Sunday, June 7, 2009

The Bermuda Triangle of Currency

Question: How long do they disappear in the Bermuda Triangle? How do they describe the experience?
By candylove Asked Jun 15 2008 3:50PM

Answer 1: By Suzycue
They don't describe it because they are never found again!

Answer 2: By Annon
They go forever. They don't describe it.

I watched a docco though. It said, one of the reasons that planes keep going down in that area is that it is a highly active storm region. You seen the movie, 'The Perfect Storm'? It's a bit like that - different drafts and different temperatures of air bashing around in that particular area, all meeting there for some unknown reason, creating some wicked storms.

But you know, they don't know, because people just disappear when they go there.

Poker and the Stock Market

In some card rooms where people play poker, there are employees called Prop Players. The name is short for Proposition Player, also known as a House Player, a Stake Player or a Shill.
Card rooms sometimes employ house players in order to ensure that there are enough players to start and maintain games or to gain an additional source of revenue from the player's winnings. Many gaming jurisdictions have rules governing whether or not house players are permitted, whether or not they are required to identify themselves, and the purposes for which they may be used. Player attitudes toward house players vary based on the type of house player in use. The use of easily identifiable proposition players is generally accepted on the one hand, while on the other hand the use of shills generates distrust.

In the poker world, these prop players play with their own money. They can win or lose hundreds or thousands in a single day. But normally, they are paid a salary for staying at the table when the paying customers start to thin out.

The main reason card rooms use prop players is to lure in real players with the illusion of a bustling and vibrant game. In the stock market, the prop players are the large market makers that receive rebate money in exchange for "providing liquidity". Keeping the market liquid means that any real participant will always be able to buy or sell, even if the price is not ideal. It gives the illusion of a bustling and vibrant marketplace.

Now imagine a card room where the majority of the people at the tables are shills. Imagine that they are not only being paid to play, but they are actually allowed to play with the casino's unlimited chips, not their own money, yet they get to keep the profits they make. Going even deeper, imagine that the casino allows them to cheat in various ways to maximize profits.

You would not want to play in this card room if you knew what was going on, right? Over time, the entire card room would become a festering snake pit of shills just waiting for an unsuspecting victim to walk through the door. What kind of a game would this be? Would you call this a scam? A swindle? A trap? A fraud? How about a racket?

The difference between Real Money and Play Money

When you first sit down at a table, you must exchange your dollars for plastic chips. This exchange of "real money" for play money is made possible by the faith of the players that at the end of the game they will be able to turn in the plastic chips at the same exchange rate. And also because of the expectation that, with a little luck and skill, the players will be able to gain some chips prior to cashing out.

In the real world, this same exact faith-based system is used to entice people to exchange real, valuable goods for paper notes. The expectation is that later, someone else will take those paper notes from you and give real, valuable goods in exchange. And while you are holding the mere paper, the real world "casino" offers you many games in which, with a little luck and skill, you MAY be able to gain some more paper notes before cashing out.

The big difference between the real world and the casino is that the casino still operates a "Cashier Window" or a "cage". In the real world they permanently closed the "Cashier Window" back in 1971. So today, in "the big game", you can only cash out your chips as long as fresh new players are coming through the door.

So now, imagine that you were lured into playing poker in that festering snake pit of shills. After a few hours of losing, you start to realize where you are. You go to cash out your remaining plastic chips and you are told that the Cashier is closed. You glance at the doors and realize that you haven't seen a new player come in for hours. Without showing your panic, you must now formulate an exit strategy. You must identify the few remaining "real" players and try to sell them your chips. As your panic grows, you may even be willing to take less than full face value for your plastic chips. What a nightmare, huh? Now you know how China feels.

Credit doesn't even matter, Neither does M2 or even M1 really

We all know that prices have collapsed. Since early 2007, the average house price has collapsed about 32% (Case-Shiller). In 2008 through late November, the S&P 500 collapsed 49%. Over the past two years, a "balanced" 401K has collapsed in value about 35%. But does this mean we have "deflation" as so many deflationists have been proclaiming? No, it does not. As Adam Hamilton explains in Big Inflation Coming 2, you must look at the cause of the falling prices:
Deflation is purely a monetary phenomenon. If prices of anything are falling simply for their own intrinsic supply-and-demand reasons, and not as a consequence of monetary contraction, then it is not deflation. In reality, the money supply was skyrocketing in the panic.

To get around this small problem, the deflationists tell us that "the money supply" is different today. They tell us that the money supply includes credit, and since credit has collapsed, so has the modern money supply, ergo, DEFLATION. But as Adam Hamilton explains, credit is simply access to someone else's money!
Only a central bank can directly affect the base money supply. Yes, commercial banks can expand credit through fractional-reserve banking, but credit is not money. Credit is just access to someone else's money. If I offered you a $100k check as a gift, you'd be pretty excited. If I offered you this same $100k as a loan, you wouldn't be. Money and credit are very different beasts, so don't make the mistake of assuming credit contraction automatically means general deflation.

