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The Problem With Modern Monetary Theory

The Problem With Modern Monetary Theory

Modern monetary theory has been…

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Counterfeiting Money - Crime or Good Economics?

Did you ever think that a counterfeiting money could be good for the economy and that the counterfeiter could be considered an economic genius or even a national hero? I received an Email from Nic Corsetti, a friend of mine, describing exactly how that might happen. Here goes from Nic:

Let's say that I invent a printing press that allows me to produce counterfeit money (let's say US dollars) by the trillions - these dollars look EXACTLY like real ones, so no one can tell the difference, not even the government or the bank. So I start off the first year by counterfeiting $3 trillion dollars.

  • I use $1 trillion to buy stocks (jump starting the bull market)
  • I use $1 Trillion to buy U.S. Treasury bonds (thus driving bond prices higher and interest rates lower)
  • I use $1 Trillion to go around to every neighborhood in every major city of the U.S. and start buying houses for 10% higher than the listed price

Obviously, this is a lot of work, so I hire a whole network of employees and consultants to help me achieve those lofty goals in a reasonable time period. The apparent benefits would be huge.


  • This will create jobs, since lots of employees and consultants will be needed to spend $3 trillion.
  • The stock market indices will soar. Everyone's 401(k) and day-trading portfolios will increase in value.
  • Home prices will increase by 10% overnight.
  • Interest rates will fall which will make it even cheaper for everyone to borrow money to buy new cars, upgrade into a bigger homes, and buy new gas plasma TVs every year hoping against hope of getting to watch the CUBs someday play in the World Series.
  • The lifeblood of America, vastly underpaid Real Estate Agents, will get a much needed and well deserved infusion of cash.
  • The economy will be humming so fine that no one will care about the loss of jobs to India and China.
  • Cheap goods will continue to pour into the US and the CPI will show only a modest 2% rise in the price of goods.

Additional Printing Presses

This is such a good plan, I decide to let some of my best friends in on the action. So I pick twelve of my closest cronies and give them identical printing presses, and instruct each of them to buy stocks, bonds and real estate with their counterfeit money. I tell them to loan the money to anyone who asks. Now we are really getting somewhere.

  • The stock market will rise 30%-50% every couple years
  • By buying massive amounts of treasuries, interest rates will stay at historic lows
  • Everyone's net worth will double every few years if they just buy more real estate
  • There will be no reason to save money, because assets will just keep skyrocketing in value.
  • Wave after wave of immigration proves adequate enough to supply the homebuilding industry with enough manpower to get the job done.
  • So much money is made in the stock market that $50 billion in bonuses can be distributed.
  • Home prices start rising so fast that people start buying two or even three of them. It's a "can't lose" venture.
  • There is so much money floating around that credit standards drop and everyone who wants a home gets one.
  • So many homes are being bought that massive numbers of jobs are created in the mortgage industry, home builders, architects, real estate agents, title insurance, property insurance, home decoration, lumber, copper, cement, truck manufacturers, granite miners, brick layers, roofing, repairmen, industry analysts, home flippers, internet bloggers, internet site maintenance, newspaper ads, Wall Street specialists(to create RMBS, CDO, CDS, Index swaps), hedge fund employees (someone has to trade all these securities, and accountants and lawyers to keep track of all of the above.
  • There are additional profits to be made on Wall Street by investing in IPOs, private equity LBOs, M&A, trading, mutual funds, and hedge funds.
  • There is job growth in investment advisers, investment analysts, day-traders, media cheerleaders, SEC regulators, state regulators, New York D.A. office, and accountants and lawyers to keep track of everything.
  • Government jobs explode. State and local governments get all sorts of funding for projects of all types - big and small. This creates still more jobs.
  • Everyone needs a place to spend their money. Shopping malls, strip malls, big box stores, specialty stores, boutiques and nail salons spring up everywhere.
  • People are so busy shopping they do not have time to cook. This creates a need for more restaurants or coffee shops on every corner.

Even with all of that there is STILL NO INFLATION! Cheap imports keep prices from rising and the best part is that those foreigners keep taking this counterfeit money as if it was real money. No one can tell the difference anyway.

This goes on and on - we have really created a tremendous virtuous cycle where everything just gets better and better.

