Economic myths and fallacies

Great Debates
221

Money multipliers have clear definitions. For one example, the M1 money multiplier is defined simply as the M1 divided by the base. The base is the total amount of monetary “liabilities” from the central bank. That’s a valid non-fictional number. The M1 money stock is the total currency portion of the base plus demand deposits. That is also a valid non-fictional number. Dividing the two, we can see that on August 21, the M1 money multiplier stood at 0.74.

There’s nothing fictional about any of this. It’s just not especially useful.

And if we ask Frylock, do you think he would have understood that this is your position from your previous discussion with him? Do you think you made this clear? Did he want this particular point clarified?

222

Thanks Hellestal. I missed that since stopped reading a few sentences in I guess. In post 183 I did make reference to the difference between the theoretical and observed multipliers but thanks for expanding on that.

223

I don’t think you addressed this to me, but I’ll take a stab.

At a commercial bank, deposits are a liability against the bank. A customer’s account is the amount it owes the customer. So it’s a debt (to you, the customer).

So suppose you take out a loan from ABC bank. The bank credits the amount of the loan to your account. Where does the money come from? The bank just types the amount into its computer.

It’s liabilities have now increased by the amount it just credited to your account.

But banks have balance sheets. And in order for banks to keep being banks, their balance sheets have to balance.

So what do they do?

They enter another number, on the other side of the ledger - the “asset” side. That number is the number the bank thinks the loan it just made to you is worth.

So say the loan was for $100k, plus interest, of course, so that in the course of paying back the loan, you’ll pay the bank $300k, over however many years. That loan - your promise to pay $300k over x number of years - has value. Lets say the value of that loan - it’s present discount value - is $120k. So now the bank’s books balance. On the liability side is $100k - the amount that was added to your account. On the asset side is $120k - the present value of the loan. The banks assets exceed its liabilities by $20k, which means its in good shape. The value of its portfolio is $20k.

The Fed is similar, except that when it “loans” money, it uses the money to buy securities - like, for example that loan currently owned by ABC bank. Or more realistically, it purchases Treasury bonds. The Fed types a number into its computer, sufficient to buy the bond. That number represents a numbe of dollars. That number goes on the liability side. On the asset side the Fed puts the value of the bond.

If the Fed ever wants to “pay back” the loan, all it has to do is sell the Treasury bond back to whoever wants to buy it. The Fed does not HAVE to sell the bond. It could just hold onto it if it wants. But as a practical matter, the Fed does buy and sell bonds all the time, depending whatever policies its trying to pursue.

In any event, the important part, at least in terms of perception, is that the Fed’s assets - all those securities it owns - are worth at least as much as its liabilities - which is the balance in Federal Reserve accounts, plus US currency.

Maybe that doesn’t help much, but to try to answer your question, the Fed is solvent - in fact, it churns out billions of profit every year. If the Fed weren’t solvent, it wouldn’t really matter in a practical sense, except that it would scare the bejesus out people. It would affect public perception of the value of our money, and the fundamental health of our economy and banking system.

And I would further argue, that when it comes to money, perception is everything. That last thing the Fed wants, or anyone wants, is for there to be some sort of financial panic, because the Fed was “bankrupt”.

So I would argue the Fed’s liabilities are “real” in the important and limited sense that it has a powerful incentive to make sure it can show it CAN pay off its “debts”, even if there’s no reason why it would ever need to. (And in fact, it would be a total disaster of it did.)

Again, it’s about perception. The Fed cannot literally go bankrupt in the sense of GM or AOL, or any private company.

224

Do you really expect anyone here to take your word for anything after I have proved you wrong time and again with cites that have contradicted you. Just a few posts ago you had the temerity to use a quote from 1975 on money and banking when monetary theory was invented almost single handedly by Milton Friedman who wasn’t recognized for the achievement until 1976. There is ignorance, willful ignorance and then deception. I would say that you have definitely veered into the second category and are careering at full speed toward the third.

225

The tip-off that someone is either making things up as they go along or is spouting nonsense from some fringe group is that even when challenged, as I’ve challenged Linus here - repeatedly - that person can’t manage to come up with even the most feeble support or authority for their claimed “explanations.” This is especially laughable since the Federal reserve has entire websites devoted to trying to educate people about what they do. I even posted a thread here about their extensive data offerings. But Linus can’t seem to find a single morsel, a single news mcnugget to support any of his positions.

For example this bit of disinformation here. When the money supply increases through the purchase of assets, those assets eventually have to be sold to drain liquidity. I supported this by linking to the wiki entry on open market operations as well as the fed’s IIRC. But Linus, like the cat running into the glass window, just bounces off like nothing happened and comes back for another run. Clearly he hasn’t learned anything and must think if he keeps saying the same thing over and over that will make it true.

Maybe if keep telling myself this is just a bad dream, that will work too.