To get around this small problem, the deflationists expand their definition of "the money supply" to include "broad money", which really means "assets" or "derivatives of money" that people generally believe to be "as good as cash". These are the assets where people "park their money". But the money doesn't stay parked. It gets loaned out or reinvested by the banks. And the people that hold these assets hold only a paper promise of the later return of their paper money notes.

To give you a few examples, M3 used to include "large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets." [Wikipedia]
M2 includes smaller CD's, savings accounts and money market accounts. "M2 represents... 'close substitutes' for money." [Wikipedia]

Even M1, which is generally considered "narrow money", is still not money. It includes checking accounts, debit accounts and traveler's checks. While these types of accounts "spend" like money, they are still one step away. They are still a derivative of money because the banks do not hold all the money you think you have in your checking account in a segregated account waiting for you to spend it. They only hold a small portion of it. The rest they loan out or reinvest. So when you empty your checking account in the process of a large purchase, the bank must demand cash from somewhere else in order to pay for your purchase.

This demand for real cash actually affects the supply and demand curve of money itself. If everyone tried to empty their checking accounts at the same time this would create a HUGE demand for real cash, whether or not it is digital credits or physical paper FRN's. This is called a run on the banks. In the 30's, this happened when people took out physical cash to stuff in their mattresses. Today it could also happen if everyone maxed out their debit cards at the same time, spending the money into the market place.

In either case, this massive demand for real cash (whether it be digital or physical) exiting the banking system will create an upward spike in the value of the dollar. As long as you are simply "hoarding" your money in a checking account, you are not affecting the supply and demand of money. You are not affecting "inflation" or "deflation". In fact, you are not holding money. You are holding the promise of "real cash".

This "real cash" is best described as M0, or the Monetary Base. M0 is "currency (notes and coins) in circulation and in bank vaults, plus reserves which commercial banks hold in their accounts with the central bank (minimum reserves and excess reserves). This is the base from which other forms of money (like checking deposits, listed below) are created and is traditionally the most liquid measure of the money supply. The monetary base is sometimes called M0, but this denomination seems to imply that M0 is part of M1, which is not the case."

The important point here is the part of the Monetary Base that is not included in the M1, M2 or M3 measurements, namely "real cash" reserves (whether digital or physical). These are the reserves from which the banks can pay your vendor when you empty your checking account. And these reserves RELIEVE the upward pressure on the value of the dollar that a modern "bank run" would cause. In other words, they RELIEVE the risk of true deflation, even amidst a wide world of misunderstanding. In fact, they not only relieve one risk, but they become potential energy poised to create the OPPOSITE effect.

So, let us take a look at what the heck is going on with the Monetary Base. For this, we return to Adam Hamilton of Zeal LLC:
M0 growth was trending lower in 2008... But then the stock panic erupted and the Fed panicked, getting swept away in the fear. Bernanke decided to inflate far faster than has ever been witnessed in the Fed’s entire history since 1913.

In October, the scariest month of the panic when the S&P 500 plummeted 27% in less than 4 weeks, the Fed suddenly expanded the monetary base by $224b. This was a 25% surge in a single month, just insane. And it led M0 to rocket to its highest YoY growth rate ever by far, up 36.7%! But the Fed was just getting started in its unprecedented inflationary campaign.

In November it grew M0 by another 27% over the prior month, yielding 73.0% YoY growth. In December it again grew M0 by 15% MoM leading to a mind-boggling 98.9% YoY gain. In 4 short months, the Fed had literally doubled the US monetary base! Something like this has never even come close to happening before, so we are deep into uncharted inflation territory here.

Click on image to enlarge

By late December this information slowly started to leak out and contrarians who have studied monetary history were appalled. Was the Fed mad? Bernanke responded to these growing criticisms in Congressional testimonies, promising that the Fed would remove its “accommodation” (a euphemism for inflation) as soon as possible. Even though the Fed has never shrunk the money supply noticeably, Wall Street curiously took Bernanke at his word.

So every month since the panic ended in mid-December, when the VXO fear gauge fell back out of panic territory, I've been watching M0. In 3 of the 4 months since (May data isn't out yet), the Fed has actually grown M0 further! In January, February, March, and April, the absolute annual M0 growth rates weighed in at 106.0%, 88.5%, 97.9%, and 111.0%! And in April alone M0 surged to a new all-time record high. And by late April the stock markets had already rallied 29%, yet the Fed was still rapidly growing M0.

Friends, this data is flabbergasting!

Friends, this is the perfect setup for hyperinflation, which is similar to "deflation" in that it happens during the WORST economic conditions, similar to "inflation" in name only, and in all practical ways, the same thing as "currency collapse".

Inflation/Deflation is the wrong focus, Currency Stability/Collapse is what we should be watching

Please don't take my illustrations the wrong way. I do not expect that my Thoughts will ever make it into an Econ 101 textbook. I am simply making some broad points for you to think about.

As Albert Einstein said, "everything should be made as simple as possible, but no simpler."

This is part of my problem with the common understanding of economics; it is far, far, far more complex than anyone realizes. And it is far too complex for our simplistic understanding of "inflation" and "deflation". In fact, the discussion of these topics, "the debate", is so horribly flawed by simplicity and misunderstanding that it is simply worthless and pointless.

