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The Beginning of the Endgame for Monetary Policy, Redux

by: David Merkel October 08, 2008    
David Merkel

David Merkel

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Here’s my updated graph of the composition of the Fed’s balance sheet, with modifications as suggested by some of my readers:vi

As you can see, the percentage of the Fed’s balance sheet containing Treasuries, whether held for itself, or together with the government, is declining.  Let’s look at it another way that contains some editorializing by me:

By lower quality assets, I simply mean assets less creditworthy than the US Government or its agencies.  That’s an estimate on my part.  Why does balance sheet quality at the Fed matter?  If the Fed wants to extend credit, it can more easily do so by having higher quality assets, like Treasuries.  Now, the Fed can lose money, and it means that seniorage profits that go to the US Treasury get reduced, or go negative, which implies increased borrowing or taxation.

Credit: The Economist

I can’t remember which Greek philosopher said something like, “Democracy is doomed when people learn that they can vote to get money for themselves from the public treasury.”  I know Tyler and de Tocqueville said something like that as well.  At a time like this there are a lot of demands on the public treasury, and they are growing:

There is  trouble here.  In the absence of a functioning market, how can the bureaucrats at the Fed figure out the right prices/yields to charge?  This is the same problem as valuing level 3 assets, but without a profit motive to aid in focusing the efforts of the businessman.

Now, the little graph above (from The Economist) describes the real cause of the problems.  As in the Great Depression, there was too much debt financing of assets.  The debt was more liquid than the assets, as well.  Borrow short, lend long.  Oh, and remember, the graph above does not contain the hidden debts of the Federal Government (Medicare, Social Security, and old unfunded DB plans), the states (low funded DB plans and unfunded retiree medical plans), and corporations (poorly funded DB plans).  Nor does it take account of the synthetic leverage from derivatives.

What we are seeing at present is not a reduction of the debt structure of the economy, but a shift from public to private hands.  That can lead to four results, when the debt of the US Treasury is so large that it cannot be serviced:

  • Inflation when the Fed monetizes the debt,
  • Depression from vastly increased taxes,
  • Debt repudiation (whether internal, external, or both), or
  • Japan-style malaise for a long time.

Japan-style malaise is sounding pretty good. ;)  No growth for several decades while the government debt bloats, and financial balance sheets slowly normalize.  Trouble is, we don’t internally fund our debts.  At some point, our creditors will tire of throwing good money after bad, and then the next cycle can begin in earnest, when the neomercantilistic nations give up, and accept that their investments in the US are worth a lot less than they had thought, and allow their currencies to come to a fairer level against the US dollar.

Financial intermediation has limits.  Financial and economic systems function better at lower levels of leverage if you want it to be sustainable.  Granted, you can have big boom phases if you pile on the leverage, but they will be followed by big bust phases, where the deleveraging is painful.

All of the government’s/Fed’s choices are bad here.  Dr. Bernanke is on a hopeless task, and his theories, borne out his academic studies of the Great Depression, means that we will get a new sort of Great Depression.  There is no easy solution; it is merely a situation where we choose which poison we want to take while the deleveraging goes on.  My guess is that we see some combination of malaise plus inflation.

As Martina McBride said in her song “Love’s the Only House,” “Yeah, the pain’s gotta go someplace.”  The pain is going somewhere; our policymakers are merely determining where.

PS — I am by nature a moderate optimist.  I invest in equities, and many of my sub-theories of the world, i.e., how well will the life insurance business fare, and how well will global demand fare versus that of the US, are being tested now, and I am finding myself the loser on both counts.  Yeah, the pain’s gotta go someplace.

