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The Falling US Dollar

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adrock3215
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I just blogged about this topic last night. Stunning, infuriating, stupid, boneheaded! What are they thinking?!!! @#$%(*&#$)(*!!!

There is really only one way to devalue the dollar, and that is to print up a vast amount of them and inject them into the economy. Can someone explain to me how lowering the Fed rate does this? Is lowering the Fed rate a means by which the Fed injects dollars into the economy, maybe by making more printed dollars available to banks?

I definitely agree that they need to stop devaluing the dollar, regardless of the means by which they are doing it. As I pointed out in the "Is Capitalism Perfect" thread, so long as the dollar is not pegged to gold in any meaningful manner, this will keep happening. The Feds run out of money, and can't tax higher due to a possible tax rebellion, so they "pay" for things by printing up a few billion greenbacks and buy things with it.

If it is inflation behind the drop in the dollar and the rise in gold, then I suspect we ain't seen nothing' yet -- I mean, if the dollar has basically halved (and based on gold it has), then the 1000 point drop in the stock market this month won't be the end of it.

Of course, I realize it isn't quite that straight forward, since the dollar is not coupled to gold, but the rise in gold, the drop in the dollar, and the plunge in the stock market are all linked together. Anyone have access to the quantity of M1 that has been printed over the past five years or so, and can you point us to it with a link?

It is times like this, however, that make me glad I'm not in then market much. If I had more discretionary income I would be trying to make my millions, but possibly not in the stock market this year.

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There is really only one way to devalue the dollar, and that is to print up a vast amount of them and inject them into the economy. Can someone explain to me how lowering the Fed rate does this? Is lowering the Fed rate a means by which the Fed injects dollars into the economy, maybe by making more printed dollars available to banks?

I believe your guess is correct. When the Fed claims to lower interest rates, what I think it really means is that they are either buying back more government bonds from banks at a higher rate or selling government bonds to banks at a lower rate. So when the Fed purchasing government bonds, it introduces more money into the banking system.

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There is really only one way to devalue the dollar, and that is to print up a vast amount of them and inject them into the economy. Can someone explain to me how lowering the Fed rate does this? Is lowering the Fed rate a means by which the Fed injects dollars into the economy, maybe by making more printed dollars available to banks?

The FED has 2 primary levers of monetary policy. Interest rate control and what is known a "Open Market Operations". In addition, in crises, the FED is lender of last resort so bailouts are a form of expansion of the money supply. OMO are the basic mechanism which few people know about. Basically the FED buys and sells govt securities on the open market. IF the FED buy govt bonds, it is essentially loaning money to itself and in the process increasing the money supply. It does not need to "print" extra money, that action is the same thing.

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Yes. Consider only an "easing" phase, as is currently in progress. A "tightening" phase works in the opposite direction. Here are some details about easing:

Every day, the Fed buys bonds from banks. i.e., The Fed gives the banks cash and the banks give the Feds bonds that they (the banks) previously bought. These are government bonds, "agency" bonds and "mortgage-backed" bonds. It is almost like a loan where the bank gives the Fed some bonds as security, and the Fed gives the bank cash. The Fed charges the banks for this loan.

The lower the rate that the Fed charges, the more desirable the trade is, to the banks. If the Fed charges an extremely high rate, the banks would say "no thanks". If the Fed charges a very low interest rate, the banks want to get more loans -- i.e. more cash from the Feds.

Here is a graph that shows the daily outstanding balances of such cash-infusions from the Fed to banks.

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(Source: Federal Reserve)

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Edited by softwareNerd
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To tell you the truth, I believe Bernanke plays by more of a Chicago School-Milton Friedman-Irving Fisher book. Of course, this book shares a chapter with the Keynesian school titled 'Monetary Policy.'

That's sort of like praising someone for being a great cyclist, while he's over in the pool drowning don't you think. :dough:

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I'm trying to understand what Kendall was saying regarding the Feds not needing to print more greenbacks in order to tamper with the money supply. I guess the problem is that I don't really understand bonds, except to say that I know it is possible to buy bonds from the government, which one can turn in for cash when their time has matured. So, I guess the issue there is what cash is the government giving to the matured bond holders -- money that has been taxed or money that has been printed?