I find myself to be a "hyperinflationist", yet I agree with the "deflationists" on economic grounds, and with "inflationists" on monetary grounds, and I agree with the "Austrians" that most of the world completely ignores human psychological factors to the point of global catastrophe.

So this is my attempt to shape my own Thought process on our developing situation. Perhaps some of you can help!

Simple minds (and I'm sure you know a few) look at the average price of everything to determine inflation or deflation.

If prices are moving up, we are in "inflation". If they are moving down, it's "deflation". For the most part, this includes the MSM.

There is just one simple dot (prices) that exerts pressure on this ephemeral thing we call 'flation. What could be simpler?

Moving along, we have government minds. They see this same dot exerting pressure in one direction or the other, but they try to control what it is saying to the world by carefully defining a basket of goodies.

When the government's "basket" is getting more expensive, we have inflation. Of course, being the government, they also have "the power of substitution"! So if steaks are getting too expensive, they will substitute ground beef. Or if gas and food is too volatile in price, they will just ignore gas and food. Or if personal computers are remaining stable in price, but the processor speed is growing, they will say that the price of "processor speed" is falling.

Suffice it to say that government minds are a "basket" case when it comes to inflation and deflation.

Also in the one-dot category we have some purist Austrian minds.

I mean no disrespect to the Austrians. Like Richard Maybury, I use the Austrian model. But to many unsophisticated modern followers of the Austrian school of economics, inflation and deflation is simply a one dimensional function of the money supply. Money supply up, inflation. Money supply down, deflation. This view ignores many important variables, like economic growth and contraction relative to the money supply (to name one).

At least the modern Austrians apply a firm definition, which you can't say for the simple minds or the government minds. But by sticking to such a strict definition and model for inflation, in my opinion, you make "inflation" itself irrelevant to the current situation. (More on this in a moment.)

As we get a little more sophisticated, we come to Keynesian minds. These highly educated (read: programmed) minds see two dimensions where simple minds and government minds see only one. The two dimensions are the supply and demand forces of both money and goods.

In this linear model, each dot can exert up or down pressure on the other. You could have money supply growth and a stable supply of goods and you will get demand pull inflation. The demand for goods from the high money supply pulls upward on the price of a limited supply of goods.

Or if you have a shrinking supply of goods in an economic contraction paired with a stable money supply, you will get cost push inflation. Here the cost of a smaller basket of goods pushes up the price relative to a fixed quantity of money.

Of course you can have varying levels of up and down pressure exerted from each side onto the other, causing varying levels of inflation or deflation. The first derivative of this supply and demand pressure is the velocity of price movements. The second derivative is what the Keynesians watch closely. This is the acceleration or deceleration of inflation. This measurement can give you readings like "disinflation", or a slowing of the rate of inflation.

After taking these measurements, the Keynesians adjust the valves, meaning they print money at a slightly different rate. You see the Keynesians believe they can control the economy with one tool, the speed control of the printing press. It is kind of like trying to build a house with only a hammer.

Personally, I believe that this thing we pay so much attention to, this thing we call "inflation", is vastly more complex than any of the models even recognize. I believe it is unimaginably complex like Richard Maybury's ecology of biological organisms (PEOPLE).

But in an effort to follow Einstein's advice, here is my diagram:

While I believe that money and goods exert supply and demand pressure on each other, I believe that the much more important variable is the psychological state of the humans through which the money and goods pass. Human psychology provides the actual demand. Money and goods provide the supply. Human psychology provides the analysis of the supply and, in certain circumstances, fear drives the action.

But because I must compete with a few different (fairly well defined) definitions of inflation and deflation, I will make the bold statement that inflation and deflation are not what we should be worried about in our current situation. Instead, we should be watching to see if our currency is stable (behaving normally) or collapsing (behaving like all fiat currencies eventually do). In other words, is our currency simply having a mid-life crisis, or is it 96 years old and dying?

I think that right now we are in the midst of the Perfect Storm for a currency like the dollar, a purely symbolic fiat currency that has spread itself over the entire globe.

Look at the above diagram. The monetary base has literally exploded parabolically. The economy is contracting which is applying at best, second derivative downward pressure on the supply of goods, and at worst downright shortages are already in the pipeline. Meanwhile the state of global human psychology is very dollar-negative. The demand for necessary goods is high and growing. The fear of inflation is starting to come back. And only God knows how long it will be before the fear of starvation starts to spread.

I know many people who are stocking up on durable food-goods. So these Thoughts are circulating. The trend is established. The second derivative is showing acceleration and we are no where near reversal.

So forget about inflation versus deflation. Think instead about currency stability versus collapse.
Julian Robertson Bets the Farm on Inflation

Simply put, Julian Robertson is the definition of a hedge fund legend. And, his success is noted by the fortune he has amassed as he now graces the Forbes' billionaire list. He has pioneered a successful investment methodology, he has generated outstanding returns at his famous hedge fund Tiger Management, and his influence has sprouted some of the most successful modern day hedge funds in the form of the 'Tiger Cubs.' And, most importantly, he predicted the financial crisis two and a half years ago in an interview with Value Investor Insight. When he talks, you listen...

