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  Quotations - Invest  
[Quote No.36081] Need Area: Money > Invest
"[Turning points in markets – boom to bust or bust to boom indicator; bearish/negative or bullish/positive divergence:] Usually if a new high in a physical market is not confirmed by the stocks in the respective sector - that is if there is a divergence in the performance between physical and financial market we call it a non-confirmation. If the non-confirmation occurs following a long term up or down trend it frequently leads to a very sharp reversal whereby an uptrend is followed by a collapse in prices and a downtrend is followed by an explosive upward move." - Marc Faber
Editor and Publisher of 'The Gloom, Boom & Doom Report,' and author of the bestselling 'Tomorrow's Gold'. Quote from 'The Gloom, Boom and Doom Report', 6 May 2005. http://www.gold-eagle.com/editorials_05/faber050605.html
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[Quote No.36089] Need Area: Money > Invest
"[In every bull market, prices can get ahead of the fundamentals and so suffer a correction. But especially at the start of a bull market as investors climb the wall of worry thinking the young bull might really be an old bear market rally for suckers gets all and sundry asking Is this a] Temporary dip or abandon the ship?" - Ryan Puplava
moneysense.com
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[Quote No.36090] Need Area: Money > Invest
"When a country's government gets in trouble, for one reason or another, usually related to having too much debt for its GDP, it can take a number of steps to improve its situation. They include reduce spending, create new taxes or increase existing ones, sell/privatize some government asset or service, print money and inflate away its debt, default or restructure its loan payments. Regardless all these will take time and in the hour of need instead of being able to roll over its maturing short and long-term debt it will often find that the hedge funds are shorting its bonds meaning that any new bond issuance will cost more than the country's finances can bear. At these times there is a global organisation called the International Monetary Fund, or the IMF for short, which was set up to use the contributions from its backers, the major industrialised countries, to fund short-term loans. In a way its like going to a family 'friend' for help or a wealthy neighbour for a short-term bridging loan, usually at much lower rates than the country could get from any other market. Usually the IMF wants to give the country some constructive advice to help it be in a better position to go to the market to repay the bridging loan, later after improving issues in the time the bridging loan provided." - Seymour@imagi-natives.com

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[Quote No.36092] Need Area: Money > Invest
"[In a world that is continually getting 'smaller' and where capital can travel easily across borders, since the great liberation of the global financial system in the 1980's, it is important to keep up with this facet of the global economy's triumvirate of Capital, Labor and Productivity.] First, while the issue of capital controls is fraught with ideological overtones, it is fundamentally a technical one, indeed a highly technical one. Put simply, governments have five tools to adjust to capital flows: monetary policy, fiscal policy, foreign exchange intervention, prudential tools, and capital controls. The challenge is to find, for each case, the right combination. This is not easy. Second, we need to better understand the costs and benefits of capital flows. The costs depend – more than is generally understood – on the institutional framework in each country: things like the exchange rate regime, the degree of dollarisation of the economy, and the credibility of the central bank. Even costs related to ‘Dutch Disease’ – the bogeyman still much in the minds of policy-makers – are in fact not well established. Over the past 18 months, we at the IMF [International Monetary Fund] have done some rethinking about the nature of the risks capital flows may bring, and how best to respond. The most recent research attempts to develop a conceptual framework to weigh the benefits of different policy responses, including capital controls... Looking at the relevant set of investors suggests higher flows to emerging markets are here to stay. This is the 'new normal', and is based on a 'fundamental re-rating of global risk' in favour of emerging market assets with better fundamentals and higher returns. But, it remains to be seen whether, for example, the new appetite of foreign investors for local currency debt comes from a durable shift in demand, or the more temporary expectation of appreciation. The nature of specific investors must inform the policy choices. We often think of inflows and outflows as coming primarily from decisions by foreign investors. The reality is that many of these inflows and outflows often come from decisions by domestic investors. When this is the case, targeting non-residents is largely misguided. On the policy options... None of the tools – be they reserve accumulation, prudential measures, or capital controls—are water-tight. So we should move away from strict policy orderings toward a more fluid approach of using 'many or most of the tools most of the time' instead of 'this now, that later'. It is not clear that the diversity of approaches we observe in practice comes from different circumstances, or from sub-optimal responses. It was interesting to observe for example that Chile relies on foreign exchange intervention, not on capital controls, but India, instead, relies on capital controls, not on foreign exchange intervention. Are these corner solutions really optimal? ...As my IMF colleague Min Zhu said...'ensuring that countries reap the full benefits of capital flows is a shared responsibility between advanced and emerging market economies, between surplus and deficit countries, between capital-exporters and capital-importers.' The challenge is to translate this into practice. What is the actual responsibility of source countries? Should they take it into account in conducting monetary policy, and if so, how? Should we worry about the 'beggar thy neighbour' effect of controls? Some of the evidence presented at the conference suggested that these spillovers across recipient countries were not very large. Theoretical and further empirical work is badly needed here. Nor did we have an opportunity to revisit, or even discuss, the current wisdom on capital account openness. In light of new research, what should we be telling policy-makers, those with mostly open and those with mostly closed capital accounts? Should Chile and China eventually converge to the same point along the continuum? And, if so, at what rate? We cannot avoid coming to views on this fundamental issue." - Olivier Blanchard
He is the chief economist at the International Monetary Fund.
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[Quote No.36093] Need Area: Money > Invest
"US Inflation: What is the Trimmed Mean CPI and What Does It Tell Us? On September 17, 2010, news headlines reported that the US Consumer Price Index for August had increased by 0.3 percent. Is this a good or bad number? Unfortunately, monthly CPI changes don't tell us much. What steps can we take to make inflation data more useful for interpreting and formulating economic policy? The first step is to convert monthly data to annual rates. If the July-to-August monthly change (which was 0.254 percent, before rounding) were to continue for a full year, the annual rate of inflation would be about 3.1 percent. Annual rates are almost universally used in discussions of economic theory and policy. Month-to-month changes are highly volatile. To reveal the underlying inflation trend, the next step is to look at changes in the CPI from the same month a year ago rather than changes from a month ago. Since inflation was lower for most of the previous year than it was in August, the year-to-year figure that month was just 1.1 percent, much lower than the annualized monthly figure of 3.1 percent. The next step takes into account the fact that some prices, like those for food and energy, lie largely beyond the influence of domestic monetary and fiscal policy. Those prices are set in world markets and are subject to influences ranging from world politics to weather to oil spills. To show inflation trends with volatile food and energy prices removed, the Labor Department publishes a core CPI series. The core CPI increased at just a 0.9 percent annual rate in August. Finally, we might ask, why adjust only for food and energy prices? Why not exclude any prices that show unusual changes in a given month? The Cleveland Fed publishes just such a series, called the trimmed mean CPI. It excludes the most extreme 16% of price movements each month. Many economists see it as the clearest indicator of underlying inflation trends, an improvement over the core CPI. The trimmed-mean CPI and core CPI numbers were about the same for August, 2010, but the trimmed mean series shows a more pronounced trend toward lower inflation over the previous two years. The bottom line: Monthly inflation figures can sometimes signal a turning point in inflation, but those turning points are just as often masked by random noise. At present, the core CPI and trimmed mean CPI show that US inflation is still on a downward trend. Expect the Fed to stick to its easy-money policy until the trend shows a clear upward turn. [The trimmed mean PCE inflation rate is an alternative measure of core inflation in the price index for personal consumption expenditures (PCE).] " - Ed Dolan
Ed Dolan's Econ Blog - Resource Center for Teaching Economics
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[Quote No.36098] Need Area: Money > Invest
"Several studies have concluded that the measured rate of inflation overstates the 'true' rate of inflation, because of several biases in standard price indexes that are difficult to eliminate in practice. " - Ben S. Bernanke
US Federal Reserve Bank Governor at that time. Quote from the footnotes of his speech, 'Deflation: Making Sure 'It' Doesn't Happen Here' - Remarks by Governor Before the National Economists Club', Washington, D.C. November 21, 2002. http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm
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[Quote No.36099] Need Area: Money > Invest
"Although with respect to those session where the FED's Permanent Open Market Operation occurred no significant end-of-day edge will be provided, FED's Permanent Open Market Operations accumulated ( e.g. at least 9 during the last 20 sessions) historically had remarkable and statistically significant positive implications with respect to the market's short- (e.g. at least one higher close over the course of the then following 10 sessions) and intermediate term performance looking 1, 2 and 3 month ahead (trading higher 3 month later on all of those 144 potential occurrences/trades). This could very well be a reason for the market's above-average month-to-date performance despite a couple of (negative) seasonalities (e.g. the historical negative week immediately following September's triple witching) and setups (e.g. the down-day immediately following the Labor Day exchange holiday). " - Frank Hogelucht
Quoted from an article, 'Permanent Open Market Operations (POMO)', published on safehaven.com, Sep 27, 2010. [http://www.safehaven.com/article/18344/permanent-open-market-operations-pomo ]
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[Quote No.36100] Need Area: Money > Invest
"[This speech/article gives great insight into central bank understandings about how to use their monetary policy power for the economic and political ‘good’ in both inflationary and deflationary periods.] ‘Deflation: Making Sure ‘It’ Doesn't Happen Here’: Since World War II, inflation--the apparently inexorable rise in the prices of goods and services--has been the bane of central bankers. Economists of various stripes have argued that inflation is the inevitable result of (pick your favorite) the abandonment of metallic monetary standards, a lack of fiscal discipline, shocks to the price of oil and other commodities, struggles over the distribution of income, excessive money creation, self-confirming inflation expectations, an "inflation bias" in the policies of central banks, and still others. Despite widespread "inflation pessimism," however, during the 1980s and 1990s most industrial-country central banks were able to cage, if not entirely tame, the inflation dragon. Although a number of factors converged to make this happy outcome possible, an essential element was the heightened understanding by central bankers and, equally as important, by political leaders and the public at large of the very high costs of allowing the economy to stray too far from price stability. With inflation rates now quite low in the United States, however, some have expressed concern that we may soon face a new problem--the danger of deflation, or falling prices. That this concern is not purely hypothetical is brought home to us whenever we read newspaper reports about Japan, where what seems to be a relatively moderate deflation--a decline in consumer prices of about 1 percent per year--has been associated with years of painfully slow growth, rising joblessness, and apparently intractable financial problems in the banking and corporate sectors. While it is difficult to sort out cause from effect, the consensus view is that deflation has been an important negative factor in the Japanese slump. So, is deflation a threat to the economic health of the United States? Not to leave you in suspense, I believe that the chance of significant deflation in the United States in the foreseeable future is extremely small, for two principal reasons. The first is the resilience and structural stability of the U.S. economy itself. Over the years, the U.S. economy has shown a remarkable ability to absorb shocks of all kinds, to recover, and to continue to grow. Flexible and efficient markets for labor and capital, an entrepreneurial tradition, and a general willingness to tolerate and even embrace technological and economic change all contribute to this resiliency. A particularly important protective factor in the current environment is the strength of our financial system: Despite the adverse shocks of the past year, our banking system remains healthy and well-regulated, and firm and household balance sheets are for the most part in good shape. Also helpful is that inflation has recently been not only low but quite stable, with one result being that inflation expectations seem well anchored. For example, according to the University of Michigan survey that underlies the index of consumer sentiment, the median expected rate of inflation during the next five to ten years among those interviewed was 2.9 percent in October 2002, as compared with 2.7 percent a year earlier and 3.0 percent two years earlier--a stable record indeed. The second bulwark against deflation in the United States, and the one that will be the focus of my remarks today, is the Federal Reserve System itself. The Congress has given the Fed the responsibility of preserving price stability (among other objectives), which most definitely implies avoiding deflation as well as inflation. I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief. Of course, we must take care lest confidence become over-confidence. Deflationary episodes are rare, and generalization about them is difficult. Indeed, a recent Federal Reserve study of the Japanese experience concluded that the deflation there was almost entirely unexpected, by both foreign and Japanese observers alike (Ahearne et al., 2002). So, having said that deflation in the United States is highly unlikely, I would be imprudent to rule out the possibility altogether. Accordingly, I want to turn to a further exploration of the causes of deflation, its economic effects, and the policy instruments that can be deployed against it. Before going further I should say that my comments today reflect my own views only and are not necessarily those of my colleagues on the Board of Governors or the Federal Open Market Committee. Deflation: Its Causes and Effects Deflation is defined as a general decline in prices, with emphasis on the word "general." At any given time, especially in a low-inflation economy like that of our recent experience, prices of some goods and services will be falling. Price declines in a specific sector may occur because productivity is rising and costs are falling more quickly in that sector than elsewhere [competition for market share between rival producers is strong and for example they are engaging in a war of discounting and sales offers where they are sacrificing margin for higher market awareness, volume and long-term market share] or because the demand for the output of that sector is weak relative to the demand for other goods and services. Sector-specific price declines, uncomfortable as they may be for producers in that sector, are generally not a problem for the economy as a whole and do not constitute deflation. Deflation per se occurs only when price declines are so widespread that broad-based indexes of prices, such as the consumer price index, register ongoing declines. The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand--a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.1 Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending--namely, recession, rising unemployment, and financial stress. However, a deflationary recession may differ in one respect from "normal" recessions in which the inflation rate is at least modestly positive: Deflation of sufficient magnitude may result in the nominal interest rate declining to zero or very close to zero.2 Once the nominal interest rate is at zero, no further downward adjustment in the rate can occur, since lenders generally will not accept a negative nominal interest rate when it is possible instead to hold cash. At this point, the nominal interest rate is said to have hit the "zero bound."[‘ZIRP’ – Zero Interest Rate Policy] Deflation great enough to bring the nominal interest rate close to zero poses special problems for the economy and for policy. First, when the nominal interest rate has been reduced to zero, the real interest rate paid by borrowers equals the expected rate of deflation, however large that may be.3 To take what might seem like an extreme example (though in fact it occurred in the United States in the early 1930s), suppose that deflation is proceeding at a clip of 10 percent per year. Then someone who borrows for a year at a nominal interest rate of zero actually faces a 10 percent real cost of funds, as the loan must be repaid in dollars whose purchasing power is 10 percent greater than that of the dollars borrowed originally. In a period of sufficiently severe deflation, the real cost of borrowing becomes prohibitive. Capital investment, purchases of new homes, and other types of spending decline accordingly, worsening the economic downturn. Although deflation and the zero bound on nominal interest rates create a significant problem for those seeking to borrow, they impose an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. This burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing (perhaps rapidly increasing) real value. When William Jennings Bryan made his famous "cross of gold" speech in his 1896 presidential campaign, he was speaking on behalf of heavily mortgaged farmers whose debt burdens were growing ever larger in real terms, the result of a sustained deflation that followed America's post-Civil-War return to the gold standard.4 The financial distress of debtors can, in turn, increase the fragility of the nation's financial system--for example, by leading to a rapid increase in the share of bank loans that are delinquent or in default. Japan in recent years has certainly faced the problem of "debt-deflation"--the deflation-induced, ever-increasing real value of debts. Closer to home, massive financial problems, including defaults, bankruptcies, and bank failures, were endemic in America's worst encounter with deflation, in the years 1930-33--a period in which (as I mentioned) the U.S. price level fell about 10 percent per year. Beyond its adverse effects in financial markets and on borrowers, the zero bound on the nominal interest rate raises another concern--the limitation that it places on conventional monetary policy. Under normal conditions, the Fed and most other central banks implement policy by setting a target for a short-term interest rate--the overnight federal funds rate in the United States--and enforcing that target by buying and selling securities in open capital markets. When the short-term interest rate hits zero, the central bank can no longer ease policy by lowering its usual interest-rate target.5 Because central banks conventionally conduct monetary policy by manipulating the short-term nominal interest rate, some observers have concluded that when that key rate stands at or near zero, the central bank has "run out of ammunition"--that is, it no longer has the power to expand aggregate demand and hence economic activity. It is true that once the policy rate has been driven down to zero, a central bank can no longer use its traditional means of stimulating aggregate demand and thus will be operating in less familiar territory. The central bank's inability to use its traditional methods may complicate the policymaking process and introduce uncertainty in the size and timing of the economy's response to policy actions. Hence I agree that the situation is one to be avoided if possible. However, a principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero [ZIRP] has most definitely not run out of ammunition. As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero. In the remainder of my talk, I will first discuss measures for preventing deflation--the preferable option if feasible. I will then turn to policy measures that the Fed and other government authorities can take if prevention efforts fail and deflation appears to be gaining a foothold in the economy. Preventing Deflation As I have already emphasized, deflation is generally the result of low and falling aggregate demand. The basic prescription for preventing deflation is therefore straightforward, at least in principle: Use monetary and fiscal policy as needed to support aggregate spending, in a manner as nearly consistent as possible with full utilization of economic resources and low and stable inflation. In other words, the best way to get out of trouble is not to get into it in the first place. Beyond this commonsense injunction, however, there are several measures that the Fed (or any central bank) can take to reduce the risk of falling into deflation. First, the Fed should try to preserve a buffer zone for the inflation rate, that is, during normal times it should not try to push inflation down all the way to zero.6 Most central banks seem to understand the need for a buffer zone. For example, central banks with explicit inflation targets almost invariably set their target for inflation above zero, generally between 1 and 3 percent per year. Maintaining an inflation buffer zone reduces the risk that a large, unanticipated drop in aggregate demand will drive the economy far enough into deflationary territory to lower the nominal interest rate to zero. Of course, this benefit of having a buffer zone for inflation must be weighed against the costs associated with allowing a higher inflation rate in normal times. Second, the Fed should take most seriously--as of course it does--its responsibility to ensure financial stability in the economy. Irving Fisher (1933) was perhaps the first economist to emphasize the potential connections between violent financial crises, which lead to "fire sales" of assets and falling asset prices, with general declines in aggregate demand and the price level. A healthy, well capitalized banking system and smoothly functioning capital markets are an important line of defense against deflationary shocks. The Fed should and does use its regulatory and supervisory powers to ensure that the financial system will remain resilient if financial conditions change rapidly. And at times of extreme threat to financial stability, the Federal Reserve stands ready to use the discount window and other tools to protect the financial system, as it did during the 1987 stock market crash and the September 11, 2001, terrorist attacks. Third, as suggested by a number of studies, when inflation is already low and the fundamentals of the economy suddenly deteriorate, the central bank should act more preemptively and more aggressively than usual in cutting rates (Orphanides and Wieland, 2000; Reifschneider and Williams, 2000; Ahearne et al., 2002). By moving decisively and early, the Fed may be able to prevent the economy from slipping into deflation, with the special problems that entails. As I have indicated, I believe that the combination of strong economic fundamentals and policymakers that are attentive to downside as well as upside risks to inflation make significant deflation in the United States in the foreseeable future quite unlikely. But suppose that, despite all precautions, deflation were to take hold in the U.S. economy and, moreover, that the Fed's policy instrument--the federal funds rate--were to fall to zero. What then? In the remainder of my talk I will discuss some possible options for stopping a deflation once it has gotten under way. I should emphasize that my comments on this topic are necessarily speculative, as the modern Federal Reserve has never faced this situation nor has it pre-committed itself formally to any specific course of action should deflation arise. Furthermore, the specific responses the Fed would undertake would presumably depend on a number of factors, including its assessment of the whole range of risks to the economy and any complementary policies being undertaken by other parts of the U.S. government.7 [Government Fiscal Policy, to stimulate or at least stabilise the economy through government spending and tax revenue reductions to hold or increase GDP refer the formula for calculating GDP] Curing Deflation Let me start with some general observations about monetary policy at the zero bound [ZIRP], sweeping under the rug for the moment some technical and operational issues. As I have mentioned, some observers have concluded that when the central bank's policy rate falls to zero--its practical minimum--monetary policy loses its ability to further stimulate aggregate demand and the economy. At a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken. Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero. The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal. What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation. Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior).8 Normally, money is injected into the economy through asset purchases by the Federal Reserve [Refer POMO – Permanent Open Market Operations]. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system--for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities. Each method of adding money to the economy has advantages and drawbacks, both technical and economic. One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation. So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero [ZIRP]? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure--that is, rates on government bonds of longer maturities.9 There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time--if it were credible--would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well. Lower rates over the maturity spectrum of public and private securities should strengthen aggregate demand in the usual ways and thus help to end deflation. Of course, if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years. Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association). Historical experience tends to support the proposition that a sufficiently determined Fed can peg or cap Treasury bond prices and yields at other than the shortest maturities. The most striking episode of bond-price pegging occurred during the years before the Federal Reserve-Treasury Accord of 1951.10 Prior to that agreement, which freed the Fed from its responsibility to fix yields on government debt, the Fed maintained a ceiling of 2-1/2 percent on long-term Treasury bonds for nearly a decade. Moreover, it simultaneously established a ceiling on the twelve-month Treasury certificate of between 7/8 percent to 1-1/4 percent and, during the first half of that period, a rate of 3/8 percent on the 90-day Treasury bill. The Fed was able to achieve these low interest rates despite a level of outstanding government debt (relative to GDP) significantly greater than we have today, as well as inflation rates substantially more variable. [This is a deliberate government policy euphemistically called (like money printing is euphemistically called ‘monetization’ or ‘quantitative easing’) ‘Financial Repression’, within the financial and political community, where interest rates available to the public are held lower than inflation – negative real rates - to allow a government with a dangerously high public debt to GDP percentage, i.e. greater than 70 - 90%, circumstances that make the public debt easier for the government to manage and pay off as it is also inflated away] At times, in order to enforce these low rates, the Fed had actually to purchase the bulk of outstanding 90-day bills. Interestingly, though, the Fed enforced the 2-1/2 percent ceiling on long-term bond yields for nearly a decade without ever holding a substantial share of long-maturity bonds outstanding.11 For example, the Fed held 7.0 percent of outstanding Treasury securities in 1945 and 9.2 percent in 1951 (the year of the Accord), almost entirely in the form of 90-day bills. For comparison, in 2001 the Fed held 9.7 percent of the stock of outstanding Treasury debt. To repeat, I suspect that operating on rates on longer-term Treasuries would provide sufficient leverage for the Fed to achieve its goals in most plausible scenarios. If lowering yields on longer-dated Treasury securities proved insufficient to restart spending, however, the Fed might next consider attempting to influence directly the yields on privately issued securities. Unlike some central banks, and barring changes to current law, the Fed is relatively restricted in its ability to buy private securities directly.12 However, the Fed does have broad powers to lend to the private sector indirectly via banks, through the discount window.13 Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral.14 For example, the Fed might make 90-day or 180-day zero-interest loans to banks, taking corporate commercial paper of the same maturity as collateral. Pursued aggressively, such a program could significantly reduce liquidity and term premiums on the assets used as collateral. Reductions in these premiums would lower the cost of capital both to banks and the nonbank private sector, over and above the beneficial effect already conferred by lower interest rates on government securities.15 The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.16 I need to tread carefully here. Because the economy is a complex and interconnected system, Fed purchases of the liabilities of foreign governments [their sovereign debt – i.e bonds, notes, etc] have the potential to affect a number of financial markets, including the market for foreign exchange [relative currency values]. In the United States, the Department of the Treasury, not the Federal Reserve, is the lead agency for making international economic policy, including policy toward the dollar; and the Secretary of the Treasury has expressed the view that the determination of the value of the U.S. dollar should be left to free market forces [neither a strong nor weak ‘dollar policy’]. Moreover, since the United States is a large, relatively closed economy, manipulating the exchange value of the dollar would not be a particularly desirable way to fight domestic deflation [to create inflation, in the case of devaluing the US currency through imported inflation where imports are therefore more expensive in US dollars as the US dollar falls in value, which has the added benefit of reducing the US domestic competitiveness of foreign produced and imported articles and services, that is imports become relatively more expensive, while increasing the price competitiveness of US exports in foreign markets, as they become cheaper in the foreign currency and thereby potentially increase their sales and market share penetration, and foreign earnings for US multinational companies increase, at least nominally on their books and when reporting their earnings, if reported in US dollars, to their shareholders], particularly given the range of other options available. Thus, I want to be absolutely clear that I am today neither forecasting nor recommending any attempt by U.S. policymakers to target the international value of the dollar. Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation [quantitative easing]. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.17 The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero [ZIRP], as was the case at the time of Roosevelt's devaluation. Fiscal Policy Each of the policy options I have discussed so far involves the Fed's acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions [ie ‘deleverage’ - reduce the leverage – debt to equity or earnings ratios of private citizens and families and business debt while the government does the opposite to stimulate the economy by taking up the reduction in aggregate spending as recommended by the economist John Maynard Keynes in Keynesian economic theory] of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money.18 Of course, in lieu of tax cuts or increases in transfers [social security payments] the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money [money printing – ‘quantitative easing’], the whole operation would be the economic equivalent of direct open-market operations in private assets. Japan The claim that deflation can be ended by sufficiently strong action has no doubt led you to wonder, if that is the case, why has Japan not ended its deflation? The Japanese situation is a complex one that I cannot fully discuss today. I will just make two brief, general points. First, as you know, Japan's economy faces some significant barriers to growth besides deflation, including massive financial problems in the banking and corporate sectors [as they have been encouraged by government and financial authorities and therefore chosen not to write off their market valuation losses, that is mark their damaged assets down to market values – they use ‘mark to model’ rather than ‘mark to market’ valuation methods (due to their enormous size that would then threaten their share market prices and even their continued liquidity and solvency – viability. This is why banks in Japan have been called ‘zombie banks’ - financially dead but not allowed to die.)(Note in early 2009 following the GFC – the Great Financial Crash, second only to the Great Depression of the 1930’s in financial destructiveness, the US Government and Congress encouraged and supported mark to model valuations from FASB under regulation FAS 157. FASB –the Financial Accounting Standards Board - has been the designated organization in the US private sector for establishing standards of financial accounting that govern the preparation of financial reports by nongovernmental entities. The SEC – US Securities and Exchange Commission - has statutory authority to establish financial accounting and reporting standards for publicly held companies under the Securities Exchange Act of 1934. Throughout its history, however, the Commission’s policy has been to rely on the private sector for this function to the extent that the private sector demonstrates ability to fulfil the responsibility in the public interest.)], and a large overhang of government debt. Plausibly, private-sector financial problems have muted the effects of the monetary policies that have been tried in Japan, even as the heavy overhang of government debt has made Japanese policymakers more reluctant to use aggressive fiscal policies (for evidence see, for example, Posen, 1998). Fortunately, the U.S. economy does not share these problems, at least not to anything like the same degree, suggesting that anti-deflationary monetary and fiscal policies would be more potent here than they have been in Japan. Second, and more important, I believe that, when all is said and done, the failure to end deflation in Japan does not necessarily reflect any technical infeasibility of achieving that goal. Rather, it is a byproduct of a longstanding political debate about how best to address Japan's overall economic problems. As the Japanese certainly realize, both restoring [‘zombie’] banks and corporations to solvency and implementing significant structural change are necessary for Japan's long-run economic health. But in the short run, comprehensive economic reform will likely impose large costs on many, for example, in the form of unemployment or bankruptcy. As a natural result, politicians, economists, businesspeople, and the general public in Japan have sharply disagreed about competing proposals for reform. In the resulting political deadlock, strong policy actions are discouraged, and cooperation among policymakers is difficult to achieve [and the share market has fallen overall for more than twenty years]. In short, Japan's deflation problem is real and serious; but, in my view, political constraints, rather than a lack of policy instruments, explain why its deflation has persisted for as long as it has. Thus, I do not view the Japanese experience as evidence against the general conclusion that U.S. policymakers have the tools they need to prevent, and, if necessary, to cure a deflationary recession in the United States. Conclusion Sustained deflation can be highly destructive to a modern economy and should be strongly resisted. Fortunately, for the foreseeable future, the chances of a serious deflation in the United States appear remote indeed, in large part because of our economy's underlying strengths but also because of the determination of the Federal Reserve and other U.S. policymakers to act preemptively against deflationary pressures. Moreover, as I have discussed today, a variety of policy responses are available should deflation appear to be taking hold. Because some of these alternative policy tools are relatively less familiar, they may raise practical problems of implementation and of calibration of their likely economic effects. For this reason, as I have emphasized, prevention of deflation is preferable to cure. Nevertheless, I hope to have persuaded you that the Federal Reserve and other economic policymakers would be far from helpless in the face of deflation, even should the federal funds rate hit its zero bound.19 [ZIRP] __________________________________________ References: -Ahearne, Alan, Joseph Gagnon, Jane Haltmaier, Steve Kamin, and others, "Preventing Deflation: Lessons from Japan's Experiences in the 1990s," Board of Governors, International Finance Discussion Paper No. 729, June 2002. -Clouse, James, Dale Henderson, Athanasios Orphanides, David Small, and Peter Tinsley, "Monetary Policy When the Nominal Short-term Interest Rate Is Zero," Board of Governors of the Federal Reserve System, Finance and Economics Discussion Series No. 2000-51, November 2000. [Abstract: In an environment of low inflation, the Federal Reserve faces the possibility that it may not have provided enough monetary stimulus even though it had pushed the short-term nominal interest rate to its lower bound of zero. Assuming the nominal Treasury-bill rate had been lowered to zero, this paper considers whether further open market purchases of Treasury bills could spur aggregate demand through increases in the monetary base. Such action may be stimulative by increasing liquidity for financial intermediaries and households; by affecting expectations of the future paths of short-term interest rates, inflation, and asset prices; through distributional effects; or by stimulating bank lending through the credit channel. This paper also examines the alternative policy tools that are available to the Federal Reserve in theory, and notes the practical limitations imposed by the Federal Reserve Act. The tools the Federal Reserve has at its disposal include open market purchases of Treasury bonds and certain types of private-sector credit instruments; unsterilized and sterilized intervention in foreign exchange; lending through the discount window; and, in some circumstances, may include the use of options.] -Eichengreen, Barry, and Peter M. Garber, "Before the Accord: U.S. Monetary-Financial Policy, 1945-51," in R. Glenn Hubbard, ed., Financial Markets and Financial Crises, Chicago: University of Chicago Press for NBER, 1991. -Eggertson, Gauti, "How to Fight Deflation in a Liquidity Trap: Committing to Being Irresponsible," unpublished paper, International Monetary Fund, October 2002. -Fisher, Irving, "The Debt-Deflation Theory of Great Depressions," Econometrica (March 1933) pp. 337-57. -Hetzel, Robert L. and Ralph F. Leach, "The Treasury-Fed Accord: A New Narrative Account," Federal Reserve Bank of Richmond, Economic Quarterly (Winter 2001) pp. 33-55. -Orphanides, Athanasios and Volker Wieland, "Efficient Monetary Design Near Price Stability," Journal of the Japanese and International Economies (2000) pp. 327-65. -Posen, Adam S., Restoring Japan's Economic Growth, Washington, D.C.: Institute for International Economics, 1998. -Reifschneider, David, and John C. Williams, "Three Lessons for Monetary Policy in a Low-Inflation Era," Journal of Money, Credit, and Banking (November 2000) Part 2 pp. 936-66. -Toma, Mark, "Interest Rate Controls: The United States in the 1940s," Journal of Economic History (September 1992) pp. 631-50. ________________________________________ Footnotes: -1. Conceivably, deflation could also be caused by a sudden, large expansion in aggregate supply arising, for example, from rapid gains in productivity and broadly declining costs. I don't know of any unambiguous example of a supply-side deflation, although China in recent years is a possible case. Note that a supply-side deflation would be associated with an economic boom rather than a recession. -2. The nominal interest rate is the sum of the real interest rate and expected inflation. If expected inflation moves with actual inflation, and the real interest rate is not too variable, then the nominal interest rate declines when inflation declines--an effect known as the Fisher effect, after the early twentieth-century economist Irving Fisher. If the rate of deflation is equal to or greater than the real interest rate, the Fisher effect predicts that the nominal interest rate will equal zero. -3. The real interest rate equals the nominal interest rate minus the expected rate of inflation (see the previous footnote). The real interest rate measures the real (that is, inflation-adjusted) cost of borrowing or lending. -4. Throughout the latter part of the nineteenth century, a worldwide gold shortage was forcing down prices in all countries tied to the gold standard. Ironically, however, by the time that Bryan made his famous speech, a new cyanide-based method for extracting gold from ore had greatly increased world gold supplies, ending the deflationary pressure. -5. A rather different, but historically important, problem associated with the zero bound [ZIRP – Zero Interest Rate Policy] is the possibility that policymakers may mistakenly interpret the zero nominal interest rate as signaling conditions of "easy money." The Federal Reserve apparently made this error in the 1930s. In fact, when prices are falling, the real interest rate may be high and monetary policy tight, despite a nominal interest rate at or near zero. -6. Several studies have concluded that the measured rate of inflation overstates the "true" rate of inflation, because of several biases in standard price indexes that are difficult to eliminate in practice. The upward bias in the measurement of true inflation is another reason to aim for a measured inflation rate above zero. -7. See Clouse et al. (2000) for a more detailed discussion of monetary policy options when the nominal short-term interest rate is zero. -8. Keynes, however, once semi-seriously proposed, as an anti-deflationary measure, that the government fill bottles with currency and bury them in mine shafts to be dug up by the public. -9. Because the term structure is normally upward sloping [positive yield curve - spread], especially during periods of economic weakness, longer-term rates could be significantly above zero even when the overnight rate is at the zero bound. -10. S See Hetzel and Leach (2001) for a fascinating account of the events leading to the Accord. -11. See Eichengreen and Garber (1991) and Toma (1992) for descriptions and analyses of the pre-Accord period. Both articles conclude that the Fed's commitment to low inflation helped convince investors to hold long-term bonds at low rates in the 1940s and 1950s. (A similar dynamic would work in the Fed's favor today.) The rate-pegging policy finally collapsed because the money creation associated with buying Treasury securities was generating inflationary pressures. Of course, in a deflationary situation, generating inflationary pressure is precisely what the policy is trying to accomplish. An episode apparently less favorable to the view that the Fed can manipulate Treasury yields was the so-called Operation Twist of the 1960s, during which an attempt was made to raise short-term yields and lower long-term yields simultaneously by selling at the short end and buying at the long end. Academic opinion on the effectiveness of Operation Twist is divided. In any case, this episode was rather small in scale, did not involve explicit announcement of target rates, and occurred when interest rates were not close to zero. Return to text -12. The Fed is allowed to buy certain short-term private instruments, such as bankers' acceptances, that are not much used today. It is also permitted to make IPC (individual, partnership, and corporation) loans directly to the private sector, but only under stringent criteria. This latter power has not been used since the Great Depression but could be invoked in an emergency deemed sufficiently serious by the Board of Governors. -13. Effective January 9, 2003, the discount window will be restructured into a so-called Lombard facility, from which well-capitalized banks will be able to borrow freely at a rate above the federal funds rate. These changes have no important bearing on the present discussion. -14. By statute, the Fed has considerable leeway to determine what assets to accept as collateral. -15. In carrying out normal discount window operations, the Fed absorbs virtually no credit risk because the borrowing bank remains responsible for repaying the discount window loan even if the issuer of the asset used as collateral defaults. Hence both the private issuer of the asset and the bank itself would have to fail nearly simultaneously for the Fed to take a loss. The fact that the Fed bears no credit risk places a limit on how far down the Fed can drive the cost of capital to private nonbank borrowers. For various reasons the Fed might well be reluctant to incur credit risk, as would happen if it bought assets directly from the private nonbank sector. However, should this additional measure become necessary, the Fed could of course always go to the Congress to ask for the requisite powers to buy private assets. The Fed also has emergency powers to make loans to the private sector (see footnote 12), which could be brought to bear if necessary. -16. The Fed has committed to the Congress that it will not use this power to "bail out" foreign governments; hence in practice it would purchase only highly rated foreign government debt. -17. U.S. Bureau of the Census, Historical Statistics of the United States, Colonial Times to 1970, Washington, D.C.: 1976. -18. A tax cut financed by money creation is the equivalent of a bond-financed tax cut plus an open-market operation in bonds by the Fed, and so arguably no explicit coordination is needed. However, a pledge by the Fed to keep the Treasury's borrowing costs low, as would be the case under my preferred alternative of fixing portions of the Treasury yield curve [spread], might increase the willingness of the fiscal authorities to cut taxes. Some have argued (on theoretical rather than empirical grounds) that a money-financed tax cut might not stimulate people to spend more because the public might fear that future tax increases will just "take back" the money they have received. Eggertson (2002) provides a theoretical analysis showing that, if government bonds are not indexed to inflation [Refer ‘Financial Repression’] and certain other conditions apply, a money-financed tax cut will in fact raise spending and inflation. In brief, the reason is that people know that inflation erodes the real value of the government's debt and, therefore, that it is in the interest of the government to create some inflation. Hence they will believe the government's promise not to "take back" in future taxes the money distributed by means of the tax cut. -19. Some recent academic literature has warned of the possibility of an "uncontrolled deflationary spiral," in which deflation feeds on itself and becomes inevitably more severe. To the best of my knowledge, none of these analyses consider feasible policies of the type that I have described today. I have argued here that these policies would eliminate the possibility of uncontrollable deflation. " - Ben S. Bernanke
US Federal Reserve Bank Governor at that time. He became the Chairman of the US Federal Reserve 1st February 2006 and instigated many of these ideas in response to the GFC – Great Financial Crisis of 2007-10, which was second only to the 1930’s Great Depression in financial damage. Quoted from his speech, ‘Deflation: Making Sure ‘It’ Doesn't Happen Here’: Remarks by Governor Ben S. Bernanke Before the National Economists Club, Washington, D.C. November 21, 2002. [ http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm ]
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[Quote No.36101] Need Area: Money > Invest
"Financial Repression: A Sheep Shearing Instruction Manual ======Overview ‘Financial Repression’ is currently a hot buzzword in the global economic community, and its effects are even worse than it sounds. Like other recent economic buzzwords such as ‘monetary sterilization’ and ‘quantitative easing’, the average person will never understand the meaning, if they hear the phrase at all. That is too bad, because governments around the world deliberately and methodically stripping wealth (and therefore security and retirement lifestyle) from hundreds of millions of people is the quite explicit objective of Financial Repression. As published in a recent working paper on the IMF [International Monetary Fund] website [refer below for link], Financial Repression is what the US and the rest of the advanced economies used to pay down enormous government debts the last time around, with a reduction in the government debt to GDP ratio of roughly 70% between 1945 and 1980. Financial Repression offers a third way out - as it allows governments to pay down huge debt burdens without either 1) default or 2) hyperinflation. [They could also consider reducing spending, increasing taxes, reducing promises of unfunded liabilities like social security so people get less or start at a later age, or they could sell, sometimes called privatize, a government asset or service and use the money to pay down debt and interest payments on their sovereign bonds, notes, etc]. If you are a senior government official of a nation that has a huge ‘sovereign debt’ problem [usually defined as debt to GDP greater than 90%] - like the United States and almost all of Europe, and you want to stay in power - this proven method is a topic of keen interest. To understand this miraculous debt cure for governments, you need to understand the source of the funding. As we will explore in this article, the essence of Financial Repression is using a combination of inflation and government control of interest rates in an environment of capital controls to confiscate the value of the savings of the world's savers. Rephrased in less academic terms - the government deliberately destroys the value of money over time, and uses regulations to force a negative rate of return onto investors in inflation-adjusted terms, so that the real wealth of savers shrinks by an average of 3-4% per year (in the postwar historical example), and it uses an assortment of carrots and sticks to make sure investors have no choice but to accept having the purchasing power of their investments shrink each year. What the IMF-distributed paper really constitutes is a Sheep Shearing Instruction Manual. The ‘way out’ for governments is effectively to put the world's savers and investors in pens, hold them down, and shear them over and over again, year after year. Uninformed and helpless victims is what makes Financial Repression work, and it worked very well indeed for 35 years [between 1945 and around 1980]… ======Understanding Financial Repression Pimco (Pacific Investment Management Co.), one of the largest investment managers in the world, released their three to five year outlook last month, and their CEO predicted that increasing debt problems would lead to higher inflation and a return to ‘financial repression’ in the United States. Earlier in May [2011], the Economist magazine had published an article on Financial Repression that included the following summary: ‘... political leaders may have a strong incentive to pursue it (Financial Repression). Rapid growth seems out of the question for many struggling advanced economies, austerity and high inflation are extremely unpopular, and leaders are clearly reluctant to talk about major defaults. It would be very interesting if debt (rather than financial crisis or growing inequality) was the force that led to the return of the more managed economic world of the postwar period.’ The phrase ‘Financial Repression’ was first coined by Shaw and McKinnon in works published in 1973, and it described the dominant financial model used by the world's advanced economies between 1945 and around 1980. While academic works have continued to be published over the years, the phrase fell into obscurity as financial systems liberalized on a global basis, and former comprehensive sets of national financial controls receded into history. However, since the [GFC – global] financial crisis hit hard in 2008, there has been a resurgence of interest in how governments have paid down massive debt burdens in the past, and a fascinating study of Financial Repression, ‘The Liquidation of Government Debt’, authored by Carmen Reinhart and M. Belen Sbrancia, was published by the National Bureau of Economic Research in March, 2011 (link below) [An abstract of that discussion paper is included at the bottom of this article. Selected quotes of interest or surprise from it are quoted separately on this website and can be found by using the Imagi-Natives’ Search facility on this website, easily found on the home page, and searching using the title or authors’ names. For the full IMF document please use the link. http://www.imf.org/external/np/seminars/eng/2011/res2/pdf/crbs.pdf ] The paper is being circulated through the International Monetary Fund, and to understand why it is catching the full attention of global investment firms and governmental policymakers, [you only have to see we have today a similar debt to GDP problem as they had in 1946 after World War II]… The advanced Western economies of the world emerged from the desperate struggle for survival that was World War II, with a total stated debt burden relative to their economies that was roughly equal to that seen today [debt to GDP of about 90% in 1946 which fell to about 25% in 1971 then grew to about 60% in 1996 and then after falling to about 50% in 2006 rose again to 90% in 2011 after most western governments had ‘bailed out’ most of their financial institutions after the GFC, Great Financial Crisis, of 2008-10. Governments also heavily stimulated their economies in accordance with Keynesian economic to stabilise aggregate spending and their respective GDP’s in a depression to avoid deflation where debt becomes harder to pay with time causing a vicious cycle of increasing asset deflation. In deflation prices fall due to lack of demand from unemployment rising and existing debt, for example mortgages, can exceed the market value realizable and home owners lose jobs and/or can’t op choose not to continue to pay mortgages, banks foreclose and try to sell their homes, the collateral for the loans, for what they are owed so prices fall still more, supply overwhelms demand and prices fall still further and so on as still more people and businesses go under water with their debt, etc further reducing demand and increasing supply, businesses lay off still more people due to reducing demand to try to reduce costs, etc and the whole economy spirals down with even banks becoming insolvent due to the market value of their collateral falling below their debt and depositors making a run on the bank by all trying to withdraw their cash at the same time especially if they think the bank may be going bankrupt]. The governments [right after 1946] didn't default on those staggering debts, nor did they resort to hyperinflation, but they did nonetheless drop their debt burdens relative to GDP by about 70% over the next three decades - and the very deliberate, calculated use of Financial Repression was how it was done [as well as the massive GDP growth and therefore tax revenue from all the rebuilding necessary. One of the more well-known European Recovery Plans after the war was called the Marshall Plan. (Soon after the Truman Doctrine promised to ‘support free peoples’ (March 1947), General George Marshall went to Europe. He was shocked by what he saw. Europe was ruined and – after the coldest winter in record – starving. Marshall told Truman that all Europe would turn Communist unless the US helped. Marshall announced his Plan to students at Harvard University on 5th June 1947. He promised that America would do ‘whatever it is able to do to assist in the return of normal economic health in the world.’ He challenged the countries of Europe to produce a plan, which the US would fund. By 12 July, the British politician Ernest Bevin (who called the Plan ‘a lifeline to sinking men’) had organised a meeting of European nations in Paris, which asked for $22 billion of aid. Stalin forbade Cominform countries to take part. Truman asked Congress for $17 bn, and Congress (after the collapse of Czechoslovakia, March 1948) gave $13 bn. Marshall Aid took the form of fuel, raw materials, goods, loans and food, machinery and advisers. It jump-started rapid European economic growth, and stopped the spread of Communism.)] [ The abstract of ‘The Liquidation of Government Debt’, authored by Carmen Reinhart and M. Belen Sbrancia, states, ‘Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts. A subtle type of debt restructuring takes the form of ‘financial repression.’ Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks. In the heavily regulated financial markets of the Bretton Woods system, several restrictions facilitated a sharp and rapid reduction in public debt/GDP ratios from the late 1940s to the 1970s. Low nominal interest rates help reduce debt servicing costs while a high incidence of negative real interest rates liquidates or erodes the real value of government debt. Thus, financial repression is most successful in liquidating debts when accompanied by a steady dose of inflation. Inflation need not take market participants entirely by surprise and, in effect, it need not be very high (by historic standards). For the advanced economies in our sample, real interest rates were negative roughly ½ of the time during 1945-1980. For the United States and the United Kingdom our estimates of the annual liquidation of debt via negative real interest rates amounted on average from 3 to 4 percent of GDP a year. For Australia and Italy, which recorded higher inflation rates, the liquidation effect was larger (around 5 percent per annum). We describe some of the regulatory measures and policy actions that characterized the heyday of the financial repression era.’ ======The Mechanics Of Financial Repression: The specifics of financial repression [in 1946-1980] took somewhat different forms in each of the advanced economies, but they shared four characteristics: 1) inflation; 2) governmental control of interest rates to guarantee negative real rates of return; 3) compulsory funding of government debt by financial institutions; and 4) capital controls. ======1) Inflation. First and foremost, a government that owes too much money destroys the value of those debts through destroying the value of the national currency itself. It doesn't get any more traditional than that from a long-term, historical perspective. Without inflation, Financial Repression just doesn't work. Historically, the rate does not have to be high so long as the government is patient, but the higher the rate of inflation, the more effective financial repression is at quickly reducing a nation's debt problem. For example, per the Reinhart and Sbrancia paper, the US and UK used the combination of inflation and Financial Repression to reduce their debts by an average of 3-4% of GDP per year, while Australia and Italy used higher inflation rates in combination with Financial Repression to more swiftly drop their outstanding debt by about 5% per year in GDP terms. As the crisis is much worse this time around, a substantially higher rate of inflation than that experienced in the 1945 to 1980 period is going to be necessary. [A useful rule to know to roughly work out the effect of inflation on debt is 'The rule of 72'. If you divide 72 by the inflation rate per annum over the time period, it will tell you the number of years for inflation to halve the original nominal value of the debt. So if inflation were arranged by the government through fiscal and monetary policies to run at 10% per annum on average then in 7.2 years you would have halved the original nominal value of the debt, if it was set to run at 7.2% p.a. then in 10 years, 5% p.a. then in 14.4 years, 3.5% then 20 years, 2.5% p.a. then in 28.8 years, etc.] ======2) Negative Real Interest Rates. In a theoretical world, some would say that governments can't inflate away debts because the free market [sometimes called the ‘bond vigilantes’] would demand interest rates that compensate them for the higher rate of inflation. [For example most 10 year bonds at the time of sale historically sell at a price that yields about 2% above the expected inflation rate over their 10 year term.] Sadly, this theoretical world has little to do with the past or present real world. In the past (and all too likely in the future), there were formal government regulations that determined the maximum interest rates that could be paid. As an example, Regulation Q was used in the United States to prevent the payment of interest on checking accounts, and to put a cap on the payment of interest on savings accounts. Regulation Q is long gone, but government control of short term interest rates has been near absolute over the last decade in the United States [although 10 year bond yields are harder for the government or central bank to dictate]. As described in detail in my article linked [and quoted] below, ‘Cheating Investors As Official Government Policy’, the Federal Reserve has been openly using its powers to massively manipulate interest rates in the US, keeping costs low for the government while cheating tens of millions of investors. So long as the Federal Reserve keeps control, there is no need for explicit interest rate controls. However, should the Fed begin to lose control, there is a strong possibility that interest rate controls will return to the US financial landscape, with similar regulatory controls being re-imposed in other nations. [Refer http://www.safehaven.com/article/20089/cheating-investors-as-official-government-policy Cheated? How so? ‘…If you don't have a free market price, but you instead have a price determined by a force outside of the market (like the Federal Reserve Open Market Committee setting the federal funds rate, which is how the Fed tries to influence or control all short-term interest rates in the United States), then you have a manipulated [rather than a free market- capitalist] price. If the manipulation is to force prices too low [yield too high], then the seller [US Treasury] is cheated, and if the manipulation is to force prices too high [yield too low], then the buyer [sovereign debt, notes and bond dealer banks that are authorized to sell to their clients, including other banks, foreign governments, insurance companies, etc] is cheated. If there is any kind of manipulation, then by definition someone is being cheated when compared to a free market. The state of many of the investment markets in the United States in 2011 is that nobody is getting a free market price for just about anything. This is crucially important, because no matter how purportedly laudable the public policy interest goal is (as explained in the media), every time there is an intervention to manipulate prices, then somebody is being cheated to pay for it. When government policy deliberately forces artificial prices upon a market because politicians don't want the market price to prevail, then in every transaction in that market one side is either paying too much, or one side is getting paid too little. This is not the conventional ‘spin’, but it is an intellectually valid perspective that has powerful real world consequences for the current and future lifestyles of many tens of millions of responsible savers and investors (whose cash interest rates are determined by this process)… The overwhelming emphasis of the historically unprecedented Federal Reserve interventions in recent years has been to keep interest rates as low as they can possibly be. Indeed, much lower than they would be in a rational market. What this means is the Federal Reserve has been manipulating short-term interest rates so that purchasers of short-term securities, as well as all savers in general, are being systemically cheated out of the yields they would otherwise get in a free market. This a fascinating example of how the remarkable becomes the norm almost without comment - when that serves the interests of powerful special interest groups. It has been a very long time since anyone in the US has been rewarded for responsibly saving their money in savings, money market or interest-bearing checking accounts. The paltry interest rates have lagged well behind even the official rate of inflation. For an economically rational person - saving money has been actively discouraged as an incidental by-product of government policy. While periodically ‘tsk-tsking’ those irresponsible average citizens and saying they really should be saving more, what the government has actually been effectively encouraging is the exact opposite - because artificially low interest rates better serve bank and corporate borrowing needs. Now let's consider our current situation where food prices are spiking, energy prices are soaring, and the Federal Reserve for the first time since the Civil War is engaged in a massive policy of straight up monetization (i.e. creating money out of thin air to directly fund endless federal deficits)[this time euphemistically called, ‘quantitative easing’]. This is surely a combination of circumstances that in a free market would lead to soaring interest rates. Inflation is not merely on the horizon, rather it is all around us when we look at food costs, fuel, heating and health care. The Federal Reserve is basically flicking lit matches at pools of gasoline when it comes to the future value of the dollar with its policy of monetization. Indeed, the (successful) strategy being pursued by the US in waging currency warfare is to threaten to destroy the value of the dollar through monetary creation [and dilution to improve our export price competitiveness and therefore the profits of our exporters]. Arguably, free market interest rates should be soaring, as investors seek protection from [imported] inflation. Yet when we look at short-term interest rates they are some of the lowest in financial history. Because the free market has nothing to do with what we as savers are being paid, this is an entirely manipulated market. Indeed the Federal Reserve has been radically increasing market interventions to try to manipulate interest rates in areas where traditionally it has not been able to do so because of previously (but no longer) limited Federal Reserve powers. One unprecedented intervention was that for over a year, between 2009 and 2010, the Federal Reserve created an almost entirely artificial mortgage market to essentially fund every mortgage being originated in the US, and keep mortgage rates well below what market interest rates would have been. This manipulation was so overt and massive that not enough buyers could be found, so the Fed had to directly create over $1 trillion in new money to fund the purchase of effectively all new conforming mortgage originations (on a net basis) at far below market yields, as covered in my article ‘Creating A Trillion From Thin Air’. http://danielamerman.com/articles/Trillions.htm While the powerful price and yield distortions drove many buyers away, there was still a continuous and functioning market, meaning every day private buyers were grossly overpaying for mortgage securities. That is, on a net basis, Federal Reserve monetary creation put enough new money into the market to effectively fund the purchase of all newly created mortgage securities, but it did not comprise the entire trading volume of the market; private parties bought and sold from each other every trading day at the manipulated prices. Individuals who knew little about the unprecedented Federal Reserve actions, but who were following the traditional strategy of the last several decades of boosting yields above Treasury bonds via buying agency mortgage securities, or who bought into funds following that strategy, were being quite blatantly cheated and were paying much more than they should have had to, because of the artificial market. The stated purpose of QE2 (the second round of so-called ‘quantitative easing’, aka running the printing presses) is for the Federal Reserve to directly manipulate medium and long-term treasury bond rates with the idea of encouraging corporate borrowing [and real estate and share market speculation – reflation]. I wrote about this in detail when QE2 was first announced, but despite the Fed openly stating exactly what it planned to do, few financial writers seem to understand exactly what the Fed is in fact doing. As announced by the Fed, and described in my article ‘Radical Difference Between Monetization 1 and QE2’ linked below, the Federal Reserve is not actually directly funding the Treasury. Even though the Federal Reserve is directly creating money out of thin air at a rate approximately equal to the US budget deficit, and using the money to buy [through POMO – Permanent Open Market Operations] Treasury Bonds, the Fed is buying them in the market rather than directly - and they aren't the same securities. Part of the reason is that it is illegal for the Fed to directly fund the Treasury (though a simple act of Congress could cure that at any time if need be). The bigger reason is that the Federal Reserve is attempting to manipulate all interest rates in the US through controlling short, medium and long term Treasury Bond rates, so it is using the money not to directly fund, but to intervene wherever it thinks the market is most in need of intervention. By controlling the secondary rather than the primary market (my apologies for the jargon), the Fed takes control of all interest rates. http://danielamerman.com/articles/Monetize1.htm As discussed in the article above, the Federal Reserve has an unlimited supply of dollars, and is using not just the massive creation of money, but the knowledge of other buyers and sellers that the Fed is in charge, to effectively control the markets in US Treasury securities. If a financial firm were to risk its capital and take a huge position speculating that interest rates will rise to an impermissible degree, the Fed has unmatched resources to force interest rates down, force a major trading loss, and quash the uncooperative firm in question. On the other hand, so long as the investment banks follow the lead of the Fed (and they are), then they make ‘free money’ and trading profits without end by following the script fed to them by their cronies at the Fed and the Treasury, profiting from the easiest counterparty in the world to trade against, that being the government. The ripple effects of this overtly manipulated and rigged insider's game reach into our day to day lives all across the nation. That is because Treasury yields are the base from which virtually all other interest rates are determined. Whether we are talking about certificates of deposit, corporate bonds, municipal bonds, junk bonds, fixed rate annuities, credit cards, prime-based lending, or home equity lines - the base is the Treasury yield for that maturity, and then a spread is added to it. Control the Treasury yields - and one controls almost everything (other than the spread). When interest rates in general are manipulated, what does that mean for savers and investors? When you put your savings into a money market fund, and the policy of the US government is to force interest rates to unnaturally low levels - you are being cheated out of the yield you should be receiving. When you buy a corporate bond or corporate bond fund - you are being cheated by overt government market interventions that have the explicitly stated purpose of lowering corporate borrowing costs. This is where that ‘spin’ comes back in. How does a government lower borrowing costs for multinational corporations, enabling them to take the proceeds and invest them overseas? (Taking the money and investing it out of country seems to be the most common behavior so far.) [Many speculators are also borrowing cheaply in the US and investing overseas for the higher growth and interest rates, in what is known as a ‘carry trade’ in the investment industry.] The government does so by manipulating the market so that investors receive much lower interest payments than they would receive in a free market. In other words, it directly creates benefits for corporations and banks by cheating ordinary investors out of the income they would receive if free market forces governed. Boil it down to another level, and this is a fairly straight up redistribution of wealth from average citizens to corporate interests. Wherever the investor goes, whatever interest-bearing investment they look to - there is no escaping the cheating, because there is no escaping the unprecedented direct government control over interest rates. Even as inflation rises (in the real world rather than the also manipulated world of government statistics), there is nowhere for the fixed-income investor to find compensation for current inflation or inflationary pressures. Which, in a free market, would likely be the dominant market forces at this point. Adding to the irony - and the tragic dilemma for us all - is that the market manipulation is being paid for by the Federal Reserve creating brand new money out of the nothingness, so to speak, at the rate of about $1,000 per US household per month. This is creating perhaps the greatest inflationary pressures of our lifetime. In other words, government policy is to risk the value of all of our savings in the future, in order to fund a program of cheating us out of market interest rates today. And this thereby ensures that none of us are compensated for the inflationary risks, or are able to prepare for the destruction of the value of our money by way of conventional methods.] ======3) Involuntary Funding [of Government Sovereign Debt]. With this popular component of Financial Repression, the government [in conjunction with the Federal Reserve and other central banks through their coordinating bank body, the Bank of International Settlements along with other governments through the G20 and IMF], establishes reserve [capital adequacy ratios – the percent of highly liquid assets the banks must hold in relation to the loans they have made – ‘quantity’, which has been significantly raised after the GFC bailouts] or ‘quality’ requirements for financial institutions that make holding substantial amounts of government debt [as they need to hold AAA rated debt, which is highly liquid and easily sold or used for collateral with a central bank worldwide, and which can only be found in government sovereign debt, especially US government debt as the US dollar is the World Reserve Currency] mandatory - or at least establish overwhelming incentives for financial institutions such as banks, savings and loans, credit unions and insurance companies to do so [for example, the price the banks are charged by governments, for example in Australia, for the insurance they provide each bank’s depositors which varies by the risk as determined by the quantity and quality of their liquid capital – ie their sovereign debt as well as the risk profile of their loans]. Of course, this is publicly phrased as ‘mandating financial safety’, instead of the more accurate description of mandating the making of investments at below market interest rates to help overextended governments recover from financial difficulties [due as a result of the governments bailing out financial institutions due to the fear of what would happen to the global finances and trade if they didn’t]. This involuntary funding is sometimes described as a hidden tax on financial institutions, but let me suggest that this perspective misses the important part for you and me. Because all financial institutions operating within a country are required to effectively subsidize this liquidation of government debt by accepting less than the rate of inflation on interest rates, the gross revenues of all financial institutions are depressed, and therefore less money can be offered to depositors and policyholders. Because financial institutions make their money not on gross revenues, but on the spread between what they pay out [to borrow, which includes the interest paid to cash depositors] and take in [from lending to businesses and home buyers, etc], then arguably, financial institution profits are not necessarily reduced, rather the guaranteed annual loss in purchasing power is passed straight through to depositors and policyholders, i.e. you and me. As an example, if a fair inflation-adjusted return were 8%, and the spread kept by the financial institution was 2%, then we as investors would get 6%. If financial institutions, through involuntary funding, are uniformly forced to accept a 3% return on the government debt that must constitute a big portion of their portfolios, then they still keep 2%, but only pass through 1%. So the financial institution keeps 2% either way, and we as savers are the ones who ultimately pay this ‘hidden tax’ in full, by getting a repressed 1% instead of a fair market 6% return. =====4) Capital Controls. In addition to ongoing inflation that destroys the value of everyone's savings and thereby the value of the government's debts, while simultaneously making sure that interest rate levels lock in inflation-adjusted investor losses on a reliable basis, there is another necessary ingredient to Financial Repression: participation must be mandatory. Or as Reinhart and Sbrancia phrase it in their description / recipe for Financial Repression, it requires the ‘creation and maintenance of a captive domestic audience’ (underline mine). The government has to make sure that it has controls in place that will keep the savers in place while the purchasing power of their savings is systematically and deliberately destroyed [as the byproduct of the government’s need and policies to inflate away the real purchasing power of their debts]. This can take the form of explicit capital and exchange controls, but there are numerous other, more subtle methods that can be used to essentially achieve the same results, particularly when used in combination. This can be achieved through a combined structure of tax and regulatory incentives for institutions and individuals to keep their investments "domestic" and in the proper categories for manipulation, as well as punitive tax and regulatory treatment of those attempting to escape the repression. A carrot and stick approach in other words, to make sure behavior is controlled. ======A Sheep Shearing Instruction Manual: Only a tiny fraction of 1% of the world's population will ever read the original paper on the IMF website, or detailed analyses thereof. This is dry and boring stuff when compared to dancing or singing with the stars! Of course, there are many millions of investors who do read daily or weekly about what is going on in the financial world - but they and the journalists and bloggers who inform them usually just follow the ever changing surface of the markets. Again, the academic papers involved are so dry, boring and fundamental as to seem to have little relevance for the practical matter of what actions to take today or this month. That said, let me suggest that few things are more important for your financial future than understanding and taking to heart Financial Repression. Because understanding Financial Repression means pulling the curtain aside and looking into the inner core of financial reality. It means understanding that much of what you have read and been taught about investment markets and long term investments over the last several decades has effectively been a sham. Investor returns are not - and arguably never have been - fully about people compounding wealth in free markets, with the collective wisdom of the markets guaranteeing returns that are based upon rational assessments of the risk [reflected by interest rates and prices for shares, etc]. Rather, investments, investment markets, investor returns and investor behavior have always been matters of governmental policy; what has varied over the years has been the form of government policy and how overt the control is. To fully understand Financial Repression, you need to understand that the Reinhart and Sbrancia paper is effectively a sheep shearing manual. You and I, along with the rest of the savers and investors of the world are the sheep, and the goal of Financial Repression is to shear as much savings from us as the governments can, year after year, without triggering excessive unrest, and while keeping us producing the resources that can be politically redistributed. The governments of the world are in trouble, and they would prefer to avoid overt global defaults, hyperinflation, or comprehensive austerity [spending cuts, asset sales/privitzations] coupled with massive tax hikes. Each of those routes is highly unpopular, and could lead to political turmoil that would remove the decision makers and the special interests who support them from power. A more overt ‘managed economy’ sounds much more attractive if you are in power, particularly since it has worked before over a period of decades, with an almost boring lack of political turmoil. To get out of trouble, the governments have to wipe out most of the value of their debts, without raising taxes to the degree needed to pay the debts off at fair value [or interest rates that reflect the true risks]. In other words, they need to cheat the investors. There is nothing accidental going on here, all that is in question are the particulars of the strategies for cheating the investors, meaning the collective savers of the world. Again, the time-honored and traditional form that governments who incur too much debt use in cheating the investors is to devalue the currency. Create enough inflation, and tax collections will rise [with bracket creep as well as people’s incomes inflate so that some goes into the next tranche of tax rates] with inflation but the debts won't, and the savers of the world will be paid back in full with currency that is worth much less than what was lent to the governments in the first place. Except that there is the technicality that in theory, interest rates will rise above the rate of inflation, so that the value of savings is not eroded. From the governmental perspective, this is demonstrably a rather absurd theory. The core point of the Reinhart and Sbrancia paper is that the advanced economies of the world quite effectively squeezed an average of 3-4% annually of the value of government debt out of investor real net worth for a period of 35 years, using a wide assortment of overt and less overt controls over interest rates and investor behavior [so inflation reduced debt at about 3.5% a year halving the massive World War II debts at 90% of GDP to 25% in 25 years – just as the ‘Rule of 72’ predicts plus GDP growth increasing to reduce the denominator to make the debt to GDP from the half at 45% to the actual of 25% achieved]. Today the mechanism is different in that the central banks are using massive monetary creation in combination with their regulatory powers over major banks to control interest rates. However, the bottom line is that interest rates are absurdly low compared to the inflation and default risks, and this is because of near complete government control. One potential sheep shearing problem is that only a minority of us ‘sheep’ directly own government debt. For maximum sheep shearing efficiency, all of us who lead productive lives and produce more than we consume (meaning we generate savings) need to be sheared - and sheared often - whether we buy government bonds or not. This next step is one of the hardest parts for non-financial professionals to understand, but through manipulations of capital requirements and the creation of regulatory incentives and disincentives (that never make the nonfinancial media) governments can effectively control the investment behavior of financial institutions, and force the institutions to take on investments that pay less than the rate of inflation. From which the institutions still take their cut [margin to keep shareholders and bank share prices acceptable in regard to the return on equity, profit, price appreciation and share dividends], and then pass through a still lower real return to their depositors and policyholders. So wherever we put our money, in whatever financial institution - we get absurdly low rates of return that help the governments reduce the real value of their debts. So we're getting sheared, we've got no choice about it, the government explicitly plans to keep on shearing us for every remaining year of our lives, and wherever we go in the meadow, we still get sheared. This leads to the more savvy of us sheep trying to escape the meadow, and again, this is anticipated in the Financial Repression structure right from the beginning, with the construction of capital control fences. Many of the controls on savings leaving the country have been loosened since 1980. However, these controls have been returning since 2008, and are just likely to grow stronger as the return to full-on Financial Repression likely grows more overt. ======Leaving The Flock: There is a way to beat Financial Repression. How? Succinctly phrased: the first step is to stop thinking like a sheep and start thinking like a shepherd. Stop acting like a sheep, and change your financial profile so that it aligns with the objectives of the ‘shepherds’, the governments of the world. Instead of fighting the governments of the world - position yourself so that the higher the rate of inflation and the greater the destruction of the value of money - the greater your real wealth grows, in inflation-adjusted terms. The fundamentals of Financial Repression are for governments to pin down their citizens, force them to take interest rates that are below the government-induced rate of inflation, and make it almost impossible for an older investor with a conventional financial profile to escape. This is a time to fight the good fight politically - but not with your savings or your future standard of living. Instead, align your financial interests with your government and the governments of the world. So that the more outrageous the government actions become in squeezing the value of investor savings from their populations - the more reliable the compounding of your wealth becomes for you, and the greater the growth in your financial security. So how does one stop thinking and acting like a sheep? This can be amazingly simple, or it can be impossibly difficult. It is you and the way your mind works that will determine whether thinking like a shepherd will become simple or be impossible. How open are you - truly - to changing the way you view investments and financial security? Can you change the personal paradigm that may have shaped your worldview for decades? View the investment world in the way in which we have all been programmed, and maintaining wealth over the coming years of inflation and Financial Repression is going to be extraordinarily difficult, particularly in after-tax and after-inflation terms. Because everything around you really is set up for sheep shearing. That's not a conspiracy theory - that is how the world really worked between 1945 and 1980, and policymakers around the world likely see variants of this proven debt reduction methodology as their only way out. The Great Sheep Shearing of the early 21st century is already in process (we're just using some different names and methods this time around), and it will likely succeed with the overwhelming majority of investors - much like it did before, only on a more thorough basis, because the problems are far larger this time around. Whether Financial Repression will successfully prevent a meltdown is a different question, but regardless, the attempt is still likely to dominate markets as well as government regulations and policy. Your alternative is to accept the world as it is, take personal responsibility for your own outcome, and educate yourself. You can seek to fundamentally change your paradigm, turn it upside down - and personally turn that same world of high inflation and Financial Repression into a target-rich environment of wealth building opportunities. It is all up to you. [As promised an abstract of the discussion paper, ‘THE LIQUIDATION OF GOVERNMENT DEBT’ about ‘Financial Repression’ is included below. Selected quotes of interest or surprise from it are quoted separately on this website and can be found by using the Imagi-Natives’ Search facility on this website, easily found on the home page, and searching using the paper’s title or authors’ names. For the full IMF document please use the link. http://www.imf.org/external/np/seminars/eng/2011/res2/pdf/crbs.pdf ]   ‘THE LIQUIDATION OF GOVERNMENT DEBT’, Carmen M. Reinhart and M. Belen Sbrancia, Working Paper 16893, [ http://www.nber.org/papers/w16893 ], NATIONAL BUREAU OF ECONOMIC RESEARCH, 1050 Massachusetts Avenue, Cambridge, MA 02138, March 2011. The authors wish to thank Alex Pollock, Vincent Reinhart, and Kenneth Rogoff for helpful comments and suggestions and the National Science Foundation Grant No. 0849224 for financial support. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. © 2011 by Carmen M. Reinhart and M. Belen Sbrancia. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source... ABSTRACT: Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts. A subtle type of debt restructuring takes the form of “financial repression.” Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks. In the heavily regulated financial markets of the Bretton Woods system, several restrictions facilitated a sharp and rapid reduction in public debt/GDP ratios from the late 1940s to the 1970s. Low nominal interest rates help reduce debt servicing costs while a high incidence of negative real interest rates liquidates or erodes the real value of government debt. Thus, financial repression is most successful in liquidating debts when accompanied by a steady dose of inflation. Inflation need not take market participants entirely by surprise and, in effect, it need not be very high (by historic standards). For the advanced economies in our sample, real interest rates were negative roughly ½ of the time during 1945-1980. For the United States and the United Kingdom our estimates of the annual liquidation of debt via negative real interest rates amounted on average from 3 to 4 percent of GDP a year. For Australia and Italy, which recorded higher inflation rates, the liquidation effect was larger (around 5 percent per annum). We describe some of the regulatory measures and policy actions that characterized the heyday of the financial repression era. " - Daniel R. Amerman
A financial author, Chartered Financial Analyst, MBA, former investment banker in the United States of America, and founder of the website, The-Great-Retirement-Experiment.com . This article was published, Mon, Jun 6, 2011 on Safehaven.com http://www.safehaven.com/article/21228/financial-repression-a-sheep-shearing-instruction-manual
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[Quote No.36103] Need Area: Money > Invest