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This article has 33 comments:

  •  
    Oct 08 04:20 PM
    A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse (money-benefits) from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury with the result that a democracy always collapses over loose fiscal policy followed by a dictatorship. The average age of the world’s greatest civilizations has been 200 years." The Decline and Fall of the Athenian Republic (1776) By Alexander Fraser Tytler, Scottish professor of history at Edinburgh
    Reply
  •  
    Oct 08 04:25 PM
    No problem. We'll just ask the Chinese if we could have our Treasury Bills back. In return we could give them Washington D.C. and all its workforce, as long as they promise to take them out of the country. We could even throw in a couple million lawyers. We'd hardly notice, although they would.
    Reply
  •  
    Oct 08 04:33 PM
    We could get Michael Milken back and ask him to sell off some of those junk bonds.

    Or we could get the Treasuries from the Social Security Trust Fund (or is it a Lock Box?). Fourth floor of the Treasury Building, in a safe behind the picture of FDR with the crown on his head. The Supreme Court has already ruled that no citizens have a right to those funds anyway so I don't expect anybody to complain.
    Reply
  •  
    Oct 08 04:35 PM
    For an expert who can not tell the difference between the FED lowering the FF and the FED lowering the rates(no such thing)Mr .Kedrosky continues to write some of "the end of the universe articles"
    I would have settled for some warnings a year or two ago.
    Humble me ,I have warned the investment community about the specific systemic risks during an interview with Mark Gilbert (Bloomberg -London).
    In fact my ignorance compelled me to say during that interview"All of the economic forces point to a dramatic slow down ahead which will turn into a serious recession,with almost no tools left to abort that possibility".
    Then my stupidity compelled me to reiterate the serious implications of the subprime issues on the economy and systemic risks that it represents on September18 ,2007 (Bloomberg TV -Brian Sullivan)
    Then the lack of my economic expertise compelled me to adjust the portfolios of my clients(including Central Bank)to reflect my ignorant opinions.
    Other than my clients, my prognosis was not a welcome conclusion.
    Now that the U.S problems have been identified and are being addressed with mega bazookas ,all we need is some incremental time
    for the measures to address the cumulative issues.
    As the measures are applied ,we will see a major economic/financial rebound in a compressed period of time.
    I have warned about the pending Armagedden ,but I am sick and tired of the comments like Mr .Kedrosky's which distort the risks without any solutions and create investors paralysis.
    The author and CNBC would make a great tag team.
    For simple me ,I will say the following ,we are short distance away from a major rally and economic rebound which will be fuelled by the record dollar inflows(flght to quality),as other economic regions head for their Armageddon-and they will.
    Reply
  •  
    Oct 08 04:37 PM
    I think you are not optimistic enough and have failed to see another factor. The U.S. government can afford to take on more debt. That is a fact. If the government issues debt and swaps it for poorly performing assets, it will essentially recapitalize financial institutions without a threat to inflation. This is what is happening now. No one is printing money. The rate on t-bills makes them practically free, while the long term return on the swapped poorly performing assets may be higher than the t-bill rate in the long term. Furthermore, the present crisis is one of confidence and trust between banks and other financial institutions. Just having the option to make the swap may cure the problem. The banks themselves may decide not to make the swap at all. None of us really knows how much poorly performing assets are on the books. All we know is that we've been lied to and hoodwinked -- blatantly. But now that banks have the OPTION to make the swap, do we really care what is on the books??? I don't, because whatever junk is there can be removed arbitrarily. And that is precisely why WFC and C are fighting for Wachovia. Barring a worldwide panic in which foreign governments panic or go under, I'd say stocks are pretty close to the bottom.
    Reply
  •  
    Oct 08 04:42 PM
    Hmmm.... look where that debt chart takes off. The dawn of the "Reagan Revolution."

    Crony capitalism that makes profit by squeezing the majority and workers is seeing its twilight.

    It produced little of value beyond financial bubbles and crises and the world is now abandoning the failed neoliberal ideology of "market fundamentalism" or the cronies get rich and everyone else is left holding the bag-- especially the taxpayers and fixed-income folks!!
    Reply
  •  
    Oct 08 05:00 PM
    Paul, your article is sobering and true. We can't borrow our way out of this hole though we will try.

