ScratchMonkey

No, I think we can skip straight to stagflation:

http://www.downsizedc.org/blog/2008/...he_environment

http://en.wikipedia.org/wiki/Stagflation

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bkelly

I understand. I gave the credit card example because it's easier to grasp, but investing still lowers the velocity of money. The federal government wants you to spend the $600, not invest it.

Have a look at http://en.wikipedia.org/wiki/Income_..._United_States.

I'm still undecided on that issue.

I was merely answering your question about why we might want to cut the taxes of the poor even though they already contribute a smaller percentage of their income.

Brian

ScratchMonkey

Why should investing (spending on capital) reduce velocity more than consumption (spending on single-use stuff)? And, if so, is that bad?

Increasing capital should increase productivity, which increases overall wealth. Increasing consumption ultimately causes more stuff to pile up in landfills.

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bkelly

A good question ScratchMonkey! The answer is complex and depends on what sort of investment we're talking about but I'll see if I can explain the gist of it.

Let's start with the idea of stuffing the $600 under your mattress. I think everyone would agree that this pretty much pulls the $600 out of the economy and the money isn't moving. It's of no help.

Okay, instead we'll buy $600 of a mutual fund of stocks and bonds, but this has the same problem. Instead of sitting on your $600, you're sitting on a promissory note for $600 plus more or less depending on how the market goes. That too is of no help.

"But", you protest, "don't the governments and companies I invested in now have more money to spend?" Probably not. Stocks and bonds are traded by brokers in the open market and unless you're involved in an IPO or a direct security auction, the issuer of the security was not involved.

"So the person from which the mutual fund purchased securities has my $600?" That is one way to look at it. A better way to think of it is that your $600 is propping up the prices of those stocks and bonds until you decide to cash it out, however investor sentiment has much more to do with those prices than your $600. So really your $600 bought investor confidence that they will be able to sell the promissory notes for a reasonable sum of money in the future.

"I don't want that, so why don't I just leave the money in a savings account in an American bank so they can loan it out?" That could be better for the US economy because the bank might loan the money to other Americans but it might also use the money to cover it's debts - pretty much like you and me paying off our credit card. Even if the bank does loan the money, by law they're required to keep 10% as reserves so they could only hand out $540. This is $60 less available money if you had just spent the $600 in the first place.

Perhaps the best investment you can make for the US economy is putting the money into a certificate of deposit or CD as banks are not required to keep reserves for such fund so they can loan out %100 of your deposit. The problem is that the banks that are currently offering the highest APR on CDs are the ones that are deeply indebted, so they want your money so they can destroy it.

So why does investing reduce money velocity?

1) The money often remains stagnant
2) If the money is stored in a checking or savings account, at least 10% becomes stagnant
3) Investees may destroy your money when they get it


It is bad for the health of the US economy today, but not in the long run, IMO. I see recession much like sick days for people. We may be able to avoid taking a sick day today by pumping up on medications but what happens to our health if we never take time out to recover?

Increasing capital does increase productivity. Increasing demand increases it more and faster.

*singing* That's what it's all about!

bkelly

tHa_KhAn

It really depends on the investment. If you are investing directly(purchasing debt) into a company, you have just infused that company with required funds. However, if you are just trading with their stocks or already purchased bonds the funds are going only to the holder of that note, not to the company directly. It's still a much better process than just sitting on the money or plopping it into a CD. Purchasing goods directly benefits more entities faster than securities.

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ScratchMonkey

By your argument, consuming by spending at the grocery store instead of at the farm where they buy their produce doesn't count, either, because the money doesn't go directly to where it gets turned into something of real value.

When I buy a stock from a broker, he's just inventorying it like the grocery store, and serving to match buyers to suppliers.

It may be that I'm taking on a stock previously held by another. Then either that person is now consuming his investment, or he's investing somewhere else, making my investment transitive.

The reserve issue is to protect from bank runs, and is a kind of insurance. Bypassing the bank increases risk at the benefit of putting more of one's money into play. Still, with Federal bank insurance, what's the point of having reserves anymore?

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bkelly

Ah, I see why you would think that. I didn't explain things well.

Buying stock from a broker doesn't help the economy, not because there is a middleman, but because a stock or bond certificate is not consumable. The economy is about providing goods and services to consumers. Groceries are a product and contribute to GDP. A stock or bond certificate is and does not.

Well, not quite. Your money is still yours and no wealth was exchanged. Perhaps an example:

Let's say you bought stock from some guy for $600 and he's now run off and buying a new TV set. Your argument is that you've contributed $600 to the economy indirectly since that was your money he used and you still have the stock certificate, the best of both worlds, no?

The problem is that the stock certificate had value before you arrived. If this guy was looking to sell his stock and if you hadn't come along he would have sold it to the next highest offer, perhaps $599. So with your $600 bid, only $1 of it would have actually made it into the economy. The other $599 is tied up in the stock certificate. Why $599? That the price you can sell it for assuming that "next highest offer" is still valid.