"[This is part one of two quotes. This is due to its unusual length. To find the rest of this quote please search under the name/s of the author of this quote or if this quote is from an article or speech that has a title which is in the quote by searching using the title's key words.] [Sections of INTEREST or SURPRISE in the portions of this IMF discussion document quoted here are CAPITALISED to make them easier to find. For the original full IMF document please use the link. http://www.imf.org/external/np/seminars/eng/2011/res2/pdf/crbs.pdf ] ‘THE LIQUIDATION OF GOVERNMENT DEBT’ ABSTRACT: Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts. A subtle type of debt restructuring takes the form of “financial repression.” Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks. In the heavily regulated financial markets of the Bretton Woods system, several restrictions facilitated a sharp and rapid reduction in public debt/GDP ratios from the late 1940s to the 1970s. Low nominal interest rates help reduce debt servicing costs while a high incidence of negative real interest rates liquidates or erodes the real value of government debt. Thus, financial repression is most successful in liquidating debts when accompanied by a steady dose of inflation. Inflation need not take market participants entirely by surprise and, in effect, it need not be very high (by historic standards). For the advanced economies in our sample, real interest rates were negative roughly ½ of the time during 1945-1980. For the United States and the United Kingdom our estimates of the annual liquidation of debt via negative real interest rates amounted on average from 3 to 4 percent of GDP a year. For Australia and Italy, which recorded higher inflation rates, the liquidation effect was larger (around 5 percent per annum). We describe some of the regulatory measures and policy actions that characterized the heyday of the financial repression era. …Throughout history, debt/GDP ratios have been reduced by (i) economic growth; (ii) a substantive fiscal adjustment/austerity plans; (iii) explicit default or restructuring of private and/or public debt; (iv) a sudden surprise burst in inflation; and (v) a steady dosage of financial repression that is accompanied by an equally steady dosage of inflation. …Hoping that substantial public and private debt overhangs are resolved by growth may be uplifting but it is not particularly practical from a policy standpoint. The evidence, at any rate, is not particularly encouraging, as high levels of public debt appear to be associated with lower growth. …The aim of this paper is to document the more subtle and gradual form of debt restructuring or ‘taxation’ that has occurred via financial repression. We show that such repression helped reduce lofty mountains of public debt in many of the advanced economies in the decades following World War II and subsequently in emerging markets, where financial liberalization is of more recent vintage. …We find that financial repression in combination with inflation played an important role in reducing debts. Inflation need not take market participants entirely by surprise and, in effect, it need not be very high (by historic standards). In effect, financial repression via controlled interest rates, directed credit and persistent, positive inflation rates is still an effective way of reducing domestic government debts in the world’s second largest economy-- China. Baai, et al [Bai, Chong-En, David D. Li, Yingyi Qian, and Yijang Wang (2001) ‘Financial Repression and Optimal Taxation’, Economic Letters, 70 (2), February 2001], for example, present a framework that provides a general rationale for financial repression as an implicit taxation of savings. They argue that when effective income-tax rates are very uneven, as common in developing countries, raising some government revenue through mild financial repression can be more efficient than collecting income tax only. … discussion of how public debts have been reduced in the past has focused on the role played by fiscal adjustment. It thus appears that it has also been collectively “forgotten” that the widespread system of financial repression that prevailed for several decades (1945-1980s) worldwide played an instrumental role in reducing or “liquidating” the massive stocks of debt accumulated during World War II in many of the advanced countries, United States inclusive. 8 We document this phenomenon… 8 For the political economy of this point see the analysis presented in Alesina, Grilli, and Milesi Ferretti (1993). They present a framework and stylized evidence to support it that strong governments coupled with weak central banks may impose capital controls so as to enable them to raise more seigniorage and keep interest rates artificially low—facilitating domestic debt reduction… Section III provides a short description of the types of financial sector policies that facilitated the liquidation of public debt. Hence, our analysis focuses importantly on regulations affecting interest rates (with the explicit intent on keeping these low) and on policies creating “captive” domestic audiences that would hold public debts (in part achieved through capital controls, directed lending, and an enhanced role for nomarketable public debts). We also focus on the evolution of real interest rates during the era of financial repression (1945-1980s). We show that real interest rates were significantly lower during 1945-1980 than in the freer capital markets before World War II and after financial liberalization. This is the case irrespective of the interest rate used--whether central bank discount, treasury bills, deposit, or lending rates and whether for advanced or emerging markets. …For the advanced economies, real ex-post interest rates were negative in about half of the years of the financial repression era compared to less than 15 percent of time since the early 1980s. In Section IV, we provide a basic conceptual framework for calculating the “financial repression tax,” or more specifically, the annual “liquidation rate” of government debt. Alternative measures are also discussed. These exercises use a detailed data base on a country’s public debt profile (coupon rates, maturities, composition, etc.) from 1945 to 1980 constructed by Sbrancia (2011). This “synthetic” public debt portfolio reflects the actual shares of debts across the different spectrum of maturities as well as the shares of marketable versus nonmarketable debt (the latter involving both securitized debt as well as direct bank loans). Section V presents the central findings of the paper, which are estimates of the annual “liquidation tax” [or ‘financial repression’ tax] as well as the incidence of liquidation years for ten countries (Argentina, Australia, Belgium, India, Ireland, Italy, South Africa, Sweden, the United Kingdom, and the United States). For the United States and the United Kingdom, the annual liquidation of debt via negative real interest rates amounted to 3 to 4 percent of GDP on average per year. Such annual deficit reduction quickly accumulates (even without any compounding) to a 30-40 percent of GDP debt reduction in the course of a decade. For other countries, which recorded higher inflation rates the liquidation effect was even larger. As to the incidence of liquidation years, Argentina sets the record with negative real rates recorded every single year from 1945 to 1980… Section VI examines the question of whether inflation rates were systematically higher during periods of debt reduction in the context of a broader 28-country sample that spans both the heyday of financial repression as well as the periods before and after. We describe the algorithm used to identify the largest debt reduction episodes on a country-by-country basis and, show that in 21 of the 28 countries inflation was higher during the larger debt reduction periods. …Finally, we discuss some of the implications of our analysis for the current debt overhang and highlight areas for further research. There are detailed appendices which: (i) compare our methodology to other approaches in the literature that have been used to measure the extent of financial repression or calculate the financial repression tax; …Financial Repression Defined: Default, Restructuring and The pillars of “Financial repression” The term financial repression was introduced in the literature by the works of Shaw (1973) and Ronald McKinnon (1973). Subsequently, the term became a way of describing emerging market financial systems prior to the widespread financial liberalization that began in the 1980 (see Agenor and Montiel, 2008, for an excellent discussion of the role of inflation and Giovannini and de Melo, 1993 and Easterly, 1989 for country-specific estimates). However, as we document in this paper, financial repression was also the norm for advanced economies during the post World War II and in varying degrees up through the 1980s. We describe here some of its main features. (i) Explicit or indirect caps or ceilings on interest rates, particularly (but not exclusively) those on government debts. These interest rate ceilings could be effected through various means including: (a) explicit government regulation (for instance, Regulation Q in the United States prohibited banks from paying interest on demand deposits and capped interest rates on saving deposits). (b) In many cases ceilings on banks’ lending rates were a direct subsidy to the government in cases where the government borrowed directly from the banks (via loans rather than securitized debt); (c) the interest rate cap could be in the context of fixed coupon rate nonmarketable debt; (d) or it could be maintained through central bank interest rate targets (often at the directive of the Treasury or Ministry of Finance when central bank independence was limited or nonexistent). Metzler’s (2003) monumental history of the Federal Reserve (Volume I) documents the US experience in this regard; Cukierman’s (1992) classic on central bank independence provides a broader international context. (ii) Creation and maintenance of a captive domestic audience that facilitated directed credit to the government. This was achieved through multiple layers of regulations from very blunt to more subtle measures. (a) Capital account restrictions and exchange controls orchestrated a “forced home bias” in the portfolio of financial institutions and individuals under the Bretton Woods arrangements. (b) High reserve requirements (usually non-remunerated) as a tax levy on banks (see Brock, 1989, for an insightful international comparison). (c) Among more subtle measures, “prudential” regulatory measures requiring that institutions (almost exclusively domestic ones) hold government debts in their portfolios (pension funds have historically been a primary target); and (d) transaction taxes on equities (see Campbell and Froot, 1994) also act to direct investors toward government (and other) types of debt instruments. (e) prohibitions on gold transactions. (iii) Other common measures associated with financial repression aside from the ones discussed above are, direct ownership (China or India) of banks or extensive management of banks and other financial institutions (i.e. Japan). Restrictions of entry to the financial industry and directing credit to certain industries are also features of repressed financial markets (see Beim and Calomiris, 2000). II. Default, Restructuring and Conversions: Highlights from 1920s-1950s Peaks and troughs in public debt/GDP are seldom synchronized across many countries’ historical paths. There are, however, a few historical episodes where global (or nearly global) developments, be it a war or a severe financial and economic crisis, produces a synchronized surge in public debt, such as the one recorded for advanced economies since 2008. Using the Reinhart and Rogoff (2011) database for 70 countries, Figure 1 provides central government debt/GDP for the advanced economy and emerging market subgroups since 1900. It is a simple arithmetic average that does not assign weight according to country size. …1. Global debt surges and their resolution. An examination of these two series identifies a total of five peaks in world indebtedness. Three episodes (World War I, World War II, and the Second Great Contraction, 2008-present) are almost exclusively advanced economy debt peaks; one is unique to emerging markets (1980s debt crisis followed by the transition economies’ collapses); and the Great Depression of the 1930s is common to both groups. World War I and Depression debts were importantly resolved by widespread default and explicit restructurings or predominantly forcible conversions of domestic and external debts in both the now-advanced economies, as well as the emerging markets. Notorious hyperinflations in Germany, Hungary and other parts of Europe violently liquidated domestic-currency debts. Table 1 and the associated discussion provide a chronology of these debt resolution episodes. As Reinhart and Rogoff (2009 and 2011) document, debt reduction via default or restructuring has historically been associated with substantial declines in output in the run-up to as well as during the credit event and in its immediate aftermath. =================================================== Figure 1. Surges in Central Government Public Debts and their Resolution: Advanced. Economies and Emerging Markets, 1900-2011. [1920 and 1929 debt to GDP 70%] -solution- WWI and Depression debts (advanced economies: default, restructuring and conversions--a few hyperinflations) [1933 debt to GDP 70%] Great depression debts (in emerging markets-default) [1949 debt to GDP 90%] WWII debts: (Axis countries: default and financial repression/inflation Allies: financial repression/inflation) [1980s Debt Crisis debt to GDP 100%] (emerging markets: default, restructuring, financial repression/inflation and several hyperinflations) [2011 debt to GDP 90%:] Second Great Contraction (advanced economies) Average debt to GDP 1900’s = 50% range from 20% to 100% ==================================== Sources: Reinhart (2010), Reinhart and Rogoff (2009 and 2011), sources cited therein and the authors. [ Refer -Reinhart, Carmen M. and Kenneth Rogoff. 2009. ‘This Time is Different: Eight Hundred Centuries of Financial Folly’. Princeton: Princeton University Press. Here is a quote from that book that relates closely to our current debt to GDP discussion: ‘Our analysis was based on newly-compiled data on forty-four countries spanning about two hundred years. This amounts to 3,700 annual observations and covers a wide range of political systems, institutions, exchange rate arrangements, and historic circumstances. The main findings of that study are: --1-First, the relationship between government debt and real GDP growth is weak for debt/GDP ratios below 90% of GDP.1 Above the threshold of 90%, median growth rates fall by 1%, and average growth falls considerably more. The threshold for public debt is similar in advanced and emerging economies and applies for both the post World War II period and as far back as the data permit (often well into the 1800s). --2-Second, emerging markets face lower thresholds for total external debt (public and private) – which is usually denominated in a foreign currency. When total external debt reaches 60% of GDP, annual growth declines about 2%; for higher levels, growth rates are roughly cut in half. --3-Third, there is no apparent contemporaneous link between inflation and public debt levels for the advanced countries as a group (some countries, such as the US, have experienced higher inflation when debt/GDP is high). The story is entirely different for emerging markets, where inflation rises sharply as debt increases.’] Notes: Listed in parentheses below each debt-surge episode are the main mechanisms for debt resolution besides fiscal austerity programs which were not implemented in any discernible synchronous pattern across countries in any given episode. …The World War II debt overhang was importantly liquidated via the combination of financial repression and inflation, as we shall document. This was possible because debts were predominantly domestic and denominated in domestic currencies. The robust post-war growth also contributed importantly to debt reduction in a way that was a marked contrast to the 1930s, during which the combined effects of deflation and output collapses worked to worsen the debt/GDP balance in the way stressed by Irving Fisher (1931). …The resolution of the emerging market debt crisis involved a combination of default or restructuring of external debts, explicit default or financial repression on domestic debt. …In several episodes, notably in Latin America, hyperinflations in the mid to-late 1980s and early 1990s completed the job of significantly liquidating (at least for a brief interlude) the remaining stock of domestic currency debt (even when such debts were indexed [to inflation?], as was the case of Brazil). 2. Default, restructurings and forcible conversions in the 1930s. Table 1 lists the known “domestic credit events” of the Depression. Default on or restructuring of external debt (see the extensive notes to the table) also often accompanied the restructuring or default of the domestic debt. …All the Allied governments, with the exception of Finland, defaulted on (and remained in default through 1939 and never repaid) their World War I debts to the United States as economic conditions deteriorated worldwide during the 1930s. [10 Finland, being under threat of Soviet invasion at the time, maintained payments on their debts to the United States so as to maintain the best possible relationship.] Thus, the high debts of the First World War and the subsequent debts associated with the Depression of the 1930s were resolved primarily through default and restructuring. Neither economic growth nor inflation contributed much. In effect, for all 21 now-advanced economies, the median annual inflation rate for 1930-1939 was barely above zero (0.4 percent). It is important to stress that during the period after WWI the gold standard was still in place in many countries, which meant that monetary policy was subordinated to keep a given gold parity. In those cases, inflation was not a policy variable available to policymakers in the same way that it was after the adoption of fiat currencies. ============================================================ Table 1. [selected for interesting methods used] Episodes of Domestic Debt Conversions, Default or Restructuring, 1920s–1950s Country Dates Commentary… Australia 1931/1932 -The Debt Conversion Agreement Act in 1931/32 which appears to have done something similar to the later NZ induced conversion. China 1932 -First of several “consolidations”, monthly cost of domestic service was cut in half. Interest rates were reduced to 6 percent (from over 9 percent)— amortization periods were about doubled in length. France 1932 -Various redeemable bonds with coupons between 5 and 7 percent, converted into a 4.5 percent bond with maturity in 75 years. Greece 1932 -Interest on domestic debt was reduced by 75 percent since 1932; Domestic debt was about 1/4 of total public debt. New Zealand 1933 -In March 1933 the New Zealand Debt Conversion Act was passed providing for voluntary conversion of internal debt amounting to 113 million pounds to a basis of 4 per cent for ordinary debt and 3 per cent for tax-free debt. Holders had the option of dissenting but interest in the dissented portion was made subject to an interest tax of 33.3 per cent. 1 Peru 1931 After suspending service on external debt on May 29, Peru made “partial interest payments” on domestic debt. United States 1933 -Abrogation of the gold clause. In effect, the U.S. refused to pay Panama the annuity in gold due to Panama according to a 1903 treaty. The dispute was settled in 1936 when the US paid the agreed amount in gold balboas. [Alex Pollock pointed out the relevance of widespread restrictions on gold holdings in the United States and elsewhere during the financial repression era.] United Kingdom 1932 -Most of the outstanding WWI debt was consolidated into a 3.5 percent perpetual annuity. This domestic debt conversion was apparently voluntary. However, some of the WWI debts to the United States were issued under domestic (UK) law (and therefore classified as domestic debt) and these were defaulted on following the end of the Hoover 1931 moratorium. Germany June 20, 1948 -Monetary reform limiting 40 Deutschemark per person. Partial cancellation and blocking of all accounts. Japan March 2, 1946–1952 -After inflation, exchange of all bank notes for new issue (1 to 1) limited to 100 yen per person. Remaining balances were deposited in blocked accounts. Russia 1947 -The monetary reform subjected privately held currency to a 90 percent reduction… III. Financial Repression: policies and evidence from real interest rates 1. Selected financial regulation measures during the “era of financial repression” One salient characteristic of financial repression is its pervasive lack of transparency. The reams of regulations applying to domestic and cross-border financial transactions and directives cannot be summarized by a brief description. …domestic government debt played a dominant role in domestic institutions asset holdings--notably that of pension funds. [NOTE WELL] High reserve requirements, relative to the current practice in advanced economies and many emerging markets, were also a common way of taxing the banks not captured in our minimalist description. The interested reader is referred to Brock (1989) and Agenor and Montiel (2008), who focus on the role of reserve requirements and their link to inflation… Table 2: Selected Measures Associated with Financial Repression- Domestic Financial Regulation Capital Account-Exchange- Country Liberalization years (s) in italics with Restrictions emphasis on deregulation of interest rates. Argentina 1977-82, 1987, and 1991-2001, -Initial liberalization in 1977 was reversed in 1982. Alfonsin government undertook steps to deregulate the financial sector in October 1987, some interest rates being freed at that time. The Convertibility Plan -March 1991- 2001, subsequently reversed. 1977-82 and 1991-2001. Between 1976 and 1978 multiple rate system was unified, foreign loans were permitted at market exchange rates, and all forex transactions were permitted up to US$ 20,000 by September 1978. Controls on inflows and outflows loosened over 1977-82. Liberalization measures were reversed in 1982. Capital and exchange controls eliminated in 1991 and reinstated on December 2001. Australia 1980, -Deposit rate controls lifted in 1980. Most loan rate ceilings abolished in 1985. A deposit subsidy program for savings banks started in 1986 and ended in 1987. 1983, capital and exchange controls tightened in the late 1970's, after the move to indirect monetary policy increased capital inflows. Capital account liberalized in 1983… Chile 1974 -but deepens after 1984, commercial bank rates liberalized in 1974. Some controls reimposed in 1982. Deposit rates fully market determined since 1985. Most loan rates are market determined since 1984. 1979, capital controls gradually eased since 1979. Foreign portfolio and direct investment is subject to a one year minimum holding period. During the 1990s, foreign borrowing is subject to a 30% reserve requirement. Colombia 1980, -most deposit rates at commercial banks are market determined since 1980; all after 1990. Loan rates at commercial banks are market determined since the mid-70's. Remaining controls lifted by 1994 in all but a few sectors. Some usury ceilings remain. 1991, capital transactions liberalized in 1991. Exchange controls were also reduced. Large capital inflows in the early 90's led to the reimposition of reserve requirements on foreign loans in 1993. Egypt 1991, -interest rates liberalized. Heavy "moral suasion" on banks remains. 1991, Decontrol and unification of the foreign exchange system. Portfolio and direct investment controls partially lifted in the 90's. Finland 1982, -gradual liberalization 1982-91. Average lending rate permitted to fluctuate within limits around the Bank of Finland base rate or the average deposit rate in 1986. Later in the year regulations on lending rates abolished. In 1987, credit guidelines discontinued, the Bank of Finland began open market operations in bank CD's and HELIBOR market rates were introduced. In 1988, floating rates allowed on all loans. 1982.Gradual liberalization 1982-91. Foreign banks allowed to establish subsidiaries in 1982. In 1984, domestic banks allowed to lend abroad and invest in foreign securities. In 1987, restrictions on long-term foreign borrowing on corporations lifted. In 1989, remaining regulations on foreign currency loans were abolished, except for households. Short term capital movements liberalized in 1991. In the same year, households were allowed to raise foreign currency denominated loans. France 1984, -interest rates (except on subsidized loans) freed in 1984. Subsidized loans now available to all banks, are subject to uniform interest ceiling. 1986, in the wake of the dollar crisis controls on in/outflows tightened. The extensive control system established by 1974, remains in place to early 80's. Some restrictions lifted in 1983-85. Inflows were largely liberalized over 1986-88. Liberalization completed in 1990. Germany 1980, -interest rates freely market determined from the 70's to today. In the year indicated, further liberalizations were undertaken. 1974. Mostly liberal regime in the late 60's, Germany experiments with controls between 1970-73. Starting 1974, controls gradually lifted, and largely eliminated by 1981. India 1992. -Complex system of regulated interest rates simplified in 1992. Interest rate controls on D's and commercial paper eliminated in 1993 and the gold market is liberalized. The minimum lending rate on credit over 200,000 Rs eliminated in 1994. Interest rates on term deposits of over two years liberalized in 1995. 1991. Regulations on portfolio and direct investment flows eased in 1991. The exchange rate was unified in 1993/94. Outflows remained restricted, and controls remained on private off-shore borrowing. Italy 1983. -Maximum rates on deposits and minimum rates on loans set by Italian Banker's Association until 1974. Floor prices on government bonds eliminated in 1992… Philippines - 1983. Partially liberalized regime. Exchange controls on non-residents abolished in 1983. Limits still apply on purchases of forex for capital and current transactions by residents. Inward investment unrestricted, outward is subject to approval if outside Common Monetary Area. Several types of financial transactions subject to approval for monitoring and prudential purposes. Sweden 1980. - Gradual liberalization between 1980- 90. Foreigners allowed to hold Swedish shares in 1980. Forex controls on stock transactions relaxed in 1986-88, and residents allowed to buy foreign shares in 1988-89. In 1989 foreigners were allowed to buy interest bearing assets and remaining forex controls were removed. Foreign banks were allowed subsidiaries in 1986, and operation through branch offices in 1990. Thailand - Article VIII accepted and current account liberalization in 1990, capital account liberalization starting in 1991. Aggressive policy to attract inflows, but outflows freed more gradually. Restrictions on export of capital remain. The reserve requirement on short-term foreign borrowing in 7%. Currency controls introduced in May-June 1997. These controls restricted foreign access to baht in domestic markets and from the sale of Thai equities. Thailand relaxed limits on foreign ownership of domestic financial institutions in October of 1997… United Kingdom 1981. -The gold market, closed in early World War II, reopened only in 1954. The Bank of England stopped publishing the Minimum Lending Rate in 1981. In 1986, the government withdrew its guidance on mortgage lending. 1979. July 79: all restrictions on outward FDI abolished, and outward portfolio investment liberalized. Oct 1979: Exchange Control Act of 1947 suspended, and all remaining barriers to inward and outward flows of capital removed. United States - In 1933, President Franklin D. Roosevelt prohibits private holdings of all gold coins, bullion, and certificates. On December 31, 1974, Americans are permitted to own gold, other than just jewellery. 1974. In 1961 Americans are forbidden to own gold abroad as well as at home. A broad array of controls were abolished in 1974. Venezuela 1991-94 and 1996 onwards. –Interest rate ceilings removed in 1991, reimposed in 1994, and removed again in 1996. Some interest rate ceilings apply only to institutions and individuals not regulated by banking authorities (including NGOs)… 2. Real Interest Rates. One of the main goals of financial repression is to keep nominal interest rates lower than would otherwise prevail. This effect, other things equal, reduces the governments’ interest expenses for a given stock of debt and contributes to deficit reduction. However, when financial repression produces negative real interest rates, this also reduces or liquidates existing debts. It is a transfer from creditors (savers) to borrowers (in the historical episode under study here--the government). [NOTE WELL THE FOLLOWING POLITICAL ADVICE TO DECEPTIVELY SPIN TO THE GENERAL PUBLIC, AS IF THE PUBLIC, WHO THEY ARE SUPPOSED TO BE SERVING AS PUBLIC SERVANTS RATHER THAN AN ELITE, MACHIAVELLIANLY MANIPULATIVE, POLITICAL CLASS, CAN’T BE TREATED LIKE INTELLIGENT, RESPONSIBLE ADULTS AND THEREFORE TRUSTED WITH THE TRUTH AND THEN REASONED WITH TO PERSUADE AT LEAST THE MAJORITY OF THEM OF THE WISDOM OF IMPLEMENTING THESE STEPS …AND IF THEY BELIEVE THEY CAN’T GET A MAJORITY THEN, IN A DEMOCRACY, SHOULDN’T THAT WARN THEM THAT MAY BE THEY ARE DOING SOMETHING THAT ISN’T RIGHT, ISN’T ETHICAL, ISN’T MORAL?… AND IF THEY’LL SPIN THIS ENCROACHMENT OF THE EQUAL INALIENABLE HUMAN RIGHT TO THEIR PRIVATE PROPERTY, WHAT ELSE WOULD THEY DO WITH SPIN? WHERE WOULD THEY DRAW THE LINE? IT’S ENOUGH TO MAKE THEM INELIGIBLE FOR SUCH HIGH OFFICE, KNOWING THE DANGEROUS TEMPTATIONS THAT THAT MUCH POWER AND OPPORTUNITY PRESENTS.] The financial repression tax has some interesting political-economy properties. Unlike income, consumption, or sales taxes, the 'repression' tax rate (or rates) are determined by financial regulations and inflation performance that are opaque to the highly politicized realm of fiscal measures [government spending]. Given that deficit reduction usually involves highly unpopular expenditure reductions and (or) tax increases of one form or another, the relatively 'stealthier' financial repression tax may be a more politically palatable alternative to authorities faced with the need to reduce outstanding debts… [This is part one of two quotes. This is due to its unusual length. To find the rest of this quote please search under the name/s of the author of this quote or if this quote is from an article or speech that has a title which is in the quote by searching using the title's key words.] " - Carmen M. Reinhart and M. Belen Sbrancia
Quoted from ‘THE LIQUIDATION OF GOVERNMENT DEBT’ Working Paper 16893 [ http://www.nber.org/papers/w16893 ] NATIONAL BUREAU OF ECONOMIC RESEARCH, 1050 Massachusetts Avenue, Cambridge, MA 02138, March 2011 The authors wish to thank Alex Pollock, Vincent Reinhart, and Kenneth Rogoff for helpful comments and suggestions and the National Science Foundation Grant No. 0849224 for financial support. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. © 2011 by Carmen M. Reinhart and M. Belen Sbrancia. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source… [ http://www.imf.org/external/np/seminars/eng/2011/res2/pdf/crbs.pdf ] More information about Financial Repression can be found by searching the imagi-natives.com website using those key words or by searching for them on the internet using Google or one of the other internet search engines.
