Money Creation.

Discussion in 'Share Investing Strategies, Theories & Education' started by dunno, 7th Aug, 2020.

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  1. dunno

    dunno Well-Known Member

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    The mechanics of money creation seems to me to be a hugely misunderstood topic.

    Ben Felix does a good job as he normally does in explaining it properly. This should be mandatory viewing (and understood) for so many people before the write such misinformed crap on the subject.

     
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  2. kitdoctor

    kitdoctor Well-Known Member

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    He nailed it. The risk few are discussing is price deflation, the value of assets declining in an environment where few want to borrow.
     
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  3. bkiat

    bkiat Member

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    Pretty good video, thanks for sharing. The currency's purchasing power also needs to be considered when thinking about inflation and deflation


     
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  4. oracle

    oracle Well-Known Member

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    Thanks for the video

    So if all the new money is product of issuing new debt and central banks quantitative easing steps is infact not printing more money.

    Can it be said that all the recent fiscal stimulus by the government by borrowing more money and issuing bonds is creating new money since it is new debt? And it is the central banks that are mostly purchasing government bonds so are helping with new money creation. Or have i misunderstood?

    Cheers
    Oracle
     
  5. bkiat

    bkiat Member

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    Quantitative Easing IS printing money - The money being used to buy government bonds came out of thin air

    If bond yields are low, and there's plenty of liquidity in the system coming from QE, surely there is an impact on asset and equity prices as this money chases yields and returns

    Lowering interest rates and QE are monetary policies used in deflationary shocks, so while the part about deflation may be true, you could most certainly have inflationary depressions as well
     
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  6. mtat

    mtat Well-Known Member

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    They're not using money to buy those government bonds. Watch the video in the OP.

    New money won't be created until the banks lend to credit-worthy borrowers.
     
  7. oracle

    oracle Well-Known Member

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    Let's say the Jobkeeper and additional Jobseeker payments the government is currently making to people is borrowed money the government got by issuing bonds. Is that not new money? Isn't credit worthy borrower here the government, right?

    Cheers
    Oracle
     
  8. blob2004

    blob2004 Well-Known Member

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    From my understanding jobkeeper and jobseeker are not monetary policy but fiscal policy.

    The video only talks about monetary policy, which involves QE. The government creates bank reserves out of “thin air” to buy bonds and create liquidity, but this money does not flow into the private sectors until people borrow them out of banks. This is why there has been no inflation with QE; it is the amount of borrowers that determine the “money printed”, which are typically reduced in this sort of environment. I think in a sense you could say the government is printing reserves that don’t necessary become money in the system.

    With regards to fiscal policy, yes the government is giving money out with jobkeeper and jobseeker but it is a debt they have to repay. It is not money printing as they still have to pay those who have bought the bonds. Money printing would be creating money out of thin air and handing it out, without the need to pay it back.
     
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  9. oracle

    oracle Well-Known Member

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    Ok maybe I am not fully understanding. I just want to understand the new money creation process. Irrespective of whether it is monetary or fiscal policy my understanding after watching the video is to create new money you need to issue debt.

    These bonds the government is issuing part of their fiscal policy which the RBA is most likely buying to keep long term interest rates low. Isn't the RBA creating money out of thin air to purchase these government bonds? How is the RBA funding these purchases?

    Care to elaborate how this process works? Government when it issues bonds it can then go and spend the money on infrastructure, handouts etc. So that is real money Government just got. If private investors purchased these bonds that is probably from their savings. But what about central banks purchasing these bonds?

    Again I am confused here, ultimately all debt needs to be repaid (unless written off). If I go out and borrow money to buy a house or expand my business I still have to pay the money back to the bank. How is that process creating new money whereas when the Government does the same thing going out borrowing money to spend in the economy which they also need to repay not creating new money?

    Cheers,
    Oracle.
     
  10. blob2004

    blob2004 Well-Known Member

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    Hey @oracle , I will try my best to explain what I think it is - although I may be wrong. I am far from knowledgeable in this topic, just interested in the discussion. This is just what I got from the video and the rational reminder podcast.

    So when the RBA/Fed is buying bonds for monetary policy - it does not pay money, it gives the private bank "bank reserves" so it can settle at the end of the day and have liquidity. It is effectively an asset swap, no new money has flown into the private system and hence no money created. When the Government issues new debt for fiscal policy (jobkeeper/jobseeker), it creates bonds/treasuries/bills etc and the private bank sector buys them, and new money is created as it is lent out to the government.

    So I think you are right, fiscal policy by the Government does indeed create new money, although monetary policy by the Fed/RBA does not. Hence fiscal policy should create inflation (and this is what the central bank also wants to achieve anyway in this deflationary environment). However the argument is that once the deflation crisis goes away, the Government can stop issuing debt and curb spending, while paying down it's debt with taxes, hopefully leading to only moderate inflation.

    My 2c, need other experts to clarify.
     