I suppose there are other means of messing with the money supply, say if there was a way to tie up or to release vast amounts of money (greenbacks) into the economy. I don't know exactly how that would be done, however, but I suppose that if someone had some sort of financial instrument that required holding onto money as collateral, then that money could not be used for anything else -- i.e. it would not be in circulation. But if that instrument were released from that condition, then all of a sudden that money could be used for something else and would effectively increase the money supply. One such way of doing this would be to lower the amount of cash banks must have on hand in order to give out loans. Say they have to have 25% cash reserves before they could lend out loans, and then this was changed to only requiring, say, 10% cash reserves; that would effectively release 15% of the banks holdings into the economy all of a sudden, which would have the same (short term) effect as increasing the M1 money greenbacks.

I've heard off and on over the years on stock programs that "we need more liquidity to get the markets going again", which effectively comes down to increasing the amount of cash in circulation by one means or another, usually by the Feds. And more cash in circulation, whether by printing more money than gold or by releasing previously tied up currency or some other means, will eventually lead to a devalued dollar -- in terms of what is actually out there chasing goods and services.

So, I think I've got it, at least in principle: There is more than one way to mess with the value of our hard earned dollars.

In short, even if they printed up vast amounts of greenbacks, but left them at the printing press where they would never go into circulation, it would have no economic effect. Fat chance of that happening; once the money paper is there, they will get it into circulation, have no doubt about that!

But the same (short term) effect would happen if, say, a trillionaire, kept his savings in his mattress, and then all of a sudden went on a buying spree spending everything he had just before kicking the bucket. That vast amount of money was not part of the "cash in circulation" formula that determines what the dollar is worth in actual practice so long as it was not in circulation. It would be like the gold rush days in California, when the price of a pick ax shot up to well over a thousand dollars because everyone was so rich they could afford to pay that kind of a price for it. Eventually, though, that sort of increase in the money supply filters down and throughout the economy and doesn't cause any long-term inflation. But the Feds printing up greenbacks will cause long-term price increases, because they just keep on doing it -- it's not just a short-term, localized fluctuation; it's everywhere and all of the time.

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I'm trying to understand what Kendall was saying regarding the Feds not needing to print more greenbacks in order to tamper with the money supply.

The money supply can be expanded without actually, in the literal sense, printing banknotes. This is achieved through the extension of credit. Think of it like when you take out a mortgage on a $300,000 home. The bank does not literally go to the back room, print 300,000 bank notes, and come out and hand you $300,000 in banknotes which you take to the home owner and hand him. The money is created first out of thin air as a credit against some amount of deposits that the bank holds and then transferred to the seller. Fractional reserve banking is a factor as well. If the Fed creates money by increasing the reserve account of a member bank, then that bank has the additional amount of money on its balance sheet that it is able to lend out 90% of due to FRB. If the Fed Funds rate is low, banks show a greater demand for the money because the cost of that money is inexpensive. This is the type of liquidity that a lot of financial gurus call for when bad times hit. They hope that this inexpensive money will trickle through down and be spent by consumers and businesses, thereby stimulating the economy. But this extension of credit is what allows the money supply to increase without the need for actual banknotes. The banknotes will be only be printed when demanded.

With the trillionaire example, since his money is under a mattress and not in a savings account, or stock brokerage account, or mutual fund or whatever, the money would not be counted in money supply statistics. So yes when he goes and spends it, there will be some effect. But the effect will be extremely small because the economy is so large. I think this is similiar as to one of the reasons why we were taken off the gold standard by Nixon. It was thought that Russia was able to mine a vast amount of gold and thereby dilute the purchasing power of it. But the amount of gold that Russia could have mined would take 100 years or more to double the supply of gold according to some, whereas the Federal Reserve can double or triple the money supply within a few years.

