1. I'm a bit confused here on a technical matter.
When the Fed wants to create money out of thin air, apparently it buys back treasury bonds from a bank and pays the bank by just scribbling into the computerized accounts the bank has with the Fed that the bank now has more money.
Why does it do it like that? Why can't it just buy whatever it wants, say tanks and guns, and pay for it by putting money into the weapons company's account? Who needs the banks?
I can take a wild guess that it's just a little bit of corruption, that the banks asked for it to be done this way so they make some money. Does anyone know for sure? Have a link?
2. I think I read that stagflation is always going to happen in a recession. Is the above drama the reason for that? The inflation from the gov printing the money and thus raising prices, the recession from the malinvestments caused by all that money and nothing to do with it, so might as well malinvest?
1. The Fed can buy just about anything it wants, but it makes most of its purchases through the primary dealers. These are several of the largest banks in the world.In the past year and a half or so, the Fed has bought more non-treasury securities, such as mortgage backed securities, from these banks than treasury securities. They also bought Bear Stearns and rolled it into an LLC called Maiden Lane.
The Federal Open Market Committee decides which assets it will purchase at its first meeting each year. The Fed trading desk is then limited to trading in these securities. The Federal Reserve of New York has plenty of good information about this on their web site. I've posted a list of the primary dealers below. You might notice that these are some of the same banks reporting extremely high executive compensation. It's not hard to make money when you have a customer that can legally create unlimited amounts of it.
2. Stagflation (however one might define it) does not always happen in a recession. A non-inflationary recession is possible if the Fed doesn't increase the money supply during the recession. It is also often possible to successfully end many recessions, for a period of time, by increasing the money supply. The stagflation occurs when the burden of the mal-investments piles up to the point where increasing the money supply is no longer effective.
Here is a list of the primary dealers:
The Fed can buy a wide range of assets. The Federal Open Market Committee decides in its first meeting each year what assets its trading desk will be permitted to buy throughout the year. In the past year and a half, it has added so many mortage-backed securites and similar assets that they now make up the majority of its ballance sheet. However, they buy their assets from a select group of big banks known as primary dealers. These primary dealers don't trade in tanks and guns but they do deal with various forms of debt, equity, and commodities.
Smiling Dave: Why does it do it like that? Why can't it just buy whatever it wants, say tanks and guns, and pay for it by putting money into the weapons company's account? Who needs the banks?
The Federal Reserve was founded to cartelize the banking industry. As a result, its job is to bail out banks when they find out that they do not have the funds to make up for the losses in bad loans (do to malinvestment). Its job is not to buy weapons. When the government wants to buy weapons then they will sell a government security to the Federal Reserve (the Treasury will).
See: Rothbard, Murray, A History of Money and Banking in the United States: The Colonial Era to World War II
Stagflation doesn't always happen. During the Great Depression there was deflation (net deflation, as the Federal Reserve still inflated controlled reserves [see Rothbard's America's Great Depression], which is one of the reasons there is so much stigma against deflation. Stagflation came as a surprise to Keynesians, and was one of the reasons it fell out of favor during the 1970s. Stagflation simply refers to an era of high inflation, low productivity and high unemployment. It is the result of monetary inflation, yes.
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Thanks guys for the enlightening answers.
About deflation during the Great Depression. I remember hearing on a tape here that there was a hidden inflation in the twenties and thirties, in that prices should have dropped, like they are always supposed to do in an advanced economy. Instead they stayed the same.
There was a lot of emphasis on "price stability", and so the Hoover administration did pressure the Federal Reserve to inflate the money supply to the point where high wages and high prices were sustained for a brief period of time. But, like I said uncontrolled reserves fell faster than controlled reserves were inflated, which led to a general period of deflation. However, this necessary deflation took just over three years to complete, while if you take the 1920 recession as an example had it been left to the devices of the market it would have happened much quicker (and probably less dramatically, as well, since it wouldn't have to clear all the new malinvestment produced). After the market cleared there was an inflation of the money supply which took place between 1933 and 1936 (my main area of research), which I believe led to (or, at least, was a factor) to the recession of 1937 (Vedder & Gallaway and Benjamin Anderson give slightly different reasons). There was a very minor fall in the money supply in 1937 and early 1938, but generally there was gradual price inflation thereafter (like there has been ever since).
Jonathan M. F. Catalán: There was a very minor fall in the money supply in 1937 and early 1938, but generally there was gradual price inflation thereafter (like there has been ever since).
