federalreserve


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The federal debt has gone from astounding to unbelievable to incomprehensible, a new problem has emerged: The US government is actually running out of places to borrow.

How Many Zeros Are in a Trillion?

The $20 trillion debt is already twice the annual revenues collected by all the world’s governments combined. Counting unfunded liabilities, which include promised Social Security, Medicare, and government pension payments that Washington will not have the money to pay, the federal government actually owes somewhere between $100 trillion and $200 trillion. The numbers are so ridiculously large that even the uncertainty in the figures exceeds the annual economic output of the entire planet.

Since 2000, the federal debt has grown at an average annual rate of 8.2%, doubling from $10 trillion to $20 trillion in the past eight years alone. Who loaned the government this money? Four groups: foreigners, Americans, the Federal Reserve, and government trust funds. But over the past decade, three of these groups have cut back significantly on their lending.

Foreign investors have slowed the growth in their lending from over 20% per year in the early 2000s to less than 3% per year today. Excluding the Great Recession years, American investors have been cutting back on how much they lend the federal government by an average of 2% each year.

The Fed is the only game left in town.

Social Security, though, presents an even bigger problem. The federal government borrowed all the Social Security surpluses of the past 80 years. But starting this year, and continuing either forever or until Congress overhauls the program (which may be the same thing), Social Security will only generate deficits. Not only is the government no longer able to borrow from Social Security, it will have to start paying back what it owes – assuming the government plans on making good on its obligations.

With federal borrowing growing at more than 6% per year, with foreign and American investors becoming more reluctant to lend, and with the Social Security trust fund drying up, the Fed is the only game left in town. Since 2001, the Fed has increased its lending to the federal government by over 11% each year, on average. Expect that trend to continue.

Inflation to Make You Cry

For decades, often in word but always in deed, politicians have told voters that government debt didn’t matter. We, and many economists, disagree. Yet even if the politicians were right, the absence of available creditors would be an insurmountable problem—were it not for the Federal Reserve. But when the Federal Reserve acts as the lender of last resort, unpleasant realities follow. Because, as everyone should be keenly aware, the Fed simply prints the money it loans.

A century of arguing about how much to increase spending has left us with a debt that dwarfs the annual economic output of the planet.

A Fed loan devalues every dollar already in circulation, from those in people’s savings accounts to those in their pockets. The result is inflation, which is, in essence, a tax on frugal savers to fund a spendthrift government.

Since the end of World War II, inflation in the US has averaged less than 4% per year. When the Fed starts printing money in earnest because the government can’t obtain loans elsewhere, inflation will rise dramatically. How far is difficult to say, but we have some recent examples of countries that tried to finance runaway government spending by printing money.

From 1975 to 1990, the Greek people suffered 15% annual inflation as their government printed money to finance stimulus spending. Following the breakup of the Soviet Union in the 1990s, Russia printed money to keep its government running. The result was five years over which inflation averaged 750%. Today, Venezuela’s government prints money to pay its bills, causing 200% inflation which the International Monetary Fund expects to skyrocket to 1,600% this year.

For nearly a century, politicians have treated deficit spending as a magic wand. In a recession? We need jobs, so government must spend more money! In an expansion? There’s more tax revenue, so government can spend more money! Always and everywhere, politicians argued only about how much to increase spending, never whether to increase spending. A century of this has left us with a debt so large that it dwarfs the annual economic output of the planet. And now we are coming to the point at which there will be no one left from whom to borrow. When creditors finally disappear completely, all that will remain is a reckoning.

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WASHINGTON — Let’s face it — Donald Trump is smarter than he looks.

For all the personality flaws the press loves to dwell on, the presumptive Republican nominee understands more about real world finance than all the deficit hawk politicians in both parties put together.

As he clarified his remarks about consolidating U.S. debt by buying back bonds at a discount when interest rates rise, he was setting the record straight on those who thought he meant to renege on the debt and effectively default.

Not at all, Trump said last week. And then he dropped another bombshell in explaining why that’s not even possible.

“This is the United States government,” Trump said on CNN. “First of all, you never have to default because you print the money, I hate to tell you, OK?”

Bingo. With a stroke, Trump demolished decades of homage by many economists and virtually all politicians to the straitjacket of a monetarist dogma that ignores the realities of present-day finance.

In fact, intentionally or not, Trump embraced a radical view of money and debt advanced by economists like James Galbraith, professor at the University of Texas and son of the legendary economist and presidential adviser John Kenneth Galbraith.

That view, known as modern monetary theory (MMT), holds that governments that control their own currency can print money without risk of inflation unless full employment creates excess demand because it is no longer tied to gold or some other measure of value.

“This is a Nixon-goes-to-China moment,” Randy Wray, a leading MMT exponent atBard College in New York, told Bloomberg, hailing Trump as “a Republican far to the left of the Democratic party apparatus who wants to promote rising living standards of Americans.” (President Nixon’s 1972 trip to China represented a major breakthrough in relations because of his past as a fervent anti-Communist crusader.)

