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7 responses to “Inflation and Counterfeit Credit, Report 19 Nov 2017”

  1. You have the right definition of inflation for sure.

    But this part leaves me curious:

    “The government is in debt up to its eyeballs, the banks, the corporations, the small businesses, the homeowners, the students, the car owners, and even the consumers with credit cards and the former students who attended university in the last decade or two. Everyone owes. Everyone relentlessly bids on the dollar with whatever they have.”

    How is borrowing dollars putting a “bid” on the dollar?

    It seems much more akin to short-selling the dollar. The borrower of dollars is a *seller* of dollars, not a buyer.

    The person who gives up a good or service in exchange for these newly created dollars is a buyer of dollars, yes. But when they accept this subsidized credit creation as payment, they tend to offer a lower bid on the dollars than they otherwise would. (Meaning, they are generally able to demand dollars for the same good or service, all else being equal.)

    Since nominal dollar price is less of an object to the borrower (or short seller) than it would otherwise be, the dollar buyer (or merchant) is able to charge a higher price than they otherwise would, therefore bidding by less for each dollar.

    This clearly must have the effect of increasing the price level from where it would otherwise be–even if the change in the nominal price level is 0%. If the price change is 0% but would otherwise be dropping by 10%, this is an effect of the inflation.

    You are correct to note that there may very well be a powerful short-term “short squeeze” of the dollar short-sellers (aka borrowers) because there are not enough dollars to ever repay all dollar debts.

    But as soon as that occurs, it is almost guaranteed that new credit would be created with increased fury. This practically guarantees that goods and services will continue to cost less in dollars than they otherwise would over the long term.

    That said, positioning oneself to remain solvent in the next dollar short squeeze seems appropriate. Expecting that short squeeze to last for very long however, does not.

  2. Keith, I may sound stupid asking this question but here goes. When you say in your piece, “Like any bank, the Fed borrows to fund its purchases of interest-paying assets. It earns a spread between what it pays (currently about 1.25%) and what its asset portfolio pays (over 2%)” where exactly does the Fed borrow the money and from whom? My understanding, and I freely admit that my understanding could well be flawed, is that the Fed does not have to borrow existing funds to “purchase” assets such as interest bearing treasury or agency notes or bonds. The Fed may agree to pay interest on excess reserves but it is not obligated to. Where did you get the 1.25% that the Fed pays to “borrow?” What stops the Fed from purchasing interest-paying assets of the U.S. government, and then returning the payments back to the U.S. government?

  3. Thanks for the comments.

    Justin: The borrowing itself is a short dollar position (with long dollar income). But the borrowing is history. Now *servicing* the debt is a bid on the dollar.

    There was a time when producers had pricing power. That time was when interest rates were rising, after WWII through 1981. Today, they do not.

    Brad: The Fed can issue new credit to buy its assets. The fact that most people call this not credit but “money” does not alter the nature of the transaction or of the credit. It just makes it harder to understand. I wrote two articles on this which shed more light:
    https://snbchf.com/gold-standard/money-printing/
    https://snbchf.com/gold-standard/who-lends-to-the-fed/

  4. Nice explanation of inflation! But You wrote “In legitimate credit, the borrower has both the means and intent to repay. But clearly in the case of perpetual government deficits, these elements are lacking. This is inflation.“ So far so good. Government is able to repay its debts by taxes. We can oppose that gov. does produce nothing just always redistributes someone´s else economic outcomes however it provides some services today which we can presuppose will be produced on market as well (some services are probably valuable for society – we do not know maybe the exact rage and we can question effectiveness and we can discuss which one is and which one is not valuable but it cannot change the presupposition – it follows from the fact that almost every action of men is somehow mixed-up with some public intervention today). It follows that gov. provides some value. Once we presuppose this it is possible to presuppose that some of the gov. borrowing should be ok. So how do we recognize which part of the borrowing is connected with “no intention to repay” and which one is at least somehow legitimate? The existence of deficit need not be the criteria. And is not this the same with private sector (not to mention that some of the activates which is exclusively provided by private sector will not exist on the free market due to the fact that now it is some sort of regulation which force you to buy some of this services)? One way or another It seems to me that we can only know answers ex post. There is no possibility to know it ex ante. Does not this erode your definition of inflation or “no intention to repay” could not be connected exclusively with government? I would say. Consider this as “loudly” thinking. matus

  5. “Like any bank, the Fed borrows to fund its purchases of interest-paying assets. It earns a spread between what it pays (currently about 1.25%) and what its asset portfolio pays (over 2%).”

    Is this 1.25% the interest that the Fed pays on short term deposits? And the 2% what it earns on its bond portfolio?

    In effect, doesn’t this mean: the lower the interest rate on government bonds, the lower the ceiling on the Fed’s short term deposit rate? I assume this also limits the short term lending rate (the Fed funds rate), since a spread between the short term deposit and short term lending rate would seem odd (although I’m not sure).

  6. “The government does not set the value of the dollar. And it has no mechanism to set it.”

    This is simply not true. The Fed is the government’s creature and has the ability to flood the world with dollars and thereby devalue it, and it will do so if the government tells it to do so. The time will come when this is necessary to deal with the unfunded liabilities of SS and Medicare; they may hesitate but they will do it.

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