Macroeconomics. Central banks are "creating" a trillion here, a trillion there, like nobody's business. But what are the consequences? What is the thought process that central bankers have gone through to make these decisions?
Also why, exactly, are they buying the exact assets that they are buying (govt. debt, high-yield bonds, etc..) and why not others (e.g. stocks or put money into startups)?
And then, what happens if a debtor pays back its debt? Is that money consequently getting "erased" again (just like it's been created)? What happens if a debtor defaults on its debt? Does that money then just stay in the economy, impossible to drain out? What is the general expectation of the central banks? What percentage of the debt is expected to default and how much is expected to be paid back?
And specifically in the case of central banks buying govt. debt: Are central banks considered "easier" creditors than the public? What would happen if a country defaults on a loan given by a central bank? Would the central bank then go ahead and seize and liquidate assets of the country under a bankruptcy procedure to pay off the debt (like it would be standard procedure for individuals and companies)?
The consequences are supposed to be inflation. Instead, we seem to only get asset inflation (houses, stocks) and not consumer goods inflation (flour). From a former econ prof who I spoke to recently: the central bankers aren't thinking about inequality or inflation right now, they're just trying to avoid the apocalypse.
The liquidity injected is supposed to be taken out later, thus removing the inflationary distortion. Whether it will or not is anyone's guess. 2008's injections have yet to be taken out.
Central banks are easier creditors because, while autonomous, they are the same country as the government! So it's technically like owing yourself money. A central bank that cooperates with the debtor country (itself) would never force a default, and is thus never an acute problem. Of course, infinite money printing should lead to dangerous inflation.
I have done plenty of serious reading on economics but as far as an approachable start, I don't think we can do better than this:
https://economixcomix.com/
If you or a friend wants a crash course on econ, check it out.
That's a really good point and I never thought about it this way. It just makes me think how powerful is for US the world relying on dollars as an international currency.
The gold standard ended in 1975. Since then, we have "virtual money", which are effectively made out of thin air at the time a bank borrows them to someone. Once they started this system there is probably no way back. But what effects has that done, are them all positive? I don't know. Some say it helps prevent the situation when rich would buy all the gold supply - banks can make more money for others. But - rich people can use stock markets and funds too. And look at one thing - the Appollo program started 1961 and completed 1975. I was quite shocked to see from the documentaries what technology they developed and had during the Apollo era. What US built during cold war. UNIX development started in 1970, right? So many awesome airplanes and technology around. It looks like what we have today is mosty (a great) improvement of many inventions developed before or around the end of Apollo and the end of gold standard. Now, that money is virtual, it looks like there won't be any major stock market crashes as they can intervene relatively easily. But why the space program basically died? NASA has just been talking about SLS for many years... Is it because politicians or bankers don't want that to continue? They could print money for it in minutes, couldn't they? Or would it be far more expensive than we think? Would printing so much money skyrocket the inflaction and bring the whole economy to its knees? Isn't by chance the "real value of work" now much higher than what inflation suggests? I read here about a year ago that some smart people are not working in scientific R&D but instead making AI to improve marketing for online e-shops selling products people don't really need. Despite many startups claiming breakthroughs daily in the news, I don't feel it that way. Those are small pieces one by one. It looks to me big human progress has stagnated somehow. Maybe the smart people are not motivated enough to do the real big things, or maybe it is because there is no need to compete with Russia anymore. But hey, there have been talks about helicopter money recently - giving people money for no reason. Does that look like a great way to improve things? We live in peace - thanks for that - but it seems to me that somehow there is no motivation to do big things anymore. It seems better to just pour the money in the stock market, consume goods and services, watch Netflix and play games. Consume gas and limited Earth resources with virtual unlimited paper money. Taxation probably doesn't make sense anymore, it is there just for historical reasons, from the time bank notes were backed by gold.
I agree this is a good starting point for understanding the financial system! For anyone with a programming background I recommend thinking of the whole financial/economic/political system as an algorithm for distributed decision making: who does what, what physical resources get committed to what projects, etc. You can then start to figure out how each component (money, banks, central banks, government, stock market, derivatives market, limited liability, interest, inflation, etc) serves to guide decisions.
The main purpose of a central bank imo is to keep money creation at arms length from government, so a rubbish government can't fiddle with the financial system too much.