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[Quote No.36104] Need Area: Money > Invest
"[This is part two of three quotes. This is due to its unusual length. To find the rest of this quote please search under the name/s of the author of this quote or if this quote is from an article or speech that has a title which is in the quote by searching using the title's key words.] [Sections of INTEREST or SURPRISE in the portions of this IMF discussion document quoted here are CAPITALISED to make them easier to find. For the original full IMF document please use the link. http://www.imf.org/external/np/seminars/eng/2011/res2/pdf/crbs.pdf ] ‘THE LIQUIDATION OF GOVERNMENT DEBT’ [continued] …As discussed in Obstfeld and Taylor (2004) and others, liberal capital- market regulations (the accompanying market-determined interest rates) and international capital mobility reached their heyday prior to World War I under the umbrella of the gold standard. World War I and the suspension of convertibility and international gold shipments it brought, and, more generally, a variety of restrictions on cross border transactions were the first blows to the globalization of capital. Global capital markets recovered partially during the roaring twenties, but the Great Depression, followed by World War II, put the final nails in the coffin of laissez faire banking. It was in this environment that the Bretton Woods arrangement of fixed exchange rates and tightly controlled domestic and international capital markets was conceived. 13 [13 In a framework where there are both tax collection costs and a large stock of domestic government, Aizenman and Guidotti, (1994) show how a government can resort to capital controls (which lower domestic interest rates relative to foreign interest rates) to reduce the costs of servicing the domestic debt.] In that context, and taking into account the major economic dislocations, scarcities, etc. which prevailed at the closure of the second great war, we witness a combination of very low nominal interest rates and inflationary spurts of varying degrees across the advanced economies. The obvious result, were real interest rates--whether on treasury bills (Figure 2), central bank discount rates (Figure 3), deposits (Figure 4) or loans (not shown)—that were markedly negative during 1945-1946. For the next 35 years or so, real interest rates in both advanced and emerging economies would remain consistently lower than the eras of freer capital mobility before and after the financial repression era. In effect, real interest rates (Figures 2-4) were, on average negative.14 [14 Note that real interest rates were lower in a high-economic-growth period of 1945 to 1980 than in the lower growth period 1981-2009; this is exactly the opposite of the prediction of a basic growth model and therefore indicative of significant impediments to financial trade.] Binding interest rate ceilings on deposits (which kept real ex-post deposit rates even more negative than real ex-post rates on treasury bills, as shown in Figures 2 and 4) “induced” domestic savers to hold government bonds. What delayed the emergence of leakages in the search for higher yields (apart from prevailing capital controls) was that the incidence of negative returns on government bonds and on deposits was (more or less) a universal phenomenon at this time.15 [15 A comparison of the return on government bonds to that of equity during this period and its connection to “the equity premium puzzle” can be found in Sbrancia (2011).] The frequency distributions of real rates for the period of financial repression (1945-1980) and the years following financial liberalization (roughly 1981-2009 for the advanced economies) shown in the three panels of Figure 5, highlight the universality of lower real interest rates prior to the 1980s and the high incidence of negative real interest rates. Such negative (or low) real interest rates were consistently and substantially below the real rate of growth of GDP, this is consistent with the observation of Elmendorf and Mankiw (1999) when they state “An important factor behind the dramatic drop (in US public debt) between 1945 and 1975 is that [NOTE WELL THE FOLLOWING] the growth rate of GNP exceeded the interest rate on government debt for most of that period.” They fail to explain why this configuration should persist over three decades in so many countries. =================================================== Figure 2: Average Ex-post Real Rate on Treasury Bills: Advanced Economies and Emerging Markets, 1945-2009 (3-year moving averages, in percent) 1945-1980 1981-2009 -1.6 2.8 -1.2 2.6 Average Real Treasury Bill Rate Advanced economies Emerging markets Financial Repression Era Notes: The advanced economy aggregate is comprised of: Australia, Belgium, Canada, Finland, France, Germany, Greece, Ireland, Italy, Japan, New Zealand, Sweden, the United States, and the United Kingdom. The emerging market group consists of: Argentina, Brazil, Chile, Colombia, Egypt, India, Korea, Malaysia, Mexico, Philippines, South Africa, Turkey and Venezuela. ========================================================== Figure 3: Average Ex-post Real Discount Rate: Advanced Economies and Emerging Markets, 1945-2009 (3-year moving averages, in percent) 1945-1980 1981-2009 -1.1 2.7 -5.3 3.8 Average Real Discount Rate Advanced economies Emerging markets Financial Repression Era ============================================ Figure 4: Average Ex-post Real Interest Rates on Deposits: Advanced Economies and Emerging Markets, 1945-2009 (3-year moving averages, in percent) 1945-1980 1981-2009 -1.94 1.35 -4.01 2.85 Average Real Interest Rate on Deposits Advanced economies Emerging markets Financial Repression Era Notes: The advanced economy aggregate is comprised of: Australia, Belgium, Canada, Finland, France, Germany, Greece, Ireland, Italy, Japan, New Zealand, Sweden, the United States, and the United Kingdom. The emerging market group consists of: Argentina, Brazil, Chile, Colombia, Egypt, India, Korea, Malaysia, Mexico, Philippines, South Africa, Turkey and Venezuela… Real interest rates on deposits were negative in about 60 percent of the observations. In effect, real ex-post deposit rates were below one percent about 83 percent of the time… ============================================= Figure 5: Real Interest Rates Frequency Distributions: Advanced Economies, 1945-2009 Treasury bill rate 1945-1980 1981-2009 0 percent 46.9 10.5 1 percent 61.6 25.2 2 percent 78.6 36.2 3 percent 88.6 55.0 Real Interest rate on T-bills Share of obsevations at or below: ================================== Discount rate 1945-1980 1981-2009 0 percent 41.9 11.6 1 percent 54.6 23.5 2 percent 69.4 37.0 3 percent 82.1 54.9 Real discount rate ===================================== Deposit rate 1945-1980 1981-2009 0 percent 58.8 24.6 1 percent 82.7 58.0 2 percent 94.7 85.4 3 percent 98.4 96.6 Real Interest rate on deposits Share of observations at or below: ================================================== The preceding analysis sets the general tone of what to expect, in terms of real rates of return on a portfolio of government debt, during the era of financial repression. For the United States, for example, Homer and Sylla (1963) describe 1946-1981 as the second (and longest) bear bond market in US history. 16 [16 They identify 1899-1920 as the first US bear bond market.] To reiterate the point that the low real interest rates of the financial repression era were exceptionally low not only in relation to the post-liberalization period but also to the more liberal financial environment of pre-World War II… The preceding analysis of real interest rates despite being qualitatively suggestive falls short of providing estimates of the magnitude of the debt-servicing savings and outright debt liquidation that accrued to governments during this extended period… IV. The Liquidation of Government Debt: Conceptual and Data Issues This section discusses the data and methodology we develop to arrive at estimates of how much debt was liquidated via a combination of low nominal interest rates and higher inflation rates, or what we term “the liquidation effect.” Data requirements… The calculation of the “liquidation effect” is a clear illustration of a case where the devil lies in the details, as the structure of government debt varies enormously across countries and within countries over time. Differences in coupon rates, maturity and the distribution of marketable and nonmarketable debt, securitized debt versus loans from financial institutions, importantly shape the overall cost of debt financing for the government. There is no “single” government interest rate (such as a 3-month t-bill or a 10-year bond) that is appropriate to apply to a hybrid debt stock. The starting point to come up with a measure that reflects the true cost of debt financing is a reconstruction of the government’s debt profile over time… For the benchmark or basic calculations (described below), this involves data on a detailed composition of debt, including maturity, coupon rate, and outstanding amounts by instrument. For a more comprehensive measure, which takes into account capital gains or losses of holding government debt, bond price data are also required. in all cases, we also use official estimates of consumer price inflation, which at various points in history may significantly understate the true inflation rates. [PLEASE NOTE THE JUST DESCRIBED DELIBERATE GOVERNMENT AND CENTRAL BANK OUTRAGEOUS DECEPTION IN UNDERSTATING INFLATION FIGURES RELEASED AT THE TIME TO THE PUBLIC AND THEREFORE THE INFLATION ADJUSTED REAL GDP WOULD ALSO HAVE BEEN OVERSTATED CREATING UNJUSTIFIED CONFIDENCE AND CAUSING POOR BUSINESS AND PERSONAL DECISIONS BECAUSE THEY’RE BASED ON FALSE INFORMATION. WITHOUT ACCURATE INFORMATION MAKING INFORMED CHOICES FOR WHAT IS BEST FOR WHAT YOU ARE RESPONSIBLE FOR IS IMPOSSIBLE. IT IS ECONOMIC SABOTAGE. BUSINESSES COULD OVER COMMIT RESOURCES AND WIND UP FINANCIALLY WRONG FOOTED WHICH MIGHT THEN REQUIRE LAYING OFF WORKERS, ETC]… 1. Benchmark basic estimates of the “liquidation effect” …A definition of debt “liquidation years.” Our benchmark calculations define a liquidation year, as one in which the real rate of interest (as defined above) is negative (below zero). This is a conservative definition of liquidation year; a more comprehensive definition would include periods where the real interest rate on government debt was below a “market” real rate.23 [23 However, determining what such a market rate would be in periods of pervasive financial repression requires assumptions about whether real interest rates during that period would have comparable to the real interest that prevailed in period when market were liberalized and prices were market determined.] Savings to the government during liquidation years. This concept captures the savings (in interest costs) to the government from having a negative real interest rate on government debt. (As noted it is a lower bound on saving of interest costs, if the benchmark used assumed, for example a positive real rate of, say, two or three percent.) These savings can be thought of as having “a revenue-equivalent” for the government, which like regular budgetary revenues can be expressed as a share of GDP or as a share of recorded tax revenues to provide standard measures of the “liquidation effect” across countries and over time. The saving (or “revenue”) to the government or the “liquidation effect” or the “financial repression tax” is the real (negative) interest rate times the “tax base,” which is the stock of domestic government debt outstanding. 2. An alternative measure of the liquidation effect based on total returns Thus far, our measure of the liquidation affect has been confined to savings to the government by way of annual interest costs. However, capital losses (if bond prices fall) may also contribute importantly to the calculus of debt liquidation over time. This is the case because the market value of the debt will actually be lower than its face value. The market value of government debt obviously matters for investors’ wealth but also measures the true capitalized value of future coupon and interest payments. Moreover, a government (or its central bank) buying back existing debt could directly and immediately lower the par value of existing obligations… 3. The role of inflation and currency depreciation The idea of governments using inflation to liquidate debt is hardly a new one since the widespread adoption of fiat currency, as discussed earlier.25 It is obvious that for any given nominal interest rate a higher inflation rate reduces the real interest rate on the debt, thus increasing the odds that real interest rates become negative and the year is classified as a “liquidation year.” Furthermore, it is also evident that for any year that is classified as a liquidation year the higher the inflation rate (for a given coupon rate) the higher the saving to the government. Our approach helps to pinpoint periods (and countries) when inflation played a systematically larger role in eroding the debts of the government. In addition, we can disentangle to what extent this was done via relatively short-lived “inflation surprises” (unanticipated inflation) or through a steady and chronic dose of moderate inflation over extended time horizons. Because we do not have a direct measure of inflation 24 As described in Appendix 2, we also calculate an alternative definition of “liquidation years” by comparing the real return of the government debt portfolio to the real return in the equity market. According to this definition, a given year is considered a “liquidation year” if the return in a given year for the government portfolio is below the return in the stock market; we use the most comprehensive stock market index available for each country expectations for much of the sample, we define inflation bursts or “surprises” in a more mechanical, ex-post manner. Specifically, we calculate a ten-year moving average for inflation and classify those years in which inflation was more than two-standard deviations above the 10-year average as an “inflation burst/surprise year”. As the 10-year window may be arbitrarily too backward looking, we also perform the comparable exercise using a five-year moving average. V. The Liquidation of Government Debt: Empirical Estimates This section presents estimates of the “liquidation effect” for ten advanced and emerging economies for most of the post-World War II period. Our main interest lies in the period prior to the process of financial liberalization that took hold during the 1980s—that is, the era of financial repression. However, as noted, this three-plus decade long stretch is by no means uniform. The decade immediately following World War II was characterized by a very high public debt overhang—legacy of the war, a higher incidence of inflation, and often multiple currency practices (with huge black market exchange rate premiums) in many advanced economies.26 The next decade (1960s) was the heyday of the Bretton Woods system with heavily regulated domestic and foreign exchange markets and more stable inflation rates in the advanced economies (as well as more moderate public debt levels). The 1970s was quite distinct from the prior decades, as leakages in financial regulations proliferated, the fixed exchange rate arrangements under Bretton Woods among the advanced economies broke down, and inflation began to resurface in the wake of the global oil shock and accommodative monetary policies in the United States and elsewhere. To this end, we also provide estimates of the liquidation of government debt for relevant subperiods. 1. Incidence and magnitude of the “liquidation tax” Table 4 provides information on a country-by-country basis for the period under study; the Incidence of debt liquidation years (as defined in the preceding section); the listing of the liquidation years; the average (negative) real interest rate during the liquidation years; and the minimum real interest rate recorded (and the year in which that minimum was reached). Given its notorious high and chronic inflation history coupled with heavy-handed domestic financial regulation and capital controls during 1944-1974, it is not surprising that Argentina tops the list. Almost all the years (97 percent) were recorded as liquidation years, as the Argentine real ex-post interest rates were negative in every single year during 1944-1974 except for 1953 (a just deflationary year). For India, that share was 53 percent (slightly more than one half of the 1949-1980 observations recorded negative real interest rates). Before reaching the conclusion that this debt liquidation through financial repression was predominantly an emerging market phenomenon, it is worth noting that for the United Kingdom the share of liquidation years was about 48 percent during 1945-1980. For the United States, the world’s financial center, a quarter of the years during that same period Treasury debt had negative real interest rates. As to the magnitudes of the financial repression tax (Table 4), real interest rates were most negative for Argentina (reaching a minimum of -53 percent in 1959). The share of domestic government debt in Argentina (and other Latin American countries) in total (domestic plus external) public debt was substantial during 1900-1950s; it is not surprising that in light of these real rates the domestic debt market all but disappeared and capital flight marched upwards (capital controls notwithstanding). By the late 1970s Argentina and many other chronic inflation countries were predominantly relying on external debt. Italian real interest rates right after World War II were as negative as 47 percent (in 1945). For the Unites States real rates were -8 to -9 percent during 1945-1947 on average the US had -3.5 percent real rates during the liquidation years). =================================================== Table 4: Incidence and Magnitude of the Liquidation of Public Debt: Selected Countries, 1945-1980 Negative Real Interest Rate - Liquidation Years Country (1) Period (2) Share of Liquidation Years (3) Liquidation Years (4) Average (5) Min(Year)(6) Australia 1945-1968, 1971,1976 48.0 1946-1953,1955-1956,1971,1976 5.6 17.8 (1951) United Kingdom 1945-1980 47.8 1948-1953,1955-1956,1958,1962,1965,1969,1971-1977,1979-1980 3.8 10.9 (1975) United States 1945-1980 25.0 1945-1948,1951,1956-1957,1974-1975 3.5 8.8 (1946) Notes: Share of liquidation years is defined as the number of years during which the real interest rate on the portfolio is negative divided by the total number of years as noted in column (2)… 3 In 1944, the negative real return was 82.3 percent. ====================================================== There are two distinct patterns in the ten-country sample evident from an inspection of the timing of the incidence and magnitude of the negative real rates. The first of these is the cases where the negative real rates (financial repression tax) were most pronounced in the years following World War II (as war debts were importantly inflated away). This pattern is most evident in Australia, the United Kingdom and the United States, although negative real rates re-emerge following the breakdown of Bretton Woods in 1974-1975. Then there are the cases where there is a more persistent or chronic reliance on financial repression throughout the sample as a way of funding government deficits and/or eroding existing government debts. The cases of Argentina and India in the emerging markets and Ireland and Italy in the advanced economies stand out in this regard. The preceding analysis, as noted, adopts a very narrow, conservative calculation of both the incidence of the “liquidation effect” or the financial repression tax. Much of the literature on growth, as well as standard calibration exercises involving subjective rates of time preference assume benchmark real interest rates of three percent per annum and even higher. Thus, a threshold that only examines periods where real interest rates were actually negative is bound to underestimate the incidence of “abnormally low” real interest rates during the era of financial repression (approximately taken to be 1945-1980). To assess the incidence of more broadly defined low real interest rates, Table 5 presents for the 10 core countries the share of years where real returns on a portfolio of government debt (as defined earlier) were below zero (as in Table 4), one, two, and three percent, respectively. In the era of financial repression that we examine here, real ex post interest rates on government debt did not reach three percent in a single year in the United States; in effect in nearly 2/3 of the years real interest rates were below one percent. The incidence of “abnormally low” real interest rates is comparable for the United Kingdom and Australia—both countries which had sharp and relatively rapid declines in public debt to GDP following World War II. 29 Even in countries with substantial economic and financial volatility during this period (including Ireland, Italy and South Africa), real interest rates on government debt above three percent were relatively rare (accounting for only about 20-23 percent of the observations. ==================================================== Table 5. Incidence of Liquidation Years for Different Real Interest Rate Thresholds: Selected Countries, 1945-1980 Share of Years with Real Interest Rate below: Country (1) Period (2) 0 percent(3) 1 percent(4) 2 percent (5) 3 percent (6) Australia 1945-1968, 1971,1976 48.0 65.4 80.8 92.3 United Kingdom 1945-1980 47.8 72.2 86.1 97.2 United States 1945-1980 25.0 63.9 88.9 100.0 Notes: Share of liquidation years is defined as the number of years during which the real interest rate on the portfolio is negative divided by the total number of years as noted in column (2). The real interest rate is calculated as defined in equation (1). ======================================================== 2. Estimates of the Liquidation Effect Having documented the high incidence of “liquidation years” (even by conservative estimates), we now calculate the magnitude of the savings to the government (financial repression tax or liquidation effect). These estimates take “the tax rate” (the negative real interest rate) and multiplies it by the “tax base” or the stock of debt, Table 6 reports these estimates for each country. ================================================== Table 6: Government Revenues (interest cost savings) from the “Liquidation Effect:” per year Benchmark Measure “Liquidation effect revenues” Alternative Measure of “Liquidation effect revenues” Country Period % GDP % Tax Revenues % GDP % Tax Revenues Australia 1945-1968, 1971, 1978 5.1 20.3 n.a. n.a. United Kingdom1 1945-1980 .6 26.0 2.4 17.3 United States 1945-1980 3.2 18.9 2.5 14.8 =============================================== …For the United States and the United Kingdom the annual liquidation of debt via negative real interest rates amounted on average from to 3 to 4 percent of GDP a year. Obviously, annual deficit reduction of 3 to 4 percent of GDP quickly accumulates (even without any compounding) to a 30 to 40 percent of GDP debt reduction in the course of a decade. For Australia and Italy, which recorded higher inflation rates, the liquidation effect was larger (around 5 percent per annum). Interestingly (but not entirely surprising), the average annual magnitude of the liquidation effect for Argentina is about the same as that of the US, despite the fact that the average real interest rate averaged about -3.5 percent for the US and nearly -16 percent for Argentina during liquidation years in the 1945-1980 repression era. Just as money holdings secularly shrink during periods of high and chronic inflation, so does the domestic debt market. 30 Argentina’ “tax base” (domestic public debt) shrank steadily during this period; at the end of World War II nearly all public debt was domestic and by the early 1980s domestic debt accounted for less than ½ of total public debt. Without the means to liquidate external debts, Argentina defaulted on its external obligations in 1982. Countries like Ireland, India, Sweden and South Africa that did not experience a massive public debt build-up during World War II recorded more modest annual savings (but still substantive) during the heyday of financial repression.31 [31 It is important to note that while financial repression wound down in most of the advanced economies in the sample by the mid 1980s, it has persisted in varying degrees in India through the present (with its system of state-owned banks and widespread capital controls) and in Argentina (except for the years of the “Convertibility Plan,” April 1991-December 2001).] ====================================================== Table 7. Debt Liquidation through Financial Repression: Selected Countries, 1945-1955 Public debt/GDP Annual average: 1946-1955 Country 1945 1955 (actual) 1955 without “financial repression inflation repression revenue”/GDP savings (est.)4 Australia 143.8 66.3 199.8 6.2 3.8 3 [United Kingdom] The savings from financial repression are a lower bound, as we use the “official” consumer price index for this period in the calculations and inflation is estimated to have been substantially higher than the official figure (see for example Friedman and Schwartz, 1963)… Notes: The peaks in debt/GDP were: Italy 129.0 in 1943; United Kingdom 247.5 in 1946; United States 121.3 in 1946. An alternative interpretation of the financial repression revenue is simply as savings in interest service on the debt. VI. Inflation and Debt Reduction. We have argued that inflation is most effective in liquidating government debts (or debts in general), when interest rates are not able to respond to the rise in inflation and in inflation expectations.32 This disconnect between nominal interest rates and inflation can occur if: (i) the setting is one where interest rates are either administered or predetermined (via financial repression, as described); (ii) all government debts are fixed rate and long maturities and the government has no new financing needs (even if there is no financial repression the long maturities avoid rising interest costs that would otherwise prevail if short maturity debts needed to be rolled over); and (iii) all (or nearly all) debt is liquidated in one “surprise” inflation spike. Our attention thus far has been confined to the first on that list, the financial repression environment. The second scenario, where governments only have long-term, fixed-rate debt outstanding and have no new financing needs (deficits) remain to be identified (however, these authors have a sense such episodes are relatively rare). This leaves the third case where debts are swiftly liquidated via an inflation spike (or perhaps more appropriately surge). To attempt to identify potential episodes of the latter, we conduct two simple exercises. In the first exercise, we identify inflation “surprises” for the core ten-country sample. In order to identify inflation surprises we calculate a 10-year moving average inflation, and count a year as an “inflation surprise” year if the inflation during that year is two standard deviations above the corresponding 10-year average… The second column shows the share of years which are “inflation surprises” during the sample period while the third shows the share of years which are both an “inflation surprise” and a “liquidation year”. As Table 8 highlights, there is not much overlap between debt liquidation years and inflation surprises, as defined here. Averaging across the 10 countries, only 18 percent of the liquidation years coincide with an “inflation surprise.” surprises. The high incidence of inflation surprises years during the early 1970s at the time of the surge in oil and commodity prices, suggests our crude methodology to identify “inflation surprises (or spikes)” may be a reasonable approximation to the real thing. More to the point, this exercise suggests that the role of inflation in the liquidation of debt is predominantly of the more chronic variety coupled with financially-repressed nominal interest rates. ================================================== Table 8: Do Inflation Surprises Coincide with Debt Liquidation? 10 countries, 1945-1980 Country Share of “inflation surprise” years Share of liquidation years which are also “inflation surprise” years Inflation surprise years* Australia 7.7 16.7 1951,1966 United Kingdom 13.9 23.5 1970,1971,1973-1975 United States 25.0 22.2 1946,1966,1968,1969, 1970,1973,1974,1979, 1980 …Our algorithm begins by identifying debt-reduction episodes and then focusing on the largest of these. Any decline in debt/GDP over a three year window classifies as a debt-reduction episode. For this pool of debt-reduction episodes, we construct their frequency distribution (for each country) and focus on the lower (ten percent) tail of the distribution to identify the “largest” three-year debt reduction episodes. This algorithm biases our selection of episodes toward the more sudden (or abrupt) ones (even if these are later reversed) which might a priori be attributable to some combination of a booming economy, a substantive fiscal austerity plan, or a burst in inflation/liquidation, or explicit default or restructuring. A milder but steady debt reduction process that lasts over many years would be identified… In the extreme cases, it is the wholesale liquidation of domestic debt, such as during the German hyperinflation of the early 1920s and the long-lasting Brazilian and Argentine hyperinflations of the early 1990s. Even without these extreme cases, the inflation differentials between the debt reduction episodes and the full sample are suggestive of the use of inflation (intentionally or because it became unmanageable) to reduce (or liquidate) government debts even in periods outside the era of heavy financial repressions. ======================================== Table 9 Inflation Performance during Major Domestic Public Debt Reduction Episodes: Average Median Average Median Australia 1948, 1949 -1953 10 .3 9.3 3.0 2.5 Germany 1922, 1923 555504 9529.6 1764.7 231 460401.3 2.3 India 1958 , 1996, 2006 7.1 6.2 6.6 6.2 UK 1836, 1846, 1854, 1936, 1940, 1948-1950, 1951-1954 4.7 3.7 2.7 1.8 US 1794-1796, 1881-1882, 1948-1952 , 1953, 1957, 1966 4.0 2.6 1.6 1.7 Venezuela 1989, 1997-1998, 2006-2007 41 .6 29.5 11.4 5.8 Major Debt Reduction Episodes * Full Sample Dates Inflation Inflation The largest annual (single-year) decline recorded in debt/GDP is shown year shown in italics under the Dates column. For example, for Germany this was the hyperinflation year 1923; for the United States it was 1952, the year following a substantial debt conversion… Concluding Remarks: The substantial tax on financial savings imposed by the financial repression that characterized 1945-1980 was a major factor explaining the relatively rapid reduction of public debt in a number of the advanced economies. This fact has been largely overlooked in the literature and discussion on debt reduction. The UK’s history offers a pertinent illustration. Following the Napoleonic Wars, the UK’s public debt was a staggering 260 percent of GDP; it took over 40 years to bring it down to about 100 percent (a massive reduction in an era of price stability and high capital mobility anchored by the gold standard). Following World War II, the UK’s public debt ratio was reduced by a comparable amount in 20 years. 34 [34Peak debt/GDP was 260.6 in 1819 and 237.9 percent in 1947. Real GDP growth was about the same during the two debt reduction periods (1819-1859) and (1947-1967), averaging about 2.5 percent per annum (the comparison is not exact as continuous GDP data begins in 1830). As such, higher growth cannot obviously account for the by far faster debt reduction following World War II.] The financial repression route taken at the creation of the Bretton Woods system was facilitated by initial conditions after the war, which had left a legacy of pervasive domestic and financial restrictions. Indeed, even before the outbreak of World War II, the pendulum had begun to swing away from laissez-faire financial markets toward heavier-handed regulation in response to the widespread financial crises of 1929-1931. But one cannot help thinking that part of the design principle of the Bretton Woods system was to make it easier to work down massive debt burdens. The legacy of financial crisis made it easier to package those policies as prudential. To deal with the current debt overhang, similar policies to those documented here may re-emerge in the guise of prudential regulation rather than under the politically incorrect label of financial repression. [NOTE THE JUST DESCRIBED HINT FOR POLITICAL OBFUSCATION AND DECEPTION] Moreover, the process where debts are being “placed” [NOTE EUPHEMISTIC CHOICE OF WORD] at below market interest rates in pension funds and other more captive domestic financial institutions is already under way in several countries in Europe. [NOTE ‘FINANCIAL REPRESSION’ ‘HIDDEN TAX’ NOT JUST BEING DISCUSSED AS THIS ‘DISCUSSION PAPER ‘ WOULD SUGGEST BUT ACTUALLY TAKING PLACE AS OF WHEN THIS WAS PUBLISHED MARCH, 2011. ALSO NOTE THE REST OF THE PARAGRAPHS FOR HONESTY TO POLITICAL DECISION MAKERS RATHER THAN POLITICAL SPIN THAT POLITICIANS AND MEDIA PRESENTING AT PRESENT TO THE GENERAL PUBLIC, DENYING THEIR RIGHT TO KNOW AND THEREBY BE ABLE TO MAKE INFORMED CHOICES ABOUT WHAT IS BEST FOR THEM INDIVIDUALLY. IT APPEARS TRUTH IS A VICTIM OF FINANCIAL CRISES AS MUCH AS IN WAR WHEN THE ‘HEARTS AND MIND’S’ OF THE PUBLIC MUST BE WON DAILY.] There are many bankrupt (or nearly so) pension plans at the state level in the United States that bear scrutiny (in addition to the substantive unfunded liabilities at the federal level). Markets for government bonds are increasingly populated by nonmarket players, notably central banks of the United States, Europe and many of the largest emerging markets, calling into question what the information content of bond prices are relatively to their underlying risk profile. This decoupling between interest rates and risk is a common feature of financially repressed systems. With public and private external debts at record highs, many advanced economies are increasingly looking inward for public debt placements. While to state that initial conditions on the extent of global integration are vastly different at the outset of Bretton Woods in 1946 and today is an understatement, the direction of regulatory changes have many common features. The incentives to reduce the debt overhang are [NOTE WELL] more compelling today than about half a century ago. After World War II, the overhang was limited to public debt (as the private sector had painfully deleveraged through the 1930s and the war); at present, the debt overhang many advanced economies face encompasses (in varying degrees) households, firms, financial institutions and governments. _____________________________________________________________ References: -Aizenman, Joshua and Nancy Marion 2010. “Using Inflation to Erode the U.S. Public Debt”, SCIIE / Department Working Paper, December. -Alesina, Alberto and Silvia Ardagna (2009) “Large changes in fiscal policy: taxes versus spending” NBER Working Paper 15438 -Andima. 1994. Divida Publica -Bai, Chong-En, David D. Li, Yingyi Qian, and Yijang Wang (2001) “Financial Repression and Optimal Taxation”, Economic Letters, 70 (2), February 2001 -Brock, Philip (1989). “Reserve Requirements and the Inflation Tax,” Journal of Money, Credit and Banking, 21 (1), February, 106-121. -Calvo, Guillermo A. 1989. “Is Inflation Effective in Liquidating Short-Term Nominal Debt,” International Monetary Fund WP/89/2 -Campbell, John Y. and Kenneth A. Froot, 1994. “International Experiences with Securities Transactions Taxes,” in The Internationalization of Equity Markets, Jeffrey Frankel ed., (Chicago: University of Chicago Press for NBER), 277-308. -Checherita, Christina, and Philipp Rother, (2010), “The Impact of High and Growing Debt on Economic Growth and Empirical Investigation for the Euro Area,” European Central Bank Working Paper Series No. 1237, August. -Cukierman, Alex. 1992. Central Bank Strategy, Credibility, and Independence. Cambridge: MIT Press. -DeVries, Margaret, 1969. The International Monetary Fund, 1945-1965: Twenty Years of International Monetary Cooperation. Volume II, Washington DC: International Monetary Fund. -Easterly, William R. 1989. “Fiscal Adjustment and Deficit Financing During the Debt Crisis.” In I. Husain and I. Diwan, eds., Dealing with the Debt Crisis. Washington DC: The World Bank: 91–113. -Easterly, William and Klaus Schmidt-Hebbel, 1994. "Fiscal Adjustment and Macroeconomic Performance." In W. Easterly et al. (eds.) Public Sector Deficits and Macroeconomic Performance. Oxford University Press for the World Bank. -Fisher, Irving. 1933. “The Debt-Deflation Theory of Great Depressions,” Econometrica, pp. 337-57 -Friedman, Milton and Anna Schwartz. 1982. Monetary Trends in the United States and United Kingdom: Their Relation to Income, Prices, and Interest Rates, 1867-1975. Chicago: The University of Chicago Press -Giovannini, Alberto and Martha de Melo. 1993. "Government Revenue from Financial Repression." American Economic Review, vol. 83, No. 4: 953–963. -Kumar, Manmohan S. and Jaejoon Woo.(2010) “Public Debt and Growth” IMF Working Paper 10/174. -Crowe et. a. eds., Macrofinancial Linkages: Trends, Crises, and Policies, Washington DC: International Monetary Fund. -Lilico, Andrew, Ed Holmes and Hiba Sameen (2009) “Controlling Spending and Government Deficits: Lessons from History and International Experience”. Policy Exchange. -Meltzer, Allan. 2002. A History of the Federal Reserve, Volume 1: 1913-1951. Chicago: Chicago University Press. -National Mining Association (2006), “The History of Gold,” mimeograph, http://www.nma.org/pdf/gold/gold_history.pdf. -Obstfeld, Maurice, and Alan M. Taylor. Global Capital Markets: Integration, Crisis, and Growth. Japan-U.S. Center Sanwa Monographs on International Financial Markets (Cambridge: Cambridge University Press, 2004.) -Reinhart, Carmen M. and Vincent R. Reinhart, 1999. “On the Use of Reserve Requirements in Dealing with the Capital-Flow Problem,” International Journal of Finance and Economics, Vol. 4 No.1, January 1999, 27-54. -Reinhart, Carmen M., Kenneth Rogoff and Miguel A. Savastano. 2003. Debt Intolerance. Brooking Papers on Economic Activity 2003, no.1: 1-62 -Reinhart, Carmen M. and Kenneth Rogoff. 2008. The Forgotten History of Domestic Debt. NBER Working Paper No. 13946, forthcoming in the Economic Journal. -Reinhart, Carmen M., 2010. “This Time is Different Chartbook: Country Histories on Debt, Default, and Financial Crises,” NBER Working Paper, (February). -Reinhart, Carmen M. and Kenneth Rogoff. 2009. This Time is Different: Eight Hundred Centuries of Financial Folly. Princeton: Princeton University Press. [Here is a quote from it that relates closely to our current debt to GDP discussion: ‘Our analysis was based on newly-compiled data on forty-four countries spanning about two hundred years. This amounts to 3,700 annual observations and covers a wide range of political systems, institutions, exchange rate arrangements, and historic circumstances. The main findings of that study are: --1-First, the relationship between government debt and real GDP growth is weak for debt/GDP ratios below 90% of GDP.1 Above the threshold of 90%, median growth rates fall by 1%, and average growth falls considerably more. The threshold for public debt is similar in advanced and emerging economies and applies for both the post World War II period and as far back as the data permit (often well into the 1800s). --2-Second, emerging markets face lower thresholds for total external debt (public and private) – which is usually denominated in a foreign currency. When total external debt reaches 60% of GDP, annual growth declines about 2%; for higher levels, growth rates are roughly cut in half. --3-Third, there is no apparent contemporaneous link between inflation and public debt levels for the advanced countries as a group (some countries, such as the US, have experienced higher inflation when debt/GDP is high). The story is entirely different for emerging markets, where inflation rises sharply as debt increases.’] -Sbrancia, M. Belen, 2011. “Debt, Inflation, and the Liquidation Effect,” mimeograph, University of Maryland, College Park. -Schedvin, C. B. 1970. Australia and the Great Depression. Sydney: Sydney University Press -Wiles, P. J. D. 1952. Pre-War and War-Time Controls In The British Economy 1945-50, London: Oxford University Press [2008] Reserve ratios are higher for emerging markets. Among the advanced economies the highest share of seignorage accounted for by reserve ratios is Italy over this period. For the emerging markets, Chile and Peru have the highest readings. …The effective interest rate on external (domestic) debt are calculated as the ratio of external (domestic) interest payments to the stock of external (domestic) debt. The government revenue from financial repression is calculated by computing the differential between the foreign borrowing cost and the domestic borrowing cost, times the average annual stock of domestic debt. Annual estimates of the “revenue from financial repression” are estimated from a low of 0.5 percent of GDP for Zaire (with its small domestic debt market to a high of about 6 percent for Mexico. Estimates for Greece and Portugal are 2-2.5 percent of GDP. …the papers dealing with reserve requirements capture the tax on financial institutions. Ultimately, (as Reinhart and Reinhart, 1999 document) the banks pass this tax on to depositors (via lower deposit rates), non-government borrowers (via higher lending rates) or both, depending who has the most access to alternatives. If households are barred from holding foreign assets and/or gold (see Table 2), lower deposits are tolerated more readily. If domestic banks are the only game in town for the firms—they will have to live with the higher lending rates. … during the heyday of the financial repression era during Bretton Woods (1945-1973)… Detailed composition of government debt is taken to indicate here as having data on: Outstanding debt stock (end of calendar or fiscal year) by coupon yield (instrument by instrument). Maturity of each instrument. In some cases it includes information on the marketable/nonmarketable distinction. " - Carmen M. Reinhart and M. Belen Sbrancia
Quoted from ‘THE LIQUIDATION OF GOVERNMENT DEBT’ Working Paper 16893 [ http://www.nber.org/papers/w16893 ] NATIONAL BUREAU OF ECONOMIC RESEARCH, 1050 Massachusetts Avenue, Cambridge, MA 02138, March 2011 The authors wish to thank Alex Pollock, Vincent Reinhart, and Kenneth Rogoff for helpful comments and suggestions and the National Science Foundation Grant No. 0849224 for financial support. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. © 2011 by Carmen M. Reinhart and M. Belen Sbrancia. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source… [ http://www.imf.org/external/np/seminars/eng/2011/res2/pdf/crbs.pdf ] More information about Financial Repression can be found by searching the imagi-natives.com website using those key words or by searching for them on the internet using Google or one of the other internet search engines.
