Financial topics

[Higgenbotham]

Bernanke may really think that since he is doing it on a computer it will not cause hyperinflation (as you seem to).

Paper dollars and electronic dollars are very different indeed. I can think of many scenarios where electronic dollars either get jammed or wiped out, either by natural or man made forces, and have mentioned that. Once a paper dollar is printed and in somebody's hands, it is quite safe from being destroyed. In no way is that true for an electronic dollar.

Do you think we are safe from hyperinflation because they mostly keep track of money on computers and don't bother printing all of it?

No. The electronic dollars can be destroyed through hyperinflation while the paper dollars become more valuable.

Electronic dollars can be destroyed by an EMP attack. I wouldn't doubt the Chinese or Russians have discovered ways to selectively target EMP. They can be destroyed by a catastrophic or man made Internet lockup. They can be jammed by lockup of the payments system (see many of mannfm11's posts regarding this). They can be jammed by market preference. Or a number of other ways.

[vincecate]

The concept that I'm flirting with is that under today's rules, it's
not only true that hyperinflation WON'T occur, it's also true that
hyperinflation CAN'T occur. The reason that it CAN'T occur under
today's rules is that the money will always flow (like water) to the
best investment opportunities in the world, and will not and cannot
contribute to the local wage and price increases related to
hyperinflation.

It is a fun thought. And interesting argument. A bit mind warping for a time.

But on second thought, I am not sure this is all that different from the "as long as it is the world commerce and reserve currency the dollar will not get hyperinflation". If the dollar stops being the reserve currency it will not be flowing around the world like it is now.

But it will get some more thought.

[vincecate]

No. The electronic dollars can be destroyed through hyperinflation while the paper dollars become more valuable.

Electronic dollars can be destroyed through an EMP pulse attack. I wouldn't doubt the Chinese or Russians have discovered ways to selectively target EMP pulses. They can be destroyed by a catastrophic or man made Internet lockup. They can be jammed by lockup of the payments system (see many of mannfm11's posts regarding this). They can be jammed by market preference. Or a number of other ways.

Oh, right. I now also remember "if there is a long bank holiday then having electronic money in your bank account is not the same as paper money in your hand". In Argentina they froze bank accounts and then devalued the currency and force exchanged your US dollars to local currency without your consent, at exchange rates worse than the day they froze your account. So if you had cash in hand it was much better. Ok, but in anything the US has had up till now was there ever anything funny like these that would make electronic base money different from paper money, or destroyed more?

Nuclear bombs can destroy paper money as well. And electronic data can be backed up in several locations, so it is probably harder to wipe out. Assuming that the Fed computers do normal database transactions that either commit or abort, how does anything on the Internet or some payment system create or destroy money? A key function of a database is to update both accounts or neither account when moving money from one account to another. They are reliable at this.

[Higgenbotham]

The concept that I'm flirting with is that under today's rules, it's
not only true that hyperinflation WON'T occur, it's also true that
hyperinflation CAN'T occur. The reason that it CAN'T occur under
today's rules is that the money will always flow (like water) to the
best investment opportunities in the world, and will not and cannot
contribute to the local wage and price increases related to
hyperinflation.

John

I would say hyperinflation can't move across the whole economic spectrum. There are mechanisms which prevent that.

One mechanism as mentioned many times here is electronic dollars are not legal tender. They are an accepted substitute. The marketplace does not have to accept electronic money and too much electronic money floating around out there could stratify the dollar market. In theory, I believe I can file a lawsuit saying I want legal tender for my stock shares or anything else at settlement. Certainly, any retailer can say they will not accept anything except cash. This has already been done - I've seen it. One chain called Woodman's has/had the world's largest grocery store at the time in Kenosha, Wisconsin. They had a big sign in the front that said in order to keep their prices low, they do not accept credit cards. Credit cards are not legal tender. Nobody is required to take them. No entity is required to accept a check from any other bank or anybody else for that matter.

The way the system is set up, electronic money can funnel through some routes but it is not necessarily interchangeable. It's not the same thing as legal tender at all in an insolvent system. The only thing that closely resembles legal tender is a t-bill.

