It's NOT our money.(The gov't doesn't need our taxes to spend)

One of the biggest misconceptions I come across everyday is the idea that the government must collect taxes or borrow in order to have the funds to spend and invest. This idea probably comes from most peoples’ self-centered view of finance. They view the government like they view themselves, in that, it is impossible to spend unless you have the funds in hand first.

This does not apply in this case because the government uses its “own” money, which it can create in limitless quantities. The money is essentially IOU’s, which can take the form of Treasuries, printed bills or simply, bank reserves (mere credits to the banking system).

Moreover, there is no constraint to how many of these IOU’s the government can issue, as stated above. Constraints can only be self-imposed, like when there is a desire to achieve “balanced” budgets or, when policymakers feel that too much spending is creating inflation. At that point they might decide to slow spending. However, these constraints are political in nature, not operational constraints.

The government can spend all it wants of its own currency and usually does so even before one cent in taxes is ever collected or before a single security is ever sold. Indeed, that is the only way that deficits can exist in the first place: the spending is done first and in greater quantities than what comes in, hence, the deficit.

Think about it: If the government first collected taxes and sold securities, there would be no deficit because it could be said to be operating on a “pay as you go” system.

Why, then, does the government need to collect taxes and sell securities if it can spend all it wants of its own money? Because doing so would quickly lead to hyperinflation. Government spending, if left unchecked would swell bank reserves beyond the Fed’s control and cause money supply to grow very rapidly. In order to prevent this, the government collects taxes and sells securities as a means of draining off some of the excess liquidity pumped in by all of the spending.

Therefore, we can correctly state that “the money to pay taxes and sell securities comes from government spending.” It’s not the other way around.

Next post: Enforcing the collection of taxes as a means to give the government’s money value.

The "stealth" gold standard

Lots of people think we ought to go back on a gold standard because that would limit the government's power to create inflation by debasing the currency.

As uncomplicated a solution as that may sound, there are many pitfalls to a gold standard, like not being able to stimulate in times of recession or worse--depression.

The fact is, in today's modern global economy the notion of going back on a gold standard is dismissed by most economists as not being practical.

But is that how they really think?

Back in 2005 then-Fed Chairman, Alan Greenspan, had an interesting exchange with Representative Ron Paul while testifying on the state of the economy.

Paul asks Greenspan why central banks and governments around the world still hold huge amounts of gold if there is no longer a gold standard?

Greenspan's answer is instructive.

"...since the late '70s, central bankers generally have behaved as though we were on the gold standard. So that the question is: Would there be any advantage, at this particular stage, in going back to the gold standard? And the answer is: I don't think so, because we're acting as though we were there."

The world may not be on a gold standard, but central banks are still acting as if we are!

That entire exchange can be found at the link below:

http://www.usagold.com/gildedopinion/greenspan-gold.html#anchor2005

Speculators at the Pump

Economist Thomas Palley has a great article about speculators and their impact on oil prices. He argues that there is strong evidence that speculation is driving up prices, and therefore, "policymakers must act to rein in behavior that has imposed huge and needless costs on the global economy."

As many of you already know, I totally agree with this view.

You can find this article, along with other great articles, on his blog (www.thomaspalley.com), or just click on the link below to read:

http://www.thomaspalley.com/?p=118#more-118

What happened to the stimulus?

We know from looking at second quarter GDP that about $30 billion of the $168 billion stimulus was spent, and that had an overall positive effect on consumption. But the question is, what happened to the rest? The answer is, it went into savings. Take a look at the chart of personal savings below.

It ballooned to $285 billion in Q2, mostly because of the money the government sent out to people. So the stimulus was far from a "one-shot-deal" as many like to say. It remains in the economy like potential energy, and over time, it will likely be spent. Even when it is spent, it still won't go away. Instead, it is transfered from consumers to firms, who then hire, spend and invest themselves and the cycle continues. Think of it like a stone being tossed into a still pond. The splash creates ripples that start off big and continue in a diminishing fashion over time. Even though we don't see them after a while, their effect on the water is still occurring.

Questions from a Biz Radio listener

The questions from the middle class/middle America are.


> > 1) Is the pressure to keep the dollar from rising mostly aimed at > reducing strain on the big three domestic autos> > until they stabilize? Is this cheaper than direct aid? Easier to hide?

PERHAPS, AT LEAST PARTIALLY. MANUFACTURING INDUSTRY LOBBY SEEKS COMPETITIVE BOOST VIA LOWER DOLLAR EXCHANGE RATE. POLICY SEEMS TO BE INFLUENCED BY THIS.


> > 2) Question for YOUR trader knowledge base. Has naked shorting been > illegal all along? Should the spotlight be turned> > on enforcement? Would new laws or regulations just be ignored as well? > Could the media at least clarify why it continues> > if it is not legal and demand enforcement?