So that common services (eg. healthcare in Canada, education everywhere, roads) can be collectively paid for.
- why even work? Can't we just print enough money for everyone and live happily ever after?
Because there wouldn't be enough resources. (Fiat) currency is just a medium of exchange for real stuff. Instead of growing wheat and trading it for your wooden furniture, the state provides a medium of exchange so we can both just transact in money. eg. when I don't need more furniture but you still need wheat.
Another thing to realise, along these lines, is that economic theories try to explain the world's economy, not dictate it.
I would say that some mathematicians went into economics to win Nobel prizes (which they did win) and I guess they would probably be quick to point this out at well.
Economics is a branch of moral philosophy and very consciously uses persuasive rhetoric to dictate policy. One of the tools used is hand-waving hidden inside differential equations to produce models that would be useless in any other discipline.
I don't think I've ever seen a mainstream economic prediction that was actually correct.
It's not hard to understand why. Reducing all the sectors of a complex economy to crayon-drawn measures like "inflation" and "unemployment" - which aren't even measured with any consistency - is like trying to predict the weather in the Bay Area using a single weather station for the entire continental US, which is conveniently located on the wall of a cow shed in Kansas.
America Inc, which dated, by I believe Mary Meeker has one view showing USA on a "GAAP" basis. It's not pretty. Leverage is too high. Profit margins are negative. "growth" (in this case government receipts) underperforms entitlement spend. Interest is some non-material portion of revenue such as 15% to 20% (caveat, even the most highly leveraged private equity bought companies don't spend more than 25% of revenue of amortization and interest, generally speaking).
A better but harder resource is I believe by Piketty (the inequality guy): from balance sheet recessions there's usually only a few ways out. He and his co-authors go through every single knkwn recession in every single country (obviously biased towards recent and Western). What I took away from it is that without population growth the US needs hyperinflation, to default on its debt, or to increase tax revenue's sharply and/or decrease entitlements sharpy. It's up to you to guess which one of those three is most likely.
- Consequences of creating a trillion? Economic policy is largely driven by political necessity. During the Great Depression, FDR's policy was based on Keynesian economics. Keynes aside, FDR tried everything to alleviate the suffering of the people, because the danger was not in implementing the wrong policy, instead the danger was in doing nothing. Later, the "Austrian" school of Monetary theory was popular where it prescribed increasing the money supply to pump up a troubled economy. During the last financial crisis, Obama's administration prescribed "Quantitative Easing" where the government bought the junk to keep the big banks solvent. The big banks were "too big to fail" and had to be rescued. The consensus of the last ten years is that "Quantitative Easing" restored the financial health of the elite and the corporations, but the middle class is still left behind.
- Assets that they are buy? The idea is to keep the banking system solvent and to prevent a domino effect where the liquidation of one big bank will result in a run on other banks. The big banks got into trouble because they took depositors money and invested in junk which went belly-up. The federal government insures everyone's bank deposits; if the banks went bellied up the FDIC would have to pay out. Better that the banks stay solvent.
- There are cases like Greece defaulting on its international loans. The EU forced Greece to agree to an austerity plan lowering Greece's payments if Greece changed its national spending which is deeply unpopular in EU and Greece. But there is no other alternative. Well the alternative is what happened to Weimar Germany after WWI: hyperinflation, economic destruction, and the longing for a savior.
You cannot really "create" money, but they do it anyway because the natural pricing mechanisms (laws of supply and demand) take a non-null time to reach a new equilibrium.
So the aim is to take advantage of this transient fluctuation and the way the ripple propagates.
But even if in a perfect (or future) world, everybody reprices instantly all the goods relatively to the new amount of available currency, there is still an effect which is how is distributed the newly "created" currency: who get the new shiny coins? So this is equivalent (if the repricing is done) to a kind of global instantaneous tax-and-subsidies. They tax everybody by the percentage of currency created (relative to the total existing amount), and the lucky ones receiving the fresh money are getting thus a subsidy.
It works like this: imagine we create some new Bank. Customer A deposits his life savings of 1 million hackerbucks.