    I was against the bailout so we would fail then start over as a free nation. Now we shall fail and start over with the rest of the world... but more like France (minus the nuclear plants)


    AlexS, I will put $1,000 of my last dollars to broker a logistics deal to make that T-bills to China in exchange for our excellent leadership out of Washington

    I'm heading to the basement to continue reloading my 30-06 shells. I'm gonna need em.
    Reply
  •  
    Oct 08 05:01 PM
    The 'Total debt' figure is fictitious, as it double and triple-counts each loan. Whenever a mortgage is securitized, sold to another investor who then repackages and resells it, it counts as three separate loans, despite the fact that it is just one. What we see in the chart is the move towards more intermediaries, as debt becomes more securitized and traded more often. The net debt burden in the US has not increased in decades, but the number of intermediaries has. The government (as opposed to Total) debt as a percentage of GDP has actually decreased for most of the period in the chart.
    Reply
  •  
    Oct 08 05:37 PM
    The liquidity injections will inflate the currency. Real Estate is an inflation hedge. Housing turns up. The real cost of debt for the property owner is eased (he is no longer upside-down on his mortgage), problem solved. Future rate hikes will be used to attempt to wring out the inflation resulting in some downturns but not nasty enough to go to your cellar and restock your shotgun shells and your baked beans. I predict the world will not come to an end in 2008.
    Reply
  •  
    Oct 08 05:40 PM
    Did we ever have a financial crisis before we took the dollar off the Gold Standard? Christmas Eve 1918 the Federal Reserve was given the power to print our money. THe Fed is an independant Corporation. We need a currancy back by Gold, or how about Micro processors!

    The old guard thought that the industrial revolution was going to last forever so they sold us into slavery. Your Social Security Number is what used to prop up the dollar because we were able to create wealth. Now that our factories are in China, what are we creating?

    We've all been had!

    Hopefully the rumors that Google will soon, (2-3 years) go live with a fiber optic WWW free broadcast will change the worlds economy so much it will litterally allow people to sidestep these economic butchers.

    This bogus creation of money is destroying us.

    Ron Paul was right!
    Reply
  •  
    Oct 08 05:45 PM
    Ted Nugent/Ron Paul in 2012!
    Reply
  •  
    Oct 08 06:23 PM
    Actually we have a lot of wealth in this country and I suggest that we are not as bad off as everyone thinks....the Real Estate that is being trashed has essential equity value...its just that the funding of the RE bubble is gradually disappearing because of a temporary evaluation...which is what you expect in a recession/depression. Believe it or not, your dollar can buy more real estate and energy/commodities than just a short time ago. It just means that you have to have dollars to do this. Money that is disposable and invested in paper assets can evaporate and it will as you can see. In my opinion excessive dollars will be cleared from the market to reflect the underlying asset valuation and thats exactly what is happening. If you have cash your buying power is increasing every day which is better than investing where it can be creamed off...MarvinMBA
    Reply
  •  
    Oct 08 07:05 PM
    Mr Kedrosky quite correctly points out the deteriorating asset quality at the Fed. The Treasury has supplanted the Fed as "lender of last resort", and that is probably why. I suspect also that much of the $850 Billion bailout will go to replace the junk on the Fed's books with more treasuries so the game can begin anew. Remember, the Fed is a private bank, and the owners want their money back, plus the usual profits, backed by the full sweat and blood of the American Taxpayer, not some bundle of worthless McMansions in Encino.

    The real question is embedded in Mr. Kedrosky's article. Through it runs a basic premise regarding the creditworthiness of the US government, and the quality of the debt it issues, US Treasuries. This appears to be the presumption that Mr. Kedrosky wishes to question, and if that is the case then I concur that it is time to question it.

    US Treasuries have for our generation been the standard by which the others are measured. Dollar bulls go into Ventricular Tachycardia whenever anyone suggests that the US Government is losing its creditworthiness. But this is just another paradigm that will be broken, slowly and over time. The last paradigm to be (recently) broken was that US Stocks always go up, except for when they briefly correct, and only to quickly resume going up again. I was amazed at the time it took to break that paradigm among a critical mass of investors. Some still cling to it; they can be seen still, here at SA and elsewhere, calling bottoms in US stocks.

