It had to happen eventually. John Tamny has written a piece that I agree with completely, in this case on the globalization of the economy.
I wish he’d taken it one step farther and I wish that economists and, even more, politicians understood what has happened. The effects of economic policy do not stop at the water’s edge. We can stimulate the global economy but that doesn’t necessarily mean we’ll be stimulating the U. S. economy.
Here we go.
A closed system requires a common currency and laws. In the US, there is a common currency, and the Constitution’s Commerce Clause provides common laws for interstate trade.
Unsurprisingly, John Tamny displays his absolute lack of understanding about the existing monetary system, and this is the source of all his and others “Free Trade” nonsense.
Quoting Adam Smith is ‘Exhibit A’. Adam Smith and all of the classical economists based their theories and observations upon hard money. Hard money and credit-backed money are not the same, and on a macro-level, it is not possible to compare the results against each other.
For Adam Smith and the classical economists, money and currency were the same thing. Contrary to his philosophy, money is a store of value, and hence, it is wealth. Currency is the medium used to facilitate value-to-value transactions. The basis for his beliefs are rendered moot, but it gets better.
In a credit-backed monetary system, credit is functionally money. (NOTE: Credit is not debt.) Currency can be obtained through credit creation, and therefore, credit becomes a component of the actual money supply. The classical concept of money as a store of value and as currency is overturned. Currency becomes wealth, and since currency is created through credit, the credit creators will have the most wealth.
The rich get richer because they have more access to currency creation, and we can observe that the easier it becomes to create credit the richer the credit creators get.
The Gold Cover, Gold Window, S&L regulations, Glass-Steagall, and other sundry banking regulations were designed to restrict credit creation by commercial banks because they were able to create currency. Investment banks were able to create credit with substantially fewer regulations, but they were not able to create currency from this credit.
With hard money, credit can be ‘created from thin air’, but it cannot be converted into currency. In a hard money monetary system, fractional reserve lending is an independent function of a bank. Banknotes and cheques can be used as currency, but their value is tied to the solvency of the issuing institute. (A fractional reserve lending bank is actually insolvent, and it fails when its trust is lost.
In a hard money monetary system, a trade deficit is limited by the money supply. Importing goods decreases money supply, and exporting goods increases the money supply. A continuing trade deficit will eventually deplete the money supply.
(The Gold Cover and the Gold Window forced the US monetary system to function like a hard money system, but trade-deficit dollars could be used for trade between foreign countries.)
In a hard money system, the exporter’s trade-deficit money could be invested in the importer’s economy, but this is also possible in a credit-backed system. It allows the importing country’s workers to substitute debt for income, and this allows the reduction in the creation of specialized jobs.
Now, production. Increased production should result in increased goods and services, but especially in a financialized economy, increased production results in the lower cost of producing the goods and services. In a financialized economy, it is possible to increase profits by decreasing the goods and services created while lowering the costs.
In a hard money system, financial fractional reserve lending investments have a higher risk because the financial system cannot create money, but in a financialized economy, fractional reserve lending investments are less risky the financial system can create money. In the existing monetary-financial system, foreign investments will flow into financial goods and services.
(The investing is facilitated by the world banking system, and the trade-deficit money does not need to be directly invested.)
In a credit-backed monetary system, the trade-deficit money will can be used to increase the credit supply by investing in financial products, and the jobs created will be in the financial industry or industries dependent upon the financial industry. The jobs created will tend to require a physical presence. Any other jobs can be exported.
Mr. Tamny’s economic knowledge is firmly rooted in the hard money system economics, but he is applying them to a credit-backed monetary system. His attempt to separate money from wealth and transform it into currency ([…] Money is not wealth as much as it facilitates the exchange of wealth. […]) is nonsensical without hard money.
( He is right, but he is clueless about the reason. Hard money in government defined denominations is not a wholly hard money system. The value of an ounce of gold is determined by market pricing, and it is not necessarily equal to the government defined denomination. In a fully hard money system, money is wealth because it has a market value. In a quasi-hard money system, money is mostly wealth.)
As usual, he has no explanation for the lack of positive “Free Trade” results, but like Medieval scholars, he attempts to philosophize this away. (Epicycles, anybody?)