Everybody Wins

After a few years of counterfeiting I am quite certain that a "new era of goodwill and fortune" would be announced and that I, Nic Corsetti, would rightfully be hailed as the first Economic Grand Wizard to have permanently vanquished recessions.

But what's the catch? Where's the hole in this story? Is there a hole in this story? If counterfeiting is such a great idea, why isn't it legal? Actually it is legal.

Legal Counterfeiting

  • My name is not really Nic Corsetti, it is Alan Greenspan (Ben Bernanke if you prefer).
  • My twelve friends are the 12 member banks of the Federal Reserve
  • My employees and consultants are the financial services industry (Wall Street broker dealers, hedge funds, mutual funds, retail banks, and commercial banks)
  • Those printing presses are currently manned by me and my 12 friends

I (Ben Bernanke) hope these printing presses don't break down and that people keep accepting these counterfeit dollars or this economy might implode. This is my only fear right now.

Mish Note: Nic Corsetti is a real person. The above idea came in from Nic via email and was rewritten and reformatted by me. Still, Nic deserves full credit for the idea. Thanks Nic.

As "proof" of the ingeniousness of legal counterfeiting, Alan Greenspan has been hailed as an economic hero and knighted by the queen of england for "contribution to global economic stability". Printing presses do work (for a time) and Greenspan's timing was perfect as discussed in an Interview with Paul Kasriel.

Kasriel: Greenspan is a fascinating study. Some day I hope to write a book about him. Right now I willing to say he is the luckiest Fed chairman in history.
Mish: Greenspan is the luckiest Fed chair in history? How so?
Kasriel: He was fortunate in two very big ways. First off, he was fortunate to preside over the economy at a time when productivity was soaring and the global supply of goods was expanding rapidly because China had entered the world trading arena. In that environment the Fed could create large amounts of money and credit without causing inflation other than in asset prices.

Synthetic Money

By the way, so many others have acquired the magic printing presses that the Fed is now basically irrelevant when it comes to credit expansion and contraction. Synthetic money is now being created in massive amounts in numerous places. For example, GSEs are now running their own printing presses. Want a $500,000 mortgage? Boom, you got it. No one cares if you can pay it back either. It is foolproof as long as home prices only go up. Multiply that by the hundreds of thousands and it all adds up, and much of it done with 0% down, and most of it based on the belief that housing prices only go one way: up. The day of reckoning comes when home prices sink. A collapse is now underway, and it has hit the subprime market especially hard. Those credit problems are guaranteed to spread.

Some may object to the term "synthetic money", perhaps preferring something like creating money by "fiduciary media". The important thing is not what we label it, but rather the general idea of what is happening. And without a doubt enormous amounts of money (credit/debt) are being borrowed into existence with increasing leverage and risk.

Broker dealers (via junk bond offerings) have figured out how to create their own synthetic money backed by essentially nothing. As yields collapsed increasing leverage had to be used to generate the same returns. Such offerings have exploded along with mammoth growth in hedge funds all wanting a piece of the pie.

Some 20,000 hedge funds are now doing things with leverage because yields are too low. Various carry traders have created synthetic dollars of sorts by borrowing Yen and investing in US dollar denominated assets such as US treasuries. This has been building and building and building on itself so that no one even knows how many printing presses are actually running. The day of reckoning on carry trades will come when the Bank of Japan is forced by the market to raise rates at a rapid rate and there is a mad scramble to get out of dollars and back into Yen. Rest assured these events will be anything but orderly when they happen.

Initial sponsorship of "legal counterfeiting" came from the Fed and Central Bankers in general, but once Wall Street got a hold of the magic printing presses, things have gotten more than a little out of hand. This is what happens when you have money backed by nothing and borrowed into existence. This is also what gold lovers see when they recommend gold.

An Austrian Perspective

After reading the above some of you no doubt will be comparing this to hyperinflation and the Weimar Republic. Instead let's look at this (as best we can) from an Austrian perspective.

Money itself (however one defines it) is a claim on real savings (a placeholder for saved goods). For example, a baker makes bread, so what he actually saves is bread. The baker only transforms his savings into money (typically a monetary commodity that has a prior demand for other uses, such as gold) because that's far more convenient. The baker can not actually save bread, as it would get old.

