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macroeconomic musings

July 20th, 2008 at 03:06 am

I'm trying to figure the big pieces of this economy out.

In the last few years, we've had a big expansion of money (dollar bills are only a small bit of the money supply) as folks buy houses and re-fi and HELOC. Banks bundled it up and sold it to other entities, then used the proceeds to make more loans. In other words, they expanded credit and manufactured money.

Now, as banks write down their debt, that "paper" money is being destroyed. So if money is being destroyed, that should be deflation. Inflation is the increase of the money supply, deflation is the decrease in the money supply.

Deflation usually causes lower prices. When fewer dollars chase the same amount of stuff, those dollars are precious - they buy more. Therefore prices are supposed to go down.

Clearly they are not - there is another, stronger element going on.

Deflation is also supposed to strengthen the dollar, because again, fewer dollars buy more stuff. But if you compare the dollar to the price of oil... well, you could look at it from the perspective of the oil - that barrel of oil has the same value, yet if it takes more dollars to buy it, those dollars are weaker.

So what we have here is a deflated (fewer) in number, yet weaker dollar.

6 Responses to “macroeconomic musings”

  1. Broken Arrow Says:

    Thank you for sharing your thoughts on this. It's informative, and I agree, baffling. I really don't know why. Just simply don't know enough.

    I could take a stab in the dark, and postulate that perhaps stronger economic growth abroad, higher overall demand for oil and commodities, and potential stagflation are contributing factors. I'm not sure.

    In the end, it's a fiat currency. Like stocks, perhaps the purchasing power is being manipulated through overall market sentiments regarding the economic climate that we're in?

  2. baselle Says:

    All currencies are fiat - dollar, euro, yen, yuan, ruble, etc. I'm sure that I'm describing a symptom and an endpoint - the panorama is that the largest American export is the T-bill.

    It looks like deflation in the things that we want (houses, clothing, electronics), inflation in the things that we need (food, energy).

  3. boomeyers Says:

    I love it when you use crazy big words like macroeconomic! Makes my head dizzy.

    I think you hit the nail on the head with your statement: "It looks like deflation in the things that we want (houses, clothing, electronics), inflation in the things that we need (food, energy)."

  4. Jared Says:

    Now, as banks write down their debt, that "paper" money is being destroyed.

    This is the error in your logic: ĎNow, as banks write down their debt, that "paper" money is being destroyed.í

    What money was destroyed? A bond was devalued. The bond is only a promise to pay money, not actual money. No money was destroyed. Just the promise of paying a bondholder was destroyed.

    The banks give you a loan; they skim a service fee off of the top and then repackage the loan into a bond and sell it to Wall Street. So, the money goes from Wall street to the bank to you to give to the guy you bought the house from who went out and invested it in stocks funds that purchased bonds from banks that gave it to some other guy who purchased a house from a builder that got rich and spent all his money on products made by the Chinese and Oil from the Oil kingdoms who purchased bonds from the US marketÖ you get the point? The problem is that this loop pushed up housing prices and included shady loans that were garbage. The assumption was the loop would never end. So, all the money went to socialist Chinaís and Oil dictators who used it to build their kingdoms and invest in bonds. But, now they see itís all a loop and that they have lots of garbage bonds, so they are dumping the garbage bonds and buying gold and other things that they think are safe instead of buying bonds that feed the loop that make us feel rich but really suck money from America and into the pockets of the ideologies for which we stand against.

  5. baselle Says:

    Jared - you are right in terms of your description of the cycle. However, you claim that the "promise of paying a bondholder" is not money, while I claim that its third pool of the money supply: M3

    M1 = paper money, dollars that you and I deal with
    M2 = personal credit
    M3 = credit extended between banks & between banks and the Federal Reserve.

    When the bank sold a loan in the first place, they treated the proceeds as money. A bank writing off loans has said that they will never see that money again. Where did it go? Did it ever exist? Well, the bank originally loaned it to someone and that someone used it to buy a good or a service ... it was pumped into the economy and worked just as well as a Federal Reserve note.

    And you also have hit on an essential truth - a bond's value is based on its rating - its reputation as it were. In 2006, those garbage bonds were treated as having a value. Now they have none. Again, more "money" being destroyed.

  6. jared Says:

    Investors give money to the bank.
    The bank gives paper IOU to Investors (Bonds/Notes).
    The bank gives you money.
    You give the bank IOU (Promissory Note/Loan).
    You give money to house builder.
    House builder gives you house.
    House builder buys cheap products from China.

    China has the money.
    Everyone else has IOUís.
    Unless the money finds a way from China back to the Investors the cycle wonít complete.

    China (and other foreign investors) suspect a bubble and therefore donít buy bonds which causes a liquidity crisis which means banks donít have money to lend people money which pushes up interest rates which makes buying a house more expensive which means you canít take out another HELOC to pay for your credit card debts which purchased cheap stuff from China.

    The money didnít disappear, it just went to China. No money was created or destroyed. It was just transferred.

    Think of the housing bubble as the beanie baby bubble. McDís sells $2 beanie babies that everyone wants. So, people auction them off at $10 each on ebay. Then, everyone has too many beanie babies and they donít want anymore. So the price drops back down to $2. Where did the money go? It went to the lucky people who sold the beanie babies first on ebay for $10. Everyone else either is out money or is stuck with a lot of beanie babies they purchased online for $5 in hopes to sell them to someone else for $10. But, now the people stuck with $5 beanie babies want to recover some of their money so they sell them for $1. Now, $2 beanie babies are being sold for $1 off of ebay. Eventually, when everyone has finished being a beanie baby investment guru the price will normalize back to $2. But, no money was ever lost, it was just transferred to some people who were in the game at the right now and lost by others who spent it on lots of beanie babies.

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