Now our Bank loans out 50,000 of those hackerbucks to Customer B. It does this by crediting her account with 50,000 hackerbucks, but notice that Customer A still has 1 million in his account - so now there's 1,050,000 hackerbucks in apparent existence - we've created 50,000 hackerbucks from thin air. If Customer B withdraws the loan money to go spend it, the Bank will have 950,000 in reserves and an asset worth 50,000 (the loan). Customer B will have 50,000 in cash.
What we've actually done is increase the "M2", one of the measures of how much money is in the economy.
If Customer B either repays the loan or defaults on it, that new money disappears. In the loan repayment case, the Bank goes back to having 1,000,000 in reserves, and in the loan default case the loan asset becomes worthless and it is left with only 950,000 in reserves (the other 50,000 is out there with wherever Customer B spent it).
So the bank's speculative asset loses value: I struggle to see this as money being destroyed as it wasn't actually money, it was an asset with a price attached to it which has now changed. In contrast to money sat in your bank account, the price was never redeemable (you couldn't go spend it on beer) unless you used that asset to get the debtor to pay you back (or convinced someone else it was worth buying from you as a speculative asset). You might as well say money is destroyed when share prices tumble. Maybe this is the point of such arguments, to make the case that money is no different to any other asset, but we don't tend to treat it like that in reality. Or do we?
It's money in the same sense as the money that was created by the loan in the first place is money - it's not physical currency, but the insight is that the money created by financial means like this bids up prices in the same way as literally minting extra physical currency and distributing it would.
When that loan asset is written down the bank has to make up the difference from its equity - this ends up reducing the amount of loans it can write, so you get a contraction in the monetary supply.
So in the end, I guess the shorter answer is that a default destroys money in the same way that writing a loan creates it - you might well complain that no actual currency has been created or destroyed, but the argument is that it has a similar overall effect.
If Customer B repays the loan, the new money disappears but the money made in interest stays. Eventually does a bank get to a point where it has enough real money, that it can lend it out instead of increasing the money supply?
That would be my intuition too. But if you go down almost any "this crisis won't cause inflation because..." rabbit hole on hacker news, you should see multiple unopposed claims that defaults lead to deflation through the destruction of money.
I'm pretty ignorant in this field, and usually I've been a day or so behind the posts (missing the window to press for more information), but I feel like there's definitely some contention there.
Suppose I'm a bank, and I lend you $10 to buy apple tree seedlings. You spend all $10 on seedlings as promised.
The person who sold you the seedlings has $10. You have the seedlings. I have an expectation of getting $10 in the future, presumably from your sales of apples.
Because most people repay their loans, I'm confident I'll get the $10 back, and being a bank, my business is lending money. I might treat the $10 loan as $7 on my balance sheet when I decide how much money is safe to lend out.
Then the price of apples crashes. You come to me and say, 'look, there's no way I'll make $10 selling apples in the time I promised to repay you. Best I can do is deliver you the seedlings or sell them to my neighbor for $3 and give you that'. I grumble a little, but take your deal.
The person you bought the seedlings from still has $10.
Your neighbor now has the seedlings and $3 less.
I now have 3 real dollars instead of 7 hypothetical dollars. In other words, 4 hypothetical dollars disappeared. When I decide how much to lend out, I'll be basing that on $3 I know I have, instead of the $10 I thought I'd probably get back. I don't lend as much money to aspiring orchardists (orchardeers?), and the price of apples rises.
Edit: This fragility is probably a major factor why some people are so against fractional reserve banking (my counting hypothetical dollars as having value) but without that hack, there's no saying I could have lent you the original $10, so it's a bit of a double-edged sword.
So in this case the business did not create as much wealth as intended (it produced apples which turned out not to be needed as much they had originally planned).
The default is a side effect of that outcome, not its cause.
I can see that the bank ended up with $4 less than it planned to, but I don't see that as money being destroyed. It happened because the original estimate of hypothetical dollars was wrong. (Also if the hypothetical dollars are "money" then you're double counting it: creating $10 in circulation has required creating $17 overall which strikes me as poor notation to say the least). (Also if all had gone according to plan, the extra $4 would have come from the pockets of people buying apples. That $4 is still in circulation, either in the same pockets or it got spent elsewhere).
