussed 7900 as the counter top.

  7. Here is a link my wife sent me. Apparently obama is already working actively to surpress this video so it might not be up for long.

  8. Thanks for the link to the video, even though I'm now depressed...

  9. Anonymous said: "From everything I've heard you post over the last year and a half, you emphatically deny that this can happen, since our debt-based economy REQUIRES that borrowing be linked to an adequate supply of LENDERS. (Sorry if I've oversimplified)"

    My understanding of FDR's position is the same as yours.

    And while I believe FDR would normally be correct about deflation being the primary trend, he appears to assume that the bankers behind the Fed only care about making a profit on the money they lend.

    I think that's a shortsighted view at best.

    The people behind the Fed don't just want money. Money is only as good as the uses it can be put to. And having just enough money to satisfy your every desire is no worse than having many times that.

    There are things even the biggest pile of money can't immediately buy. One is a military machine as powerful as the one the U.S. has, and the ability to project military and political power that comes from it. You can build such a thing from scratch eventually if you have to, but that takes time.

    The people behind the Fed *cannot* afford to let the U.S. fail. It's that simple. If they do so, they lose the power that control over the U.S. currently gives them. They can replace it but that takes a great deal of time -- during which they won't have the power they currently have. And during that time, they would be more vulnerable than they are now.

    So you have to ask yourself: what would be more important to such people? Money in the short term, or power in the short and long term? I think the answer to that is obvious on its face: the latter.

    And if that's your answer, then you *must* concede that the people behind the Fed will prop up the U.S. *EVEN IF THEY HAVE TO INFLATE THE CURRENCY SUPPLY*.

    And yes, they *can* inflate the currency supply. All they need do is issue more federal reserve notes to the U.S. government, so that the USG can use it to pay expenses and debts.

    I'll explain why in my next message.

  10. FDR's understanding of how the current economic system works is fundamentally correct as far as I can tell. But I think the conclusions he draws about inflation and deflation are incorrect. Allow me to explain, and hopefully at least one of us will learn something (whether it's me, through correction, or him).

    The currency supply is debt-based. What this means is that the amount of currency is equal to the sum of the cash currency in existence plus the amount of outstanding debt.

    But there's a catch to the "plus the amount of outstanding debt" bit: the debt has to be issued by a fractional reserve banking institution. Any institution that does not operate under fractional banking rules must have in its coffers all money it intends to lend out.

    Which is another way of saying that except for fractional reserve operations, the money supply is *conserved*. That is, that any financial transaction that does not involve a fractional banking institution neither creates nor destroys money.

    If money is created only through loans issued from fractional reserve institutions, it similarly can only be destroyed by paying those loans back.

    Deflation in such a system occurs only when more money from loans is being paid back than is being issued.

    Now, that's very important. Why? Because the "debt destruction" we're seeing is *not* from loans being paid back. It's from loans being *defaulted upon*. When a loan is defaulted upon, the money that was issued for that loan *remains in circulation*. Even if the bank goes out of business, that currency is still in circulation.

    On the other hand, the Fed buying treasuries *is* printing money, and thus inflating the currency supply, at least until it gets paid back. Unlike other fractional reserve institutions that operate with a reserve limit, the Fed operates without one.

    So unless loans are actually being paid back to the banks, how in the world are we in a deflationary environment from a currency supply perspective?

  11. Just one question, I'm just wondering if banks lend on, say, 20 to 1 ratio, and the loan isn't paid back wouldn't that reduce available currency by the same ratio?

  12. Nope. The money is still in circulation. What it does is reduce the amount of additional money the institution can lend, at least until the institution gets additional money from depositors. I think (but am not sure) the amount of additional deposit money needed is only 1/(ratio) times the amount of money defaulted on, though...

  13. If you lent $100,000 based on 20 to 1 ratio, $5,000 deposit)and the loan was never paid back, haven't you really taken $100,000 out of circulation (deposits), also. Plus the loss of lending capacity on $95,000?