226

Earlier in the thread, the OP clearly stated the points of debate:

On the first point, it seems that many people do believe this, as evidenced by articles such as thisthat attempt to clarify the confusion. I chose this particular article because it makes a distinction between “cash (money)” and “value”, which, I think, clears up a lot of the confusion.

On the second point, although there is a lot of discussion, both here and elsewhere, about the valid role of the stock market in aiding the development of businesses, I haven’t found any support for the notion the market itself, that is the trading of stocks CREATES wealth. That’s not saying that one cannot become wealthy through trading stocks, but that wealth was not created, it was transferred from some other place.

As I said before, I’ve been enjoying the discussion, and I don’t consider this a boxing match where someone has to be declared the winner,and I don’t think anyone has been “buried”.

227

Then please read and try to understand my previous post and the points they were addressing.

As to trying to narrow the debate to those 2 narrow points, that’s disingenuous at best. This discussion has ranged far beyond that and if you honestly believe otherwise then frankly, you haven’t read much of this thread.

As to whether or not the market itself creates wealth, you will note I have been silent on that point except to say that the market attempts to estimate the future earnings of companies and historically has been a reasonably good leading economic indicator.

228

Money in Fed accounts is always a liability on the Fed, not an asset.

Of course, if the Fed leant money to a member bank, it would demand a promissory note, and probably collateral. The promissory note would be the corresponding asset.

229

And yet they’re in charge of writing the laws that govern the country, including the Fed.

230

Delta, sorry, you don’t get to decide what I post or don’t post. Don’t like Galbraith? Fine, that’s your opinion. Like Friedman, great for you. Whatever. I’m not derailing my own thread “proving” things to you you ever have any intention of accepting anyway. You’ve already said your mind’s closed to whatever I have to say, so I don’t understand why you think I’m going to accept homework assignments from you.

My only suggestion is that you try to respond substantively, rather than with insults, if you want me to respond to your posts.

231

Poor baby. I’ll respond how I like w/in the rules. If you don’t like it, suck eggs.

I’ve asked you to “respond substantively” more times than I care to count by providing cites but you don’t seem to know that means. OK. It’s not like i give a shit. You just demonstrate your intellectual cowardice, that’s all. It’s not like that’s much of a secret at this point.

As to the Galbraith quote, it was irrelevant and I explained why. If that wasn’t clear, then I don’t know what else to say. Here is the definition of monetary theory:

While primitive notions regarding money have existed since the beginning of time, modern monetary theory began with Friedman. Don’t believe me? Read the link - at least I provide one unlike *some *posters here.

232

I think that’s very close to being right. No additional dollars are created. The dollars are transferred from one pocket to another.

A certain kind of wealth is created, however: financial wealth:

Financial wealth is a special kind of wealth, in that it has no use or use or intrinsic value in itself, but only in terms of what you can buy or acquire with it. Real wealth, is stuff that has intrinsic value. That can be used for some purpose, like a house (for living in) or a car or whatever.

Financial wealth can be conjured “out of thin air”, like money. Or it can be be created by bidding up the value of some real or imaginary thing: stocks, or gold, or copyrights, or options, or derivatives, or whatever.

Real wealth, on the other hand, is either natural (clean air, water, land) or created by human work and ingenuity.

Financial wealth is important, because it can have a substantial impact on the real economy (see the recent financial panic, for example). But does not build or create anything in and of itself.

When people feel wealthy - because the market’s gone up, for example, they may buy more, creating more employment, which in turn increases real wealth - the product of all the work all the newly employed people are doing. But again, it’s the increased employment that’s creating real wealth, not the market.

And since the market can’t be depended upon to go up forever - and, historically, not even to behave rationally - allowing market gyrations control the real economy seems like a poor strategy.

233

Money is always a liability in Fed accounts—but if that’s so, then for them to loan out money is already in itself for them to have an asset… (giving a liability away… double negative… turns out positive…) And the fact that it’s a loan means the other guy has to pay the money back–and them paying the money back would be, for the Fed, a liability!

I have no idea whether what I just said is true or not.

234

What you’re probably talking about is the fed discount window:

235

If you’re trying to say that dollars are nice but it’s not the real thing, then I’ll have to disagree with you. If you want to say that money is somehow inferior to owning things, I’ll have to disagree with you even further. If you want to say that owning money is different than owning things? Then I’ll have to say from a practical standpoint, you’re also wrong. Owning things with “intrinsic value” can be as risky, or even riskier than owning things. A brand new car loses half of its “value” the second you drive it off the lot. An ipod classic from 2004 is worth fractions of what it’s worth now. All things depreciate.

The fact is that money doesn’t just impact on the real economy, it is a part of the real economy. It is the vehicle with which value is transferred in the modern world. By modern world, I mean the past 6000 years. It has build/created the economy we have today because it’s easy to trade money than it is to barter with things. If you want to continue arguing this point, it would be an exercise in pedantry to a laughable extreme.