Julian Robertson is "betting the farm" on inflation. Billions!! Yet he avoids gold, saying, "I've never been particularly comfortable with gold as an investment. Once it's discovered none of it is used up, to the point where they take it out of cadavers' mouths. It's less a supply/demand situation and more a psychological one - better a psychiatrist to invest in gold than me." Adding, "Zinc would also seem to me to be a very good inflation hedge."

The point is that this exemplifies the danger of being right when you are watching the wrong thing. Jim Sinclair is exactly right...
[Julian] Robertson is right, so we are right, as the [interest] rates he looks for come compliments of a currency event that delivers hyperinflation. He just has to be sure the other side or sides of his OTC derivative puts up margin on a daily basis or he could be 100% right and not get paid one penny.

If you are cruising through this crisis with your wealth stored in financial products that derive their value from someone else's promise, or if you are "going to cash" as the deflationists recommend, then you might as well be flying through the Bermuda Triangle in a rickety old airplane, low on fuel, during the perfect storm. And actually, that is a poor analogy, because the dollar faces more dangers than that airplane.

This IS the perfect storm for the dollar. The trend is established. The second derivative is showing acceleration and we are no where near reversal. The Fed is still expanding the monetary base. This man is your pilot. He has mastered (Keynesian) ground school, but he has never flown through a storm like this. But don't worry, he has "theories" on how to make it through.

So do I.



Dave Eriqat said...

Consider too, that this game we play is almost obligatory. Imagine trying to exist without using the house “chips.” We are forced to play the game almost from the day we are born until after we die (our funeral must be paid for with house “chips”). Oh, and if we attempt to avoid using the house “chips” by bartering, guess what? The house comes along and demands a tax on the fair market value (expressed in house “chips,” of course) of what we bartered. Now that’s what I call a racket! Enforced with the barrel of a gun.

I hear all this talk of deflation, presumably meaning price deflation, yet I can’t seem to find it. With the exception of houses, stocks, and as someone astutely pointed out yesterday, wages, I don’t see deflation anywhere. Everything I buy seems to go up relentlessly. Frequently I see things I want to buy but don’t because I feel they are too expensive. I wish there was some price deflation going on because I’d love to take advantage of it.

I’m so glad you brought psychology into the discussion because I’ve come to believe it’s the most important factor in the valuation of everything. After all, what is value? It’s what human beings decide it is. And what governs the value human beings ascribe to things? Our minds, our psychology. I like to use this allegory to explain what I mean. Suppose you bring a man into a room. In the room is a table, and on the table is a cheeseburger and a bar of gold. Which is more valuable? Many would say the gold bar. But what if the man is starving and near death? Then the cheeseburger is more valuable. Yet if the man is sated and can walk out of the room with the bar of gold, then it is more valuable. In other words, the concept of “intrinsic value” is fallacious. Value is determined by human psychology alone and is ephemeral. That explains why a popular restaurant can suddenly go out of fashion. It explains how markets can remain levitated in the absence of fundamental supporting factors. And it explains how hyperinflation can occur, because all of a sudden the currency goes “out of fashion” and everyone wants to get rid of it, even if it’s irrational.

So when people try to dismiss the idea of hyperinflation, they usually do so from the aspect of fundamentals, ignoring the importance of human psychology.

Dave - Erstwhile Urban Wanderer

Shanti said...

Indeed enlighted piece with the psychology attached to it.

Remind me of the METATRON'S CUBE

Inside the small box where this monetairy infla- deflation phenomen circles around.

So here with this piece you come out of the small box and wider your view, so more the fundamental points are becomming clear and interconnected into a model.

The quotes on the end of ASMIT Goswami are i.m.h.o Clear as cristal.

Back to to the confidence in the monetary base where it is all aboud, and hope it can be afloat some longer.....

Matt C said...


I agree about psychology, but who's?
How to weight the America vs rest of
globe? We are like the cukhold I'm
afraid, always last to know...

Siege said...


Your model is a nice improvement on basic theories too many subscribe to. I'm interested to see how (and if) purchasing power parity would fit in. I think hyperinflation is held at bay by a belief that US dollars buy X, when in reality the volumes held by foreign debt holders never can. I don't mean to hijack your thread; I've been considering your model and how purchasing power partity fits into it, and I've drawn some strong conclusions.

Right now, the strength of the US dollar is a concern for China and other developing nations; they don't want to invest in a dollar that will be worth less in the future, or a bond paying less than inflation and so forth. What they may not realize is how significantly the value of these dollars is overstated today.

To measure the actual value of the USD, compare the price of two like baskets of goods, one produced by the US and one produced by the developing nation. Price the developing nation basket in local currency and the US basket in US currency. The two currency amounts are equal, regardless what exchange rates would imply.

