Thursday, August 18, 2011

Schooling Rick Perry on the Money Supply (2)

As we saw in the previous blog instalment, money is not some fixed or immutable entity, say like CO2, for which we know the chemical bonds identifying it always occur the same way, with the same valence and atomic electron configurations. And this arises because it is largely a matter of judgment, especially as the real money supply includes different components (e.g. M1, M2, M3) that embody differing definitions based on varied measures and degrees of liquidity. Thus, to get fired up about the "Fed printing money" is meaningless, pseudo-populist ranting unless one clarifies the context!

In addition, no one really knows or can say with absolute, uncontested authority how much money (say M1, or M2)there ought to be! Perry's transgression was in not only uttering a bald statement in which the context of "printing" money was ambiguous, but also making it with such bravado and certainty that HE knows what the definite amount printed needs to be. Why else make such a huge "treasonous" kerfuffle about the Fed printing money (and Ben Bernanke in particular)?

To clarify, one would think in the first instance that we need to have in circulation enough money so that we can purchase- at the current prices - any good or service the economy is able to produce. Hence, theoretically, the supply of money would affect the spending rate and the more money the more people spend. This leads to inflation if too many dollars are chasing too few goods and services. But this isn't the problem currently. The problem is that most goods and services are unaffordable to under-employed and unemployed Americans still digging out of a mountain of debt. Thus, no one can aver the money supply is "too great" right now, so the Fed can't be "printing money".

Next thing: Yes, we need a money supply large enough to generate the right amount of spending (especially now with low aggregate demand) but money supply by itself won't majorly alter the spending rate or propensity. That only applies if all other things are equal and they aren't. For example, in an economic climate rife with low wages, or cut pensions and benefits like health care (or worse, soon to be coming slices in once ensured benefits - such as to Medicare and Social security) it won't matter a jot what the REAL money supply is in toto (M1 + M2 + M3,) if people's spending confidence is low because they foresee hard times on their pocketbooks.

So in that condition, even with putatively more money in the supply there is less money spent by the average citizen, who is in the majority. So where is all the money if there's so much money supply? It is in the hands of private corporations ($2.5 trillion now) and the wealthiest (the 1% who control 65% of the wealth). This is also reflected in the most used barometer for income inequality: the Gini coefficient, which currently shows the U.S. is one of the most unequal societies in the world.

(Aside: In terms of practical applications, a Gini index of zero would denote perfect equality. In terms of western industrial nations, most developed European nations and Canada tend to have Gini indices between 24 and 36, the United States' and Mexico's Gini indices are both above 40, indicating that the United States and Mexico have greater inequality..In the whole panoply of criteria, and the full spectrum of research, the Gini coefficient (the prime indicator of income inequality) is the key factor. If the austerity measures proposed for deficit reduction are enacted, specifically targeting Medicaid and Medicare - and possibly Social Security by altering its COLA- the U.S. Gini coefficent will increase to more than 50.)

Now, moving on, currency like dollar and hundred dollar bills, is manufactured in money "factories" (e.g. The Bureau of Engraving and Print) under the auspices and direction of the Federal Reserve. It is then shipped under heavy armed guard to the Dept. of the Treasury and the Federal Reserve for further distribution (i.e., to the main banks in Federal Reserve districts and around the country). On average, the Fed brokers into the economy about $65 billion a year which is then placed into potential circulation. This is actualized when people or businesses cash checks at local banks.

Note here that the Fed is not particularly concerned with the fraction of the money supply that is in one form or the other (hence, they wouldn't necessarily be half crazed to print currency) but rather the total of demand deposits plus currency. In this regard they're especially vested in knowing each bank's cash reserves vs. demand deposits held. Thus, a bank with too low a ratio - say $20 in deposits to each $1 in cash reserves, is in danger of failure. Many banks reached this parlous stage during the financial meltdown in 2007-08 because they used depositors' money to make speculative bets in the credit defaults derivatives markets. This is why many went under.