There was a very minor fall in the money supply in 1937 and early 1938, but generally there was gradual price inflation thereafter (like there has been ever since).
Thanks for the added info.
The line you wrote about there being a fall in the money supply confuses me a bit. How can there ever be a fall in the money supply? Once the paper money is printed, doesn't it exist forever? Is it from wear and tear?
Most of the money that had entered the market was probably in the form of credit. There was an increase in the carried money supply, as well, as people preferred to carry their own money instead of warehouse it in what were risky banks. But, the general money supply deflated. The majority of money expansion comes in the form of credit. Usually, when Austrian authors refer to "running the printing press" I think they use it figuratively in the greater sense. Ultimately, literally running the printing press and expanding credit is the same. But, credit expansion has less barriers and can be done at a greater pace (especially if the banking industry is monopolized, which it was in 1913 by the creation of the Federal Reserve). What causes credit to contract is when businesses begin to default on their loans (or consumer, in regards to consumer credit, which is a newer phenomenon but still applies).
Credit contraction is deemed as inevitable by Austrians because malinvestment is the natural product of credit expansion. Why there has not been a long-lasting deflation in this current recession (and ever since stagflation in the early 1970s) is because of the introduction of fiat currency, I think (and the official drop from the gold standard). It gave the Federal Reserve greater power to expand credit at an ever accelerating pace (at least, it allowed the Federal Reserve to expand credit at an accelerating pace for a longer period of time), which allows it to postpone the greater amount of the necessary defaults to happen. Ultimately, they postpone the clearing of the market, which is of utmost necessity. It's like pumping bacteria into a body which has already heated up in an effort to rid itself of the harmful organisms.
Smiling Dave:Why does it do it like that? Why can't it just buy whatever it wants, say tanks and guns, and pay for it by putting money into the weapons company's account? Who needs the banks?
A new $100 to the weapons company's account is just $100 plus to the money supply. But a new $100 to banks is usually more than just the $100. It gets multiplied so many times, based on the reserve ratio. For example, a 10% ratio would mean the $100 would add $1000 to the economy's money supply.
So basically it depends on the goal of the central bank.
First of all, you have to understand that the money supply is broader and more abstract than paper money. In fact, the amount of paper money in circulation has no effect on the money supply. There are several measures of the money supply, including M1, M2, and MZM. All of these include checking accounts. When you pay a bill by check, the payment is transferred directly from your account to the account of the person or business that you paid. There is no paper money involved. The only function of paper money is to satisfy the demands of branch bank customers who visit the bank and want cash. When cash wears out, the banks send it to the Fed in return for new cash. The Fed shreds the old cash.
A decrease in the money supply occurs when the Fed does the opposite of what it does to increase the money supply. The Fed sells securities to increase the money supply and buys securities to decrease it. Some measures of the money supply include credit instruments and various investments, and these can increase or decrease with changes in these items. Generally, though, it's Fed open market policy that determines the money supply.
Oops, sorry. The Fed buys securities to increase the money supply and sells them to decrease it.
DougM: Oops, sorry. The Fed buys securities to increase the money supply and sells them to decrease it.
Yeah, even I caught that one.
Since you seem to know alot about this stuff, I want to ask another q. In a Peter Schiff video, he talks about how low interest rates will make people borrow dollars, take them to some other country with high interest rates and make a profit. I think he said that will produce inflation because it means the Fed has to keep printing money to give these people. So they will have to raise the interest rates.
My q is, can't they say "Sorry, piggy bank is empty." Do they have to give money to whoever wants it? Why must they raise interest rates to do that?
Or does he mean that with a given money suppl\y, and a high demand for dollars to use in carry trade, whoever has money to lend will charge high interest, unless the fed counters that by printing money?
I haven't seen the video that you refer to, but I suspect that Schiff was refering to something similar to your last explanation.
There's typically a market-clearing spread between short-term U.S. treasury securities and any other debt instrument. If the spread between treasury bills and euribors (EMU short-term debt) is 20 basis poiints (0.20%) and the Fed FOMC wants to lower the Fed funds rate from 0.50% to 0.00%, they will buy treasury bills. This will increase the price and lower the yield. However, if the yield on euribiors remains the same, the spread between them and treasury bills will be driven above the market-clearing spread. Arbitragers will then take a short position in treasury bills and a long position in euribors, driving the price of treasury bills down and the yields up. In order to counter this, the Fed will have to buy more treasury bills to drive the yield back down.
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