Therefore money, as such, is a claim on real goods. Credit by contrast, is a claim on money itself, which in turn is a claim on real goods. In our present system, credit claims on money to be paid back in the future masquerade as actual money and can thus be termed "synthetic money". In addition there is a "multiplier" effect. Someone gets a loan and spends it on goods. That money is deposited and is treated as money regardless of whether or not it is backed by real goods. Via sweeps and still more lending (see Money Supply and Recessions), the same money is lent out time and time again (the multiplier effect). This is the failure of the central bank administered fiat system: monetary claims proliferate beyond actual production of goods to back them up. In a honest system, only actual savings would be transferred from savers to borrowers (with banks acting as middlemen).

This "credit inflation" is thus fundamentally different from the "Weimarian printing press inflation". The Weimar situation brings about hyperinflation as the monetary unit itself is inflated in its physical form, as banknotes. By contrast, a credit inflation that creates claims that masquerade as money is prone to deflation because the money needed to pay back the credit is in a shortage (relatively speaking) compared to the outstanding credit claims.

This does not entirely preclude an inflationary outcome. After all, the Fed could in theory decide to monetize just about anything. It could monetize defaulted bonds and loans, it could even go and buy up foreclosed houses if it is prepared to go the Weimar route in order to avert what it would deem a deflationary calamity. As we have discussed in the past, this is unlikely to happen for a variety of reasons (see An Interview with Paul Kasriel and Q&A on the Psychology of Deflation). In addition to the ideas expressed in those articles there is bureaucratic inertia to the fear of losing wealth and power. One key point in this regard is the fact that the Federal Reserve system is made up of creditors. Those creditors will not like the Weimar solution because it would debase their credit claims.

This I believe is the message Trichet, Poole, and Weber were attempting to convey in Central Bankers Cry Wolf.

Weber: European Central Bank council member Axel Weber said investors shouldn't expect central banks to bail them out in the event of an "abrupt" drop in financial markets. "If you misprice risk, don't come looking to us for liquidity assistance," Weber said in an interview in Davos, Switzerland at the annual meeting of the World Economic Forum. "The longer this goes on and the more risky positions are built up over time, the more luck you need."

Trichet: Current conditions in global financial markets look potentially "unstable", suggesting that investors need to prepare themselves for a significant "repricing" of some assets, Jean-Claude Trichet, president of the European Central Bank. "We are currently seeing elements in global financial markets which are not necessarily stable," he said, pointing to the "low level of rates, spreads and risk premiums" as factors that could trigger a repricing.

Poole: "The Fed can provide liquidity support but not capital".

The most important facet of all of this is that monetary claims very likely exceed the pool of real funding by several orders of magnitude. When push comes to shove, this house of cards will eventually collapse in some way.

It is important to recognize that what is happening right now with stock buybacks, leveraged buyouts, and various carry trades for what it is: one giant Ponzi scheme. This will end the way all Ponzi schemes end: when the willingness or ability of consumers or or businesses to take on more debt stops and/or when the willingness to further speculate stops. When either of those happens there will be a mad rush for the exits and no more buyers for "overpriced tulips" will be found. Be prepared.

Note: This post originally appeared in Whiskey and Gunpowder. The section "An Austrian Perspective" was a last minute addition for this blog.


I have several significant announcements to make. I would greatly appreciate it if everyone would read all of these announcements. The announcements are very different in nature.

Sitka Pacific Capital Management

I recently passed the series 65 exam and have joined Sitka Pacific Capital Management as an Investment Adviser Representative. Those wishing to see free Monthly Commentary from Sitka Pacific can click on the commentary link and sign up. Some might be interested in Sitka Pacific Annual Results for the last two years (scroll to the bottom of that link for a quick glance at performance after all fees).

We beat the overall markets even though there were many periods where we were significantly hedged and/or high in cash. The idea behind the existing managed portfolios is low risk, low volatility, and high risk adjusted reward. When conditions merit we take on more risk, otherwise we are likely to be hedged or in shorter term cash/treasury instruments.

We have other ideas in the works at Sitka Pacific such as precious metals, gold, and/or energy specific portfolios. Those products would be managed in the same way as the general portfolios (taking advantage of opportunities as they happen instead of the stance 100% invested 100% of the time). You will likely see a few banner ads from me on this blog and elsewhere announcing these ideas and events. If you are interested in any of these products or ideas drop me a line.