  14. "If you lent $100,000 based on 20 to 1 ratio, $5,000 deposit)and the loan was never paid back, haven't you really taken $100,000 out of circulation (deposits), also. Plus the loss of lending capacity on $95,000?"

    Yes. Plus the decrease in collateral price on the borrower's end of the world.

    One deflated home/car/asset sold in distress reduces the bank's net worth, the borrower's net worth, and the worst of all, the entire neighborhood's (non-default) net worth.

    The total deflationary leverage of every dollar burned is high.

    The opposite applies during inflations, but people and businesses mistakenly attribute all that inflationary leverage to their own business intelligence.

  15. Hi FDR,

    Excuse my ignorance here because I was fairly certain I understood deflation and hyperinflation in a debt-based fiat currency system until recently... Is the poster above who suggests increases in the 'currency' supply should be a source of inflation missing that many of the write-offs are merely 'computer entries' so to speak? For example, loss-generating derivative bets and the like, based on imputed value rather than 'tangible' value, reduce the total 'wealth' in the economy, thereby determining the macro status of the economy - whether that be deflation (losses greater than currency increases) or inflation (currency created at a faster rate than total losses).

    I agree with you that we are experiencing deflation and likely to experience inflation in the future.


  16. I want to add to the above: I understand devaluing the currency by printing will cause inflation, but isn't the broader picture deflation because the losses are so gargantuan?

  17. Oh, dear. Where to begin...

    First, remember that currency has no value except as a medium of exchange. Exchange of what? Wealth? No. Labor.

    If you take any financial transaction and trace it back through all the other financial transactions involved, you'll find it ends with someone being paid for their time. This is true of every good, service, or raw material.

    The service is obvious on its face: you're paying for the person's time. Obviously you're also paying for some of his equipment, overhead, etc.

    What of a piece of equipment? For that, you're paying for the raw materials, the labor required to manufacture the parts, assemble it, test it, market it, and sell it. And, of course, some of what you're paying for is the equipment necessary to manufacture it, etc. Apply this recursively to the equipment.

    What of raw materials? For that, you're paying for the labor to extract the raw materials and to convert them to a usable form. And, of course, for the equipment used (to which you apply the previous comment).

    When all is said and done, all you're really paying for is someone's time.

    Why is that important? Because it is highly relevant to the discussion of currency and the currency supply. The price someone is willing to pay for something is ultimately measured by that person not in the currency price of that something, it's measured in the AMOUNT OF TIME IT TOOK TO EARN THE MONEY TO PAY FOR IT. Someone who makes $1 million a year has a very different view of the cost of food than does someone who makes $1 thousand a year. To the latter person, the cost of food is very high. Not because it costs any more in dollar terms, but because it costs so much more in terms of how much work he has to do to earn the necessary money.

    When the currency supply increases uniformly, as it tends to do (more or less) in a typical fractional reserve induced inflationary environment, everyone has more money available later than they had before. The price of everything readjusts upwards to compensate. Has the actual *value* gone up? No. The amount of labor required to buy things hasn't changed in the least, nor has the amount of labor required to produce it. Increase the currency supply and everyone gets slightly "richer" (in terms of currency), and goods and services appear "cheaper", so the price goes up, either due to increased demand or due to the knowledge that the market will bear the increase. The price trend is thus upwards, and it tends track the inflation rate.

    The same is true of currency deflation, provided it happens relatively uniformly -- prices drop because if they didn't, everyone would have to work more to buy the same things, and that reduces demand. The prices drop to accommodate the lower demand, and the end result is that the prices again track inflation -- which is now negative.

    The kind of deflation FDR talks about in the message above this one is not currency deflation. It's price deflation as a result of changes in supply and demand. That kind of deflation tends to be relatively tightly constrained. As long as the currency supply remains constant, a drop in prices results in greater demand, which stabilizes the prices.

