[jmherbener]

There is a mercantilist fallacy at work according to which trade surpluses (more exports than imports) are good for our economy and trade deficits (more imports than exports) are bad. Trade surpluses mean more domestic production and employment and trade deficits less domestic production and employment. By artificially devaluing one’s currency, exports become cheaper for foreigners and imports more expensive for domestics,

Of course, economics demonstrates both domestics and foreigners are better off with a natural division of labor. Any government intervention shifts resource uses into less economizing patterns. Trade deficits and surpluses, then, have nothing to do with overall production and employment. Prices adjust so that resources will be used regardless. If the U.S. devalues the dollar to stimulate foreign purchases of domestically-produced cars, then labor, steel, and other resources will be reallocated away from more valuable lines of production into automobiles. Also, the effect of devaluation is temporary. If the money stock is increased it may devalue the currency sooner than it decreases the domestic purchasing power of the currency, but the two tend to conform.

The article seems to be claiming that it isn’t devaluation per se that different governments are aiming at but stimulating production by quantitative easing and that devaluation is a happy by-product for some of them. Each government is trying to avoid the dreaded price deflation by inflating its money stock (thus, stimulating production by pushing prices higher), but only some currencies get the extra stimulus to production (in the form of trade surpluses) of currency devaluation.

[jmherbener]

Rising interest rates will collapse the capital value (i.e., the market price) of assets banks hold. If they have existing T-bonds at 3% and interest rates on newly issue T-bonds rise to 6%, the price investors will be willing to pay for the 3% bonds collapses. When that happens, banks become insolvent.

[jmherbener]

2. The money went to non-bank institutions, like Fannie Mae, Freddie Mac, and AIG and foreign banks.

3. Banks are less eager to lend than in normal times. But as the Fed bailout improves their balance sheets, they will return to a more normal outlook on issuing fiduciary media and creating credit. At that point, the Fed will have to drain the excess reserves to prevent significant monetary inflation.

[jmherbener]

Entrepreneurs will provide the spectrum of quality that people’s demands make profitable. The spectrum will range from used goods to tailored made. If your friend is noticing a deterioration of quality in the clothes, phones, cars, and so on she is used to buying, it might just be a change in brand positioning by the entrepreneurs whose products she frequents. It’s likely that there are higher quality brands available.

Though it’s an empirical not theoretical question, one would suspect that as standards of living rise, people’s demands would skew towards higher quality and so entrepreneurs would adjust production accordingly. Government policies that make us poorer, then, would tend to reduce quality. This effect will likely be specific to markets which government intervention burdens more heavily. If the government imposes costs on producing certain goods, entrepreneurs react by lowering other costs, including perhaps buying cheaper, lower quality inputs. Price inflation works in a similar way on product quality. If an entrepreneur is producing a good for which input prices are rising faster than output prices, then he may lower the quality of his product or the size of a unit of it to best adjust to people’s demands. But the effect of rising prices on quality comes from the disproportional increases in the prices of different goods and not price inflation per se. If all prices rose in proportion, then, entrepreneurs would make no adjustments in production.

[jmherbener]

Further monetary expansion during the bust may not increase the discrepancy but instead delay liquidation and reallocation. What I was referring to was further monetary expansion during the boom which lengthens the production structure beyond what less monetary expansion would do.

[jmherbener]

When people lower their time preferences, they save and invest a larger proportion of their incomes and consume a smaller proportion. Their reduced demand for consumer goods lower their prices, which reduces the demand entrepreneurs have for producer goods used to produce those consumer goods. Losses in these lower- stage production processes are balanced by profits in higher-stage production processes. With the additional investment funds, entrepreneurs will buy capital goods that prove profitable by satisfying the patterns of consumer demands that emerge in the future. Their additional demand bids up the prices of these capital goods making their production more profitable, which makes the production of higher-stage capital goods more profitable. The entire production structure of the economy lengthens in response to lower time preferences.

Monetary inflation and credit expansion increase the supply of credit and push down interest rates, but the proportion of saving-investing to income has not risen and the proportion of consumption to income has not fallen. Any lengthening of the production structure will prove to be malinvestment because people’s time preferences will not make it profitable in the future. Fed monetary policy causes an inter-temporal misallocation of resources.