Click here to Email Mish at Sitka Pacific.

The Market Traders

Some of you may have noticed that I have been posting a bit less on places such as the Motley Fool and Silicon Investor. Those are places where I am in active communities and at least for some time I will stay active in those communities. But I am starting a new community of my own, and it has taken a lot of time and effort to build the framework for that community.

That community is now ready. It is called The Market Traders. The Market Traders is more than just "trading markets" it about sharing ideas on economics, stocks, energy, precious metals, geopolitics, housing, and even things like medicine and sports. If you want to take ownership of an open board or a forum within a board (e.g. football within sports) or if you want to sponsor a new board, just drop me an email after reading the rest of this announcement. An Email link is provided at the end of this blog.

One of the problems with blogs in general is they do not easily lend themselves to interaction. I am willing to say that even though there are a whopping 236 comments to Delinquency Footnote # 12 and 214 comments to January 2007 Jobs - the Good, Bad, and Ugly.

Problems with the blog comment format

  • Not all comments or questions are pertinent to the topic and belong elsewhere. Those ideas need to see the light of day in some sort of organized fashion.
  • A couple days later it is difficult if not impossible to find something that you or someone else wrote.
  • Replies are purely flat sequential making it hard to see a thread of comments
  • There is no good "order" to anything.

We have solved most if not all of those problems at The Market Traders. For example please consider the discussion board called Trotsky & Mish's Metals and Macros. (I am pleased to have Trotsky, an old friend from Silicon Investor/Kitco/VOY joining my discussion group.) A quick look at that link will show you forums within the board on Metals, the Economy, Geopolitics, this Blog, and Energy. Someone only interested in this blog and gold can easily sort out all of the other stuff they do not want to see. Those interested only in gold and precious metals and energy do not have to wade through everything else. This helps address an often heard issue on many sites about the inability to easily find posts that someone is interested in.

Best of all it is free. There will be no gotchas, no gimmicks, no later deciding to charge for the boards. This service is being offered at the "inflation busting" price of zero. It will stay free. The best things in life are free: the air you breathe, a friendly smile from a neighbor, this blog, and The Market Traders.

Some of you may have other relationships at other places but I ask that you please give us a try. You may decide it is for you or not but you will not know unless you try. Posting on The Market Traders does not mean you have to give up those other communities. I will still be active, just less active at other places.

Others of you may be asking "OK Mish, what's in this for you?" Good question. I am a small part owner of The Market Traders. I will share in the ad revenue. I also share in the decision making. The message boards were setup with features that I asked for. I believe we offer significant improvements over other sites. Those features (that I helped develop) makes The Market Traders an attractive place for me to post.

What's in it for you?

  • It's free. Join the community.
  • Some very good posters from other places have joined up already.
  • The features are nice: true message threading, private messaging, an ability to find posts by general category. We have an ability to easily bold or italicize text without using cumbersome HTML codes like other sites force you to use.
  • We have an easy ability to cut and paste charts (there are some limitations on this but our capabilities exceed nearly everyone else).
  • More features are planned: a true "flat view" within a board is needed and planned. Polls are needed and planned. We will also be offering a way to do things like quickly find all precious metals posts for the day regardless of what board or forum they are in.
  • Our site is search engine friendly. You can make a name for yourself and be discovered if you want.
  • Over time we believe we will attract the right talent to make you want to stay.
  • The boards will be actively moderated. Administrators can cut out the riffraff. Trolls will be banned. Racial, ethnic, religious slurs will not be tolerated. Dissent is welcome but blatant personal attacks are not. We believe we can find the right line between disagreement and disruption.
  • We will not suppress ideas. In fact we welcome ideas from bulls, bears, and everyone sitting on the fence.

So please give Trotsky & Mish's Metals and Macros a whirl. Thoughts on this blog belong in the forum Mish's Global Economics Blog Discussion. Post away. New posters will be asked to signup and there will be a verification process that you will have to respond to. If volume is heavy it may take a half hour or so but typically it is a matter of minutes. Those using Firefox and those interested in RSS feeds should read the How-To forum (there is a small, easy to apply, Firefox cut and paste fix that is not required but may make things easier for some).

Join Today!

As always, your comments are appreciated.
Click here to Email Mish about The Market Traders.
Click here to Email Mish about Sitka Pacific.

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