Does bad money drive out good money?

realitykeeper · 31-10-2018 11:22am #1

According to the economist Mike Maloney, the ancient Greeks and Romans tried to finance war by mixing cheap metals like copper with gold when minting coins. The coins had the same value printed on them but everyone could see the difference between coins that had copper in them and the pure gold coins that were originally issued. Naturally, people started saving the pure gold coins and they only spent the coins that were mixed with copper.

Today, the digital money that is typed into existence on a computer at the ECB is not quite the same as physical cash a person might have or even digital money in a person`s bank account that was earned through work. The new money being generated by the ECB and spread all over the EU is eventually going to devalue the hard earned money a saver already had in his/her bank account.

How should the saver respond to protect the value of their money? In the case of Ireland where the money is borrowed from the ECB, the people here with savings suddenly find themselves faced with an oncoming tsunami of other people`s debt which they will be expected to pay. Again, how should a saver respond before that tsunami arrives? I know a lot of people think that we are already paying the debt by maintaining interest payments but what about when interest rates rise and when the next recession impedes our capacity to pay? Would the state look to those savers with their hard earned money in the bank to make up the shortfall? What should savers do? More to the point, will the bad money generated by the ECB and lent to Ireland, drive out the good money earned with blood, sweat and tears? How would that happen? What would it look like? Just curious. I don`t think it will because people believe this recovery is strong and they do not make a connection between ECB generated currency, loans to Ireland, other people`s debt and the value of money.

Geuze · 31-10-2018 11:25am

realitykeeper wrote: »

How should the saver respond to protect the value of their money? In the case of Ireland where the money is borrowed from the ECB,

Who in Ireland is borrowing from the ECB?

realitykeeper · 31-10-2018 9:33pm

Geuze wrote: »

Who in Ireland is borrowing from the ECB?

The government and probably the largest companies listed on the ISEQ. This money trickles down through the economy because the Government and corporations spend a lot of this money on various projects and they pay a lot of salaries. Without ECB money, a lot of this would not be possible as we would have to live within our means. The government would only have tax revenue to spend and large corporations would have their earnings only, not ultra cheap credit to spend.

Why should people who worked hard for their money have to compete with the purchasing power derived from borrowings, typed into existence and spent by others? I mean, would it not be in their interests to protect the value and purchasing power of their money in some way? If so, how could they do that?

Geuze · 01-11-2018 12:51am

realitykeeper wrote: »

The government and probably the largest companies listed on the ISEQ.

This statement is incorrect.

The Govt has never borrowed from the ECB.

The ECB does not lend to any Govts.

It is illegal to do so.

It has never happened.

Companies do not borrow from the ECB, either.

Geuze · 01-11-2018 12:54am

Please note that during the last few years, Ireland has been a net saver.

The nation has saved more than we have invested.

This is reflected in our BoIP surplus.

You seem to be suggesting that the nation is spending more than its income.

In fact, the opposite is the case.

Expenditure in Ireland is less than income, and the nation is a net saver.

realitykeeper · 01-11-2018 4:32am

Geuze wrote: »

This statement is incorrect.

The Govt has never borrowed from the ECB.

The ECB does not lend to any Govts.

It is illegal to do so.

It has never happened.

Companies do not borrow from the ECB, either.

I take it you do not know what a bond is. By buying bonds, the ECB is lending money.

realitykeeper · 01-11-2018 4:43am

Geuze wrote: »

Please note that during the last few years, Ireland has been a net saver.

The nation has saved more than we have invested.

This is reflected in our BoIP surplus.

You seem to be suggesting that the nation is spending more than its income.

In fact, the opposite is the case.

Expenditure in Ireland is less than income, and the nation is a net saver.

Is this deliberately vague? Who precisely are you referring to when you say Ireland? If you are talking about the government, I think this is the first year since the crisis of 2008 that they came close to merely balancing the books and rather than make a token payment on the principle on the national debt, they have been talking about a rainy day fund.

You also mention the nation. It is possible a lot of people are paying down debt or defaulting on their debt in order to save but an awful lot of this money is only available to savers because of the trickle down effect of state borrowings (bonds issued by the government and bought by the ECB). Similarly, major corporations benefit from ECB money issued at ultra low interest rates. How could you not have known that?

Geuze · 01-11-2018 10:26am

realitykeeper wrote: »

I take it you do not know what a bond is. By buying bonds, the ECB is lending money.

When the ECB buys bonds in the secondary market, that is not directly lending to Govts or corporations.

Yes, I accept that as a large scale buyer of bonds, the ECB has helped create positive conditions within the bond markets, and so this makes it easier for Govts and corporations to issue debt.

Note that the ECB's actions are described as asset purchases, not lending.

The ECB does lend directly to banks.