This exercise shows how overvalued 1st world currencies are. Eventually, China and other developing nations must realize this, exposing a fallacy of 1st world money. Purchasing power parity must become known. When this reality is clear, creditor nations can simply look at what their US dollar holdings will buy compared to their local currency and they'll see how little US value is really in their hands. This would start an endgame where the low value asset (USD) is traded for goods of higher value. Hyperinflation would destroy their ability to exit before the system collapses, so they would rightfully fear it, but it would result from panic during exit strategies, it wouldn't be the reason behind the exit.

I hope the above element can be of use in your model; we're all trying to get a sense of the forces at play so we can determine timing and minimize uncertainty. I have given some thought to how I would respond if I were a 2nd world creditor nation. If my thoughts are accurate, this might provide an understanding of how events will unfold.

A creditor nation at risk might:
1. Exchange 1st world currency for tangibles and transport them to its own soil (metals, oil, durable inputs)
2. Take on minimal new 1st world debt, while maintaining an outwardly supportive appearance
3. Ensure infrastructure and currency can withstand the collapse
4. Invite future trade partners into a meeting to discuss the analysis, helping them remain viable, and kicking off a trade network... ensuring a market for its goods. June 16th might be a good date for such a meeting.
5. Help future trading partners execute their strategy
6. Continue the strategy until 1st world nations collapse of their own devices

Siege said...

This last point is a major one... as a 2nd world creditor nation, I'd not cause a collapse. I'd try to support the 1st world (with words and actions and very little money) while I extracted every drop of value I could from USD holdings and minimized my losses. I doubt any creditor nation will intentionally cause a collapse as it limits the value received in recovery. Assuming other 2nd world nations also realize the risk of bailing too rapidly, this means a 1st world descent at a velocity determined by the failing nation.

As a side-note, selling to 2nd world nations would mean providing goods of moderate quality. Price sensitivity of emerging markets is much greater than that of developed nations, at least until said nations reset their standards. This emphsizes that it's the 2nd world that will meet 2nd world demand, not the 1st world. The US and developed nations are incorrectly positioned... the price/value matrix of 1st world manufacturing doesn't fit a 2nd world market.

Hyperinflation? You bet! Without a source of fresh capital, debt reliant gubermints would be forced to balance their books or print currency faster.

I've been trying to figure out where this fits into your model, as you have captured elements that explain a closed model well. I'm not sure how the linkage works... I think what I've stumbled upon is a flaw in the global currency model exploited by the US. I'll post again if new thoughts on how this fits together enter my mind. In the interim, I'm interested to see your perspective on if and how this might fit. Hyperinflation is a hard beast to nail down. I do think the risks of it are excasserbated by the apparent over-valuation of the USD that's already in the system.

FOFOA said...

Hello Siege,

You phrase your 2nd world exit strategy as a hypothetical one, but it sounds eerily like a description of what is actually happening right now.

I think our currency collapse will be a purely psychological event given the proper setup (which is already in place). Hyperinflation will be exacerbated by the government's knee-jerk reaction.

Just like musical chairs. When the music stops.... The big question is who will pull the plug on the 8-Track that has been running since 1971? Or will it just overheat and die on its own?

The doubters point to the structure of the USDX and the problems with other currencies. But none have the big problem the dollar does! Most WILL go down with the ship though. In a global paper fire, all paper burns.

The USDX started in 1973 with a value of 100. Today it is 81. So the dollar has declined in value 19% since 1973?? Do you see what I am getting at? The metrics we rely on lie. The world needs a metric that DOESN'T lie.


myself said...

I agree with all of you. I believe, like you,that U.S. creditors would not tip the cart for fear of losing the value of their dollar holdings. But, we can't lose sight of the FOREX. There are a lot of players there who could, cumulatively cause the appearance of an exodus. I believe that the FOREX trades $ 3 trillion a day.
Also, there are some indications that COMEX and other PM markets are soon to run out of physical metal to satisfy delivery. The Germans took their gold out of the U.S. The arabs took their gold out of London. COMEX could soon get caught naked. It recently happened to deutches bank and had to be covered on an emergency basis by GB.

There are other outside pressures that could derail the dollar besides the major dollar holders. A shock from COMEX or FOREX could cause big problems. As you pointed out, psychology plays a big part.

Christian Pickett said...

i like a few of the concepts/perspectives you touch on in the article but i think you got one IMPORTANT THING WRONG...

First thou.. i like how you say the only thing hyperinflation has in common with inflation is the wording "inflation"......

Second seeing things in terms of stable currency/collapse is also a simply yet needed IMO way of looking at things.......remind ourselves that a stable currency will also have it's up and downs..

However...The fed IS NOT DOUBLING the Money Supply.......look at Currency in Circulation...also look at MZM....from the fed chart...the first is up 15%(currency in circ) in the period you say they are "doubling"

the MZM

The Monetary Base charts are distorted and not representitive of uncle ben phsyically printing tangible notes ...but dont' take it from me take it from somone much SMARTER...John Mauldin (linked by Ritholtz)

in addition the monetary base chart and the adjusted monetary base chart are not representitive of money printing in THIS situ...because things like a substantial amount of interest being paid to banks to keep excess reserves at the fed may be included in the monetary base calculation...(considering the uptake in Mon..Base co-incides with the fed offering to pay interest on excess reserves kept at fed) where as this capital was usually involved in other (more risky) overnite transactions between banks before the fed announcement of paying interest...
i.e risk free money

please respond....since this is imporant....