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[Quote No.36129] Need Area: Money > Invest
"The Essential Nature of Infrastructure: The need for infrastructure is one of the biggest challenges in moving a project toward development. If you've discovered a new gas field, you need a pipeline to take that gas to market. If you've developed a way to tap into the tidal currents at a narrow pass, you need a transmission line to connect your power to the grid. And if you've discovered a mineral deposit, you need a road and an electrical connection to power the massive crushers, grinders, and pumps involved in extracting the mineral from rock. Of course, resources often turn up not where it's convenient but in the middle of nowhere. And the need to build a power line or pipeline can easily tip the cost-reward balance into the red, leaving development plans to gather dust on the drawing board. To tip these projects back into the black, companies have to work with each other and with governments on permitting and building infrastructure... Building infrastructure is a complicated, expensive task. Permitting alone can take years, especially when a project crosses borders. After that, financing can provide another major challenge. During those years, the cost of supplies and labor often change dramatically - in the case of Nabucco, consider that the price of iron ore - the main component in steel pipes - has risen 50% over the last year. Yet these projects are essential, and their presence or absence impacts commodity prices in multiple countries. So what does all this have to do with your investments? Add an item to your due-diligence checklist: the presence of infrastructure, even at early-stage exploration. Whatever commodity a company seeks, hand in hand with discovery comes the question: How can we get it out of here? If researching infrastructure isn't really your cup of tea, you can fall back on the first item on your checklist: good management. Knowledgeable and experienced people at the top are always planning for success, so the projects they consider will either already have access to the necessary infrastructure or it will be technically and economically feasible to build. So if a story seems too good to be true - perhaps a company is telling you about an untapped, highly prospective gas field or a massive copper-gold deposit - check into the local infrastructure. There likely isn't any, which means there won't be a gas development or a mine anytime soon." - Casey Research - Energy Team
Financial newsletter, 'Casey Research'.
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[Quote No.36130] Need Area: Money > Invest
"[Fiat currency:] It's taken almost two centuries for bankers to pull the wool over Americans' eyes, but today you and I are working for intrinsically worthless paper that can be created by bureaucrats-created without sweat, without creative ability, without work, without anything but a decision by the Federal Reserve. This is the disease at the base of today's monetary system. And like a cancer, it will spread until the system ultimately falls apart. This is the tragedy of the great lie. The great lie is that fiat paper represents a store of value, money of lasting wealth." - Richard Russell

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[Quote No.36131] Need Area: Money > Invest
"It should be noted that inflation in the US for the consumer is called Personal Consumption Expenditure - PCE - while in other countries, like Australia, it is called the Consumer Price Index - CPI." - Seymour@imagi-natives.com

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[Quote No.36133] Need Area: Money > Invest
"Japan's foreign exchange reserves consist of securities and deposits denominated in foreign currencies, International Monetary Fund reserves, IMF special drawing rights (SDR's) and gold, and are the second largest in the world after China's." - Australian Investment Review
9th June, 2011.
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[Quote No.36135] Need Area: Money > Invest
"Have you ever wondered why the CPI [Consumer Price Inflation], GDP [Gross Domestic Production] and employment numbers run counter to your personal and business experiences? The problem lies in biased and often-manipulated [deliberately deceptive] government reporting. [The website shadowstats.com was set up to provide an independent from government assessment of these figures as well as other US government economic statistics.]" - John Williams
Walter J. 'John' Williams was born in 1949. He received an A.B. in Economics, cum laude, from Dartmouth College in 1971, and was awarded a M.B.A. [Master's of Business Administration] from Dartmouth's Amos Tuck School of Business Administration in 1972, where he was named an Edward Tuck Scholar. During his career as a consulting economist, John has worked with individuals as well as Fortune 500 companies. 'Formally known as Walter J. Williams, my friends call me John. For nearly 30 years, I have been a private consulting economist and, out of necessity, had to become a specialist in government economic reporting. One of my early clients was a large manufacturer of commercial airplanes, who had developed an econometric model for predicting revenue passenger miles. The level of revenue passenger miles was their primary sales forecasting tool, and the model was heavily dependent on the GNP (now GDP) as reported by the Department of Commerce. Suddenly, their model stopped working, and they asked me if I could fix it. I realized the GNP numbers were faulty, corrected them for my client (official reporting was similarly revised a couple of years later) and the model worked again, at least for a while, until GNP methodological changes eventually made the underlying data worthless. That began a lengthy process of exploring the history and nature of economic reporting and in interviewing key people involved in the process from the early days of government reporting through the present. For a number of years I conducted surveys among business economists as to the quality of [US] government statistics (the vast majority thought it was pretty bad), and my results led to front page stories in the New York Times and Investors Business Daily, considerable coverage in the broadcast media and a joint meeting with representatives of all the government's statistical agencies. Despite minor changes to the system, government reporting has deteriorated sharply in the last decade or so. An old friend -- the late-Doug Gillespie -- asked me some years back to write a series of articles on the quality of government statistics. The response to those writings (the Primer Series available on this page) was so strong that we started Shadow Government Statistics in 2004. The newsletter is published as part of my economic consulting services.' - John Williams. [http://www.shadowstats.com/ ]
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[Quote No.36151] Need Area: Money > Invest
"German outbreak adds to Europe's pain: While the headlines are focused on the unfolding debt crisis in Greece, Europe has other economic headaches as well. Economic growth is still quite tentative. Even the best performer -- Germany -- is still recording unemployment of 7 per cent. At the same time, inflation is running at 2.7 per cent and is expected to go higher, well above the 2 per cent target. This sounds like a case of old-fashioned stagflation. This rise in inflation is largely driven by commodity prices, particularly food. There is a good case for looking through this sort of price increase, focusing instead on the underlying or core inflation rate, while waiting for headline inflation to subside. Core inflation is running at 1.5 per cent. But the European Central Bank (ECB) has inherited German low-inflation ideology. One of its Board members has gone public in urging the ECB to follow its mandate and respond to the excessive headline rate. Whatever the rights and wrongs of this esoteric argument for the specifics of the German economy, tighter monetary policy will make life tougher in the peripheral countries. Portugal, Ireland, Italy, Spain and Greece all need to make drastic improvements in their external competitiveness vis-à-vis their Euro partners. If German inflation is tightly constrained by ECB monetary policy, this makes it just that much harder for the crisis countries to change their relative prices: they need to have substantial falls in wages and prices, which is always painful. All this is playing out in an environment of painful fiscal austerity. The prospect of a further €60 billion euros of assistance, on top of the €110 billion euros provided last year, holds Greek creditors at bay, but does nothing to ease the mammoth task of restoring international competitiveness. One of the advantages of having your own exchange rate is that a devaluation administers a country-wide fall in wages, relative to foreign wages. Substantial adjustments of international competitiveness are more feasible, as sensitive domestic wage relativities are largely unchanged: people are more prepared to accept a wage cut if all their compatriots share it. Currency union precludes this possibility. Tough policies at the ECB make it just a bit more likely that the euro will not survive in its present form. It’s not clear if those members of the ECB who are advocating such policies are ignoring this possibility, or are in fact in favour of it." - Stephen Grenville
Economist, formerly at the Reserve Bank of Australia. Originally published by International Policy thinktank, The Lowy Institute, publication 'The Interpreter'. Republished on the businessspectator.com, 7 Jun 2011, with permission.
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[Quote No.36156] Need Area: Money > Invest
" 'The destructive power of weak money': The rate at which money is being manufactured out of thin air has accelerated in recent times, as shown by... the US Monetary base... The exponential rise in the monetary base from the post-war years was enough on its own perhaps to eventually guarantee a hyper-inflationary outcome for the dollar, even before the credit bubble suddenly burst in 2007. The Federal Reserve Board then responded to contracting bank credit by increasing the quantity of money threefold in less than four years. This raises the question of inflationary implications for prices, given the Quantity Theory of Money as understood by mainstream economists. Milton Friedman, who is associated with monetarism, summed it up by repeating Hazlitt’s earlier assertion: inflation is always and everywhere a monetary phenomenon.['The basic cause of inflation, always and everywhere, lies in the field of money and credit.' Henry Hazlitt in Newsweek, December 22, 1947, p. 68] Indeed, it is generally forgotten that there cannot be an increase in the general level of prices without an increase in the quantity of money. This is too imprecise for modern economists who theorise over what measure of money to use [M1, M2, M3, etc]. Today, the economists at the Fed lead us to assume that the link between monetary inflation and prices applies to the broadest measure, which includes bank credit. This is suspiciously convenient, given the deflationary implications of a contraction of bank credit, which left unchecked would threaten the end of the fractional-reserve banking system. Using the broadest measure allows the Fed to argue that deflation arising from contracting bank credit must be balanced by the expansion of raw money, when their true concern is the prevention of a banking collapse. Indeed, this unprecedented expansion in the monetary base has not yet been reflected in a substantial rise in consumer prices. Monetarists point out that the bulk of this expansion is due to an accumulation of non-borrowed reserves, or money left on deposit at the Fed owned by commercial banks, and so not in general circulation... In the neat world of the mathematical economist, price inflation will only take place when the banks draw down on these reserves to expand bank credit, presumably to lend to the private sector when the economy recovers. But the point that our neat mathematical economists miss is that the money is already in circulation, having been lent by the Fed to the Government through its purchases of Treasury bonds and T-bills. The replacement of bank credit by expanding non-borrowed reserves amounts to a gift given by the Fed to the banks. Without it, the American banking system would simply be insolvent. The hope was that the banks’ future solvency would be guaranteed by the economic recovery, eliminating the need for the Fed’s continuing support. In the last few weeks it has become apparent that the US economy is not recovering as forecast, and the decision has to be taken as to whether or not more monetary expansion is appropriate. While more quantitative easing may be required to keep the banks afloat, as a means of stimulating the economy, monetary expansion has not worked. The Fed will remain focused on keeping the Wall Street banks solvent, which is after all its primary function. It is therefore very likely that QE3 will happen in one form or another. To allay fears of price inflation, QE3 will probably be explained as necessary to stop an ailing economy from sliding into deep recession, so it will be introduced when this new trend is confirmed in the coming weeks. And it is interesting to note that Mr Bernanke in his speech at Atlanta this week has prepared the ground: 'The economy is still producing at levels well below its potential; consequently, accommodative monetary policies are still needed.' But this represents the triumph of hope over experience. There has been no net benefit to the economy from zero interest rates and an unprecedented expansion of the monetary base. In the face of a deteriorating economic outlook, the banks will continue to deposit the bulk of any new money at the Fed in the form of excess deposits, as they have been doing for the last three years. This might matter less if there is little practical difference between the monetary base and bank credit, but they are two very different things. To understand the different effects of the expansion of one relative to the other, we must differentiate between the drivers for changes in the general price level of goods and services, compared with those of assets typically used as collateral at the banks. An increase in the quantity of money tends to be spent on goods and services, pushing up prices, as we have recently seen. The effect on capital goods is similar, though bank finance can play a role in overall demand, depending on the capital good. The effect of an expansion of money quantity on bank collateral is more complex: the lower interest rates that usually accompany monetary expansion tend to underwrite collateral values; however, in most cases buyers require bank credit to facilitate actual market transactions, and if this credit is not available prices will trend lower as forced sellers find no buyers. Put more simply, narrow money tends to fuel purchases of everyday items, while bank credit is required to sustain asset prices. Consequently, a rapid expansion of the monetary base results in a fall in the currency’s purchasing power, or a rise in the general price level, while contracting bank credit can, at the same time, lead to lower asset prices. We see this in the US today with price inflation rising and house prices continuing to fall. In the absence of growing demand for goods and services, the rise in prices is classic stagflation. Stagflation seems to be poorly understood by mainstream economists, who habitually associate price inflation with excess demand, not understanding that over-supply of paper money produces the same price effect. The Fed appears to have fallen into this same trap, but being closer to the markets than theoretical economists it almost certainly understands better what is happening to prices. It is aware of the slide in the dollar against other currencies, and against commodities and raw materials generally. It also sees that despite expanding the monetary base in dramatic fashion the value of bank-held collateral is not improving. However, it cannot admit to stagflation and it continues to conceal its true motives of keeping the banking system solvent. The moment the Fed tells the truth, the markets would anticipate more inflation by devaluing the dollar and the big banks would suffer a run on deposits: the spell would be broken. Instead markets prefer not question the Fed’s strategy too closely. Economists and market analysts, who rarely concern themselves with purely financial matters, discuss further quantitative easing only in an economic context. They are confused that monetary stimulation and the lower dollar have not led to a stronger economy. However, the failure of monetary stimulation to spark economic recovery was entirely predictable. It fails to address the underlying problem of excessive levels of debt; instead, monetary policy is intended to grow that debt even further. At some stage, these inconsistences will be revealed for what they are. The markets’ ability to ignore the gathering clouds of stagflation, coupled with a banking system moving back into crisis, will be tested. The financing of a rising budget deficit at negative real interest rates, as the economy slides and revenues collapse, is unlikely to continue for long. The scene is set for both a lower dollar and rising bond yields. The distortions have been wound up so much that a return to normality will be a violent, disorderly event. This is the eventual cost of expanding the monetary base so dramatically. And the option of abandoning weak monetary policies is not available, because a move towards sound monetary policies would break the banks, the stock market and the Government. The banking system, which is central to it all, has to be kept going at all costs. Gold has only just started to anticipate this risk with its rise from severely depressed levels. The Western financial system, which has been in thrall to Keynes, is short of gold, and this folly is about to become more widely understood. Those central banks not sitting at the Bank for International Settlement’s high table see the danger, and are accumulating gold. Into this mix is thrown the West’s cold-war enemies, who have broken its monopoly of economic sophistication, replacing it with a newer, better model. Both China and Russia now have sounder monetary bases than America, Europe and Japan, because their banks are less geared and they recognise paper money for what it is. They have cleaned the market out of physical gold, and are certain to hold considerably more than they officially admit, while the US is suspected of exaggerating her holdings. Here again, the distortions are simply incredible, with over $50,000 of bank liabilities and monetary base in the US for every ounce of gold officially held by the US Treasury. Those economists who think that any transition from today’s problems into tomorrow’s can be managed as an orderly event are simply naïve. But then they didn’t see the financial crisis of 2007/08 coming either. Ever greater manipulation of markets has developed distortions so large that a return to reality will almost certainly be sudden and violent. And then the Fed really will start creating money in earnest, to save the world. That’s when it all begins to fall apart." - Alasdair Macleod
http://www.financeandeconomics.org/Articles%20archive/2011.06.09%20Weak%20money.htm
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[Quote No.36157] Need Area: Money > Invest
"The basic cause of inflation, always and everywhere, lies in the field of money and credit." - Henry Hazlitt
[1894 – 1993], an American economist, philosopher, literary critic and journalist. Quote published in 'Newsweek', December 22, 1947, p. 68.
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[Quote No.36160] Need Area: Money > Invest
"Economics is haunted by more fallacies [and more theories] than any other study known to man." - Henry Hazlett
[1894 – 1993], an American economist, philosopher, literary critic and journalist.
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[Quote No.36161] Need Area: Money > Invest
"An individual is led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was not part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it ['enlightened' self-interest]. I have never known much good done by those who affected to trade for the public good." - Adam Smith
Famous economic and social philosopher.