Geuze · 01-11-2018 10:30am

realitykeeper wrote: »

Is this deliberately vague? Who precisely are you referring to when you say Ireland? If you are talking about the government, I think this is the first year since the crisis of 2008 that they came close to merely balancing the books and rather than make a token payment on the principle on the national debt, they have been talking about a rainy day fund.

You also mention the nation. It is possible a lot of people are paying down debt or defaulting on their debt in order to save but an awful lot of this money is only available to savers because of the trickle down effect of state borrowings (bonds issued by the government and bought by the ECB). Similarly, major corporations benefit from ECB money issued at ultra low interest rates. How could you not have known that?

To be precise, there are two sectors in the domestic economy:

(1) the Government sector, where their balance is T - Tr - G

(2) the private sector, households and firms, whose balance is Spriv - I

Overall, the two sectors comprise the nation.

Overall, the two sectors have been running a surplus

This surplus is the Current Account balance.

CA = (T - Tr - G) + (Spriv - I)

While the fiscal balance has been negative, the hh and firms sector has been running a bigger surplus.

So overall the nation is a net saver.

Geuze · 01-11-2018 10:36am

Note that Inv exp has been volatile in recent years, so we actually moved from a CA surplus in 2015, to a deficit in 2016, back to a surplus in 2017.

This is due to MNC activity.

Geuze · 01-11-2018 10:38am

realitykeeper wrote: »

If you are talking about the government, I think this is the first year since the crisis of 2008 that they came close to merely balancing the books and rather than make a token payment on the principle on the national debt, they have been talking about a rainy day fund.

Yes, the fiscal balance has been negative, but is falling towards zero, and hopefully a small surplus this year and next year.

2014 = -7.0 bn

2015 = -5.0 bn

2016 = -1.5 bn

2017 = -0.7 bn

Geuze · 01-11-2018 10:42am

realitykeeper wrote: »

You also mention the nation. It is possible a lot of people are paying down debt or defaulting on their debt in order to save but an awful lot of this money is only available to savers because of the trickle down effect of state borrowings (bonds issued by the government and bought by the ECB). Similarly, major corporations benefit from ECB money issued at ultra low interest rates. How could you not have known that?

Yes, it's true that the ECB's programme of QE has helped drive down LT int rates, and so reduced borrowing costs for the Govt and large firms.

That is one of the aims of QE.

It seems to have worked reasonably well.

Ryanair issued bonds at under 2%.

Fixed mortgage rates have fallen, to 2.5-3%, although not by enough.

Govt can borrow at about 1% over 10 years.

How can we judge has this policy worked?

Well, has output, employment and inflation recovered?

Geuze · 01-11-2018 10:47am

realitykeeper wrote: »

It is possible a lot of people are paying down debt or defaulting on their debt in order to save but an awful lot of this money is only available to savers because of the trickle down effect of state borrowings (bonds issued by the government and bought by the ECB)

Yes, it's good to see household debts falling.

They were too high.

They are still high, but thankfully falling.

Repaying debt is saving.

You seem to suggest that households repaying debt/saving is helped by the ECB.

Yes, that is the point of the ECB QE programme.

By reducing long-term interest rates, it makes it easier for hh to refinance debt at cheaper rates, and many are doing so.

realitykeeper · 01-11-2018 8:08pm

Thank you for this info, much of which I did not know. That said, when the ECB purchases Irish government bonds, the national debt goes up.

Geuze wrote: »

Repaying debt is saving.

Geuze/ wrote:

Sort of. Personally I believe in saving before spending, that discipline is good for people.

Geuze wrote: »

You seem to suggest that households repaying debt/saving is helped by the ECB.

Yes, that is the point of the ECB QE programme.

By reducing long-term interest rates, it makes it easier for hh to refinance debt at cheaper rates, and many are doing so.

Geuze wrote:

But what about people who did not need this help. They get low interest on their savings and the risk of high inflation at some point in the future. For years the ECB were saying they were concerned inflation was too low and the image that comes to mind is of inflation being pulled back slightly in a catapult with that energy set to be released leading to high inflation in the future.

Instead of allowing a recession with deflation so those who worked hard, saved, avoided risk could be rewarded, they punished the responsible people. Was that wise? What should the people who were prudent do in the face of this new money competing for goods and services? What should they do about the low interest they get on their deposits and what should they do with regard to the potential for higher inflation in the future?

Geuze · 01-11-2018 11:23pm

realitykeeper wrote: »

Thank you for this info, much of which I did not know. That said, when the ECB purchases Irish government bonds, the national debt goes up.

Geuze wrote: »

Please note that this is incorrect.

If I borrow 10m today, by issuing a bond, and a few months later the bond is bought and sold, my debt is unaffected. I still owe 10m.

The Irish Govt issue bonds, borrow 5bn.

The bonds trade on the secondary market.

A few months later the ECB buy the bond.