FROM WHAT I UNDERSTAND, YES, IT HAS ALWAYS BEEN ILLEGAL. ENFORCEMENT IS INCREASING, BUT GRUDGINGLY, IT APPEARS.

> > 3) How can brilliant people ( Art L./Dan F.) say we should "don't > worry, be happy" and just buy energy from OPEC because> > they are good at producing and we are good at consuming? Do you buy > your ammunition from people who want to> > kill you just to get a discount? Energy IS ammunition!! No! It is more > important than ammunition.

ALL THINGS BEING EQUAL, IF IT WERE A PURELY COMMERCIAL RELATIONSHIP, DAN F. AND ART L. ARE RIGHT (AND BOONE PICKENS, WRONG) WE SHOULD BE BUYING FROM OPEC FOR THE REASONS THEY SITE. HOWEVER, IT IS NOT PURELY COMMERCIAL: THERE ARE REAL IDEOLOGICAL DIFFERENCES THAT MAKE IT A DANGER TO NATIONAL SECURITY. THAT IS WHAT WE ARE "FUNDING."

> > 4) Most of us off wall street folks could get behind some form of > assistance for financial's if we heard more conversation> > about what would come after. Business as usual? Are the same people > already working on the next scam?> > Many wallstreet indians may be suffering but the chiefs who stole the > apples remain in place, or leave with more than> > enough booty to open up a new scam across the street.> > As for the point of B. Sterns goes down, I will feel it in my middle > class life..... I already do... Commodities went up,> > disrupting my life and business because money fled from financial's. It > had to go somewhere. I had to make dramatic> > adjustments.. Just tell me what will change on wall street and who will > change it.

ASSISTANCE IS NECESSARY BECAUSE OF THE SYSTEMIC RISKS THAT WE NOW FACE. IN THE FUTURE, GREATER REGULATION AND OVERSIGHT SHOULD PREVENT THESE EVENTS OR KEEP THEM TO A MINIMUM. AND, (DARE I SAY THIS), WE SHOULD RETHINK TAX POLICY THAT ENCOURAGES THIS TYPE OF SPECULATIVE EXCESS.

> > > Sorry about the venting... Thanks A. C.

The U.S. IS "fiscally responsible."

The national debt is $9.4 trillion and that is a big number, to be sure. Yet, when viewed as a percentage of GDP it is far lower than where it was at the end of WWII. (See chart.)








And the debt held by the public is actually shrinking and is now at the lowest level in 24 years as a percent of GDP

Lieberman to propose ban on index speculation by institutions

Lieberman's Senate committee will hold hearings on this subject on June 24. Here is an article that covers it in the New York Times:

http://dealbook.blogs.nytimes.com/2008/06/12/lieberman-seeks-limits-to-reduce-commodities-speculation/#comment-285680

You can contact Lieberman's office and leave a comment by following this link:

http://lieberman.senate.gov/contact/

CNBC Poll: Should government ban speculation

A CNBC poll that asks the question, "Should the government bar big institutions from investing in the commodities market?" shows that 60 percent of the respondents say, "Yes," while 34 percent say, "No." (4.5 percent say, "Not sure yet.")

Poll: http://www.cnbc.com/id/25119026/site/14081545/

While there is a majority in favor of the ban, it is not overwhelming. This suggests to me that there is only grudging belief that speculation has something to do with the problem.

The bigger the trade deficit, the better!

Tell me, do you grow or gather your own food? Do you make your own clothes? Did you build the home that you live in or generate the electricity that runs it? Do you proide your own medical care or legal services? Do you make the movies that you watch for entertainment?

Well if you don't do some or all of these things then you probably run a deficit of trade with the many vendors, producers and service providers that provide you with the stuff you need to live your life.

Yet, you don't call it a "defiict." You call it the normal course of doing business and the normal course of living your life. On the other hand, if the United States, as a country does this with its trading partners, we call it a deficit and it's seen as bad.

On the micro level it's probably very easy for you to understand. The reason why you don't grow your own food or make your own clothes or build your own home or provide the myriad other goods and services you need to live your life is because it is far more efficient to have someone else do it. That allows you to do what you do best: work at your chosen profession and earn an income.

If we still made and produced all of those things ourselves, we'd be living as the cavemen did tens of thousands of years ago. I'd venture to say that no matter how bad you think things are, you would agree that your standard of living beats that of a caveman. (No offense to those loveable Neanderthals from the Geico commercial.)

We run a deficit of trade with the rest of the world for the very same reason that you run a deficit of trade with your local grocery store. It is far more efficient for us to buy the goods and services produced by nations like China, Japan, Korea, Taiwan and elsewhere than it is to make it here. It saves us time and money and allows us to go about what we do best: build the world's largest economy based upon technology, information, service and finance. They build the cars and make the textiles, while we write the software programs that run their modern factories. We also find them the capital that allows their economies to grow.