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[Quote No.36162] Need Area: Money > Invest
"Firstly though there is a very useful indicator that is helpful to understanding how the various asset class values are interrelated around the world. In investment circles this study of the interconnections between markets is called 'intermarket analysis'. The indicator is called FRODOR. It is an indicator of global liquidity which is used to measure the rate of change in the quantity [i.e money supply - MZM, M0, M1, M2, M3, M4 -please note and refer to how loan growth, especially through the fractional reserve banking system effects and multiplies the growth of the money supply, especially the liquidity - M1 of a country and its economy] of the official global/world reserve currency, the US dollar, which is particularly important because it is used to denominate most international trades of commodities/basic goods, like food, oil and minerals including the industrial and precious metals. Most countries therefore keep a good portion of their foreign reserves in US dollars and then store it as US sovereign debt/bonds which are very quick and easy to liquidate when they are ready to use the funds, even in great times of global economic difficulty, which is part of their great appeal. Also those countries trying to sell exports to the very large US market buy US bonds and sell their own currency in order to try to keep their own currency pegged to the US dollar so their prices don't become uncompetitive, so they regularly buy and hold US bonds. The more the more they are selling to the US. The US benefits by having many countries willing to buy their sovereign debt at yield lower than they otherwise would be able to sell them for. It's a little like vendor financing where the manufactures outside the US finance the US government and banks to lend to the US consumer and business so they can buy the goods they export to the US. [As they have exchanged the US dollars used to pay their exporters for their own currency in order not to flood their market with increased money supply and create unwanted inflation they often sterilise/remove this new money supply in their economy by selling bonds to their citizens, banks, insurance companies, etc.] The economist Ed Yardeni developed the measure called FRODOR, for Foreign Official Dollar Reserves held by central banks around the world, to be a LEI - leading economic indicator along with the other LEI's -for example the OECD's LEI for all OECD countries, the US Conference Board LEI's for selected countries, ECRI's WLI for the US - for people to follow. But why follow it? The reason most people follow it is that statistically it has correlations to most asset markets and therefore helps investors anticipate market behaviour through the business cycle as well as prepare for booms and busts. It is positively correlated to - moves in same direction as - : gold, commodities -soft and hard - especially copper, non AAA bonds so corporate bonds, real estate, share markets - especially Asian share markets, inflation and GDP in general. It has negative correlations to - moves in opposite direction to - : credit spreads -which characteristically widen when more risk is perceived, and the US Dollar - which is considered a defensive risk-off currency that people buy and drive up in price when they think there is more risk around in the global economy. The USD itself is inclined to move with US interest rates as higher rates from the Federal Reserve are designed to slow down the economy especially inflation through reducing the money supply base and thereby credit growth and consumer consumption and business investment, which should contract the US trade deficit as there is less buying which should in turn mean that the many emerging markets - especially in Asia - that manufacture and export to the US require less raw commodities as selling and making less, so the price of commodities falls and thereby inflation around the globe falls as the global economy slows with the US economy, which explains why investors watch the US so closely. This is why they say, 'If America sneezes the rest of the world catches a cold.'" - Seymour@imagi-natives.com

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[Quote No.36163] Need Area: Money > Invest
"The velocity of money is the number of times that money supply changes hands during a given time period. Velocity of money = GDP / Value of the money supply. The velocity is different depending on which measure of money you use - i.e. MZM, M0, M1, M2, M3, M4. As we move up the ladder of the types of money supply M1, M2, M3, etc., the liquidity and the velocity of money decreases." - 'Professor Simply Simple'
http://www.tatamutualfund.com/Knowledge-Center/Prof.%20Simply%20Simple%20-%20Measurements%20of%20Money%20Supply.pps
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[Quote No.36164] Need Area: Money > Invest
"Q- What is money supply i.e. M1, M2, M3? A- M1 = cash and checking account deposits. M2 = M1 + savings accounts & money market accounts. M3 = M2 +large deposits and other large, long-term deposits. Quote from wiki: --M0 = Physical currency. A measure of the money supply which combines any liquid or cash assets held within a central bank and the amount of physical currency circulating in the economy. M0 (M-zero) is the most liquid measure of the money supply. It only includes cash or assets that could quickly be converted into currency. This measure is known as narrow money because it is the smallest measure of the money supply. --M1= M0 + demand deposits, which are checking accounts. This is used as a measurement for economists trying to quantify the amount of money in circulation. The M1 is a very liquid measure of the money supply, as it contains cash and assets that can quickly be converted to currency. --M2= M1 + small time deposits (less than $100,000), savings deposits, and non-institutional money-market funds. M2 is a broader classification of money than M1. Economists use M2 when looking to quantify the amount of money in circulation and trying to explain different economic monetary conditions. M2 is a key economic indicator used to forecast inflation. --M3= M2 + all large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets. The broadest measure of money; it is used by economists to estimate the entire supply of money within an economy." - answers.yahoo.com
http://answers.yahoo.com/question/index?qid=20080719181443AA7BTPx
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[Quote No.36165] Need Area: Money > Invest
"Investment management is simply capturing the arbitrage available between perception and reality. It is paramount to know both." - Kevin Duffy
comanager of Bearing Asset Management
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[Quote No.36166] Need Area: Money > Invest
"Money supply: In economics, the money supply or money stock, is the total amount of money available in an economy at a particular point in time. There are several ways to define 'money,' but standard measures usually include currency in circulation and demand deposits (depositors' easily-accessed assets on the books of financial institutions). Money supply data are recorded and published, usually by the government or the central bank of the country. Public and private sector analysts have long monitored changes in money supply because of its possible effects on the price level, inflation and the business cycle... ----Empirical measures: Money is used as a medium of exchange, in final settlement of a debt, and as a ready store of value. Its different functions are associated with different empirical measures of the money supply. There is no single 'correct' measure of the money supply: instead, there are several measures, classified along a spectrum or continuum between narrow and broad monetary aggregates. Narrow measures include only the most liquid assets, the ones most easily used to spend (currency, checkable deposits). Broader measures add less liquid types of assets (certificates of deposit, etc.) This continuum corresponds to the way that different types of money are more or less controlled by monetary policy. Narrow measures include those more directly affected and controlled by monetary policy, whereas broader measures are less closely related to monetary-policy actions. It is a matter of perennial debate as to whether narrower or broader versions of the money supply have a more predictable link to nominal GDP. The different types of money are typically classified as 'M's. The 'M's usually range from M0 (narrowest) to M3 (broadest) but which 'M's are actually used depends on the country's central bank... The [US] Federal Reserve previously published data on three monetary aggregates, but on 10 November 2005 announced that as of 23 March 2006, it would cease publication of M3. Since the Spring of 2006, the Federal Reserve only publishes data on two of these aggregates. The first, M1, is made up of types of money commonly used for payment, basically currency[notes and coin] (M0) and checking account balances. The second, M2, includes M1 plus balances that generally are similar to transaction accounts and that, for the most part, can be converted fairly readily to M1 with little or no loss of principal... The following details their principal components: --M0= The total of all physical currency, plus accounts at the central bank that can be exchanged for physical currency. --M1= The total of all physical currency part of bank reserves + the amount in demand accounts ('checking' or 'current' accounts). --M2= M1 + most savings accounts, money market accounts, retail money market mutual funds,and small denomination time deposits (certificates of deposit of under $100,000). --M3= M2 + all other CDs (large time deposits, institutional money market mutual fund balances), deposits of eurodollars and repurchase agreements... As of 4 November 2009 the Federal Reserve reported that the U.S. dollar monetary base is $1,999,897,000,000 [nearly 2 trillion]. This is an increase of 142% in 2 years. The monetary base is only one component of money supply, however, M2, the broadest measure of money supply, has increased from approximately $7.41 trillion to $8.36 trillion from November 2007 to October 2009, the latest month-data available. This is a 2-year increase in U.S. M2 of approximately 12.9%... [Other countries count their money supply in slightly different ways. For example:] --United Kingdom: There are just two official UK measures. M0 is referred to as the 'wide monetary base' or 'narrow money' and M4 is referred to as 'broad money' or simply 'the money supply'... --Australia: The money supply of Australia 1984–2007. The Reserve Bank of Australia defines the monetary aggregates as: --M1= currency bank + current deposits of the private non-bank sector. --M3: M1 + all other bank deposits of the private non-bank sector. --Broad Money= M3 + borrowings from the private sector by NBFIs, less the latter's holdings of currency and bank deposits. --Money Base= holdings of notes and coins by the private sector plus deposits of banks with the Reserve Bank of Australia (RBA) and other RBA liabilities to the private non-bank sector... --Monetary exchange equation: Money supply is important because it is linked to inflation by the equation of exchange in an equation proposed by Irving Fisher in 1911. [ MV = PQ ] -M is the total dollars in the nation’s money supply. -V is the number of times per year each dollar is spent. -P is the average price of all the goods and services sold during the year. -Q is the quantity of assets, goods and services sold during the year. In mathematical terms, this equation is really an identity which is true by definition rather than describing economic behavior. That is, each term is defined by the values of the other three. Unlike the other terms, the velocity of money has no independent measure and can only be estimated by dividing PQ by M. Adherents of the quantity theory of money assume that the velocity of money is stable and predictable, being determined mostly by financial institutions. If that assumption is valid, then changes in M can be used to predict changes in PQ. If not, then the equation of exchange is useless to macroeconomics. Most macroeconomists replace the equation of exchange with equations for the demand for money which describe more regular and predictable economic behavior. However, predictability (or the lack thereof) of the velocity of money is equivalent to predictability (or the lack thereof) of the demand for money (since in equilibrium real money demand is simply Q/V). Either way, this unpredictability made policy-makers at the Federal Reserve rely less on the money supply in steering the U.S.economy. Instead, the policy focus has shifted to interest rates such as the fed funds rate. In practice, macroeconomists almost always use real GDP to measure Q, omitting the role of all transactions except for those involving newly-produced goods and services (i.e., consumption goods, investment goods, government-purchased goods, and exports). That is, the only assets counted as part of Q are newly-produced investment goods. But the original quantity theory of money did not follow this practice: PQ was the monetary value of all new transactions, whether of real goods and services or of paper assets. U.S. M3 money supply as a proportion of gross domestic product. The monetary value of assets, goods, and service sold during the year could be grossly estimated using nominal GDP back in the 1960s. This is not the case anymore because of the dramatic rise of the number of financial transactions relative to that of real transactions up until 2008. That is, the total value of transactions (including purchases of paper assets) rose relative to nominal GDP (which excludes those purchases). Ignoring the effects of monetary growth on real purchases and velocity, this suggests that the growth of the money supply may cause different kinds of inflation at different times. For example, rises in the U.S. money supplies between the 1970s and the present encouraged first a rise in the inflation rate for newly-produced goods and services ('inflation' as usually defined) in the seventies and then asset-price inflation in later decades: it may have encouraged a stock market boom in the '80s and '90s and then, after 2001, a rise in home prices, i.e., the famous housing bubble. This story, of course, assumes that the amounts of money were the causes of these different types of inflation rather than being endogenous results of the economy's dynamics. When home prices went down, the Federal Reserve kept its loose monetary policy and lowered interest rates; the attempt to slow price declines in one asset class, e.g. real estate, may well have caused prices in other asset classes to rise, e.g. commodities... --Bank reserves at central bank: When a central bank is 'easing' [monetary policy], it triggers an increase in money supply by purchasing government securities on the open market thus increasing available funds for private banks to loan through fractional-reserve banking (the issue of new money through loans) and thus the amount of bank reserves and the monetary base rise. By purchasing government bonds (especially Treasury Bills), this bids up their prices, so that interest rates fall at the same time that the monetary base increases. With 'easy money,' the central bank creates new bank reserves (in the US known as 'federal funds'), which allow the banks lend more. These loans get spent, and the proceeds get deposited at other banks. Whatever is not required to be held as reserves is then lent out again, and through the 'multiplying' effect of the fractional-reserve system, loans and bank deposits go up by many times the initial injection of reserves. In contrast, when the central bank is 'tightening' [monetary policy], it slows the process of private bank issue by selling securities on the open market and pulling money (that could be loaned) out of the private banking sector. By increasing the supply of bonds, this lowers their prices and raises interest rates at the same time that the money supply is reduced. This kind of policy reduces or increases the supply of short term government debt in the hands of banks and the non-bank public, lowering or raising interest rates. In parallel, it increases or reduces the supply of loanable funds (money) and thereby the ability of private banks to issue new money through issuing debt. The simple connection between monetary policy and monetary aggregates such as M1 and M2 changed in the 1970s as the reserve requirements on deposits started to fall with the emergence of money funds, which require no reserves. Then in the early 1990s, reserve requirements were dropped to zeroin what countries? on savings deposits, CDs, and Eurodollar deposit. At present, reserve requirements apply only to 'transactions deposits' – essentially checking accounts. The vast majority of funding sources used by private banks to create loans are not limited by bank reserves. Most commercial and industrial loans are financed by issuing large denomination CDs. Money market deposits are largely used to lend to corporations who issue commercial paper. Consumer loans are also made using savings deposits, which are not subject to reserve requirements. This means that instead of the amount of loans supplied responding passively to monetary policy, we often see it rising and falling with the demand for funds and the willingness of banks to lend. Some academics argue that the money multiplier is a meaningless concept, because its relevance would require that the money supply be exogenous, i.e. determined by the monetary authorities via open market operations. If central banks usually target the shortest-term interest rate (as their policy instrument) then this leads to the money supply being endogenous. Neither commercial nor consumer loans are any longer limited by bank reserves. Nor are they directly linked proportional to reserves. Between 1995 and 2008, the amount of consumer loans has steadily increased out of proportion to bank reserves. Then, as part of the financial crisis, bank reserves rose dramatically as new loans shrank. In recent years, some academic economists renowned for their work on the implications of rational expectations have argued that open market operations are irrelevant. These include Robert Lucas, Jr., Thomas Sargent, Neil Wallace, Finn E. Kydland, Edward C. Prescott and Scott Freeman. The Keynesian side points to a major example of ineffectiveness of open market operations encountered in 2008 in the United States, when short-term interest rates went as low as they could go in nominal terms, so that no more monetary stimulus could occur. This zero bound problem [ZIRP - Zero Interest Rate Policy] has been called the 'liquidity trap' or 'pushing on a string' (the pusher being the central bank and the string being the real economy). --Arguments: The main functions of the central bank are to maintain low inflation and a low level of unemployment, although these goals are sometimes in conflict. A central bank may attempt to do this by artificially influencing the demand for goods by increasing or decreasing the nation's money supply (relative to trend), which lowers or raises interest rates, which stimulates or restrains spending on goods and services. An important debate among economists in the second half of the twentieth century concerned the central bank's ability to predict how much money should be in circulation, given current employment rates and inflation rates. Economists such as Milton Friedman believed that the central bank would always get it wrong, leading to wider swings in the economy than if it were just left alone. This is why they advocated a non-interventionist approach—one of targeting a pre-specified path for the money supply independent of current economic conditions— even though in practice this might involve regular intervention with open market operations (or other monetary-policy tools) to keep the money supply on target. The Chairman of the U.S. Federal Reserve, Ben Bernanke, has suggested that over the last 10 to 15 years, many modern central banks have become relatively adept at manipulation of the money supply, leading to a smoother business cycle, with recessions tending to be smaller and less frequent than in earlier decades, a phenomenon termed 'The Great Moderation'. This theory encountered criticism during the global financial crisis of 2008–2009. Furthermore, it may be that the functions of the central bank may need to encompass more than the shifting up or down of interest rates or bank reserves: these tools, although valuable, may not in fact moderate the volatility of money supply (or its velocity). [It should be noted that Austrian economists, like other countries have other methods, have a slightly different understanding of what constitutes money and therefore calculate the money supply in a slightly different way.] " - wikipedia.com
[ http://en.wikipedia.org/wiki/Money_supply ] Downloaded 13th June, 2011.
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[Quote No.36167] Need Area: Money > Invest
"Central Banks Say Gold Most Important Reserve Asset In 25 Years: UBS recently surveyed more than 80 central bank reserve managers, sovereign wealth funds and multilateral institutions at an annual conference [June 2010]. The results of the survey revealed that nearly a quarter of central banks believe gold will become the most important reserve asset in the next 25 years. Apart from the positive long term prospects of gold, the same survey revealed that central bankers believe gold will be the best-performing asset class in the next six months, ahead of equities, bonds, oil and currencies, according to the poll. The results of this most recent survey show a drastic change in the attitudes of central bankers and investors towards their view of Gold and it’s function as a hedge against inflation, as a reserve currency, and as an investment. For over 20 years, central banks around the world were net sellers of gold. However, more recently this trend has done a 180 as central banks in Europe are scaling down their sales and others, such as China, India and Russia, are making significant purchases. According to the Russian Central Bank, Russian gold reserves just hiked 1.1 million ounces in May. Current global mining production is just 6.8 million ounces a month, this represents 16.1% of monthly global mining production. This is the largest one month purchase of gold by the Russian Central Bank, which has been buying gold at a rate of 250,000 ounces a month for the past three years. All in all this means Russia is quadrupling its gold purchases and meanwhile the Russia’s president Putin is pushing for a single world currency and last week revealed the currency’s first proof coin. Back in the middle east, Saudi Arabia just announced that it has more than doubled its gold holdings from 143 tonnes in the first quarter of 2008 to 322.9 tonnes. That’s 241,000 ounces a month, about the same as the massive Russian increase. It’s still unclear what China is currently doing as far as increasing their gold reserves because they’re being very secretive about their intentions and actions. However one thing is for sure, China isn’t selling any gold. Between 2003 and 2009, China’s central bank bought an average of 76 tons of gold a year. That amounts to approximately 185,000 ounces a month. The likelihood of China slowing its purchases is non existent. China will most likely not want to be outdone by Russia and Saudi Arabia, and will almost surely want to ramp up it’s gold hoarding on par with Russia and other central banks. Even if China is purchasing just 250,000 ounces a month, that would mean just thee central banks are sucking up 24% of global gold mine production. In all likelihood, China’s gold purchasing is probably much much higher, given the fact that it needs to shore up it’s currency with something of value other than fiat dollars." - Inflation-nation
[http://www.inflation-nation.net/articles/central-banks-say-gold-most-important-reserve-asset-in-25-years/] Thursday, June 24th, 2010
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[Quote No.36168] Need Area: Money > Invest
"There are about three hundred economists in the world who are against gold, and they think that gold is a barbarous relic - and they might be right. Unfortunately, there are three billion inhabitants of the world who believe in gold." - Janos Fekete

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[Quote No.36170] Need Area: Money > Invest
"Job Openings and Labor Turnover Survey - JOLTS: A survey done by the United States Bureau of Labor Statistics to help measure job vacancies. It collects data from employers including retailers, manufacturers and different offices each month. Respondents to the survey answer quantitative and qualitative questions about their businesses' employment, job openings, recruitment, hires and separations. The JOLTS data is published monthly and by region and industry... JOLTS data has many uses, not least of which is to help guide the government in formulation of economic policy through economic research and planning. The JOLTS publications provide data that can help in the analysis of industry retention rates, business cycles and industry-specific economic research. Also, JOLTS has been used in conjunction with the Help-Wanted Index, which is published by the Conference Board, for a more accurate reading of job-market efficiency in the country. [Other countries have other employment leading indicators. In Australia they have the monthly job advertisement." - investopedia.com
[ http://www.investopedia.com/terms/j/jolts.asp ] Dounloaded 13th June, 2011.
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[Quote No.36171] Need Area: Money > Invest
"Many investors ‘date’ stocks, but some ‘marry’ gold. The 'holding period for stocks has been shortening, but I expect holding periods for gold have been lengthening. And for many gold bugs, their holding period is 'forever — till death do they part' [as they envisage the steady devaluation of fiat currencies by deficit and debt ridden governments - especially the US in whose currency, gold is denominated, so as it is being deliberately devalued - in 2009-11 - to make the US exports more globally competitive, gold will rise." - Philip Romero
finance professor at the University of Oregon and former chief economist of California.
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[Quote No.36172] Need Area: Money > Invest
"Gold is primarily and inversely tied to the dollar, and anything causing the dollar to lose value will cause gold to rise in price. Gold’s rise makes sense because the [U.S.] government has increased the money supply and expanded credit, which cheapens the dollar relative to gold’s value. " - Lee Martinson
owner of retirement planning firm PGA Financial in Yucaipa, Calif.
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[Quote No.36173] Need Area: Money > Invest
"Gold trades off a myriad of inputs, including the U.S. dollar, world economies, geopolitical developments, technicals and inflation. So, it often does the opposite of what people think if they solely watch the dollar. It is sometimes difficult to ascertain which dynamic is exerting the most influence on any given day. This is why it is so important to follow all on a daily basis and try to put the pieces of the puzzle together... gold is currently [2011] being driven by liquidity, or excess money floating around, which makes gold a store of value. Usually, gold has a strong inverse correlation to the dollar and positive correlation to oil." - Charles Nedoss
senior market strategist at Olympus Futures in Chicago
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[Quote No.36174] Need Area: Money > Invest
"Fractional-reserve banking: The different forms of money in government money supply statistics arise from the practice of fractional-reserve banking. Whenever a bank gives out a loan in a fractional-reserve banking system, a new sum of money is created [the money supply is multiplied]. This new type of money is what makes up the non-M0 components in the M1-M3 [money supply] statistics. In short, there are two types of money in a fractional-reserve banking system: --1.central bank money (obligations of a central bank, including currency and central bank depository accounts), --2.commercial bank money (obligations of commercial banks, including checking accounts and savings accounts). In the [US] money supply statistics, central bank money is MB while the commercial bank money is divided up into the M1-M3 components. Generally, the types of commercial bank money that tend to be valued at lower amounts are classified in the narrow category of M1 while the types of commercial bank money that tend to exist in larger amounts are categorized in M2 and M3, with M3 having the largest. In the US, reserves consist of money in Federal Reserve accounts and US currency held by banks (also known as 'vault cash'). Currency and money in Fed accounts are interchangeable (both are obligations of the Fed). Reserves may come from any source, including the federal funds market, deposits by the public, and borrowing from the Fed itself. A reserve requirement is a ratio a bank must maintain between deposits and reserves. Reserve requirements do not apply to the amount of money a bank may lend out. The ratio that applies to bank lending is its capital requirement. [Central banks can alter the required reserves and/or the capital adequacy ratios allowed in order to increase or decrease the money supply within an economy, as part of their monetary policies to tighten or loosen and increase or decrease interest rates as well as increase the prudential stability of the banking system specifically and the economy's financial system in general.] Example [of how fractional reserve banking multiplies the money supply and how this is reflected in the breakdown of the money supply into its various money supply accounting components - M1, M2, etc]: Note: The examples apply when read in sequential order. ------M0: Laura has ten US $100 bills, representing $1000 in the M0 supply for the United States. (MB = $1000, M0 = $1000, M1 = $1000, M2 = $1000). Laura burns one of her $100 bills. The US M0, and her personal net worth, just decreased by $100. (MB = $900, M0 = $900, M1 = $900, M2 = $900). -------M1: Laura takes the remaining nine bills and deposits them in her checking account at her bank. (MB = $900, M0 = 0, M1 = $900, M2 = $900). The bank then calculates its reserve using the minimum reserve percentage given by the Fed and loans the extra money. If the minimum reserve is 10%, this means $90 will remain in the bank's reserve. The remaining $810 can only be used by the bank as credit, by lending money, but until that happens it will be part of the banks excess reserves. The M1 money supply increased by $810 when the loan is made. M1 money has been created. ( MB = $900 M0 = 0, M1 = $1710, M2 = $1710). Laura writes a check for $400, check number 7771. The total M1 money supply didn't change, it includes the $400 check and the $500 left in her account. (MB = $900, M0 = 0, M1 = $1710, M2 = $1710). Laura's check number 7771 is accidentally destroyed in the laundry. M1 and her checking account do not change, because the check is never cashed. (MB = $900, M0 = 0, M1 = $1710, M2 = $1710). Laura writes check number 7772 for $100 to her friend Alice, and Alice deposits it into her checking account. MB does not change, it still has $900 in it, Alice's $100 and Laura's $800. (MB = $900, M0 = 0, M1 = $1710, M2 = $1710). The bank lends Mandy the $810 credit that it has created. Mandy deposits the money in a checking account at another bank. The other bank must keep $81 as a reserve and has $729 available for loans. This creates a promise-to-pay money from a previous promise-to-pay, thus the M1 money supply is now inflated by $729. (MB = $900, M0 = 0, M1 = $2439, M2 = $2439). Mandy's bank now lends the money to someone else who deposits it on a checking account on yet another bank, who again stores 10% as reserve and has 90% available for loans. This process repeats itself at the next bank and at the next bank and so on, until the money in the reserves backs up an M1 money supply of $9000, which is 10 times the M0 money. (MB = $900, M0 = 0, M1 = $9000, M2 = $9000). ------M2: Laura writes check number 7774 for $1000 and brings it to the bank to start a Money Market account (these do not have a credit-creating charter), M1 goes down by $1000, but M2 stays the same. This is because M2 includes the Money Market account in addition to all money counted in M1. ------Foreign Exchange: Laura writes check number 7776 for $200 and brings it downtown to a foreign exchange bank teller at Credit Suisse to convert it to British Pounds. On this particular day, the exchange rate is exactly USD 2.00 = GBP 1.00. The bank Credit Suisse takes her $200 check, and gives her two £50 notes (and charges her a dollar for the service fee). Meanwhile, at the Credit Suisse branch office in Hong Kong, a customer named Huang has £100 and wants $200, and the bank does that trade (charging him an extra £.50 for the service fee). US M0 still has the $900, although Huang now has $200 of it. The £50 notes Laura walks off with are part of Britain's M0 money supply that came from Huang. The next day, Credit Suisse finds they have an excess of GB Pounds and a shortage of US Dollars, determined by adding up all the branch offices' supplies. They sell some of their GBP on the open FX market with Deutsche Bank, which has the opposite problem. The exchange rate stays the same. The day after, both Credit Suisse and Deutsche Bank find they have too many GBP and not enough USD, along with other traders. Then, To move their inventories, they have to sell GBP at USD 1.999, that is, 1/10 cent less than $2 per pound, and the exchange rate shifts. None of these banks has the power to increase or decrease the British M0 or the American M0; they are independent systems. [----M0: In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is referred to as the monetary base, or narrow money. ----MB: is referred to as the monetary base or total currency. This is the base from which other forms of money (like checking deposits, listed below) are created and is traditionally the most liquid measure of the money supply. ----M1: Bank reserves are not included in M1. ----M2: represents money and 'close substitutes' for money. M2 is a broader classification of money than M1. Economists use M2 when looking to quantify the amount of money in circulation and trying to explain different economic monetary conditions. M2 is a key economic indicator used to forecast inflation. ----M3: Since 2006, M3 is no longer tracked by the US central bank. However, there are still estimates produced by various private institutions. (M2 +large deposits and other large, long-term deposits). ----MZM: Money with zero maturity. It measures the supply of financial assets redeemable at par on demand. The ratio of a pair of these measures, most often M2/M0, is called an (actual, empirical) money multiplier. ] " - wikipedia.org
[ http://en.wikipedia.org/wiki/Money_supply ] Downloaded 14th June, 2011.