    The huge deflation that occurred during the Great Depression was currency deflation. It occurred because there was a big run on the banks. The amount of money in circulation, which is the total amount of deposits plus any cash people are holding, decreased towards the amount of cash in the wild as banks went under and took the bulk of the deposits with them (because in a fractional reserve system, most deposits are not backed by cash or anything else -- they are money from loans, remember?). As FDR has, I believe, pointed out elsewhere, dollars became very valuable during that time.

    That's not the situation today. If a run on the banks occurs, banks which are the targets of these runs will fail and be taken over by the FDIC. While the FDIC is ostensibly funded by insurance payments by the banks, under such a situation it *will* have access to cash directly from the treasury if necessary. And in that case, the only thing that would allow the FDIC to fail would be the Fed failing to buy enough treasuries. And when the Fed buys treasuries, guess what it's doing? You got it: it's loaning the government money, fractional reserve style. But the Fed doesn't have to adhere to fractional reserve rules -- it can print as much money as it wants. So while currency deflation in the style of the Great Depression can't be ruled out entirely, it's *much* less likely than it was during the Great Depression. Inflation is much, much more likely.

    FDR talks about net worth. I don't quite understand why. Net worth is generally *meaningless*. It is the sum of the price someone could get at the time for everything they own. That means that in the general case, most of what comprises someone's net worth is *illiquid*. It's either difficult, time consuming, or inconvenient to sell, or it is something the person in question has no desire to sell because it has some kind of non-monetary value (a home is such a thing). The only thing a person's net worth is generally useful for is as something to borrow against.

    So if everyone's net worth is dropping as a result of a decrease in price of the most expensive item most people have, their home, it is *not* massively deflationary in the way the Great Depression was. It's deflationary, yes, but only because it serves to reduce the demand for goods and services. The amount of money in circulation does *not* decrease as a result of this, and as a result the amount of deflation that will happen is almost certainly much more limited than what we've experienced in previous deflationary cycles.

    There is a difference between "deflationary" and "less inflationary". A drop in the net worth of individuals reduces inflation, because it leaves them less to borrow against, and the end result is that money cannot be loaned as quickly. It may cause some temporary deflation as prices adjust downwards somewhat due to the anticipation of smaller amounts of borrowing (and thus less spending), but that will last only as far as the primary assets fall in value.

    How much will they fall in value? In this case, enough to cause the prices to be considered affordable again. Remember, the real estate price hike was a *bubble*. The prices went out of control, well beyond the range of reasonable affordability. They must revert to the mean, and are doing so now. They will drop below the mean for a bit (most reversions to the mean result in this), and then come back up again. But they will stabilize, and they'll stabilize at roughly the same value levels as they had historically been: between 2 and 3 times the median household income (which is under downwards pressure, but not at the same rate as real estate, so the two curves will converge). When that happens, fractional reserve institutions will become willing to lend against real estate again, and the economy will stop freefalling.

    However, that's not the only deflationary pressure. There's another one that's at least as important, and may be enough to get us deflation on a scale rivaling that of the Great Depression.

    And that is: the U.S. has been in a trade deficit for at least the last 30 years. A trade deficit means you consume more than you produce. A trade surplus means the opposite. In the case of the U.S., we've been consuming more than we've been producing. That's an unsustainable condition.

    There are two ways we can do that: by spending our savings, or by borrowing from outside sources (and not from within as we had been). We've already done the former, and we've been doing the latter for the last 10 years. The sale of various financial instruments is what has financed the past 10 years, and that is now at an end.

    So we cannot borrow any more, and we don't have any savings left to spend. There's nowhere left to go but towards being a producer nation. At the very least, we must begin producing for ourselves, because we haven't the means left to continue operating under a trade deficit.

    For us to become a producer nation, we must produce goods and services at prices competitive with the rest of the world. Right now we can't do that because the price of living in the U.S. is far too high. It has to drop. That will happen as a result of massive unemployment and the resulting competition for jobs. People will become poorer. Their standard of living will drop. And when the standard of living drops, so does the price. Eventually it may drop enough that labor here in the U.S. will start to be price competitive with the rest of the world.