You’ll have to be specific when you say market. I’m assuming you mean stock market. People just don’t “feel” wealthier. They are wealthier. It doesn’t matter HOW they came into the money, as long as they got the money. If someone won the lottery, inherited a ton of cash, robbed a bank, or invented cold fusion - it doesn’t matter. At the end of the day it’s about how many slips of paper with numbers on it that you have in your possession. That’s the world we live in. You’ll have to come to terms with that.

So what’s the strategy? It sounds like you want to outlaw money. That to me sounds like an even poorer strategy.

236

Think of a dollar as an IOU. It says IOU $1, and it’s signed “Federal Reserve Bank of the United States”. Suppose the Fed has a stack of these promissory notes it keeps in a drawer. They belong to the Fed. It hasn’t issued them to anyone (yet).

Is that stack of notes an asset or a liability on the Fed?

It’s neither. A debt owed to yourself is nothing. You could scribble out IOUs to yourself all day long, and it wouldn’t make you any richer or poorer.

Now suppose somebody comes up to the Fed and asks for one of the Fed’s notes.

Fed says, “what are you going to give me for it?” And the fellow says “I’ll give you $2 years from now,” and signs his name to another promissory note, promising to pay $2 at the end of a year.

Now the Fed has a liability: the $1 it loaned Sam, and it has an asset: the $2 Sam’s promised to pay a year from now.

Now Sam won’t actually be able to pay back those $2, because (up til now) only one Federal Reserve Note has been issued. But luckily, Fed goes on and loans out lots of money to lots of people. So if Sam works hard at it, he can come up with $2 to pay the loan back.

Anyway, the Fed’s assets are all the promissory notes of people like Sam, promising to pay the Fed money in the future. It’s liabilities are the notes it’s issued to people like Sam.

As you can see, in the ordinary course of business it’s not hard for the Fed to turn a profit. So long as you’re in the business of trading 1 now for 2 later, you’re pretty much destined to be profitable.

So the Fed can use its profits for whatever it wants. It can spend some Federal Reserve chairs, or on new carpeting, or a really big fancy fancy building. Or on salaries for all the people who work there.

But mostly the Fed just turns its profits over to Uncle Sam, who is after all, his best customer.

But to answer your question, whether a Federal Reserve Note is a liability on the Fed depends on who owns it. If the Fed owns it, it’s not. If someone else does, it is. It’s the same as with any other IOU.

237

For anyone who wants to understand why LinusK is doing nothing more than repeating a common misconception perpetuated by the Zeitgeist movie read this fairly good HuffPo article. The author isn’t an economist, but compared to Linus . . . . well, you get the idea.

238

Only because you’ve misconstrued what I’ve said.

Of course money is important. Who could argue otherwise? Without it, we’d have to spend all our time bartering - incredibly inefficient.

“Real” and “financial” wealth aren’t meant to imply one is valuable and the other worthless. To say that financial wealth is in some sense imaginary doesn’t mean it’s unimportant. Lots of imaginary things are important. Stories, culture, even law itself could be considered the exercise of our collective imagination. All important. So is money and other forms of financial wealth. Still, food can be eaten, money is just engraved pieces of paper.

You’re right that ordinarily real things depreciate. I wonder what it’d be like if financial assets ordinarily depreciate, too.

People feel wealthier when the stock market (or the housing market, or any market) goes up in value. They don’t actually have any more dollars, though. Nevertheless, they feel wealthier. Their net worth has gone up. If the value of your house goes up, you don’t actually have a bigger house than you had before. But you feel wealthier, so maybe you go on a vacation you wouldn’t gone on, otherwise.

But of course, what goes up can also go down. When the housing market crashed, real people lost jobs, and the output of real goods and services went down. People lost their homes. They didn’t just feel like their houses were smaller. In any case, letting the. Financial economy control the real economy is a case of the tail wagging the dog.

Well of course I don’t want to outlaw money. I would continue and increase the Fed’s policy of monetizing the debt, and I’d increase the Federal deficit (although this is getting less and less important as the economy slowly improves). I’d advocate keeping interest rates permanently low - not just for now, but indefinitely. And if there are unemployed people with valuable skills who are able and and willing to work, I’d put them to work. This country needs lots of things. There’s no reason to let the potential output of all those people go to waste, when it could be put to work making us all richer.

239

If only there were some generally accessible compendium of knowledge where we could look up the concept of ‘wealth’:

240

I’m confused. I thought we were talking about fractional reserve banking. It sounds like you’re talking about money multipliers in reference to something else? I mean, I have no doubt that any number is some multiple or fraction of some other number, whether it’s M1 or anything else.

The fractional reserve theory of money creation is (and I’m sure you know this, so you can skip this next block of text):

Fractional-reserve banking - Wikipedia

I’d describe the fractional reserve banking model of money creation as an unnecessary fiction.

How would you describe it?