Suppose I buy a painting. I believe it to be an original Van Gogh so I pay $10 million for it. I then find out it is fake, and worthless. Was $10 million (of money) destroyed? Of course not, I just mis-valued an asset. Suppose it then turns out to be real after all. Owing to the fascinating history of this painting it is now valued at $20 million. Was $10 million of money created (relative to the moment when I originally thought it was a Van Gogh)? No. Was $10 million of wealth created? Yes as the world now has one more thing worth $10 million in it.
Money != wealth, even in the materialist sense where wealth consists purely of goods and services. Money is a metric we use to keep track of wealth, and in general it's considered helpful if that relationship holds, so if we're trying to maintain that relation rigorously the central bank should print another $10 million (or create it by making loans) to reflect our knowledge and appreciation of the Van Gogh - if it doesn't then the existing fixed quantity of money in the system will now be representing a greater quantity of wealth, causing deflation.
As I said in my other post I am not an economist by training. If the economists want to call this thing that got created/destroyed here "money" then I guess I should let them, but I would like to hear a good reason why it makes sense to do so, and I haven't heard one. Absent of a good reason I might as well call it haddock. Or, considering the OP was asking which things that could be explained better, we could acknowledge what any good programmer knows: part of a good explanation is choosing the right names for things.
As I think of it, credit (what got destroyed) and currency (what was used to create the credit) are interchangeable - $10 of credit buys as many seedlings as $10 of currency, hence we think of them as one 'thing' - I might call 'money' the category including both, though I'm no expert in economics either and these might be nothing like the official jargon. But what does seem reliable is that destroying $4 of credit has the same effect on the price of apples as would destroying $4 of currency, though the latter is a more rare event.
The difference is that it's the liquidation process from defaults that causes deflation, not the defaulting itself. Without the liquidation process, if you assume defaulting had no consequences, that's indeed inflation - as everyone is allowed to create money without consequence.
Thanks. I think this point has made it a lot clearer.
So sure, the loaned money might still be in the system in some naive sense, but value has been destroyed in the asset price? Suddenly a lot less money buys a lot more asset and that's where we find the deflation.
If I borrow 1M for an asset in good times and can't pay it back, the creditor gets the asset and probably gets a good portion of that 1M back. If that same scenario plays out in bad times and my whole street defaults on the same asset at once, there's a resulting fire sale and far more value is destroyed (including being wiped off neighbouring, non-creditor-owned assets of the same type) than money added by leaving the loan sloshing around somewhere else in the economy.
PhD student here. Not expert on all those questions but:
> Macroeconomics. Central banks are "creating" a trillion here, a trillion there, like nobody's business. What is the thought process that central bankers have gone through to make these decisions?
The general consensus is that central banks should stay passive and keep prices stable. However, in periods of crisis, like the one we live in, the central bank could support economy. In ordinary times, creating trillions would lead to inflation. But here the idea is more to save the economy in the short term because it's always cheaper than reparing it. Central bankers agreed to create trillions such that banks do not go bankrupt like they did in 1929. By creating trillions, they also keep interest rates low for government such that they can still borrow.
> But what are the consequences?
Some inflation. Another consequence is that investors will invest in riskier assets afterward to keep their profitability target. (Again, because lending trillions will lower the interest rates)
> Also why, exactly, are they buying the exact assets that they are buying (govt. debt, high-yield bonds, etc..)?
They usually buy low risk, higly liquid assets. Putting trillions in startups is infinitely infinitely complicated for a central bank because it implies high monitoring costs, and it also takes a lot of time to create those kind of contracts. Remind that the goal is to provide lot of liquidity to the economy as fast as possible.
There is also an academic debate about giving money directly to the general public (known as "helicopter money"), but with little attention from central bankers.
> And then, what happens if a debtor pays back its debt? Is that money consequently getting "erased" again ?
Yep, pretty much...
Appart from fiat money, money is constantly created and destroyed. It is mostly created by private banks when they grant loans. And it is destroyed when you repay it. Of course they cannot do whatever they like and create at will, but remember that "Deposits DO NOT make the credits (but in some way it defines how much you could create)"
> What percentage of the debt is expected to default and how much is expected to be paid back? What would happen if a country defaults on a loan given by a central bank?