    I hate to see what that will look like, but I see no other possible outcome, aside from the U.S. economy becoming essentially a closed economy not due to protectionist measures, but because it may be the only way for people in the U.S. to be producers and consumers in equal measure.

  18. Great post hun...

    Inflation is the way by which central bankers pay virtually nothing for our time and labor.

  19. I understand that kcb, (given I alerted many in MW to the fact that fractional reserve banking was an issue). What I've had difficulty in understanding is whether the government stimulus will lead the system to implode. There are many factors to consider here - endless debt and endless losses, whether the model can sustain 'perpetual growth' (unlikely since consumer demand globally is pretty tapped out), the dollar as reserve currency, economic alliances and political aims.... Hence, isn't the outcome more predictable when we know the strength of our foreign relations?

  20. "The amount of money in circulation, which is the total amount of deposits plus any cash people are holding"

    That is a part of it. The primary method of currency creation is (more like, was) commercial banks printing up to 40:1 above actual reserves so they can collect interest on principal they do not have.

    It is true that these banks don't own the principal they create (print), since printing cash (counterfeiting) and sticking it in your own pocket remains, for the time being, illegal.

    But the principal they loan (launder) still enters the currency base as spendable cash. And with legal 40:1 leverage, who needs to pocket phony principal?

    In other words, if I can print and lend (counterfeit and launder) 20x reserves at 5% interest, I have doubled my money no matter how you parse the words.

  21. FDR wrote: "That is a part of it. The primary method of currency creation is (more like, was) commercial banks printing up to 40:1 above actual reserves so they can collect interest on principal they do not have."

    Well, actually, what I mentioned was all of it, but deposits and cash usually come from loans issued by banks (money loaned to someone usually winds up in someone else's bank account as a deposit), so what I mentioned doesn't contradict what you're talking about in the least.

    My point was, simply, that during the Great Depression, one of the primary deflationary mechanisms was the run on the banks, and this is much less likely to occur now than it was then.

  22. "My point was, simply, that during the Great Depression, one of the primary deflationary mechanisms was the run on the banks, and this is much less likely to occur now than it was then.

    Yes, you are right that the printed money just sloshes from bank to bank.

    As far as bank runs, I think they are much more likely today and we are seeing that now.

    The difference between now and then is people like me transferring account balances into the US Treasury from home, crushing T bill yields.

  23. kcb, what does T bill yields tell ya?

  24. T bill yields tells me that people believe the banks won't make it. I do expect that many banks will fail (perhaps even most of them).

    The question is whether or not the FDIC will be able to do its job. The T bill yields tell me that many people believe it won't be able to do its job.

    What's lost on them is that if the FDIC can't do its job, THEY WON'T BE ABLE TO GET THEIR MONEY BACK FROM THE TREASURY, EITHER. And the only way that statement can't be true is if the government intentionally withholds funds from the FDIC. Do you really think that's likely?

    I don't.

  25. Even worse than that, kcb, the US government CAN'T fund the FDIC under our current (unconstitutional) system.

    The Fed has to finance any payout, at interest. That sucks double the currency out that it puts in.

  26. FDR wrote: "Even worse than that, kcb, the US government CAN'T fund the FDIC under our current (unconstitutional) system."

    The system has been unconstitutional since day one. Nobody in a position to do anything about it cares (or, alternatively, understands), and nobody who cares and understands is in a position to do anything about it. It's been that way for nearly a century.

    So unconstitutional or not, the system is what it is and is place whether we like it or not. And yes, the U.S. government *can* fund the FDIC -- all it has to do is continue to borrow money from the Fed.

    "The Fed has to finance any payout, at interest. That sucks double the currency out that it puts in."

    Yes, it does, but it does so at a controlled time (the time at which the government pays it back) and at a controlled rate (both of which are determined by the lender), and furthermore you *know* that the only way the government will pay it back is through further borrowing, either directly or indirectly by taxpayers (where do you think the taxpayers get *their* money from?), or by the government itself.

    This is a debt-based monetary system. It's inflationary by its very nature. Unlike the currency system during the Great Depression, which was tied to gold, this one isn't tied to anything at all. It can inflate forever and at any kind of rate.