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Thanks, Kendall, that was a very helpful link, and it confirmed my guesses about how the Feds can control the money supply without necessarily having to print more greenbacks. The long and short of it, however, is that even if the money supply is increased or decreased in terms of financial means of money in circulation, that would be short-term and would be absorbed by the overall economy over time, probably with short-term increases or decreases in prices more on a local level. The printing of banknotes (or greenbacks and coins) leads to more long-term problems as the actual amount of cash in circulation increases across the board in the economy utilizing those banknotes as cash. I suspect, though I can't confirm it, that M1 has increased substantially. Someone who keeps track of this told me a few years ago that M1 was being steadily increased and inserted into the economy, which is why we are having a problem now. Basically, the price of gold tells the story (though maybe not the details) of how many extra dollars have been printed and inserted into the economy.

On a gold standard (or better yet, gold meaning money), sure it is possible for someone to find a rich gold vein and upset the currency, but that happens rarely, and due to the cost of production (mining and refining) gets absorbed by the economy on a very spread out mechanics. Prices may well shoot up locally, as during the gold rush days, but even that amount of gold found didn't effect the overall economy that much, because there was already a lot of gold in circulation. Of course, the answer to this type of problem isn't to get off the gold standard on a hypothesis that Russia or any other country might find a large vein of gold. The Feds are now quite capable of destroying the value of your dollars by fiat any time they want.

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The long and short of it, however, is that even if the money supply is increased or decreased in terms of financial means of money in circulation, that would be short-term and would be absorbed by the overall economy over time, probably with short-term increases or decreases in prices more on a local level. The printing of banknotes (or greenbacks and coins) leads to more long-term problems as the actual amount of cash in circulation increases across the board in the economy utilizing those banknotes as cash.

Thomas,

I'm afraid that is incorrect, the printing of banknotes is a minor way in which the fed maniupulates the money supply. Electronic deposits of the type of these Open Market Operations is the PRIMARY way which the FED controls the money supply and for all practical purposes is EXACTLY the same as printing up extra cash. The idea that this is "absorbed" by the overal economy could be argued exactly the same for extra paper money. The mechanism of "absorption" is the same in either case, inflation. If you think of the FED as a spigot, the fundamental characteristic of increasing the money supply is the spigot turning on. It doesn't matter wether the FED "manufatures" money out of thin air, or if it simply takes money from an already existing pile of money it had, the net effect when it injects it into the economy is that the overall money/credit suppy is increased. Those electronic account balances can be turned into paper money simply by the banks requesting to have that done, and so the essential is not hte form of which the balance exists, but the fact that it does now exist.

Those account balances are PART of the M0 tallies, so they naturally will show up in the M1-M3 numbers as increases in the money supply.

Edited by KendallJ
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If you think of the FED as a spigot, the fundamental characteristic of increasing the money supply is the spigot turning on. It doesn't matter wether the FED "manufatures" money out of thin air, or if it simply takes money from an already existing pile of money it had, the net effect when it injects it into the economy is that the overall money/credit suppy is increased.

I think I agree.

I found this interesting article about M1, M2, M3 and Fed policies regarding these. Seems they don't even care to track M1 any longer, if I understand the article correctly.

Federal Reserve Bank of New York, The Money Supply

Fixed the previous link.

Edited by Thomas M. Miovas Jr.
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The link to the article did not work Thomas, but the Feds stopped tracking M3 at one point. They still track M1 and M2.

As for the quantity of M1, the rate of increase has been very controlled in the last decade, when compared to the 60's, 70's and 80's. Here are two graphs, showing the total M1 (average for each year). One has an arithmetic scale and the other a logarithimic one (which shows slower growth, and is more relevant, because it speaks to the rate of change, rather than the absolute change).

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Edited by softwareNerd
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The link to the article did not work Thomas, but the Feds stopped tracking M3 at one point.

The above link in my previous post works now. The article explains a lot about money supply and policies.

Thanks for the charts, they show a lot about how our money has been greatly devalued due to over printing.

I found another table that breaks M1 down into its components, including currency.