If the Chinese were required to use the dollar, exclusively, and be subject to Federal Laws, the worker incentive would vanish, and cheaper goods would be less abundant.
T. Bits, I read that three times, and I’m still lost. Please post some educational links for dummies regarding your point about debt is now money?
@Gray Shambler
Debt and credit are not the same. A credit card is actually a debt (not debit) cards. Credit is an asset that can be bought, sold, used as collateral, or leveraged to create more credit.
Furthermore, I use the term ‘credit’ to cover a lot of financial products that are not typically considered credit. Interest rate swaps are included in my definition of credit, and a lot of these financial products are private.
If you do not understand “financialization”, there is a short (4:53) YouTube video that explains it. Search YouTube for “Financialization Explained” by Complexity Labs. There is another longer video, but I have not watched it in a while. Search YouTube for “The Dangers of Financialization” by New Economic Thinking.
I am not sure where my links explaining MBS’s and CDS’s. (These are what caused the 2008 Financial Collapse.) They were for a woman who worked in the industry, and she explained it in simple english. She passed away from cancer if I am not mistaken. @Icepick knows who she is.
If you do not understand how money is created and how bank lending works, the best place to start is Quarterly Bulletin 2014 Q1 from the Bank of England.
The two pdf files you should read are:
Money in the modern economy: an introduction and Money creation in the modern economy
The video is good also.
If that has not scared you off or you want to learn more, I would suggest Jeffrey P. Snider. He has columns at RealClearMarkets and Alhambra Partners. David Stockman is another, but he is behind an expensive paywall. You need to be more cautious with Stockman. Some of their articles are re-posted on the ZeroHedge website.
If you are not familiar with Zerohedge, you need to be cautious. There are mostly libertarian, anti-Fed, pro-gold standard, and somewhat conservative, but the re-posts need to be considered as part of the author’s body of work. I usually do not bother with the comments.
I am closest to the Austrian economic school of thought, but they would probably consider me a heretic.
@Gray Shambler
Another link that goes towards my concept of the credit supply as an extension of the money supply:
Central Banks Have Run Out of Excuses
(Jeffrey P. Snider, of course)
She posted at Calculated Risk. I don’t recall her handle.
“….Glass-Steagall, …………….[was} designed to restrict credit creation by commercial banks because they were able to create currency.”
Glass Steagall was designed to prevent deposit taking by investment banks (brokers). The purpose was to force partners capital to be put at risk during a brokered underwriting, (as opposed to depositors capital, like a commercial bank loan) thereby acting as a check on excess underwriting risk. Over time the check degraded and the rest is history.
Debt and credit are not the same. A credit card is actually a debt (not debit) cards. Credit is an asset that can be bought, sold, used as collateral, or leveraged to create more credit.
Credit, more properly the “extension of credit,” is a contractual arrangement to exchange current goods or services in return for a promise to pay principal plus some metered rate. It is a process, and its accounting treatment is as an asset for the extender of credit, and a debt for the recipient. The credit card is a piece of plastic. The balance on the credit card statement, reflecting the contractual arrangement, is, accordingly, both an asset and a liability. Because the asset represents a future cash flow stream it can be used as collateral or structured into a security, like any such instrument.
These are distinctions with a difference.
“She posted at Calculated Risk. I don’t recall her handle.”
Could have been Tanta, though think she was dead by 2008 so might have been BondGirl.
Tanta is who I was thinking of.
@Guarneri
Glass Steagall was designed to prevent deposit taking by investment banks (brokers).
The four main provisions pertain to commercial banks, and they outlaw the commingling of commercial and investment banking.
The purpose was to force partners capital to be put at risk during a brokered underwriting, (as opposed to depositors capital, like a commercial bank loan) thereby acting as a check on excess underwriting risk.
The purpose of the Banking Act of 1933 was to prevent a repeat of the 1929 Stock Market crash and the subsequent commercial bank failures.
Commercial banks were overnight lending to investment banks, and when investment banks failed, the commercial banks followed. There were other ties, but this was a major one. And, the Fed was facilitating the process.