No change in the level of public debt, all that happens is the owner/holder of the debt has changed.

Geuze · 01-11-2018 11:31pm

By reducing long-term interest rates, it makes it easier for hh to refinance debt at cheaper rates, and many are doing so.

Geuze wrote:

But what about people who did not need this help. They get low interest on their savings and the risk of high inflation at some point in the future. For years the ECB were saying they were concerned inflation was too low and the image that comes to mind is of inflation being pulled back slightly in a catapult with that energy set to be released leading to high inflation in the future.

Instead of allowing a recession with deflation so those who worked hard, saved, avoided risk could be rewarded, they punished the responsible people. Was that wise? What should the people who were prudent do in the face of this new money competing for goods and services? What should they do about the low interest they get on their deposits and what should they do with regard to the potential for higher inflation in the future?

Yes, the ECB cut ST interest rates to 0%, and so retail savings rates fell towards 0%.

Yes, QE means falling LT int rates also, with 10yr bond yields down to 0-1%.

The ECB would not have done this unless they felt it was needed.

Indeed, they were accused of acting too little and too slowly in the face of unemployment over 10% in many countries.

The depth of the recession in 2008-2010 required this type of response.

Inflation was not the worry, people were worried about deflation.

There is little sign that QE has led to consumer price inflation.

Now, you could argue it has led to asset price inflation, especially bond and property prices.

realitykeeper · 02-11-2018 4:39am

Geuze wrote: »

Please note that this is incorrect.

If I borrow 10m today, by issuing a bond, and a few months later the bond is bought and sold, my debt is unaffected. I still owe 10m.

The Irish Govt issue bonds, borrow 5bn.

The bonds trade on the secondary market.

A few months later the ECB buy the bond.

No change in the level of public debt, all that happens is the owner/holder of the debt has changed.

But the ECB say they buy government and corporate bonds directly.

Geuze · 02-11-2018 10:48am

realitykeeper wrote: »

But the ECB say they buy government and corporate bonds directly.

Yes, the ECB does buy existing bonds that are already trading in the bond market.

They do not buy them in the primary market.

See the details of the primary dealers here:

http://www.ntma.ie/business-areas/funding-and-debt-management/government-bonds/

When the ECB buys the assets from an existing owner, this has no effect on the size of the Govt liabilities.

KyussB · 03-11-2018 2:28am

The concept of bad money driving out good money, is known as Greshams Law - it's very interesting:
https://en.wikipedia.org/wiki/Gresham%27s_law

The 'nobel' prize winner George Akerlof expanded this concept, into Greshams Dynamic - which describes how "dishonest dealings drive honest dealings out of the market":
http://scholarfp.blogspot.com/2014/10/greshams-dynamic-why-bad-actors.html

This is probably the single most useful concept to know, when looking at how fraud affects economies. Economist (and previous regulator in the US, who helped put thousands of fraudsters in jail) William K. Black, is a major proponent of this concept, and is a good author to follow - his book 'The Best Way to Rob a Bank is to Own One', is the best detailed explanation of the type of fraud that led to the crisis a decade ago (but derived from a prior banking crisis) that I've read.

Greshams Law, however, is more applicable to understanding potential problems with e.g. a parallel currency run alongside the Euro - it is not at all useful, in a discussion mixing up commodity money with fiat money.

Geuze · 03-11-2018 2:47am

Yes, I have been thinking that the title of this thread bears little relation to the content.

Gresham's Law is about good and bad money, but the posts have been about saving and investing.

realitykeeper · 03-11-2018 11:12am

Geuze wrote: »

Yes, the ECB does buy existing bonds that are already trading in the bond market.

They do not buy them in the primary market.

See the details of the primary dealers here:

http://www.ntma.ie/business-areas/funding-and-debt-management/government-bonds/

When the ECB buys the assets from an existing owner, this has no effect on the size of the Govt liabilities.

That is like saying I am not buying car insurance from a major insurance company if I buy it through a broker. Technically, semantically and legally that may be the case but it boils down to the same thing. The big insurance company get the bulk of the money and I get the insurance.

I know the ECB cannot be seen to be propping up failed states but that is exactly what they are doing behind a very thin veil. What is not clear to me is what happens next time the system fails. Surely the banks cannot believe the government can bail them out again and in any case the next financial crisis may be more noted for its failing states and not just failing banks.

Also, if the ECB falls back on QE for the next crisis, will the interest on government bonds have to increase substantially? Could the QE of yesteryear cause inflation to rise at the same time, a double whammy?

Geuze · 04-11-2018 12:02am

realitykeeper wrote: »

Also, if the ECB falls back on QE for the next crisis, will the interest on government bonds have to increase substantially? Could the QE of yesteryear cause inflation to rise at the same time, a double whammy?

QE causes LT int rates / bond yields to fall.

That's the whole point of it.