It's a table so you have to scroll down, but notice that currency has increased more than ten times the amounts from 1975. That means that if the Feds hadn't printed up so many greenbacks and coins, that the money in your pocket would be worth ten times what it is worth now! Of course, you wouldn't be making the amounts per hour that you are making either, but nonetheless the Feds printing up all of that cash has definitely devalued the dollar compared to gold over time. And not all of that is a straight effect, either; that is, the distortions from printing up so much extra cash doesn't go into the economy evenly.

But that is what they can do when people are not aware of these issues and just blame the sitting President for economic woes. Bush did it! Bush did it! So, he tries to compensate by handing out government checks. Placate the people! But, good God, don't tell them the Feds have been doing it for 30 years or more! How could we finance our policies if we didn't print up so many greenbacks? We'd go broke if we had to live off our means instead of turning up the spigot one way or the other. Let the American people pay for it via inflation!

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It's a table so you have to scroll down, but notice that currency has increased more than ten times the amounts from 1975. That means that if the Feds hadn't printed up so many greenbacks and coins, that the money in your pocket would be worth ten times what it is worth now!

This isn't necessarily true. The increase in prices is not in exact proportion to the increase in money supply. A popular way of expressing the relationship is with the quantity theory of money.

Simplification of the equation shows that P = (M*V)/Q where:

P is the price level

M is the total amount of money in circulation in an economy

V is the velocity of money, that is the average frequency with which a unit of money is spent

Q is an index of the real value of expenditures

Take the derivative of this equation with respect to time and you will find that if and only if V and Q are constant, then an increase in the money supply will directly equal an increase in prices.

Edited by adrock3215
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Here are two charts lined up. First, the price of gold in US $. And second, an M1 chart that was posted above. Notice that the relationship is far from clear-cut.

Notice the period marked by a "?". By most theoretical accounts of a M1-Gold relationship, this period should have seen a spurt in Gold prices, yet it did not. Quite the opposite. There was a particular run-up of money supply in the years before, as well as during the late 1980's and early 1990's.

This is not to discount the idea that money supply is a factor in the price of gold. However, I often see such a relationship being posited as a rationalistic argument, without concern for the reality of the data. Hence, this graph. I suggest that anyone saying there is a relationship, should keep this chart in the fore-front, and then explain how reality fits the theory. I think it can be done, but only by referring to factors outside of what is shown on this chart.

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Edited by softwareNerd
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The falling dollar has to do with one thing and one thing only, the printing of money by the Fed. That's it. There are other factors but they are negilible.
First, explain "printing of money". Do you mean physical currency and coinage? Or do you mean M1? Do you mean M3? Or, something else?

Second, could you point to some facts in reality that validate the thesis? For instance, can you point to some data on the changing levels of such "printing of money" over time, and the changing levels of the "value of the dollar", so that we can compare that to the value of the dollar and see if the hypothesis is true, and in what sense. If other factors are negligible, then it should not be hard to spot a relationship in reality.

Too much of economics is formulated in a rationalistic manner: e.g. "if I push on this, it will obviously move", without actually pushing and getting the surprise of "hey! it does not move". There was a time when I would have said just what you did, thinking it's obvious. However, it is important to take every theory and check it against facts, not simply think, "yeah, that obviously makes sense".

Edited by softwareNerd
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The apparent discrepancy between the price of gold and the M1 shown (which would have to be only currency anyhow to be accurate) can probably be explained in terms of the US Government buying and selling gold; otherwise, the total amount of money in circulation and the price of gold should track one another rather closely, leaving out panics (which tends to drive gold higher apart from currency).

Given that gold was about $45-$65 an ounce back in 1971, and is now about $900 an ounce, then in the long run, gold has tracked currency, because currency is now more than 10 times the quantity it was back in 1971 and so is the price of gold.

One would have to look at what the government is doing regarding it's gold holdings -- i.e. buying or selling them -- which given the large holdings of gold could easily effect the price of gold in that action alone apart from what they are doing to currency. In fact, given how the price of gold has track pretty well over the last five years or so, I would say that the government isn't doing much to try to manipulate the price of gold during that time, and as currency rose, so did gold.