Christian said...

(in addition to the other points i made in last comment)......there was something else i would like to mention...i beleive commercial banks excess reserves (kept at the fed).....are included in the monetary base we know.. A large number of banks in the 3'rd Q of 2008 applied to become commercial banks.....which could be a additional reason for the uptick in monetary base shortly thereafter (in additon to the fed paying intrest in excess reserves) which also gives banks reasons to move capital from more risky positions to collecting free money).

FOFOA said...

Hello Christian,

Thank you for your comments. I always respond to well considered comments and questions. Your's are definitely well considered!

This particular discussion topic can explode out of control like the Zimbabwe money supply if we are not careful. So I have distilled your comments down to three points which I will respond to...

1.) That MZM shows no doubling of the money supply.
2.) That I should use MZM instead of the Monetary Base, mainly because...
3.) the doubling of the Monetary Base is not because the Fed is printing money, but because of incentives to banks to increase their reserves.

Hopefully these three points encapsulate your Thoughts. Here are mine...

1.) You are correct, the MZM measurement has not doubled.

2.) Monetary Base versus MZM - There are many different measurements of "the money supply". There are the old standards, M1, M2, etc..., the newer MZM, the Austrian TMS, Mish's M Prime, etc... The point of all these measurements is the great quest to find the best correlation to "inflation".

But this is not what I am looking for. I am trying to determine what matters most to a "currency collapse" or to hyperinflation.

What I am looking at is physical cash plus the only physical cash equivalent, reserves held by the Fed.

Through fractional reserve banking, the banks are performing a gigantic juggling act. Any transaction you make with a bank must be balanced with an opposite transaction somewhere else. Every day your bank clears its internal transactions, then it clears the transactions with other banks. This clearing mechanism ends with the reserves held at the Fed and ultimately, inter-bank imbalances are settled by transferring those reserves from one bank to another (usually just a bookkeeping notation).

The only "real money reserves" the banks hold other than those stored at the Fed is the physical cash they have on hand. The reserves at the Fed are the ONLY exact equivalent of physical cash because ONLY the Fed can print new cash to cover those reserves in the case of a bank run.

ALL other money is the mere PERCEPTION of money because it is held in a variety of very liquid ASSETS which is the way the banking system performs it's gigantic juggling act. It is a game of constantly clearing the outgoing with the incoming. But ultimately, any imbalance must be settled with either physical cash on hand, or a transfer of reserves held at the Fed.

The big problem with bank runs and hyperinflation is that the LIQUIDITY of all those near-cash assets starts to disappear, and the only thing that matters is the real cash (and the reserves held at the Fed, which are ultimately backed not by gold, but by the Fed's physical printing press).

Incidentally, I did read that piece by John Mauldin back in December. I get his newsletter from a friend.


FOFOA said...


John is very much on our topic in that piece, but he is talking about one thing (currency collapse vs. stability) and looking at something else (MZM, a measurement with a correlation to inflation).

Here is a good (short) critique of the MZM measurement by Frank Shostak of the Mises Institute:

"The problem of double counting is also not resolved by the money of zero maturity definition of money (MZM)—a relatively recent money supply definition. The essence of MZM is that it encompasses financial assets with zero maturity. Assets included in MZM are redeemable at par on demand. In short, MZM includes all types of financial instruments that can be easily converted into money without penalty or risk of capital loss. This is precisely what is wrong with this definition, since it doesn't identify money but rather various assets that can be easily converted into money. In short, it doesn't tell us what money actually is and where money is located, which is what a definition of money is supposed to do."

3.) Is the Fed actually "printing" this money? - The Fed DID do something absolutely astonishing. It started buying complete junk from the banks at face value. Lots and lots of it.

The reason the Fed did this was to "add liquidity" to the system. That "junk" the banks were using as reserves for their balancing act was losing value faster than the banks could sell it. The only buyer left was the Fed.

Yes, the Fed gave the banks an incentive to keep this newfound liquidity within the Fed vaults, but that doesn't change the fact that it actually IS new reserves.

Yes, the Fed says that later it will sell this JUNK back to the banks to remove the liquidity. This will never happen unless we have a full recovery back to the 2006 status quo. Not happening.

Perhaps in Ben Bernanke's theoretical world this is the perfect scenario... a helicopter drop of cash without the risk of inflation! My point is that this is the PERFECT setup for HYPERINFLATION.

What puts the biggest strain on reserves... what the Fed is most worried about... is when real money LEAVES THE BANKING SYSTEM. This makes the bank juggling act impossible. Taking the balls away from the juggler!

This is caused by fear. The fear of illiquidity in the assets the banks use for their near-cash juggling act. Ben Bernanke has PROVEN that he is prepared, ready and willing to deal with this. Just like Gideon Gono!

If the Chinese (or ANYONE for that matter) starts a run on the US dollar, Ben is going to have to frantically start turning those reserves into physical cash. It would take him YEARS to do that. And he knows this. He'll have to start printing HIGHER DENOMINATION bills in order to cover the demand. On top of that, he'll have to keep funding the federal government!