Commercial banks under the Fed can practice fractional reserve lending and have access to the Fed window. A fractional reserve lending bank is bankrupt as a result of lending more money than it has, and the Fed system consists of bankrupt lending institutions. The only way to keep them solvent is through fiat money facilitated by the Federal Reserve System.
(A farmer can practice fractional reserve farming by issuing IOU’s against his future crops, but IOU’s cannot be eaten and are worthless if his future crops fail.)
Credit, more properly the “extension of credit,†is a contractual arrangement to exchange current goods or services in return for a promise to pay principal plus some metered rate.
In fractional reserve lending, the current goods or services do not exist. The principal lent does not exist, and it cannot exist. (If it does exist, it is fully reserved lending) In a fractional reserve lending system, banks get paid interest for money they lent but did not have.
(The Navy can practice fractional reserve bunking by ‘hot racking’, but there is no extra pay.)
It is a process, and its accounting treatment is as an asset for the extender of credit, and a debt for the recipient.
Under the Federal Reserve System, extending credit is an accounting treatment, and this is how it magically becomes an asset. The recipient is always receives debt.
(A borrower can practice fractional reserve lending through No Doc loans or check kiting.)
The credit card is a piece of plastic.
So, it does not get heavier as you add more charges. Wow, thanks for clearing that up.
(Yes Virginia, a Personal Equity investor has some use.)
The balance on the credit card statement, reflecting the contractual arrangement, is, accordingly, both an asset and a liability.
For the debtor, the balance on the credit card statement is never an asset. It is always a liability.
(I do not know if the unused portion is accounted for as an asset on the bank’s accounting balance sheet, or if it becomes an asset when it is used.)
Because the asset represents a future cash flow stream it can be used as collateral or structured into a security, like any such instrument.
It is an asset as an artifact of an accounting tautology, but if this is applicable to banks, it should be applicable to the US government. Somehow, I doubt that you have decided that the amount of US debt is meaningless, but I could be wrong.
(Our PE investor has become an MMT’er.)
These are distinctions with a difference.
Yes, they are. I have stated many times that my usage of the word ‘credit’ is more encompassing than common or technical usage, but it is easier than calling it ‘an asset created by leveraging accounting tautology which generates profit as it is destroyed. I will refer to Jeffrey P. Snider’s article in my third comment. Among other things, it addressed the money-like quality of various financial products.
Central Banks Have Run Out of Excuses
(He is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor, and he knows a lot more than I do.)
Fiat money is a non-existent object/concept acting as money. Money has value, but fiat money no value, intentionally. The Federal Reserve banking system is only solvent because imaginary assets are treated as real assets, and it is legal.
(When criminals create fiat money, it is called counterfeiting.)
Yes, Tanta at CalculatedRisk.
She was in the investing or real estate industries, and she had several posts that explained how Mortgage Backed Securities (MBS’s) and Credit Default Swaps (CDS’s) worked, and a normal person could understand it.
Anybody that followed her knew that there would be the 2007-2008 Housing Bust, and that would lead to the 2008 Financial Collapse. (NOTE: Those dates were known in 2006. Period.)
She should never be forgotten.
BondGirl was a different woman, but she was also an insider explaining things for normal people. Eventually, she or others revealed her identity, but I do not think she was hurt by it. I did not follow her much.
Is anybody noticing a pattern? Female insiders explaining things in a way normal people can understand. If these things can be understood by normal people, they cannot be “too complicated to comprehend”. So, simple concepts are rendered incomprehensible, and somebody becomes fabulously wealthy.
“Anybody that followed her knew that there would be the 2007-2008 Housing Bust, ”
Anybody that knew what liars loans were knew the market would crash, just not when. Have never been an especially good market timer. Got out of the banks in 2004 but the crash didn’t come until 4 years later.
Steve
For the 4,000th time, the problem was the 2005-2006 subprime ATM mortgages with low teaser rates. When the interest reset (2007-2008), it was going to be multiples of the original rate, and some of the payments would be 50-100% higher. Many of the borrowers would never be able to make the payments, and subprime housing would have a larger default rate than normal.