[Higgenbotham]

Nuclear bombs can destroy paper money as well. And electronic data can be backed up in several locations, so it is probably harder to wipe out. Assuming that the Fed computers do normal database transactions that either commit or abort, how does anything on the Internet or some payment system create or destroy money? A key function of a database is to update both accounts or neither account when moving money from one account to another. They are reliable at this.

Paper money is virtually indestructible. It is diffuse so any conflagration would have to burn the entire earth. A limited conflagration only makes paper money more valuable if a portion of it is destroyed. That would be deflation in action. Electronic money is not diffuse nor is it necessarily discrete. Electronic data can be backed up at an instant in time but that doesn't necessarily make the electronic money flow or the account interactions get updated. Payment system lockup has to do with solvency and what discerning humans will accept as payment. A check drawn on a certain bank or fund where there is a rumor of insolvency doesn't need to be accepted. Once it is known people aren't accepting checks from one or more entities, the system shuts down and the armored car companies will be busy delivering legal tender.

[vincecate]

Nuclear bombs can destroy paper money as well. And electronic data can be backed up in several locations, so it is probably harder to wipe out. Assuming that the Fed computers do normal database transactions that either commit or abort, how does anything on the Internet or some payment system create or destroy money? A key function of a database is to update both accounts or neither account when moving money from one account to another. They are reliable at this.

Paper money is virtually indestructible. It is diffuse so any conflagration would have to burn the entire earth. A limited conflagration only makes paper money more valuable if a portion of it is destroyed. That would be deflation in action. Electronic money is not diffuse nor is it necessarily discrete. Electronic data can be backed up at an instant in time but that doesn't necessarily make the electronic money flow or the account interactions get updated.

So the whole world financial system depends on the data in the Fed computers. If those were taken out there would be chaos. Paper money is in hundreds of millions of locations and far harder to destroy. Ok. I see.

One counterpoint is counterfeit paper money. In many places they no longer take 100 dollar bills as there are too many counterfeit 100s and they are too hard to detect. So if there were massive amounts of counterfeit paper money, we could have paper money become worthless and electronic money hold value.

Payment system lockup has to do with solvency and what discerning humans will accept as payment. A check drawn on a certain bank or fund where there is a rumor of insolvency doesn't need to be accepted. Once it is known people aren't accepting checks from one or more entities, the system shuts down and the armored car companies will be busy delivering legal tender.

I can see a payment system no longer be accepted. But this does not destroy any "base money", right? All the money on the Fed computers is still there and all the paper money is still there, someplace.

[vincecate]

In the cartoons characters walk off of cliffs but only fall after they look down. The bond market is falling most every day, with really a large total drop in the last 1.5 months. But stocks are up in the last 1.5 months. It is almost like the stock market has not looked at the bond market and when it does it will fall.

[Higgenbotham]

Payment system lockup has to do with solvency and what discerning humans will accept as payment. A check drawn on a certain bank or fund where there is a rumor of insolvency doesn't need to be accepted. Once it is known people aren't accepting checks from one or more entities, the system shuts down and the armored car companies will be busy delivering legal tender.

I can see a payment system no longer be accepted. But this does not destroy any "base money", right? All the money on the Fed computers is still there and all the paper money is still there, someplace.

A point may come, say the Euro may collapse or who knows what, where the knowledge or perception that certain banks are insolvent begins to matter in the marketplace, the checks are no longer accepted and the payment (clearing) system shuts down. At that point, there are lots of different pathways available but the end result is probably that the insolvent banks are put through some kind of process whereby the base money is used to cover the liabilities and somebody takes a haircut. If the Fed had not done QE2, the assets (treasuries) would be liquidated in the marketplace in exchange for cash. Since the Fed has done QE2, the increment of electronic base money is still in the system and the haircut will still come in the form of reduced stock and bond values of the insolvent entity or partial losses in deposit accounts. In the meantime, in a case like this, I think base money lays idle while the insolvency is cleaned up. In a nutshell, I'm saying that there isn't a way to distinguish a bad check from an insolvent bank from any other claim on the bank's assets. The solution to that is to require legal tender as payment.