In the micro example no one complains that running a deficit of trade with the local grocery store is a bad thing. Moreover, the wealthier a person is, the bigger that person's deficit of trade probably is. He or she is buying far more food, clothing and shelter along with health care, leisure, education and other things than the average person. In fact, one could look at the size of an individual's monthly deficit and surmise just how wealthy that person was.

On a macro level, however, that perspective is somehow lost. As a nation we believe that it would be better for us to toil away producing basic necessities, so as to not give that "advantage" to someone else in a foreign country. That's crazy.

Adam Smith said that a nations wealth was not merely measured by the gold or silver (money) that it held, but also by the abundance and affordability of its consumables.

Smith argued that imports were a benefit and exports were a cost: "The man who buys, does not always mean to sell again, but frequently to use or to consume; whereas he who sells, always means to buy again."

In countries that rely on exports, land, labor and capital are used to provide finished goods, which are then sent out of the country to foreigners, for them to consume. But the exporter will then have to buy these items for himself. The importer (or buyer, in Smith's example) gets the benefit of owning and using these items the first time around.

Adam Smith knew that a nation's trade deficit was a not a reflection of how poor it was, but how rich it was. We seem to have forgotten that important lesson and in our zeal to "reduce the deficit" we will make ourselves poorer and lower our standard of living compared to the rest of the world.

Monetary policy and inflation

The current price pressures we are feeling are rooted in oil. Oil prices have been rising on a combination of factors: limited spare capacity, strong global demand, monopolistic forces (the Saudis and the Russians) and index fund investment. Furthermore, we linked the price of food to oil as a result of the biofuels policy.

Just as the Fed did not create the global tightness in the oil supply as a result of low interest rates, it will not cure it via high interest rates. There will not suddenly be new discoveries of oil if the Fed puts the Fed funds rate back to 5.25 percent. And raising the funds rate to 10 percent will not cause the world to be awash in oil.

The Fed will, however, destroy the economy if it reverses course and hikes rates. The cure will be worse than the disease.

Please read Joseph Stiglitz's eye opening article on the failure of inflation targeting. Professor Stiglitz is the 2001 Nobel Prize winner in Economics.

http://www.project-syndicate.org/commentary/stiglitz99

Dollar and oil

The media and most mainstream economists will have you believe that there is a link between the weak dollar and the price of oil The fact of matter is, there is no link whatsoever. The price of oil is dictated by one thing: supply and demand.

The current, $135 per barrel price is there because demand is higher than supply, pure and simple. That would be the case whether the price of oil were quoted in euros, yen, renminbi, British pounds, or any other currency. Even if the price of oil were quoted in Beanie Babies, it would still take the equivalent of $135 worth of Beanie Babies to buy one barrel because of supply and demand factors. (I'll leave aside the discussion of demand for now--whether it's real demand, i.e. related to what is being used for consumption, or investment demand, which is where a good chunk of the "new" demand is coming from.)

Many mainstream thinkers believe that the rise in oil prices has to do with the Fed or U.S. Government fiscal policy. It doesn't. A falling Fed funds rate and a fiscal deficit did not create a global shortage of oil. It's true, however, that both may be contributing to slightly higher levels of demand but not enough to explain the current price.

If a weaker dollar has been an outgrowth of the Fed's monetary policy, that, too, has not been responsible for the rising price of oil. Case in point: Oil quoted in euros has risen too, even though the euro has doubled in value against dollar in the past six years and the ECB maintains relatively tight monetary policy. Moreover, in other countries where monetary policy has been restrictive, such as China, oil prices are on the rise as well.

In fact, one could argue that a declining dollar is actually bearish for oil. Since oil is quoted in dollars and the United States is the world's biggest oil consumer, a decline in the dollar, by definition, would mean that U.S. purchasing power is reduced and therefore, less oil is consumed, putting downward pressure on the oil price. If I am the biggest collector of Beanie Babies in my neighborhood and I suddenly experience a big loss to my income, the price of Beanie Babies should not rise. If anything the price should come down or stay the same. Same thing should hold true with oil, but it doesn't.

Some might conclude that while the U.S. would experience a loss in purchasing power because of a decline in the dollar, other countries would simultaneously gain purchasing power (as other currencies appreciated vis-a-vis the dollar), enabling them to buy more oil. This is true, but the net change in demand due to currency adjustment would be zero, so there should be no price effect. Oil has, however, continued to climb.

To repeat: prices are determined by supply and demand and demand trends related to exchange rates (as opposed to economic growth rates, investment, etc) have no net effect.