    The beginning of this paradigm break may have come today at the Treasury auction that didn't go quite as well as expected:
    www.cnbc.com/id/270815...
    "Bonds Plunge on Debt Supply Plans, Note Sales"

    The credit needs of the US government going forward may be better understood by our (previous) creditors than we at first suppose. No one in the MSM has been talking about the debt explosion at Treasury in the past few weeks. No one has been talking about the intergenerational debt.

    If we continue down this path, borrowing our way to rescue and prosperity, we will destroy what is left of the US Dollar. Since I hold my assets (most of them still) and earn my living in US Dollars I'd like to see this trend stopped, then reversed. But the folks who run the show, and the Congressmorons who are their enablers, think otherwise.
    Reply
  •  
    Oct 08 07:29 PM
    I have to disagree Jolly-rancher, the governemnt can't increase debt. Debt is money earned. In other words, the government must pay off those obligations in some form. When they don't, we are just artifically creating money to people. Instead of the natural exchange of goods, services, and currency to pay for those services, we have the exchange of goods and services on borrowed funds. Thus our dollar can not be worth as much as it would be if our obligations are paid off. If we can't guarantee what tax revenues and other methods used to pay off debts and U.S. obligations, when the time is needed we will have to print money to pay for our obligations and in addition our backing of the "full faith" of U.S. money on our treasuries will be downgraded because we may not in the short term raise enough money to pay off the obligations. I'll break it down in mortgage fashion. Say you take out a mortgage for $100,000, you're liabilities at the time is actually $100,000, and your assets are 100,000. Thus your net worth or equity in the home is zero. If you pay off 20,000 dollars in the home, you're liabilites are 80,000 and if the housing value is still the same, the equity is now 20,000. If you take out a uncollateralized loan steadily for the next 20 years for home improvements, 10,000 per year then you owe 200,000 and maybe your home is worth substantially less, but you have liabilities that are worth more than home, so you're actually in a worse position then you were to start out with. And no one can trust you to pay off all your debts, and your net worth is in the negatives because of the substantial liablities, you have. If an accident happened, and you needed a quick loan for 10,000 at year 21, you mostly likely won't get it, because no one's going to trust you at the point to loan you money and you don't have the net worth to collateralize the loan. The same can be applied to the government. It is a necessity to pay off some the debt limits so are backed by full faith of the U.S. government holds true, and the dollars which needs to be worth something in the U.S. economical system, can eventually increase in value. If the person above printed out money to pay off the obligations than that would be counterfeitiing, and that would place them in prison for crimes that affect the U.S. The same can be said for the treasury if it didn't issue loans, and it just paid off its debt using newly minted money. It just wouldn't be a crime, just a misfortunate incident for the dollar.
    Reply
  •  
    Oct 08 07:57 PM
    You left one option out. Europe is nationalizing its banks . USA can do the same to stabilize the system . Fanny and Freddie were once government owned.
    Reply
  •  
    Oct 08 08:05 PM
    blisterchick, If memory serves me correctly we came off the gold standard (actually it was the last vestige of the gold standard-silver) in 1962. I think there were a number of financial crises before that time including the crash and depression of '29'. Maybe I didn't understand your statement.
    Reply
  •  
    Oct 08 08:16 PM
    Demand on Treasury when everything goes bad is the last resort of the US financial system. If that thing blows up, then Armageddon is upon us. But it just like to say as long as a ship has a pump to pump water out, the ship isn't going to sink. Is that true? Not really. Every pump has its limit. Just let Paulson issue 200billion treasury every week in the future to use that money to recapitalize the financials and let's see what will happen. I guarantee you that before the recapitalization is over, the Treasury market is gonna collapse too.
    Reply
  •  
    Oct 08 08:58 PM
    <I>"Did we ever have a financial crisis before we took the dollar off the Gold Standard?"</I&...