Going to the window of an insolvent bank to draw your cash out and close your account is the same thing in principle as a refusal to accept a check from that bank as payment. It has the potential to turn into a run which can have systemic effects.

[Higgenbotham]

http://books.google.com/books?id=BzYVWv ... %22&f=true

Some discussion about payment system freeze-ups. I am by no means an expert on the subject of payment systems, but try to look at the all the factors that affect the big picture.

As mentioned above:

Until 2004, Woodman's allowed payment only by cash or check, when they began to accept debit cards. Woodman's does not accept payment by credit card as they will not pay processing fees or assess them on their customers. The company advertises relatively little, and attributes their lower prices to these practices.

http://en.wikipedia.org/wiki/Woodman's_Food_Market

[John]

Dear Higgie,

> A point may come, say the Euro may collapse or who knows what,
> where the knowledge or perception that certain banks are insolvent
> begins to matter in the marketplace, the checks are no longer
> accepted and the payment (clearing) system shuts down. At that
> point, there are lots of different pathways available but the end
> result is probably that the insolvent banks are put through some
> kind of process whereby the base money is used to cover the
> liabilities and somebody takes a haircut. If the Fed had not done
> QE2, the assets (treasuries) would be liquidated in the
> marketplace in exchange for cash. Since the Fed has done QE2, the
> increment of electronic base money is still in the system and the
> haircut will still come in the form of reduced stock and bond
> values of the insolvent entity or partial losses in deposit
> accounts. In the meantime, in a case like this, I think base money
> lays idle while the insolvency is cleaned up. In a nutshell, I'm
> saying that there isn't a way to distinguish a bad check from an
> insolvent bank from any other claim on the bank's assets. The
> solution to that is to require legal tender as payment.

> Going to the window of an insolvent bank to draw your cash out and
> close your account is the same thing in principle as a refusal to
> accept a check from that bank as payment. It has the potential to
> turn into a run which can have systemic effects.

So if we put together your concepts and my concepts, we see the
following scenario:

• QE money will flow into banks, and from there into "hot" investment
  opportunities. This will create new asset bubbles, but not inflation.
• The choice of bubbles is a matter of fashion. The real estate
  bubble was highly fashionable five years ago, but now it's passé.
  Today's hot bubble are commodities and stocks, and investors are as
  oblivious to the dangers of commodity investing today as they were to
  real estate investing five years ago.
• What's really changed today, versus previous centuries, is that
  bubbles are being created with "electronic money," rather than
  physical money.
• There's already a multi-tier stratification of securities, with
  companies like Moody's serving as arbiter.
• Some event will cause a panic, leading people to lose faith in
  electronic money. This is a new concept that I've never seen
  discussed before.
• The multi-tier stratification of securities will be extended
  to "cash." Presumably physical money will be considered the safest,
  while various other forms of electronic money will be rated as
  safe or unsafe in some way.
• This panic will immediately reduce the money supply by anywhere
  from 10% to 50%, causing an enormous deflationary shock. People won't
  receive paychecks, landlords won't receive rents, creditors won't
  receive monthly payments.
• Initially, whatever commerce occurs will be only through physical
  money. As time goes on, faith in some forms of electronic money
  will be rebuilt from backup disks and paper records.
• One possible government response at this time will be to
  make a lot more paper money available, thus returning to the original
  meaning of "printing money." At that point, the huge deflationary
  shock may be offset by some inflation, but the net will still be
  deep deflation.

One thing that always keeps nagging at me is the hundreds of trillions
of dollars (nominal value) of structured securities, including
credit default swaps and interest rates swaps.

These are almost never discussed by the popular financial pundits,
but this continues to appear to me to be a huge mega-mountain of risk.

Right now, we see bond yields increasing in America and Europe. This
could easily reverberate in the interest rate swap market. And with
some $300 trillion outstanding, even a tiny 5% collapse leads to an
enormous $15 trillion less money in the world. That alone would be a
huge deflationary shock.

John