Ben has a tough road ahead.

So do we.


FOFOA said...

One more Thought....

If gold passes $1000 permanently, OR... if COMEX implodes and physical pricing takes over, this will remove MASSIVE amounts of real cash from the banking system. This is what they fear.


FOFOA said...

True or False: U.S. Economic Stats Lie

"If Williams is right, unemployment is over 20%, gross domestic product is shrinking by 8% and consumer prices are jumping by nearly 7%. His forecasts border on apocalyptic. The government is creating so much new money, he says, that the all but inevitable result is hyperinflation, where "your highest denomination, the $100 bill, becomes worth more as toilet paper than money." Buy physical gold, he advises..."

Jimmpy said...

Hello FOFOA,

Maybe, another dot to add to your collection.

Just trying to help

FOFOA said...

Thanks Jimmpy!

This is the third time I've seen this story pop up on the radar. 3 times usually means "pay attention".

The story gets deeper each time. Something strange is going on.

This guy has an unusually large portion (50%?) of a US$7bn fortune tied up in one bank? HSBC? Takes a loss of roughly half of that investment? Then decides to exit his position? Then has his accounts frozen?

Something doesn't add up. Could be a dot. Keep an eye on this one.


Siege said...


Ever had one of those 'oh shite' moments when you realize just how quickly the lies of gubbermint could unravel? Take a look at this chart Denninger found...

FOFOA said...


Eerie timing you have.

I was just reading Martijn's quotes from an article asking why Obama isn't doing the right thing? (they are at the bottom of the previous post's comments).

I was just thinking about how the entire system right now is built on lies, and how truth is like Kryptonite to such a system. So Obama is being advised to keep piling on the lies and the media is going along with the program.

I assume their hope is that the sheeple WANT lies. And that enough lies will ultimately change reality.

The alternative is that the advisors are participants in a scorched earth personal retreat strategy.

Either way, things are not looking good for the "gubbermint". The Potemkin village is crumbling.


FOFOA said...

Must see video.

Jim Grant of Grant's Interest Rate Observer compares Ben Bernanke to Gideon Gono on CNBC!

Andrew said...

I'm not sure I really understand your disagreement with the Austrian definition of inflation/deflation. The definition, at least as I take it, is talking about strictly the money supply.

If the money supply is expanded, an Austrian will call this inflation. If it's contracted, he'll call it deflation. You can, i.e., have inflation of the money supply while not necessarily experiencing a decrease in money value (because of the other forces you allude to), and I think Joe-Austrian would surely agree with this.

But regardless of the net effect, it's of course accurate to say there was an expansion of the money supply. And I think that's all the Austrian definition is referring to-- it doesn't *attempt* to explain the many dynamic forces at play. It's just talking about one particular force, and defining each direction.

The relevance is to define movements in the money supply, rather than to necessarily explain movements in the real economy. So it's intended to be narrow. (Some people like to lump this all together when they refer to "inflation" and "deflation", because then it's convoluted to know if you're talking about, i.e., people creating money or some other force that lowers the value of money. But this doesn't mean that defining movements in the money supply needs to be complicated.)

FOFOA said...

Hello Andrew,


You are correct. I guess I didn't throw out enough disclaimers like "no offense to the Austrians", "I count myself as one", etc...

The Austrians have the best and most concise definition of inflation. In fact, I agree that it is the true definition of inflation. But this fact alone confuses the whole discussion unless you are in a room full of Austrian economists.

The way inflation is discussed in the modern lexicon is with regard to its impact. I am talking about the inflation/deflation debate that has been raging for most of a year now. And I have read many comments where "Austrians" pipe in on the debate in disagreement. To someone who understands what they are actually saying this is frustrating to observe.

This is part of the reason I have shifted my focus away from the question of deflation versus inflation. Instead, I think that what matters right now is "is our currency stable or collapsing?" Stability can be inclusive of both deflation and inflation. Collapse always ends in hyperinflation.

From a definitional perspective, you can't really criticize any of those charts I made. If everyone accepts the given definition of a word, then a discussion is possible. My point is that the discussion will be irrelevant to our current predicament unless the model being discussed addresses the massive complexity present in the system.

Another issue in the discussion of the [Austrian] understanding of inflation is the accepted definition of the money supply. Among Austrians this is generally the TMS formulated by Murray Rothbard. TMS is a fine calculation when your goal is to correlate money supply growth with consumer price inflation. But it still includes close substitutes for money, like Total Checkable Deposits, Savings Deposits, U.S. Government Demand Deposits and Note Balances, Demand Deposits Due to Foreign Commercial Banks, and Demand Deposits Due to Foreign Official Institutions.

All of these kinds of deposits exert pressure on the actual monetary base whenever they are moved. And the TMS does not include the most important part of the monetary base that has been exploded by Ben Bernanke, reserves held at the Fed.