The further the misallocation proceeds, the greater the divergence between the lengthened production structure and people’s time preferences. That’s why more monetary inflation and credit expansion cannot restore normalcy to the economy. The only way to do that is to adjust production processes to satisfy our preferences.

[jmherbener]

Treasuries have varying maturities from 3 months to 30 years. Investors buy them despite longer maturities because there are active secondary markets in which they can sell Treasuries to other investors anytime. Both stocks and bonds have secondary markets making them highly liquid.

[jmherbener]

If you’re referring to the Fed and not commercial banks, then we can look at its balance sheet to see which liabilities increase as it increased its Treasury holdings.

The PP slides on the Fed’s balance sheet are in the lecture on monetary policy.

Here’s the summary:

On Jan. 30, 2003 the Fed held $630 billion in Treasuries (an Asset) against $643 billion in Federal Reserve Notes (a Liability).

On April 4, 2012 the Fed held $1,669 billion in Treasuries and $837 billion in Mortgage Backed Securities against $1,060 in Federal Reserve Notes and $1,542 billion in Deposits.

The Fed has expanded base money from $669 billion to $2,602 billion to buy the additional assets. The Fed’s equity (past “profits” it is holding) rose from $17 billion to $55 billion over the same period. So, clearly, the Fed did not draw down its accumulated “savings” to pay for acquiring the additional assets.

[jmherbener]

Banks pay higher interest rates to borrow from savers than they earn from Treasuries of the same maturity. So, they would suffer losses intermediating credit in this way.

http://www.bloomberg.com/markets/rates-bonds/government-bonds/us

http://www.bankrate.com/cd.aspx

They could, of course, borrow short term and lend long term and earn an interest rate differential. But this is risky and issuing fiduciary media, while also risky, is more profitable.

[jmherbener]

If you total the value of capital markets in the world it comes to $212 trillion. U.S. bonds make up 24% of the total value of all bonds and U.S. stocks constitute 45% of the total value of all stocks. If you want to raise capital, the biggest markets are denominated in dollars. This is the main reason that the dollar is the world’s reserve currency.

http://qvmgroup.com/invest/2012/04/02/world-capital-markets-size-of-global-stock-and-bond-markets/

[jmherbener]

A falling purchasing power of money (or rising prices in general) occurs when the money stock increases relative to the demand to hold money. Although the money stock has been increasing during the past few years, the demand for money has been rising also. On balance, then, prices have not increased much.

Here’s the great economic historian, Bob Higgs, on the topic:

http://blog.independent.org/2012/12/15/more-monetary-peculiarities-of-the-past-five-years/

[jmherbener]

Yes, the U.S. Treasury department has to pay the to the holder of T-Bonds, T-Notes, and T-bills the interest due each period and the principle on maturity. Someone who is holding Treauries can maintain his overall amount by buying more as some of them mature and are paid off.

As you can see from the following chart, China has been reducing its holdings overall in the last few years and now holds around $1.2 trillion:

http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt

Someone who is holding Treasuries can sell them right now for cash in capital markets to other holders or buy Treasuries right now from other holders. But these secondary market trades do not involve the U.S. Treasury directly.

[jmherbener]

Roger Garrison has explained and critiqued Friedman’s argument against boom-bust theories in this article:

http://www.auburn.edu/~garriro/fm1pluck.htm

[jmherbener]

Corporate profits are cyclical, running up during booms and down during busts. The recent recovery in corporate profits has been influenced by Fed expansionary monetary policy.

http://research.stlouisfed.org/fred2/series/CP?cid=109

National income varies much less. So as a percent of national income, profit vary quite a bit.

http://research.stlouisfed.org/fred2/series/NICUR?cid=109

As the charts show, in Q3 2012, national income was $13,912 billion and corp. profits were $1,752 billion. So corp. profits were 12.6% of national income.

[jmherbener]

The losses were realized when the Fed bought toxic assets from banks and other financial institutions paying them cash at face value and putting the assets on its balance sheet. The losses were born by society at large. The investors who were bailed out received new money which they used to outbid others who hadn’t received the new money. These other people bore the loss by suffering a reduced command over resources.

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