Central banks buy bonds, and bonds are pretty much always paid back. And if not, the central bank will not suffer much. Cases of countries not reimbursing are very scarce and exceptional (I can just think of Argentina). Anyway, a country CANNOT go bankrupt like a person. And in general, comparing countries with individuals or companies is not a good idea. Countries are here pretty much forever (in a financial sense), you don't. Countries can waive taxes, individuals cannot.
>> And then, what happens if a debtor pays back its debt? Is that money consequently getting "erased" again ?
>Yep, pretty much...
I would add that if the system is fractional reserve then it increases the proportion of the bank's reserve allowing more money to be created. So while it's technically true that it's destroyed you could see the next loan as its reincarnation, no..?
I didn't go here in my response above because my vague understanding is that we're not strictly a fractional reserve system any more, though I don't understand how.
There's also a concept of "capital deepening". Basically, while vague, when your monetary supply growth outpaces GDP, which is not hard to do with low single digit GDP growth you have more capital available for "one unit of GDP". Therefore asset prices go up.
At least for non private companies ...asset prices go up....auctions clear at values with maximum leverage...recession....monetary stimulus....repeat.
My thoughts on this Modern Monetary Theory is that central banks are just creating these trillions, but they are doing it at a relative rate to each other.
I think eventually it will have bigger consequences, but it will take some time for these trillions to filter on down.
I remember once outcome of the 2008 crisis was that consumer goods like cereal boxes stayed the same size, but the bag inside the box got smaller.
Not sure I'd class it as a science, but here's my take... though I'm no expert and certainly agree this stuff could be better explained!
> Macroeconomics. Central banks are "creating" a trillion here, a trillion there, like nobody's business. But what are the consequences?
Nobody quite knows; it's still hotly contested between left wing lovers of Keynes and right wing believers in austerity.
> What is the thought process that central bankers have gone through to make these decisions?
Probably largely a political one. Central banks may be trying to fulfill a remit set by law (e.g. bank of england: keep inflation below x%) and are trying to deliver on that. (why? too much or too little inflation both cause problems, I guess we somehow reached consensus on a "sane" amount that keeps pace with genuine growth of wealth within the economy)
> Also why, exactly, are they buying the exact assets that they are buying (govt. debt, high-yield bonds, etc..) and why not others (e.g. stocks or put money into startups)?
I think this is about distributed decision making. The central bank does not have the expertise to decide which stocks or startups represent the best investments. The examples here involve lending money to government, presumably the idea being the latter is better placed to decide what to do with the money. Another example is buying assets from other banks, which are again better placed to decide which businesses/homeowners/etc represent a more sound investment as they do it on a daily basis (from a profit/loss point of view ... of course we debate whether or not that's the case on a societal level).
> What would happen if a country defaults on a loan given by a central bank?
Internally it would depend on laws/balance of political power within the country. Between countries, depending on the currency the country could do crazy stuff like print excessive amounts of money to repay the loan (Germany did this in the 1930s leading to hyperinflation) or they could just as you say, default. The country's credit rating would then be downgraded, making it harder for them to raise credit in future.
> Would the central bank then go ahead and seize and liquidate assets of the country under a bankruptcy procedure to pay off the debt (like it would be standard procedure for individuals and companies)?
Not the bank, but the country making the loan, may first negotiate some debt relief with strings attached e.g. preferential trade agreements. Beyond that, I have no idea what precedent exists.
A lot of these things are kind on unknowable because they depend on future human behaviour in ways you can't really predict. A lot of George Soros's theory of reflexivity is along those lines. People think they are calculating on the basis of fundamentals but the things that look like fundamentals are actually functions of human behaviour so the system is inherently unstable. He's made a few bob from that.
Also why, exactly, are they buying the exact assets that they are buying (govt. debt, high-yield bonds, etc..) and why not others (e.g. stocks or put money into startups)? And then, what happens if a debtor pays back its debt? Is that money consequently getting "erased" again (just like it's been created)? What happens if a debtor defaults on its debt? Does that money then just stay in the economy, impossible to drain out? What is the general expectation of the central banks? What percentage of the debt is expected to default and how much is expected to be paid back?
And specifically in the case of central banks buying govt. debt: Are central banks considered "easier" creditors than the public? What would happen if a country defaults on a loan given by a central bank? Would the central bank then go ahead and seize and liquidate assets of the country under a bankruptcy procedure to pay off the debt (like it would be standard procedure for individuals and companies)?