Along with all his controversial views on immigration, terrorism, and trade, Trump is bringing a new perspective to public finance and to financial regulation based on his first-hand experience of dealing with real financial issues around the world.

 

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I haven’t had much time to write about economic theory in a couple of years, but this snippet is worth a response.

“People work in order to convert their time into a unit of account,” he said. “We call that money, and it’s an invention that allows us to store time.” Most people have stored little or none. So when they receive money, they quickly purchase necessities; food, shelter, health care. “People who are able to save money inevitably purchase real estate, stocks, bonds – all of which are alternative vehicles for storing time.” One share of Google stores 30 hours of work for the average American, or 30 minutes of copying-and-pasting formation documents for the average hedge fund attorney. “Bill Gates has stored enough time to fund a 1bln person army for 20 years.”

As the gulf between people’s income has grown, the amount of stored time has accumulated in fewer hands. “Wealthy people convert their hours into financial assets so that they can accumulate excess hours relative to their fellow man. But the average worker is simply thinking how to exchange hours for dollars and then exchange those for food.” Central banks face a different problem altogether. They need to get people who’ve saved time to exchange it for something other than clever inventions that store it. They’ve largely failed. So now, everything that stores time is extremely expensive and offers little or negative return, while the pace of economic activity slows. “The problem that we face now is that there is simply too much time that’s been saved. Another way of saying it is that there’s too much capital in the world, in too few hands.”

To restart the system, capital needs to exchange hands or be destroyed, spurring people to rebuild their store of time, rather than just save it. “It is an elemental truth that at some point, through inflation, war, or confiscation and redistribution, this imbalance will correct, and the system will then restart.”

The quote addresses ‘time preferences’. It addresses the choices available to any individual who is involved in an exchange of property rights. This is only addressed tangentially. Property rights are exchanged and stored as ‘money’. This rather begs the question, what exactly is money?

An individual can: [i] exchange money directly, [ii] hold money as cash, [iii] save [invest] money. These are all time preferences.

Investing requires free market interest rates. We do not currently have these as the Central Banks around to world seek to hold nominal interest rates low. There is still however the ‘natural rate of interest’.

In paragraph three, the author asserts that capital needs to be destroyed or change hands. Capital will likely be destroyed, but these are mal-investments.

Mal-investments  are predicated by artificially low nominal interest rates, which, we currently have and have had for quite some time, since the late 1980’s when Greenspan took over the Fed Chair.

Currently we are reaching the end game of artificial rates.

Of course should ZIRP/NIRP end, all business that exists because of these artificial rates, the mal-investments, will likely collapse, which is the destruction of capital that the author refers to.

This would almost certainly lead to a major bear market, which is the bear case. We saw a taste of it in 2008. The unemployment shot through the roof. There are not many ‘depression proof’ industries, the pain is felt everywhere.

Currently, the next internet/housing bubble is most apparent in social media, which relies on advertising revenue for almost 100% of its revenues. This is a problem and is a major destination of current mal-investments.

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In a new interview with King World News, Cashin warns that financial market conditions remain very risky. From the interview:

What I am saying is: They thought they were going to solve a desperate problem by desperate measures. I don’t believe it’s having the effect they wanted, and it’s building up a very, very dangerous situation. If that money were suddenly to get velocity, inflation could break out.

Conversely, by pushing on a string and not getting anything done, they may wind up being in a spot where, if the economy moves to stall-speed, we’ll get deflationary pressure. Yes, they’ve begun treating the patient with very, very drastic remedies, and my concern is: Is it ultimately damaging the body in a way that will bring back some of the horrors they tried to avoid?

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The Federal Reserve;

FED DOESN’T ACCEPT BLAME FOR LATEST EMERGING MARKET SELLOFF: In a section in its official report to Congress, the Fed accepts that talk of pulling back on its bond-buying program last summer triggered stress in emerging markets. But officials don’t accept that the latest round of selling is due to the Fed. “Rather, a few adverse development – including a weaker-than-expected reading on Chinese manufacturing, a devaluation of the Argentine peso, and Turkey’s intervention to support its currency-triggered renewed turbulence in emerging markets, the Fed said. In her testimony, Ms. Yellen said this doesn’t yet look like a threat to the U.S. economy. But the Fed warns in its report that a number of emerging markets, “harbor significant economic and financial vulnerabilities.” An index of vulnerability presented in this report (Page 29) highlights Turkey, Brazil, India, Indonesia and South Africa as among the most vulnerable.

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There’s always plenty of speculation about what the U.S. Federal Reserve will do next from every corner of the financial world, but, late on Wednesday, the result of Ben Bernanke’s final policy conclave in the Chair reminded markets that, first and foremost, the Fed is America’s central bank.

With not even a mention of the turmoil engulfing emerging markets from South Africa to Turkey and back again, the Open Market Committee stuck to the plan and announced another $10-billion-a-month hack at its asset-purchase program. This takes it down to a trifling $65 billion. What’s more the cut was agreed unanimously by the Open Markets Committee. No dissent.

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