    Deflation under such a system *requires* that loans be paid back faster than they are made. When everybody is in financial trouble (including the government), that *can't* happen.

    Why? Because the natural result of a debt-based fiat currency system is that everybody eventually owes someone else more than they can pay back. The nature of the system is that there's never enough money in circulation (cash plus current deposits) to pay back what is owed.

    As I explained before, defaults on loans DO NOT result in deflation in this kind of monetary system, because a default on a loan DOES NOT touch any of the current deposits on hand at any of the banks. And since the size of the money supply is the total of the cash in circulation plus the current deposits, that means the size of the money supply DOES NOT shrink when a loan is defaulted upon.

    So the Fed lending the government money will never be deflationary until the economy is strong and the U.S. becomes a producer nation again, because the government will never be able to pay it back otherwise. The government can't tax what isn't made, and a weak economy produces little.

    So unless the U.S. economy grows strong again, the Fed will always be left with the choice of either lending the government yet more money, forgiving the obligation altogether, or letting the U.S. default.

    I've explained several times already why the last option isn't going to happen. And we know that the Fed will never forgive the obligation. So that means that we *know* that the Fed will continue to lend for as long as it takes for the U.S. economy to become strong again. Because it's the only way for them to get their money back.

    And so, the only deflation we're going to see will be the result of lower demand for goods and services, something which is much less abrupt and deep than currency deflation.

    If you can poke any holes in the above, please do so. But I, for one, don't see any.

  27. FDR wrote: "The Fed has to finance any payout, at interest. That sucks double the currency out that it puts in."

    I think I may have misunderstood your meaning here in my last reply.

    I think your statement here implies a gross misunderstanding of what the Fed does in our fiat currency system.

    (Of course, it's possible that my understanding is incorrect, so I guess we'll see who has the right interpretation)

    The Fed *is* the money printing machine. When it loans money, that money is created from thin air. Unlike a fractional reserve bank, which requires that a fraction of the total amount it has loaned be on hand in the form of cash deposits, the Fed operates under no such restriction.

    Normally the Fed creates this money in order to supply fractional reserve institutions, but that's not the only way it can create money. It can create money by lending it to the government, as it's doing when it buys T bills.

    The Fed's fractional reserve rate is ZERO! There is no way for it to act as the "lender of last resort" otherwise.

    This is the very nature of a fiat currency. It can grow without bounds, at any rate those who control it want it to grow.

    So when you say that the Fed must "finance" the loans it makes to the government, that's obviously false on its face. The Fed is a lending institution, *not* a borrowing institution (it can choose to borrow by selling securities, but it is under no obligation to do so)! It has no reserve requirements, so it can lend as much money as it wants.

  28. I wish there were a way to edit one's comments here. Maybe I should create an account here on blogspot. Would that enable me to edit my comments?

    Anyway, it seems that my assertion that the Fed has a reserve rate of zero is incorrect. Apparently the Fed banks are required to maintain a reserve at the same ratio as standard fractional reserve institutions do.

    So the Fed is indeed limited in terms of how much in the way of T bills it can buy.

    Of course, the reserve requirement is a matter of law (or so I expect, for if it's not then it's arbitrary and can be changed on a whim), and that's something the government can change if it wants to be able to borrow more money from the Fed.

  29. This comment has been removed by the author.

  30. FDR wrote: "Even worse than that, kcb, the US government CAN'T fund the FDIC under our current (unconstitutional) system."

    As I said, if the government can't fund the FDIC, then it can't pay back the treasuries that were purchased, either.

    And that means that buy purchasing treasuries, you're burning your money in a fire as surely as if you put it in a bank that you knew was going to fail.

    In other words, with the FDIC system in place, keeping your money in a fractional reserve bank is *no worse* than keeping it in treasuries, provided you maintain a balance less than the FDIC limit.

    In fact, I expect that treasuries are even worse, since the yield is less than the interest rate on a typical savings account, no?