(ATM rates reset at fixed times, and the rates are based upon the Prime Rate at that time. There is information about mortgage market that can be used to determine the number/percentage of subprime mortgages, the reset dates, the reset rates
There was a recession on the horizon, and the recession defaults combined with the subprime ATM defaults would combine to make the ‘perfect storm’. The recession affects both prime and subprime borrowers who have a loss of income, but prime borrowers have a better chance of not defaulting.
(The experts assured everybody that there was no coming recession, and as usual, the experts were as correct as always.)
The reason a borrower is deemed subprime is because of their history, and except for this history, there is no difference between prime and subprime. Once a subprime borrower improves their credit history, they will become a prime borrower. One way to do this is to make sure all the bills are paid on time.
(Most mortgages have no early payoff penalties, but some subprime mortgages had them added. For these subprime borrowers to refinance, they would need to repay or include the penalty in the new principle, and this would be a further barrier. Also, the refinance may be precluded if the mortgage was higher than the house’s value.)
As a prime borrower, the interest rate would be lower if the borrower refinanced the original loan, and this was the sales pitch for subprime borrowers. It is true, but there are a lot of caveats.
The prime rate may still be higher than the teaser rate. Any negative credit event would prevent prime status, and this could be a late water bill. A housing market downturn may cause the house to drop, and the loan-to-value (LTV) rate to drop.
Any of these conditions would prohibit a borrower from refinancing, but these were not fully explained to the borrowers. At some point the number of defaults impacts the housing market, and with the coming ‘perfect storm’, it was highly likely the number of defaults would be substantially higher than normal. These defaults would cause a housing downturn to worsen, substantially.
No doc loans are for borrowers who have a good credit history but cannot document their income. There are various legitimate reasons why a borrower cannot document their income. Subcontractors, people who work on commission, and housing-flippers are a few. The theory behind these loans was that a borrower would not want to damage their credit history.
Prime – good credit history & income verifiable. Subprime – bad credit history & income verifiable. NoDoc – good credit history & income unverifiable.
(Since their are few people who understand the difference between prime, subprime, or no doc loans, I would guess that few ‘responsible borrowers’ have a better understanding of mortgage mechanics than the irresponsible type.)
Historically, these three types of borrowers have had predictable default rates, and their interest rates are based upon this. In the early 2000’s, there were changes to the mortgage lending which affected these historic default rates – increased securitization, financial engineering, GSE’s (Freddie & Fannie ), Congressional pressure (Dodd and Frank, anybody?), and risk assessments.
The entire housing industry was altered, but the underwriting was not.
The problem started in subprime ATM’s that were resetting, and this caused the nodoc loan default rates to increase. The value of the nodoc loans would be higher than the subprime, but without the subprime catalyst, the housing bust would have been an unremarkable housing downturn.
Not understanding how the housing market and mortgage underwriting is the reason for the housing bust, and it is the reason why it will be repeated. Again, liars loans were not the problem. The only timing factor was the coming recession, but the subprime ATM resets were established by the mortgage terms.
(The Prime Rate was an unknown, but it would be substantially higher than the teaser rates. It was possible to predict a high and low result using a high and low range for the Prime Rate.)
The reason the housing bust caused the financial collapse was due to uncovered/naked Credit Default Swaps (CDS’s). The Mortgage Backed Securities (MBS’s) were covered by CDS’s, and while the underlying financial engineering was faulty, the financial industry could have weathered MBS failures even with the CDS failures. TARP would have covered these.
A CDS is like default insurance for an MBS. If the CDS and MBS both fail, the losses are limited to the original MBS amount (or thereabout). An uncovered/naked CDS is like a side bet based upon the MBS performance, and these can total multiple amounts of the original MBS.
These uncovered/naked CDS’s were underpinning a large portion of the financial industry, and this is why TARP was funnelled through AIG. Bush & Obama did not want the fat cats to lose money on the carnage they caused. TARP was large enough to cover the MBS & CDS problems, but it was nowhere near what was required to cover the remaining damage.
This is why zombie banks exist. If they were declared insolvent, the financial industry would cause a mega-Great Depression, and more importantly, the ‘one percent’ would be selling apples on a street corner.