    Only about once every decade or so. The 19th Century was full of them. We even had a populist presidential candidate (William Jennings Bryan) blame one of these financial crises (a wave of deflation) on the gold standard.
    Reply
  •  
    Oct 08 09:05 PM
    The key cause for optimism here is the resilience of the U.S. dollar and the demand for U.S. Treasury securities. That gives the government the ability to borrow at low rates to buy up distressed assets, provide more fiscal stimulus to the economy, provide direct capital injections into key companies, etc. Our debt as a percentage of GDP compares favorably to that of some other first world countries.

    After the current crisis dissipates, and the flight to quality recedes, the bond market may drive up the U.S. government's borrowing costs, but this can be ameliorated if we pass reforms that put our entitlement spending on a sustainable trajectory.
    Reply
  •  
    Oct 08 09:06 PM
    debtacid:

    while it's a great quote, source is questionable. see....

    see: www.americanvision.org...

    "Then there’s the attribution of the following citation to historian Alexander Fraser Tytler (or Tyler) (1747–1813). It supports what many believe are important political observations, but is it authentic? Can it be found in any of the works of Alexander Tytler?:

    A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship. The average age of the world’s greatest civilizations has been 200 years.

    Great nations rise and fall. The people go from bondage to spiritual truth, to great courage, from courage to liberty, from liberty to abundance, from abundance to selfishness, from selfishness to complacency, from complacency to apathy, from apathy to dependence, from dependence back again to bondage.

    Like the dubious James Madison quotation, the Tytler extract is cited on a regular basis and often finds its way into published works.5 While there was an Alexander Tytler, there is no extant evidence that puts these words in his mouth or in any of his published works. Supposedly it can be found in a book supposedly written by Tytler that goes by the title The Fall of the Athenian Republic or The Decline and Fall of the Athenian Republic. There is no such book in circulation or attributed to him. Others claim that the quotation can be located in Tytler’s Elements of General History: Ancient and Modern, a book that does exist. The following response from the library of the University of Edinburgh states that their research has shown that the quotation does not appear in the library’s holdings of Tytler’s books:

    Edinburgh University Library occasionally receives enquiries, particularly from North America, about this particular work. However, this title is not in our Library holdings, nor does it appear in the stocks of the other major research libraries in the United Kingdom. . . . Locally, the chapters of Tytler’s General History . . . (which we DO have) has been checked on the off-chance that The Decline and Fall [of the Athenian Republic] might have been a chapter title . . . but it is not. . . . We have scanned our holdings pretty thoroughly on different occasions, going back a few years now, but we have not found the quotation or anything similar to it, but we cannot absolutely rule out the possibility that we have missed it.6

    Even the United States Library of Congress has been called in on the search with no success in finding the much cited but elusive quotation. Even so, the Madison and Tytler quotations continue to circulate as authentic history. Here’s the lesson to be learned: If there are so many who are willing to accept the authenticity of historical citations with something less than a shred of evidence, then it shouldn’t surprise us when students accept historical accounts found in textbooks and scholarly journals that have about the same amount of evidentiary support. The difference, however, is that so much of what finds its way into textbooks and popular works of history affect the way Christianity and the Bible are portrayed. It’s one thing to be wrong about a few unsupported quotations; it’s another thing to reshape a school curriculum based on fabricated history that relegates the Bible to the dust bin of history. "

    ----------------------...
    just thought readers might be interested.....//
    Reply
  •  
    Oct 08 09:31 PM
    Hello USC-Col 2006-HonorsFinance/Eco... Grad MD,