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[Quote No.36175] Need Area: Money > Invest
"There are risk on (boom) and risk off (bust) investment assets. For example global currencies. Risk on currencies, for example, include the commodity currencies of the Australian Dollar (AUD) in the Asia Pacific and the Canadian Dollar (CAD) in the Americas. Risk off currencies, for example, include the Swiss Franc (CHF) in Europe, the United States Dollar (USD) in the Americas and the Japanese Yen (JPY) in the Asia Pacific. One way to measure the greed (risk on/boom)or fear (risk off/bust) sentiment of the market is by watching the actual behaviour of the market participants, voting with their money, rather than say being contrarian with sentiment indexes or volatility indexes like the VIX. Set up charts that compare the relative performance of the risk on and risk off trades. For example, the cyclical risk on sectors of the share market, for example consumer discretionary, resources and banking, graphed against the risk off defensive sectors of health care and utilities. This will show when the share market sentiment is changing from risk off to risk on and vice versa. The same can be done with the risk on - AUD and CAD - and risk off - CHF, USD and JPY - currencies. This can be done for bonds - risk on high yield 'junk' company bonds and risk off - AAA sovereign bonds in the bond market and it can even be done with commodities, although it is less decisive, - risk on - copper and oil and risk off gold and precious metals." - Seymour@imagi-natives.com

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[Quote No.36176] Need Area: Money > Invest
"Repurchase agreement: A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively representing interest, sometimes called the repo rate. The party that originally buys the securities effectively acts as a lender. The original seller is effectively acting as a borrower, using their security as collateral for a secured cash loan at a fixed rate of interest. A repo is equivalent to a cash transaction combined with a forward contract. The cash transaction results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price and the spot price is effectively the interest on the loan while the settlement date of the forward contract is the maturity date of the loan. ----Structure and terminology: A repo is economically similar to a secured loan, with the buyer (effectively the lender or investor) receiving securities as collateral to protect him against default by the seller [in a similar way to the way a pawn shop works]. The party who initially sells the securities is effectively the borrower. Almost any security may be employed in a repo, though highly liquid securities are preferred as they are more easily disposed of in the event of a default and, more importantly, they can be easily obtained in the open market where the buyer has created a short position in the repo security by a reverse repo and market sale; by the same token, illiquid securities are discouraged. Treasury or Government bills, corporate and Treasury/Government bonds, and stocks may all be used as 'collateral' in a repo transaction. Unlike a secured loan, however, legal title to the securities passes from the seller to the buyer. Coupons (interest payable to the owner of the securities) falling due while the repo buyer owns the securities are, in fact, usually passed directly onto the repo seller. This might seem counterintuitive, as the legal ownership of the collateral rests with the buyer during the repo agreement. The agreement might instead provide that the buyer receives the coupon, with the cash payable on repurchase being adjusted to compensate, though this is more typical of sell/buybacks. Although the transaction is similar to a loan, and its economic effect is similar to a loan, the terminology differs from that applying to loans: the seller legally repurchases the securities from the buyer at the end of the loan term. However a key aspect of repos is that they are legally recognised as a single transaction (important in the event of counterparty insolvency) and not as a disposal and a repurchase for tax purposes. [Some of the specific industry terms include: Repo, Reverse Repo, Participant, Borrower, Lender, Seller, Buyer, Cash receiver, Cash provider, Sells securities, Buys securities, Near leg, Far leg.] -----Types of repo and related products: There are three types of repo maturities: overnight, term, and open repo. Overnight refers to a one-day maturity transaction. Term refers to a repo with a specified end date. Open simply has no end date. Although repos are typically short-term, it is not unusual to see repos with a maturity as long as two years. Repo transactions occur in three forms: specified delivery, tri-party, and held in custody. The third form is quite rare in developing markets primarily due to risks. The first form requires the delivery of a prespecified bond at the onset, and at maturity of the contractual period. Tri-party essentially is a basket form of transaction, and allows for a wider range of instruments in the basket or pool. Tri-party utilizes a tri-party clearing agent or bank and is a more efficient form of repo transaction. ----Due bill/hold in-custody repo: In a due bill repo, the collateral pledged by the (cash) borrower is not actually delivered to the cash lender. Rather, it is placed in an internal account ('held in custody') by the borrower, for the lender, throughout the duration of the trade. This has become less common as the repo market has grown, particularly owing to the creation of centralized counterparties. Due to the high risk to the cash lender, these are generally only transacted with large, financially stable institutions. ----Tri-party repo: The distinguishing feature of a tri-party repo is that a custodian bank or international clearing organization, the tri-party agent, acts as an intermediary between the two parties to the repo. The tri-party agent is responsible for the administration of the transaction including collateral allocation, marking to market, and substitution of collateral. In the US, the two principal tri-party agents are The Bank of New York Mellon and JP Morgan Chase. The size of the US tri-party repo market peaked in 2008 before the worst effects of the [global financial] crisis at approximately $2.8 trillion and by mid 2010 was about $1.6 trillion. As tri-party agents administer hundreds of billions of US$ of collateral, they have the scale to subscribe to multiple data feeds to maximise the universe of coverage. As part of a tri-party agreement the three parties to the agreement, the tri-party agent, the repo buyer and the repo seller agree to a collateral management service agreement which includes an 'eligible collateral profile'. It is this 'eligible collateral profile' that enables the repo buyer to define their risk appetite in respect of the collateral that they are prepared to hold against their cash. For example a more risk averse repo buyer may wish to only hold 'on-the-run' government bonds as collateral. In the event of a liquidation event of the repo seller the collateral is highly liquid thus enabling the repo buyer to sell the collateral quickly. A less risk averse repo buyer may be prepared to take non investment grade [so called 'high yield' or 'junk' corporate, etc] bonds or equities as collateral, these may be less liquid and may suffer a higher price volatility in the event of a repo seller default, making it more difficult for the repo buyer to sell the collateral and recover their cash. The tri-party agents are able to offer sophisticated collateral eligibility filters which allow the repo buyer to create these 'eligible collateral profiles' which can systemically generate collateral pools which reflect the buyer's risk appetite. Collateral eligibility criteria could include asset type, issuer, currency, domicile, credit rating, maturity, index, issue size, average daily traded volume, etc. Both the lender (repo buyer) and borrower (repo seller) of cash enter into these transactions to avoid the administrative burden of bi-lateral repos. In addition, because the collateral is being held by an agent, counterparty risk is reduced. A tri-party repo may be seen as the outgrowth of the due bill repo, in which the collateral is held by a neutral third party. ----Whole loan repo: A whole loan repo is a form of repo where the transaction is collateralized by a loan or other form of obligation (e.g. mortgage receivables) rather than a security. ----Equity repo: The underlying security for many repo transactions is in the form of government or corporate bonds. Equity repos are simply repos on equity securities such as common (or ordinary) shares. Some complications can arise because of greater complexity in the tax rules for dividends as opposed to coupons. ----Sell/buy backs and buy/sell backs: A sell/buy back is the spot sale and a forward repurchase of a security. It is two distinct outright cash market trades, one for forward settlement. The forward price is set relative to the spot price to yield a market rate of return. The basic motivation of sell/buy backs is generally the same as for a classic repo, i.e. attempting to benefit from the lower financing rates generally available for collateralized as opposed to non-secured borrowing. The economics of the transaction are also similar with the interest on the cash borrowed through the sell/buy back being implicit in the difference between the sale price and the purchase price. There are a number of differences between the two structures. A repo is technically a single transaction whereas a sell/buy back is a pair of transactions (a sell and a buy). A sell/buy back does not require any special legal documentation while a repo generally requires a master agreement to be in place between the buyer and seller (typically the SIFMA/ICMA commissioned Global Master Repo Agreement (GMRA)). For this reason there is an associated increase in risk compared to repo. Should the counterparty default, the lack of agreement may lessen legal standing in retrieving collateral. Any coupon payment on the underlying security during the life of the sell/buy back will generally be passed back to the seller of the security by adjusting the cash paid at the termination of the sell/buy back. In a repo, the coupon will be passed on immediately to the seller of the security. A buy/sell back is the equivalent of a 'reverse repo'. ----Securities lending: In securities lending, the purpose is to temporarily obtain the security for other purposes, such as covering short positions or for use in complex financial structures. Securities are generally lent out for a fee and securities lending trades are governed by different types of legal agreements than repos. Repos have traditionally been used as a form of collateralized loan and have been treated as such for tax purposes. Modern Repo agreements, however, often allow the cash lender to sell the security provided as collateral and substitute an equivalent security at repurchase. In this way the cash lender acts as a security borrower and the Repo agreement can be used to take a short position in the security very much like a security loan might be used. ----Reverse Repo: A reverse repo is simply the same repurchase agreement from the buyer's viewpoint, not the seller's. Hence, the seller executing the transaction would describe it as a 'repo', while the buyer in the same transaction would describe it a 'reverse repo'. So 'repo' and 'reverse repo' are exactly the same kind of transaction, just described from opposite viewpoints. The term 'reverse repo and sale' is commonly used to describe the creation of a short position in a debt instrument where the buyer in the repo transaction immediately sells the security provided by the seller on the open market. On the settlement date of the repo, the buyer acquires the relevant security on the open market and delivers it to the seller. In such a short transaction the seller is wagering that the relevant security will decline in value between the date of the repo and the settlement date. ----Uses: For the buyer, a repo is an opportunity to invest cash for a customized period of time (other investments typically limit tenures). It is short-term and safer as a secured investment since the investor receives collateral. Market liquidity for repos is good, and rates are competitive for investors. Money Funds are large buyers of Repurchase Agreements. For traders in trading firms, repos are used to finance long positions, obtain access to cheaper funding costs of other speculative investments, and cover short positions in securities. In addition to using repo as a funding vehicle, repo traders 'make markets'. These traders have been traditionally known as 'matched-book repo traders'. The concept of a matched-book trade follows closely to that of a broker who takes both sides of an active trade, essentially having no market risk, only credit risk. Elementary matched-book traders engage in both the repo and a reverse repo within a short period of time, capturing the profits from the bid/ask spread between the reverse repo and repo rates. Presently, matched-book repo traders employ other profit strategies, such as non-matched maturities, collateral swaps, and liquidity management. ----United States Federal Reserve [central bank] use of repos: Repurchase agreements when transacted by the Federal Open Market Committee of the Federal Reserve in open market operations adds reserves [increases money supply - liquidity] to the banking system and then after a specified period of time withdraws them; reverse repos initially drain reserves [money supply - liquidity] and later add them back. This tool can also be used to stabilize interest rates, and the Federal Reserve has used it to adjust the Federal funds rate to match the target rate. Under a repurchase agreement ('RP' or 'repo'), the Federal Reserve (Fed) buys U.S. Treasury securities, U.S. agency securities, or mortgage-backed securities from a primary dealer who agrees to buy them back, typically within one to seven days; a reverse repo is the opposite. Thus the Fed describes these transactions from the counterparty's viewpoint rather than from their own viewpoint. If the Federal Reserve is one of the transacting parties, the RP is called a 'system repo', but if they are trading on behalf of a customer (e.g. a foreign central bank) it is called a 'customer repo'. Until 2003 the Fed did not use the term 'reverse repo' — which it believed implied that it was borrowing money (counter to its charter) — but used the term 'matched sale' instead. ----Risks: While classic repos are generally credit-risk mitigated instruments, there are residual credit risks. Though it is essentially a collateralized transaction, the seller may fail to repurchase the securities sold at the maturity date. In other words, the repo seller defaults on his obligation. Consequently, the buyer may keep the security, and liquidate the security in order to recover the cash lent. The security, however, may have lost value since the outset of the transaction as the security is subject to market movements. To mitigate this risk, repos often are over-collateralized as well as being subject to daily mark-to-market margining. Conversely, if the value of the security rises there is a credit risk for the borrower in that the creditor may not sell them back. If this is expected to happen then the borrower may negotiate a repo which is under-collateralized. Credit risk associated with repo is subject to many factors: term of repo, liquidity of security, the strength of the counterparties involved, etc. Repo transactions came into focus within the financial press due to the technicalities of settlements following the collapse of Refco. Occasionally, a party involved in a repo transaction may not have a specific bond at the end of the repo contract. This may cause a string of failures from one party to the next [counter-party risk], for as long as different parties have transacted for the same underlying instrument. The focus of the media attention centers on attempts to mitigate these failures. ----History: In the US, Repos have been used from as early as 1917 when war time taxes made older forms of lending less attractive. At first Repos were used just by the Federal reserve to lend to other banks, but the practice soon spread to other market participants. The use of Repos expanded in the 1920s, fell away through the Great depression and WWII , then expanded once again in the 1950s, enjoying rapid growth in the 1970s and 1980s in part due to computer technology. ----Market size: The US Federal Reserve and the European Repo Council (a body of the International Capital Market Association - ICMA) both try to estimate the size of their respective repo markets. At the end of 2004, the U.S. repo market reached US$5 trillion. The European repo market has experienced consistent growth over the past five years, from €1.9 billion in 2001 to €6.4 trillion by the end of 2006, and is expected to continue significant growth due to Basel II, according to a 2007 Celent report entitled 'The European Repo Market'. Especially in the US and to a lesser degree in Europe, the repo market contracted in 2008 as a result of the [great] financial crisis. But by mid 2010 the market had largely recovered and at least in Europe had grown to exceed its pre-crisis peak. Other countries including Chile, India, Japan, Mexico, Hungary, Russia, China, and Taiwan, have their own repo markets, though activity varies by country, and no global survey or report has been compiled." - wikipedia.org
[ http://en.wikipedia.org/wiki/Repurchase_agreement ] Downloaded 14th June, 2011.
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[Quote No.36180] Need Area: Money > Invest
"If Gold’s Going Up... Why Are Gold Stocks Falling? Gold stocks normally amplify the gains from gold. If gold goes up 10%, then a good gold stock should go up 20%. So traders look for this ‘leverage’ to the gold price in gold stocks. That was until ETFs became such a big force on the market. Now traders can invest directly in gold ETFs with borrowed money to get the same effect. It saves having to do all that annoying research into a gold company. So with all that money heading for the ETFs – instead of the stocks – the gold price and gold stocks are diverging. It looks like some of them are even short selling the gold stocks to reduce their risk. This suppresses the price of the gold stocks even more. But the ETFs can only push this trade so far. For one thing, wherever the price goes, gold stocks are still worth the price of their future cash flows. And as the gold price rises further, so does the stock’s value. Gold stocks at current prices are incredible value. And good value will lead to good buying. If we start to get bargain hunters taking this opportunity up, then at some point the traders will start having to close their short positions. This increases the price, and soon the traders could start a stampede as they all try to get out. This could lead to a big spike in the price, blowing up months’ worth of profits in minutes. This will happen at some point, and gold stocks will go ballistic as they get back to where they should be. Closing this trade would also mean selling the gold ETF. It’s amazing to think that the largest gold ETF in the world now holds more gold than most central banks. Or so they say... Apparently, the US Commodity Futures Trading Commission, with the Gold Anti-Trust Action Committee, reckon there is now one hundred times more gold in ETFs in the world...than physically exists above ground. ETFs are convenient. They are the cheapest way to buy and sell precious metals and they have their role in the market. They let you buy and sell metal via Etrade or Commsec quicker than you can say ‘Goldfinger’. At the other end of the spectrum, buying physical gold or silver metal is more expensive – because dealers charge a premium. You then have the cost of delivery, storage and insurance. Dealers also take their cut when you sell. So why bother with bullion? For one reason – to avoid ‘counterparty risk’. This is the risk of trusting another party with your investment. When you buy an ETF, the metal you buy is generally not held by the ETF provider, but by a large global bank like HSBC or Morgan Stanley... " - Dr. Alex Cowie
Money Morning Australia, Monday, 13th June 2011
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[Quote No.36181] Need Area: Money > Invest
"How To Buy REAL Gold And Silver... And Then Keep It Safe From Banks And Governments: Maybe I watched [the movie] 'Goldfinger' too many times as a kid, but a part of me has always been drawn to actually owning precious metal. Or perhaps this classic Bond film just tapped into the instinctive human draw to the metal – the urge that has been behind a three thousand year history of collecting it. Maybe it’s the sheer weight of the stuff. It’s reassuring to hold. It doesn’t do anything – sure. But part of its beauty and value is that it is so inert and unchanging. Despite all the evidence that gold is money and worth owning, gold ownership today is still controversial. But not with people who know better. Chinese gold ownership has gone from nothing – to an avalanche in just a few years. With hundreds of millions of newly-wealthy middle classes wanting to protect against inflation, and tap back into their long cultural history of gold ownership, gold demand is not going to drop off any time soon. Last week I talked about the new Exchange Traded Fund – QAU – that allows you to cheat the Aussie dollar [which is rising as the US dollar falls - the US Dollar as the world reserve currency denominates gold so a fall in the US dollar exchange rate means a rise in the number of dollars per ounce of gold , or in other words, the price of gold in US dollars. The Australian dollar however also rises as the US dollar falls reducing the profit from gold ownership at least in Australian Dollars] and get the same gold returns as US investors. ETF’s like this are the cheapest and most convenient way to buy, and sell, the metal. But the downside that I mentioned is that you never get to see the gold. It’s held in a vault overseas. This means that you have counter-party risk: the risk that the bank that holds it could go belly up. Or even let the government confiscate it. Sound far-fetched? Maybe in today’s more civilised times... but just read U.S President Franklin Roosevelt’s Executive Order 6102, where ordinary Americans were forced to hand in their gold to a Federal Reserve Bank, or face fines and imprisonment. Or ask the many citizens who lost their gold to the Nazi regime. This is extreme stuff of course. But the world we live in is getting increasingly extreme. I like to think of the ownership of precious metals as being the one-stop-shop to protect your wealth against government [financial] stupidity. By buying gold and silver, and actually arranging storage yourself, you are boiling down the process of precious metals ownership to the absolute basics... " - Dr. Alex Cowie
Alex holds a graduate degree in finance and investment from the Financial Services Institute of Australia. Trained in Industrial Equity Analysis and Applied Portfolio Management, he is the editor and chief analyst for 'Diggers and Drillers'. Tuesday, 7th June 2011.
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[Quote No.36182] Need Area: Money > Invest
"How Aussie Investors Could Make US Gold Gains Like Bill Gross: In the last few years, investors buying gold in US dollars have made astonishing gains of 24.4% each year on average. In the same time, Australian investors have made just 5.7% each year. Why the big difference? The Aussie dollar. While the US dollar has gone down the toilet, the Aussie dollar has gone off like a rocket. The US gold price may have risen, but our ever stronger currency has made investing in it a bit like swimming against the tide. If you take a look over the last eight years, it’s a similar story. Aussie gold investors getting a raw deal thanks to the strong Aussie dollar. As Editor of Diggers & Drillers, precious metals have always been the core of our investment strategy, with junior gold stocks leading the way. One of the frequent questions I get from readers is: ‘Hi Doc, I want to buy some gold metal, but why bother when that darn Aussie dollar keeps going up as fast as the gold price? In the last few years I would have done better with the money in the bank.’ It’s a good question, and I didn’t have a good answer until now. But Aussie investors can now make the same returns as if they were investing in US dollars. For example you would have made about 27.1% last year, instead of 13.3%. How? I’ll explain in a second. First it’s good to remind ourselves why gold is going to keep heading up. The saying goes that debt is the currency of slaves, which makes slaves of most of us, but few more so than those in the US. We all know that the US is up to its ears in debt. The official figure for the national debt is $14 trillion, which is a ridiculous number however you cut it. Call us sceptical, but we reckon the US government's statistical department is full of it. So, we prefer to listen to a former professional blackjack gambler from Vegas: Bill Gross. These days he is the famous MD of PIMCO, which successfully manages hundreds of billions of dollars worth of bonds. Gross estimates the actual figure for US debt is more like $75 trillion. This is a guy you want to listen to. He has made many fortunes for himself and his clients by carefully investing in bonds. Government bonds, municipal bonds, and corporate bonds – from the US and all over the world as well. Recently he sold his entire holding of US treasuries. The simple reason is that the tide of inflation is rising – and that is the nemesis of the bond investor. What good is a 3% return if money is losing 4% of its purchasing power each year? To be honest, I'm surprised he stuck around as long as he did. Again – you can chuck the government stat’s on inflation in the bin. You reckon [US President] Obama would get re-elected if the people knew the government was destroying 7% of their wealth each year? Real inflation is much higher than the official statistics would have you believe. [Refer 'Financial Repression' which is the government euphemism for a deliberate economic policy that allows heavily indebted nations to install a 'hidden tax' on savers to help them pay off their debt by inflating it away.] We prefer to listen to John Williams at ShadowStats [shadowstats.com] for the real story. By his calculations, US inflation is closing in on 7%. This certainly makes more sense to friends of ours over in the States who are running flat out just to stand still. But don't just listen to one source. Take in a few. And who could be watching it more closely than Wal-Mart, the American budget convenience store. These guys make the skinniest margins on their goods but are profitable because they have so many shops. The CEO, Bill Simon warned this week that: '...rising inflation is about to become serious, and that Wal-Mart was seeing cost increases starting to come through at a pretty alarming rate.' When they sound the inflation alarm, you have to listen. So what does Obama do? There’s talk of him raising the debt ceiling by 50% to $21 trillion. Just stop reading for a second and take that in. A 50 per cent raising of the debt ceiling? If you aren't yelling at your computer, then you're not paying attention. If this happens then we are witnessing the [US] dollar's end game. Time to buckle up. It would enable shenanigans that make QE2 [Quantitative Easing, or 'money printing' monetary policy initiated by the US Federal Reserve Bank under the leadership of Chairman, Ben Bernanke] look like some light stretching before a marathon. So what to do? As with most of the economic problems in this world, the solution is precious metals. That same saying that says 'debt is the currency of slaves' actually begins with 'gold is the currency of kings, and silver is the currency of the free man'. Never is that truer than now. As inflation gets a grip of the world's largest economy, precious metals' prices will soar. The US-centric media doesn't seem to have noticed that China and India are in fact the biggest markets for precious metals. And inflation is already well underway there – thanks to years of importing inflation-infected US dollars. Chinese inflation is already up to 5.3%, and Indian inflation has just hit 8.7%. As editor of Diggers & Drillers we've always recommended gold and silver. But in recent months we've made four more precious metals tips to increase precious metals exposure to half of the portfolio. There's more on the way too. And we’re not the only one. Bill Gross has recently launched an equities fund that has most of its $1.2 billion in gold positions. Bill Gross... in gold? What the! This is the man who made his money in interest-bearing securities, and now he's got a billion dollars in gold? It's a bit like finding out that your family GP is the biggest boozer of anyone you know. You know it makes sense – but it still comes as a bit of a shock. Gold has been in an uninterrupted bull market for 10 years, and is basically a no-brainer. Buy gold, buy good gold stocks, buy gold jewellery – just buy gold! If you want to invest directly in gold metal, but don’t want the risk, premiums and cost of doing it yourself, then your best bet is an Exchange Traded Fund (ETF). This makes it as easy to buy gold as picking up the phone to your broker, or logging onto your broking account, and putting in your order. It’s that easy. No need to install a safe at home, or increase your home and contents insurance. The downside of course, is that you don’t get to hold the shiny metal bars in your hand, and if the proverbial ever hits the fan, you may never get to grab them on the way to your hide-out in the hills! The ease, safety and low cost have made ETFs the way to go for millions of investors worldwide, and they are now a massive force in the market. Yet in Australia, it’s still early days but we are starting to catch up now. So how does an ETF get around the strong Aussie dollar, to let investors profit from gold like American investors? By hedging the currency. This involves using simple one-month currency forwards to remove the currency risk. This straightforward strategy removes most the effect of the strong Aussie. Meaning you can ride the US gold price, instead of the frustratingly slow Aussie gold price. This is exactly what the Betashares Gold Bullion ETF (Aussie Dollar hedged) aims for – and the ‘ticker’ is QAU. If the last 2.5 years are anything to go by, this means you could more than quadruple your returns over unhedged gold exposure. Sounds too good to be true? There are always a few risks to think about with any investment, so what are they here? The main one is that the price of gold falls of course...but we all know that ain’t gonna happen! One other small risk is that QAU will underperform unhedged Aussie gold if the US dollar recovers from its death spiral, but we know that ain’t gonna happen either! The hedging strategy is the other thing to think about. It’s simple and effective, but it’s not perfect. It’s based on the difference in the interest rates between the US and Australia so won’t give an exact match, and surprise rate changes could take the edge off returns. This a minor risk, and the ETF is a total game changer for Aussie gold investors. It doesn’t just make it easy and cheap to invest, but gets around that pesky Aussie dollar as well." - Dr. Alex Cowie
Editor of 'Diggers & Drillers'. 1st June, 2011.
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[Quote No.36187] Need Area: Money > Invest
"...a derivative is what it means. The price is derived from something else. Derivatives serve many purposes. They help you benefit from a climbing income or asset price. Or they can protect or insure against a drop in income or asset price. Farmers use derivatives to lock in the price of crops. It helps them plan for the future. They know the price today that they’ll get when delivering the crop at a future date. Without derivatives the farmer can’t plan for the future. But with derivatives, he or she can invest in capital or pay employees. Simply because the farmer knows the price they’ll get for the crop. Of course, it’s not just farmers who get to play. Derivatives benefit all investors. Speculators and investors play an important role in adding liquidity to the market. In this respect they work like any other investment. They provide others with the opportunity to profit – and potentially lose – from price movements in certain assets. Restricting or banning access to these markets would be bad for investors. It would be the equivalent of only allowing shopkeepers to buy shares in Woolworths [ASX: WOW] or bank employees to buy shares in Westpac [ASX: WBC]. A derivative allows you to profit without having to own the underlying investment – whether it’s wheat, corn, copper or frozen concentrated orange juice. Any restrictions would have a negative impact on liquidity by reducing the number of people taking part in the market. You see, the real problem behind the growth in derivatives isn’t the derivatives themselves. The real problem is the expansion of the money supply by central bankers and the ability of banks to create money from thin air. Without this, it wouldn’t be possible – as Bloomberg News put it – for 'The total value of derivatives in the world to [exceed] total gross domestic product by a factor of 10.' Don’t get me wrong. You could still have a market where the value of derivatives is bigger than the total value of an individual market. But in a free market money system, an expansion of money in one market would mean a contraction in another. In other words, prices in one market would fall while another would rise. Trouble is, when central banks and bankers create credit and money from thin air, it leads to booms in all markets at the same time. While that may sound great, it has a consequence. That is, when credit growth doesn’t expand fast enough to keep the market inflated, it’s not just one market that falls, but the whole darn lot..." - Kris Sayce
Money Morning Australia, 31st May, 2011.
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[Quote No.36188] Need Area: Money > Invest
"The Value of Gold and Money:... If only sound money was something the world’s central bankers believed in. What is sound money? Put simply, sound money is a currency that’s backed by something. Throughout history that’s mostly been gold. Although silver has been used too – hence the term pound sterling to describe the UK currency. Backing a currency with gold and/or silver prevents central bankers and retail bankers from inflating the money supply. Without the backing of gold or silver, bankers can’t resist temptation. If the bankers know they have no legal obligation to swap notes for gold or silver, there’s no disincentive for them to create money from thin air. The more the banks create, the more credit they can issue, and the more interest they can charge. That’s inflation. Trouble is, as this newly created money filters into the economy it begins driving up prices. Commodity prices rise and eventually consumer goods prices rise. The last thing to increase is wages… in other words, inflation brings about a decline in living standards as wage increases always lag price increases. Sure, some will benefit. But only those that get the newly created money first, plus those that get to keep their job and higher wage at the expense of those who lose their job. Unfortunately, most mainstream economists don’t get it. [Since most of them work for the government or banks, perhaps they don't want to 'get it' or at least admit it.] They believe in inflation and central bank involvement. The problem is they confuse economic growth with inflation. The two are completely separate, yet somewhere at some point economists [and politicians] have lumped the two together. So they now believe economic growth and therefore higher living standards, are only possible with inflation. But that’s not their only problem. Like most mainstream economists and bankers [and politicians], they believe they can drive the economy exactly where they want it to go. It explains this comment from Federal Reserve Bank of Chicago President, Charles Evans: 'We’ve seen pretty good growth and the employment numbers are improving. It’s quite likely that 600 [billion dollars] could be about the right number.' He’s referring to the QE2 stimulus. The reality is the stimulus has just pushed up commodity prices. Including food prices, energy prices, and gold and silver. The QE2 programme has been great for commodity investors. But not so good for those who need to use commodities... Gold is a great store of wealth. It has been used for centuries as a unit of currency. It has been used by individuals [then and now] to protect themselves against the excesses and inflationary policies of corrupt politicians and central bankers..." - Kris Sayce
Money Morning Australia. 9 April 2011.
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[Quote No.36207] Need Area: Money > Invest
"As a general rule, the most successful man in life is the man who has the best information!" - Benjamin Disraeli
British Prime Minister
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[Quote No.36241] Need Area: Money > Invest
"The investor of today does not profit from yesterday's growth." - Warren Buffett

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[Quote No.36291] Need Area: Money > Invest
"The best defense against central banks, such as the ones in the U.S. and Japan, that print money [euphemistically called 'quantitative easing' or 'debt monetization'], is holding real assets, such as silver, rice or other commodities." - Jim Rogers
Legendary commodities investor, who along with his George Soros, created what is possibly the world's most successful international hedge fund. He is an unabashed free-market capitalist and has stated that he's a believer in the Austrian School of economics. June, 2011.
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[Quote No.36292] Need Area: Money > Invest
"SPDR Gold Trust Shines: So, you want to invest in gold but find heavy gold bars or stacks of coins to be too inconvenient? Not interested in buying them from an advertiser on your favorite cable news channel and paying extra for storage? SPDR Gold Shares is likely to be a better option for the investor who seeks the safety and current high returns of Gold without all of the inconveniences normally associated with holding it. Listed on the NYSE since 2004 it has consistently been one of the fastest growing ETF's in the US. TheStreet.com mentions that SPDR Gold Trust consistently exhibits relative strentgth against other commodities and even other ETF's. Some analysts are warning that: Packaging gold in the form of an ETF, which trades throughout the day like a stock, has transformed perception of the metal. Toussaint says: 'We have financialized gold.' Now, notes Jim Ross, senior managing director of State Street Global Advisors (STT), which markets the fund, 'If you want to express a view on gold, you can buy it just like you buy IBM.' That’s made the gold market more volatile, says commodity trader Jeffrey Friedman, senior market strategist at brokerage Lind-Waldock in Chicago. Compared with even just five years ago, when the cost and price of trading gold made investors cautious, now 'when data points come out that conflict with the theory you have as an investor, money travels in the blink of an eye and volatility no question has increased,' says John Stephenson, portfolio manager at First Asset Investment Management and author of 'The Little Book of Commodity Investing.' " - TheLibertyWatch.com
3rd June, 2011.
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[Quote No.36293] Need Area: Money > Invest
"...the market can ...function well ...only when those who comprise the market (Investors! Us!) become informed of at least the basics of how stock investing really works." - Rob Bennett
Respected US financial educator, commentator, author and blogger.
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