  31. Indeed, inflation is not the dominant trend at this time.
    Deflation will prevail until the banks restart lending to reflate the economy. They however have no incentive to do this at this time as they are currently benefiting from a blank check from the FED. Indeed, they may prefer to let deflation prevail in order to increase the amount you owe them already in real terms.

    So what to do? Personally I find it ill-advised to invest in either treasury bills or USD. I think the Swiss Frank is looking ok simply due to the fact that the market has not understood the extent of UBS bad credit exposure on the SNB balance sheet and they are currently benefiting from significant save haven inflows allowing them to print CHF to pay off the rubbish.

  32. by kcb's hypothesis, safest currency to be is the one with highest amount of insured deposit per depositor.

    by kcb's hypothesis, this currency should also produce the lowest yield because it is the least risky.

    unfortunately, he can't be right both times.

  33. Perceived risk and actual risk aren't necessarily the same thing at all. Travel by aircraft is an excellent example which illustrates the difference: many are much more comfortable driving than they are flying the airlines, yet driving is much riskier.

    Yield is a function of perceived risk, not actual risk.

    I actually think treasuries are ever so slightly less risky than insured deposits, but I also think the difference is very, very small -- much less than the difference in yields would imply. The difference in risk primarily has to do with the possible inconvenience of getting at your money if the FDIC takes over your banking institution.

  34. "Travel by aircraft is an excellent example which illustrates the difference: many are much more comfortable driving than they are flying the airlines, yet driving is much riskier."

    That's silly airline propaganda.

    In 2006 there were 535 deaths from 47.1M flying hours of total air travel in the U.S.

    There were 32,018 auto driver/passenger deaths.

    To match the two ratios, you only need 2.8B driving hours in total. That equates to each citizen driving only 8 hours per year.

    If we drive more than 8 hours per year, average, then driving is safer.

  35. hey kcb, just wanted to say i enjoy your comments. i have been a follower of FDR since the beginning, but different points of view and healthy debates are what really offer the most education.

    after your post in response to comments directed towards you from a few people on this blog, i thought you were not going to come back to this blog. glad to see that is not the case.

  36. This comment has been removed by the author.

  37. Arrgh. I really wish there were a way to edit one's posts, instead of being forced to delete them and reenter them. Ah, well.

    FDR wrote: "In 2006 there were 535 deaths from 47.1M flying hours of total air travel in the U.S."

    There's a *reason* I said "flying the airlines" instead of just "flying", but I suppose I should have made myself more clear about that.

    Flying the airlines in the U.S. is much safer than driving, especially on a per-passenger-mile basis. But flying in total (whether restricted to the U.S. or not) is not: private aircraft have a much higher accident rate than the airlines do, both in terms of aircraft and in terms of passengers.

    The safety record of U.S. airlines has been rather impressive. For instance, in 2007 there were no deaths due to U.S. airline accidents at all.

    It wasn't always that way, of course, but I'm talking about now, not 50 years ago.

    So I think my point stands, but I'm open to being corrected on that.

  38. There is a difference between perceived safety and actual safety.

    Actual safety is number of safely travelled passengers per trip. Perceived safety is based on accident rates.

    If you compare actual safety, aircraft travel is far safer than driving.

  39. Part of the problem is that safety and risk can be measured in so very many different ways. And some of those ways may be more relevant to a given person than others, for a number of reasons. It's hard to entirely eliminate the subjective nature of risk assessment as a result, because in the end, the measure of risk that's relevant depends on one's goals.

    There are some activities for which perceived risk and real risk tend to converge nicely, and others where they seem not to. Airline travel in the U.S. seems to fall more into the latter category than the former.

    In the case of treasuries, I don't really think we have enough information to really say just how risky they really are. In normal times, of course, the risk would have to be very, very low. But these are hardly normal times, and history tends to rhyme more than it repeats.

    I think we're in for seriously hard economic times, whether we get inflation or deflation.

    Oh, and ginandtonic, thanks very much for your very kind words of encouragement!

  40. Thanks your encouragements are mutual.


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