My argument is that the whole system is based on cold hard cash, or its ONLY equivalent, reserves held at the Fed. Only the reserves at the Fed can be counted as cash because the Fed is the ONLY bank in the world that can turn them into cash. All those deposits counted in the Austrian TMS when moved must be either countered by opposing book entries or balanced out by a bank's sale or purchase of assets. Any imbalance at "the end of the day" must be settled by either the physical moving of cash or a book entry at the Fed.


FOFOA said...

...Cash (and reserves held at the Fed) have become the reserves of the system ever since gold stopped being the reserve. My argument is that the Fed has dramatically increased those reserves. This is the beginning of Weimarization. Everything else (that is normally used to correlate inflation to CPI price inflation) is simply liquid assets. But the problem with this view is that in a collapse, the liquidity collapses.

This collapse of liquidity (or the fear of it) causes a run on the banks, which is possible today in many more ways than it was in 1933. This is what the Fed fears MOST. And this is why the Fed has done what it has done with the monetary base.

The Fed's argument is that this is a precautionary measure that will be withdrawn once the threat is gone. My argument is that this "precautionary measure" is the same thing as, let's say Zimbabwe printing up a bunch of new "Quadrillion notes" and holding them in the vault. And then saying, "we aren't really going to use them, they are just in case.... in a few months we'll burn them". Would you believe them?

So, Andrew, I hope you can see why the simple definition of inflation does not really apply to our current predicament. It is hopelessly bound by the argument over what is the true money supply. And it is hopelessly limited by the widespread misunderstanding of the word "inflation".

On the other hand, the word "collapse" seems to be widely agreed upon. And the word "hyperinflation", (even though its probability is heavily disputed) is pretty clearly defined by pictures like this.

It was my goal in this post to reshape my own thought process around the current predicament. Not to insult the longstanding Austrian definition of inflation. That definition clearly has important uses. Perhaps it is just a little too simplistic for a wide discussion of what we face today.


Andrew said...

Ya, I know you think similarly and didn't figure you were trying to poopoo the Austrian school. Thanks for taking the time to respond, interesting to read.

Is it the Austrian explanation itself you find limiting, or rather the mindset of certain people? For example, the weather is complex. If someone looks at a thermometer and sees that it's 78 degrees and then takes this to believe he has a complete picture of the day's weather, he would have a limited view. But the measurement of degrees farenheit is still entirely accurate and entirely helpful if used the right way.

And isn't the fact that it's hard to know the true money supply a boundary to all explanations/discussions? It's just a natural barrier, right? (Like for example, it could be difficult to determine if an assault occurred and to what degree and exactly who was guilty, but an accurate conceptualization of "assault" does not depend on being able to sort out the information.)

So I definitely see why the Austrian definition isn't very useful to you-- you're interested in a very detailed take on the unwinding process. (And like you said, any definition is fine once it's clear what you're referring to, so I can certainly understand why you might bow to what's more practical.) But I don't agree that the Austrian definition is itself limited-- I think it's just *not relevant* to much of what you're getting into.

(I would actually say that the other definitions are limiting, in the sense that they are a prerequisite for the current arrangement. I doubt a situation like we have today evolves when people don't have such a muddy conceptualization of the money supply. And then it becomes hard to sort out all the corruption and lack of information, etc. and so on. So I think in principle the Austrian explanation is for sure the most conventional. It just can't possibly explain the short-term movements of madness, because it seeks to prevent madness.)

Thanks for the welcome! (That was actually my 2nd post though, fwiw!)

FOFOA said...


"Not relevant" is correct. "Simple" is also correct. "Limiting", to my discussion, yes.

"Is it the Austrian explanation itself you find limiting, or rather the mindset of certain people?"

It is both. I was trying to follow Einstein's advice: "everything should be made as simple as possible, but no simpler." And in order to do so I had to break free of the limitations.

"And isn't the fact that it's hard to know the true money supply a boundary to all explanations/discussions?"

It is hard to know (or to trust) the size of the true money supply. But it is not hard to apply a definition in order to discuss a theoretical correlation to a collapse of the currency. My definition is simple. It is physical cash plus digital credits stored on the computer of the only guy who can print physical cash. I would also include the vast amount of counterfeit super-notes that are circulating and accepted by banks so as not to create a scandal/panic. But that is another story, and only adds fuel to the fire.


Andrew said...

Well, on a semantical level I don't really agree that "limiting" and "not relevant" both work, since if it isn't relevant it would just be ignored (and not used in any capacity).

I think the distinction is important, because "limiting" might suggest that shedding light on what you're getting into (analyzing the fall) is what Austrian theory is intended for, when rather it's concerned with how to prevent the instability.

But nitting aside I definitely see where you were going now, so thanks again for the response, and keep up the good work with the blog.

Anonymous said...

It seems like the income of the entire country has dropped like a stone and continues to fall. Demonstrated by the 20% increase in welfare payments last month.

While the money supply is expanding, the purchasing power of the market has reduced, thus the diagrams are hard to match against the real situation - because although the prices of consumables remain stable, people can afford less.

Off topic - can anyone tell me how to find out if the gov has started to sell it's weapons of mass destruction? That seems the only asset left to sell to foreign powers as collateral....

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