    I read your post, understand it, and appreciate your point. However, the moment you speak of is not quite upon us though maybe by next economic downturn it will be. The one basis of you argument that doesn't hold water is that the U.S. is just one of many economies in the world that creditors like China and Japan don't really need, that can be tossed like used tissue because we may be over leveraged. Really, the rest of the world needs us right now very badly to prop up the world economy with our reckless spending on consumer goods. I assert that China-Japan et al will continue to hold our debt and take a lot more until their economies are much more independent. The treasure debt will sell and will be swapped for bad debt and there will be a rebound in the economy sooner than many believe. From this point you and I and the rest of America are charged with bringing production back to this country and reducing debt to support our standard of living. But based on past experience and present trends, I'd say the prognosis is poor.
    Reply
  •  
    Oct 08 09:35 PM
    SWRichmond has spotted the seminal event of the day. I've been waiting for this to happen, and hoping it magically wouldn't. I pray it was only an anomaly, but fear not.
    The fed has driven rates historically low by decree, and like the citizens of Oz obeying the wizard, the credit markets have followed. When yields get too low, debt buyers will not show up at the auctions, and real world yields will decouple from the decrees of the guy behind the curtain. What happens when the treasury has to give 7% to sell a 10 year note, while the fed rate is 1.5 %, or 1%, or 0 % ? I don't know - my brain shuts down thinking about it. But it will be ugly.
    Reply
  •  
    Oct 08 09:39 PM
    Indeed, DaveinHackensack, you are correct. As a matter of fact, the history of America is fraught with real estate bubbles. Our present situation is nothing new. Such a lust for fast bucks is built into our psyche. The state of Texas actually arose from Stephen Austin's attempt to escape such bubbles, his father having lost everything when his Missouri bank went belly-up during the real estate bubble of 1930+/-. Fast talkers peddling snake oil sold to gullible greedy guffaws is the norm here. Is it a wonder that much of our real productivity moved abroad?
    Reply
  •  
    Oct 09 10:06 AM
    Paul,
    What's up with life insurance?
    Reply
  •  
    Oct 09 10:51 AM
    "Oh, and remember, the graph above does not contain the hidden debts of the Federal "Government (Medicare, Social Security, and old unfunded DB plans), the states (low funded DB plans and unfunded retiree medical plans), and corporations (poorly funded DB plans). Nor does it take account of the synthetic leverage from derivatives."

    Hey Paul, you forgot to mention the war bill which is also off the USA's balance sheet. How many trillions would we have to add for Iraq and Afghanistan? Someone must know the latest accurate tally? All told including all of the above that must be an extra 100 trillion to add (unfunded socail medicare is 60 trn alone!).

    Considering US GDP is approx 13.5trn, that graph should stop somewhere near the 1000%, instead of 350%
    Reply
  •  
    Oct 09 11:04 AM
    to DaveinHackensack

    the resilience of the US dollar?
    dont make me laugh-your precious dollar is just about to be flushed down the economic toilet.

    Once confidence is finally lost in this fetid piece of paper (along with its treasuries) and the overissuance thereof, which has dragged this global economy to its knees, you will see the mighty USA isolated upon the world stage.

    We are all fed up of the abuse the US has shown to holding the world reserve currency and cant wait to see the back of it. Once the flight from the dollar begins as countries holding US debt finally realise a sacrifice must be made to save their own economies, you will truly see the USD index plummet like a stone. good riddence. the soon we purge the system the better as any contined fiat money pumping will only exaccerbate the collapse once it arrives.
    Reply
  •  
    Oct 09 11:15 AM
    Nice job Paul. Well written ,concise, logical...and of course scaaaaary!
    I have come to similar conclusions writing my own blog but I have been reading people like John Hussman and Nouriel Roubini for quite a while. The only thing that has surprised me has been the suddenness and rapidity of it all and we can thank the computer and the internet for speeding things up. Lawr's comment amplifies your comments on debt to GDP ratios which I think holds the real key to where we go from here. I have no idea what the real debt to GDP ratio is here but it's 12:1 in Iceland, it was 2.5:1 in 1932 and 3.6:1 right now here in the good ole US of A. If those nice folks in KSA, Japan and China stop buying our debt, the depression will no longer just be a theoretical issue.
    Reply
  •  
    Oct 09 11:28 AM
    Prior to the Federal Reserve system each bank issued their own currency which was (in theory) redeemable in gold at $20/oz. Most of the banking 'panics' which occurred were as a result of individual banks issuing more currency than they had gold to redeem (an independent fractional reserve system). Banks could make more loans with a given amount of gold deposits and earn more in interest this way, until depositors needed their gold back.