QE is designed to try to increase expenditure / output / inflation.

QE is implemented when inflation is too low.

So the whole point of QE is to cause higher inflation than there otherwise would be.

Geuze · 04-11-2018 12:04am

realitykeeper wrote: »

I know the ECB cannot be seen to be propping up failed states but that is exactly what they are doing behind a very thin veil.

I suppose you could argue that QE helps fiscally irresponsible States by reducing the cost of borrowing, and maybe encouraging them to borrow more.

However, the Fiscal Compact prevents public deficits and debt from rising.

realitykeeper · 04-11-2018 3:39am

Geuze wrote: »

QE causes LT int rates / bond yields to fall.

That's the whole point of it.

QE is designed to try to increase expenditure / output / inflation.

QE is implemented when inflation is too low.

So the whole point of QE is to cause higher inflation than there otherwise would be.

On the last point, printing your own money to pay your debts is what central banks have traditionally been all about, so being in the Eurozone may make that strategy more tricky. Of course the ECB wants inflation to rise.

On your former point, it is worth pointing out that first comes the crisis e.g. falling share prices. Next comes the government stimulus in the form of QE, intended to inject confidence back into the markets. Then bond investors demand higher returns for their increased risk, so interest payable on bonds then rises.

Geuze · 05-11-2018 1:02am

realitykeeper wrote: »

On the last point, printing your own money to pay your debts is what central banks have traditionally been all about, so being in the Eurozone may make that strategy more tricky. Of course the ECB wants inflation to rise.

The ECB wants inflation to be below, but close to 2%.

So when inflation was at 0%, 0.5%, yes, the ECB wanted the economy to recover and inflation to move back towards 2%.

Geuze · 05-11-2018 1:22am

realitykeeper wrote: »

On your former point, it is worth pointing out that first comes the crisis e.g. falling share prices. Next comes the government stimulus in the form of QE, intended to inject confidence back into the markets. Then bond investors demand higher returns for their increased risk, so interest payable on bonds then rises.

QE leads to lower bond yields.

realitykeeper · 05-11-2018 11:19am

Geuze wrote: »

QE leads to lower bond yields.

QE is inflationary. Receiving a return in bonds in a currency that is becoming worthless is a reason to demand much higher yields. It is only a question of how long confidence in the currency will last.

realitykeeper · 05-11-2018 11:34am

Geuze wrote: »

The ECB wants inflation to be below, but close to 2%.

So when inflation was at 0%, 0.5%, yes, the ECB wanted the economy to recover and inflation to move back towards 2%.

The ECB cannot say they want everyone to pay more in order to deflate the debt they issue at ultra cheap rates (covertly through various machinations), to big business and governments.

That is what an their target inflation rate of below but close to 2% would do. Unfortunately for the ECB, inflation can only be manipulated, not controlled. Enormous inflationary pressures have been building thanks to QE while actual inflation has only crept up very slowly and by a very small margin in the past few years. A dam will often begin to leak before it bursts.

Geuze · 08-11-2018 1:27am

realitykeeper wrote: »

QE is inflationary. Receiving a return in bonds in a currency that is becoming worthless is a reason to demand much higher yields. It is only a question of how long confidence in the currency will last.

The ECB QE programme started in 2009.

On 2 July 2009, the Eurosystem launched its first covered bond purchase programme (CBPP1). The programme ended, as planned, on 30 June 2010 when it reached a nominal amount of €60 billion. The Eurosystem intends to hold the assets bought under this programme until maturity.

More programmes followed:

https://www.ecb.europa.eu/mopo/implement/omt/html/index.en.html

No sign of any large consumer price inflation yet.

Asset price inflation, yes.

Indeed it's a bit of a mystery that the QE didn't lead to more CPI inflation.

Geuze · 08-11-2018 1:29am

realitykeeper wrote: »

QE is inflationary. Receiving a return in bonds in a currency that is becoming worthless is a reason to demand much higher yields. It is only a question of how long confidence in the currency will last.

There is a lot of discussion of why QE in USA and EA didn't lead to CPI inflation.

https://www.google.ie/search?q=why+qe+did+not+cause+inflation&rlz=1C1CHBF_enIE787IE787&oq=Why+QE+did&aqs=chrome.0.0j69i57j0l4.9022j1j4&sourceid=chrome&ie=UTF-8

https://www.cnbc.com/2013/12/09/quantitative-easing-doesnt-cause-inflation-or-deflation.html

Geuze · 08-11-2018 1:31am

http://www.themoneyillusion.com/

This is a blog on monetary policy.

There are several posts on QE and inflation:

http://www.themoneyillusion.com/noah-smith-on-the-qe-causes-high-inflation-fallacy/

http://www.themoneyillusion.com/excess-money-lower-rental-cost-or-lower-price/#comments

Does bad money drive out good money?

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