    Last edited: 15th Aug, 2020
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  11. dunno

    dunno Well-Known Member

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    Hi @blob2004. Got a bit of the processes in your post back to front, but hey money is a ***** to get a proper handle on. Admitting you don't understand it is a great basis from which to start gaining an understanding.

    Government sells bonds to anybody BUT the RBA. This breaks the direct link of government being able to spend from printing currency.

    When Gov’t sells bonds, they are bought using existing money thus draining money from the system. When the government spends or makes welfare payments using the proceeds from the bond sale it replenishes the money supply. Net result (after bond proceeds are spent) is no impact on money supply but importantly for the underlying physical economy there is a transfer of liquidity from those with a propensity to save to either direct govt spending or transfer to those with a propensity to spend. (welfare). Ie this is Fiscal Demand stimulation.

    The RBA buys bonds at arm’s length in the secondary market as part of non-conventional monetary policy in order to move towards its objective of price stability (inflation range of 2-3%) and full employment. Funding the gov’t spending is coincidental to managing monetary policy objectives.

    When the RBA buys Bonds the money supply is expanded. IF the RBA later sell it would contract the money supply. The RBA expansion and contraction of money supply through its balance sheet is not to the same scale as the expansion or contraction of private debt movement, It uses its balance sheet to buffer some of the volatile movements in private debt creation and interest rates to influence the private creation.

    When supply overwhelms demand like it basically has since GFC a lot of the RBA tools are like pushing on a string – zero interest rate – and demand is still not absorbing the capacity. Its times like this I believe that MMT suggest that Gov’t can step in to spend all spare capacity and keep the physical economy from shrinking. That would take a lot more aggressive expansion of the RBA balance sheet than what is currently occurring. Or it would take doing away with the debt creation element of raising bonds to cover non-tax funded spending. (true helicopter money).

    Merits of MMT and how it would operate is a whole other discussion. Despite the recent commentary central banks are nowhere near adopting it. Governments are spending (or transferring) more aggressively which seems MMT like but are they converts or reacting to a unique situation and trying to fund hibernation rather than absorb excess supply. Will there even be any excess supply left after Covid? Could be a return to the old supply deficient world where interest rates start to rise, and all those debt holders need to get productive to pay the interest bill. Good old-fashioned central bank tools start to pull on the strings again. Then again maybe technology makes everything abundant and no one needs to work again rendering positive interest rates and their ability to promote new supply, permanently redundant. I knew there was a reason I shouldn’t start a post on money, I’m sure I’m now sidetracked from where I started this post and the head spins at the range of future possibilities for what money could become.

    I have found the best way for me to get any sort of grip on the big big picture of money is to come at it from money is unimportant, the physical economy is important and drives what governments do with money. Most people think of it the other way around which for me is the tail wagging the dog and they draw all sorts of wrong conclusions which don't stand if they did more research. Most importantly, if the value of one needs to diminish to protect the other. Money will always be the loser. History hasn’t been kind to money as a store of value but the physical economy has done well. Money also works well for transactions, or at least the digital expression of it does. In the big picture you could say money has served its purpose well so long as you haven't tried to use it as a store of value.

    At the end of the day though, I'm just a simpleton in this complex world, so I just invest in productive equity as soon as I have any surplus and leave the hard stuff of investing in money and derivatives of it to those smart enough to understand how it truly operates and how it is evolving.
     
  12. bkiat

    bkiat Member

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    Hi @oracle, I'll have a go. I think we're all saying the same thing in a roundabout sort of way. When interest rates are lowered, this stimulates lending (which creates new money). When Central Banks buys bonds, they do so using newly printed/created Bank Reserves unless there's a budget surplus (and there definitely isn't!).

    I think the video is simply making the distinction that money being created everyday is a routine part of writing loans. This is not, however, what is referred to when Central Banks use the term 'Quantitative Easing'.

    I am also just a guy behind a keyboard learning how the economy works, so I could most certainly be wrong !
     
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  13. kitdoctor

    kitdoctor Well-Known Member

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    Did I get this tiny bit right about the video? I'm sure one process described was that when a central bank creates extra "bank reserves" this "money" does not actually find its way into the economy and therefore it can't be said this process provides the money that banks lend to customers and taking this further this money is not linked to the increase in price of assets like property, shares etc. (This process is not the process whereby governments borrow money to fund their spending).
     
  14. kitdoctor

    kitdoctor Well-Known Member

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    Be mindful many of us (and the general population and commentators) use the words inflation and deflation incorrectly. When they use these words they really are referring to price inflation/deflation, the effects of inflation/deflation.

    Going forward, I see more of the same, price inflation of some consumer essentials (e.g. energy, health care costs, food), price inflation of property and other assets but eventually price deflation of property and other assets is coming with the next worldwide economic collapse.
     
  15. dunno

    dunno Well-Known Member

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    No, the central bank creating reserves (depositing into Exchange Settlement a/c in RBA’s case) does create money.