    The panics were periods where the public realized that a specific bank's currency was worth much less than its face value and so they demanded redemption in gold in numbers large enough to drive the issuing bank to insolvency. They would run out of gold before the deposits ran out.

    As a result depositors and shareholders in that bank often lost great deals of money when the gold ran out and banks had to call in loans or foreclose on borrowers to raise money and/or liquidate. If a bank didn't "overdo" the fractional reserve issuance they could survive such a run and remain in operation. Only the banks which egregiously overissued currency were put out of business for following such bad practices.

    The "cross of gold" speech in essence complained that the poor average Joe was hurt because the need for redemption in gold would put the banks who took risky schemes to the extreme out of business and hurt not only their depositors, but their borrowers as well (if the bank went under you would lose your savings and then not be able to pay your mortgage and wind up losing your home too when another bank bought your mortgage in the liquidation). Savings were lost but the debt remained and it was expectd to be repaid in gold.

    While it is true that innocent people were hurt by this system if their bank was overzealous in issuing unbacked currency, the effect was usually not widespread and it prompted people to remain aware of the financial state of their bank (and to move gold deposits to another bank if excess currency was issued). Bankers who wished to remain viable had to be very prudent in any use of fractional reserves, even if only temporarily.

    This was the market based limitation on fractional reserve banking. Issue too much unbacked currency and your depositors may change banks and begin a run that put you out of business.

    What the Federal Reserve brought was the same system on a national scale but (eventually) without the redemption in gold to keep banks 'honest'.

    What we are seeing today is the natural outgrowth of removing the market based limits on fractional reserve banking. The central banks of the world have issued so much unredeemable currency and debt that it cannot ever be repaid. Depositors and creditors are becoming much more wary and the system is imploding because nobody wants to be left holding the bag.

    Instead of small, contained runs on individual banks we now are seeing a virtual run on all the banks at once. There aren't any other banks to run to that offer any better chance of saving your money.

    Of course the central banks will simply continue to issue more currency as a band-aid. This will eventually dilute the value of each dollar issued to nearly zero. Already the dollar has lost over 95% of its purchasing power since the FED was founded in 1913.

    When it is widely accepted that the dollar isn't worth the paper it's printed on and that no meaningful repayment of US debt will ever be made, the exodus from the dollar will commence in earnest.

    There is a reason why it is getting very difficult to find physical gold to buy these days. More and more people are purchasing it as a means of storing the value of their labors instead of watching their dollars erode into valueless coupons.

    Everything the central bankers are doing is nothing more than an attempt to keep the fractional reserve game going. The extremes to which they are going indicates that it is becoming more and more difficult to keep it afloat.

    The most difficult choice for market participants is yet to come. One day holders of dollars will have to choose between abandoning it or accepting it as real money even though it is losing value very quickly.
    Reply
  •  
    Oct 09 11:42 AM
    On the plus side ...

    If you rip the pages out of Keynes book you can use one page a day as kindling to start a fire and it will last almost an entire year.
    Reply
  •  
    Oct 09 12:49 PM
    My apologies to both Paul Kedrosky and David Merkel for originally and erroneously listing Mr. Kedrosky as the author of this article.
    Reply
  •  
    Oct 09 03:15 PM
    Your quote is not from some Greek philosopher but is a paraphrase of a statement made by an eighteenth century Scottish historian, A.F. Tyler. To qoute, "A democracy cannot exist in a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury." This was subsequently restated by deTocqueville.
    Reply
  •  
    Oct 09 07:27 PM
    I think we will wake up monday morning to several bank failures and the stock markets-in a worlwide coordinated move will be shut down.
    Reply
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    Oct 09 07:28 PM
    Oh one other thing, Dave Merkel, do you know a guy by the name of Scott Stolz? Just curious, I used to go to school with him and he's been a senior VP at a couple of insurance outfits. Thought you might know him.
    Reply
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