Many of us (on the Left) believe the door was opened for this nonsense after the Depression-era Glass-Steagall law was repealed in 1999, thereby dissolving the barriers that had previously existed between investment and commercial banks. After that ill-fated move, any commercial bank was able to speculate with depositors' funds and they did - mainly in the realm of the subprime mortgages. (For which credit default swaps bets were made on their mass failure, e.g. by Goldman-Sachs. Others who placed bets and lost, like many commercial banks, needed the TARP program to escape failure.)

Now rather than "printing money", according to Rick Perry's cartoon version of reality, it is actually through the Fed's bank reserves' policies that it influences banks lending and investing and thereby the money supply. Hence, as opposed to literally "printing money" the Fed manipulates the reserves of the banking system and the number of checking accounts they can support. This is only done within prescribed limits already established by Congress, so it is preposterous the Fed is doing anything at any president's behest. Just doesn't work so!

Thus, for any bank or bank system the Fed can specify a reserve requirement percentage, say 12%. This means the bank must have at least 12% of its total holdings or assets in cash reserves. Any lowering of the reserve requirement %, say from 12% to 9% instantly increases banks' excess reserves, which enables banks to purchase more securities as well as expand deposits.

Another tactic entails making specific facilities available for discounting. Usually in this scenario a member bank in the Federal Reserve district (say New York) can temporarily borrow money from the Federal Reserve Bank of New York. But...the ability to borrow such reserves, means the money supply remains unchanged! Hence, it can be seen the first principle of the Fed is money supply stability, as opposed to just wildly churning out excess currency as Perry has implied.

Lastly, the Fed can use moves such as it did with its Quantitative Easing 1 and 2, to essentially make a preponderance of "cheap money" available. In these cases, the Fed bought government securities (mainly short term treasurys) thereby enlarging bank reserves. In the last round (QE2) some $600 billion were purchased, but the effect was to send treasury yields lower, as well as the value of the dollar (vs. major currencies like the euro and yen). This, combined with the Fed's low interest rates have created what many believe is the basis for a new stock bubble. We know, for one thing, Wall Street usually loves cheap money, and in addition, always expects more ordinary folks flooding into stocks to chase yield when the interest rates are so low.

THIS was the problem I have mainly had with the Fed and which is a logical one to hold and express, as opposed to simply ranting like a nut about Ben Bernanke "printing money". (And note: "printing money" is not even a very good verbal synopsis of the QE1, QE2 processes, but more like a lazy reduction that too many will take literally - like "Jonah living inside the belly of a whale"!)

The tragedy of the Perry anti-Bernanke and anti-Fed remarks is they may lead many of the less perceptive in our populace to come away with the belief that actual monetary policy (e.g. of the Fed) directly affects people's wealth and influences their spending as opposed to the nation's fiscal policy (in taxes, dealing with budget deficits etc.) But as I showed earlier this simply isn't so. Even if the Fed were really printing money at the rate of $100b a month it wouldn't make much difference in the demand- poor fiscal environment we have today. Which will soon get much worse if austerity spending cuts are imposed on the most vulnerable people while massive military spending is left off the table.

The harsh truth is that any expansion of the money supply - whether by actual literal printing, or via the manipulations I described above - cannot increase national wealth directly. It can't do so because the public gives up assets as part of the very process through which a money component (e.g. M1) rises. Thus, the public for the past ten years - because it's made no fuss over receiving yearly Bush tax cuts (even in a high deficit environment) will have soon given up "assets" translated into their Medicare, Social Security and other benefits. Since no one bothered to explain this to them, they deludedly thought they were getting "free money" (as they do now, via not having to pay payroll taxes on S.S., Medicare) not understanding that those taxes help to PAY FOR Medicare, Social Security!

When politicians stop playing political games with our citizens, maybe they will become more intelligent, and begin to understand they can't have their economic cake and eat it too - say like having extended yearly tax cuts in a deficit environment while preserving Social Security and Medicare from future cuts.

Maybe they will also begin to vote more in ther own self interest, as opposed to playing into a charlatan's hands...or a drawling snake oil salesman's. ...Listening, Mr. Perry?

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