    The private bondholder has swapped his promise from the government to redeem in the future for cash today. That cash can now slosh through the economy

    As far as money creation goes there is no difference between a central bank creating a deposit against a promise and a domestic bank creating a deposit against a promise.

    When the government originally sold its promise to the private investor, no money was created because the private investor had to withdraw money from his account to deposit into the government’s bank account.

    The process of money creation seems to be unnatural and intuitively misunderstood by most. But It probably doesn’t matter.

    I think it is the Austrian school of Economics whose theories place most emphasis on money supply as a driver of inflation or dis-inflation, other economic theories place varying levels of importance on money supply. Personally, I think it has little relevance – Money velocity (or the amount money turns over) is not observable and also not stationary. If velocity increases, money supply can fall and vis versa without creating monetary impacts. I think generally the RBA is just right sizing money supply to suit changes in the physical economy.

    What changes the physical economy is the real question? Certainly, price of money which RBA has control of through interest rates has some impact. But end of the day price signals don’t seem to account for all of people’s propensities to save or spend, be productive or not. I think wealth differentiation (inequality) has a huge impact on this ‘collective’ propensity as does an X factor of us being “humans”.

    Price stability (inflation) is a mystery. I’m pretty sure the answer doesn’t lay in any current theory of money supply, so what matters if you don’t understand money supply economics fully. More important insights probably exist in understanding us weird arse humans and our propensity to chase stuff, seemingly at any price at one time and bunker down in fear at others.

    If you are trying to gauge future price stability through the prism of money supply I suspect there’s a decent chance of getting blindsided at some point, so it’s got me buggered how people are so certain that we are in a low and stable interest rate environment for a long time. Obviously, they know something that I dunno.

    Was it you @kitdoctor that had an interest in charting more abstract socio-economic trends. Probably more value in that than a study of the dismal arts of economics.
     
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  16. Beano

    Beano Well-Known Member

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    Can we simplify it
    On a island there are three people
    1 who fishes
    1 who is the boss and only gives orders
    1 who grows potatoes

    One day a virus hits the island and they cannot grow spuds anymore
    With one less productive person no matter what the boss does he cannot create anymore food (fishes)

    Overall there must be less food to share than before even if the "boss" issues bonds for fish and chips:p


    Epilogue
    Ten years later the virus is gone
    1 potatohead goes back to work
    The boss is still the boss
    The fisherman is still fishing and he has a box full of bonds (issued by the boss ) that can be redeemed only for fish and chips

    Moral
    The productive people are the only ones who can pay
     
    Last edited: 18th Aug, 2020
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  17. bkiat

    bkiat Member

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    Hi @dunno, I'd like to offer you some of my thoughts and pose to you some questions. With your background and knowledge, you may already know some of this anyways.

    When you say you focus more on the physical economy, I assume you are referring to personal productivity, and GDP.

    You are obviously familiar with debt cycles. Debt pulls forward future demand, boosts productivity, income, demand and so forth, until that debt cannot be supported and has to be repaid. This is why we have cycles. You probably already know that pushing on a string is a tool used in the latter stages of a debt cycle.

    Given Australia's unemployment rate is expected to hit almost 10% by year end, I can't see demand going back to post-Covid levels anytime soon. Which means there will be oversupply, deflation and probably low interest rates for the short term.

    While its revenue is shrinking, the government is adding debt like there's no tomorrow on top of a structural deficit that's persisted even in boom times, Since 2010, the government debt has increased from 147B to 684B (365%) for 20% growth in GDP. This adds to what Jeff Booth is saying in how much debt is being used around the world to resist deflation.

    I guess what I'm thinking is, it's looking pretty messy.

    The only way the RBA can meet their inflation targets, if they refuse to let the economy go into recession, is to print, print, and print. If they stop QE, the market will collapse. Australia's private debt is over 200% of GDP. The government's is 45%, and growing. Eventually, we may really end up with an inflationary depression.

    I am nowhere near as accomplished an investor as yourself, nor as knowledgeable. Just a guy who's been on the sidelines for a long time feeling something's not right, and trying to figure out how all these moving pieces are going to come together.

    Would be interested to hear your thoughts, or anyone else's. I could be totally misreading the situation.
     
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  18. bkiat

    bkiat Member

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    Hi @kitdoctor, on top of what @dunno has already said, which I agree with, the thinking is that the money created from QE (so far) is flowing into and inflating asset prices. This creates a wealth effect and benefits those who have assets. Hence why there has been negligible CPI inflation so far
     
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  19. Omnidragon

    Omnidragon Well-Known Member

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    The purpose of the system involving the boss and the bonds is to entice the other two people back to work. But if they both become crippled, no amount of bonds will increase the potatoes or fish and chips on the island
     
  20. kitdoctor

    kitdoctor Well-Known Member

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    The bit that got my attention was at 14:41 in the video.