I have no idea why that would have happened in terms of laws or whatever that would buy / sell gold and printing of currency, so someone would have to look at those details. In other words, in a way, SoftwareNerd is correct to say that those charts don't tell the whole story, because the tracking ought to have been more closely related than is shown. But it would probably take an economist to ferret out those transactions of government buying / selling gold, unless someone can find the data on that via the Internet.

Basically, given where those charts started, and where they are now, gold is about at what it ought to be based strictly on amount of currency to gold. It may go higher in the short term -- $1200 an ounce perhaps -- but it should settle back down, assuming the government keeps their paws out of the mix, which they won't.

*EDITED TO ADD: One would also have to look at the operations of gold mining during that time period from 1971-2008, since more gold is mined when gold is high. The price of gold has two sides as well, supply and demand, and as demand goes up, more gold is mined changing the overall equation.

Edited by Thomas M. Miovas Jr.
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Here are two charts lined up. First, the price of gold in US $. And second, an M1 chart that was posted above. Notice that the relationship is far from clear-cut.

I haven't averaged the data points or anything, but it appears to me that the overall trajectory of both graphs are fairly consistent. If you draw an averaged slope, that is.

Perhaps the wild fluctuations have to do with where and how the printed money is spent(this could cause a time delay in it's effect on commodity prices....examples: money spent overseas for foreign aid, or held in reserve by the banks/governments, etc might cause a delay in the effect of the money.) Printing it is only the first part, the way it is circulated probably has far more to do with wealth transfer.

Moves like water so ultimately it has to balance out;of course ultimately can be a long ways off.

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Here are two charts lined up. First, the price of gold in US $. And second, an M1 chart that was posted above. Notice that the relationship is far from clear-cut.

post-4304-1201354701_thumb.jpg

This chart shows the more accurate money supply figure M3 (green line) on the left and rate of change (blue line) of M3 on the right. Notice that for the period you described (1989-1995), the rate of change in M3 is very near to 0%, and the slope of M3 (green line) is almost flat.

It is a moot point not worth discussing much though because money supply is not the only determining factor in the price of gold. Moreover, to the extent that money supply is involved in the price of gold, the anticipation of future increases in money supply will be what is reflected in the market price of any given time, not the money supply that is in existence when the trade actually occurs. During the late 90's, people took capital out of gold (and all other asset classes for that matter) and moved it into equities, because there was a bubble in equities which offered extremely high rates of return for what seemed like little risk. Of course, when the euphoria died down, money flowed back into gold because it was seen as the only safe haven while markets were crashing. Here is another M3 chart which also shows a leveling off of M3 during the period you described.

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Lastly, just for fun, a graph of price indexes daring back to 1665. Observe the period after 1971, when Nixon officially removed us from even the pseudo-gold standard we used to have:

post-4304-1201355041_thumb.gif

Edited by adrock3215
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People behave differently in areas of finance than they do when making daily economic decisions pertaing to the production or consumption of goods and services. In the economic realm, rational decisions are made based on accurate price information related to supply and demand. Financial markets appear to have a psychological component that distorts the supply/demand relationship because people are more likely to behave irrationally. This is seen when higher prices actuallyattract more buyers rather than less, or when buyers disappear in the face of collapsing prices. This occurs in markets for stocks, bonds, commodities, collectibles, and real estate.

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Lastly, just for fun, a graph of price indexes daring back to 1665. Observe the period after 1971, when Nixon officially removed us from even the pseudo-gold standard we used to have:

post-4304-1201355041_thumb.gif

Nice depressing graph. So since 1913 it appears that the federal reserve/government has stolen approximately 98% of the peoples wealth through inflation. If you started making money in the mid 90's then they've taken 47% so far. With theft rates like that I'm surprised that they need to tax at all on top of it.

With the trajectory of that curve I can't wait to see the next 30 years inflation rates.

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