On the other hand if you stay out of the stock market this guy still buys a $599 TV and the two of you could boost the economy a total of $1199 if you do the same.

One thing the notice, the stock certificate acts much like your mattress (provided many other people are exchanging money with your mattress). Money put in to either becomes stagnant.

The reserves rules are in place to keep a handle on the money supply. Without it, banks could create as much money as they wanted and cause the economy to crash. Look up information on fractional-reserve banking for an idea of how it works.

bkelly

Kerostasis

You have a warped view of stock investing, Kelly...

Granted, the number of pieces of stock paper floating around stays constant through your average daily stock transaction. But its still a bad analogy for a mattress, since every dollar put into the stock market by one person is simultaneously taken out of the stock market by someone else. There aren't actually any dollars at all tied up inside it. The only time dollars put into stocks actually leave the realm of consumption is when a new issue of stock is purchased and the purchasing money becomes capital for the business that issued it. And that is exactly the type of investment spending we wanted all along anyway.

When we say that investing grows the economy, we aren't really talking about stock investing, we are talking about capital investing. Stock investing is simply the most visible and popular way to access capital investing, even though its a few layers removed from pure capital investing.

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Equally interesting is your take on the creation of money through banking. Just a few posts ago you were telling us how depositing money in the bank destroys the ability of that cash to contribute to the economy, and now you tell us reserves only limit the ability of a bank to create new money out of thin air. I think your second position is somewhat closer to the truth than your first. Banking allows each dollar to be spent more than once, increasing its effect on the economy rather than diminishing it, and the reserve rate controls how much that effect is increased.

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ScratchMonkey

For banks to print as much as they wanted, they'd need a negative reserve. A zero reserve would mean they could loan out all the money deposited, keeping none in the vault. At that point the bank is just a loan broker, just like the stock broker. (A stock broker just brokers a specific kind of loan.)

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bkelly

For a single transaction, you're correct but the money loaned eventually makes it back to the bank and, with a zero reserve, can be loaned out again. Another example:

The bank has $1000.

I take out a $1000 loan to pay a contractor to make improvements to my house. The contractor deposits the money into his account. I have a $1000 debt, the contractor has $1000 credit and the bank has $1000.

Next, you borrow $1000 from the bank to buy a car. The dealership deposits the money to the bank. Now you and I owe $2000 combined while my contractor and your dealership has $2000. The bank still has $1000.

...and the cycle continues with each time creating money. Before long there would be so much credit that the value it represents is horribly diluted and hyperinflation would follow.

Again, it's all about fractional-reserve banking. Read a bit about it.

bkelly

ScratchMonkey

Slippery use of the word "have". If someone deposits money in a bank, either he has the money (he still owns it) or the bank does (it has physical possession). They don't both have it, in the same sense.

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bkelly

He-he. If that's all that's warped, I'm in better shape than I thought.

Okay, then don't use it. Your points are correct. I thought the mattress analogy might illustrate that you're sitting on your own money, just in a different form.

Right, and that was my point. Your original statement regarding investing talked about the stock market and its prices, neither of which have a direct effect on the economy or the companies the stocks represent.

Great! But that is hard to do. IPOs often require some sort of invitation and are normally at a set price anyway so your participation gets a company no more funding. You can get a company/government more money by partaking in a bond auction, but again only as much as the difference between your bid and the next-highest bidder.

IMO, the best capital investment? Use the $600 to support yourself away from work for a month to create some sort of useful tool then sell it.

That's not quite what I said. Depositing money in a bank would allow it to loan that money to another party minus a reserve, 10% in the case of checking or savings accounts, 0% in the case of CDs. The catch is that you may be depositing money in a bank that has already loaned too much money and doesn't meet it's reserve requirement so your money is sat upon or used to pay off debts. If this happened it would destroy the money or negate it's effect on the economy.

I must not be too warped. We seem to only disagree on a few details.

Or perhaps we're both warped in the same way...

bkelly

bkelly

No? What's to stop the bank from giving another $1000 mortgage, the contractor from buying a $1000 TV on his debit card and the dealership writing a $1000 salary check to its employees?

bkelly

Kerostasis

The most pure way to invest capital is to skip the stock market entirely, and find a new company that needs capital and loan it to them directly.

The stock market exists to make this transaction easier by abstracting and centralizing it, with the result that most stock transactions are between investor A and investor B, rather than between investor and investee. But you can't overlook the fact that the investees are still in the market, since it wouldn't exist without them. Companies have the ability to change their total amount of outstanding stock at any time without going through a new IPO -- they just sell more stock to the market. The transaction looks identical to your average investor A trading with investor B transaction, except the source of the stocks is the company treasury instead of your neighbor. So this results in increased investment capital (or decreased if they were buying up stock instead).

The relation between that and the overall market price is a bit beyond my level of understanding right now, so I won't offer anything more to backup my random comment about the market having fallen 2k points. However, I can still counter your previous comment about money sent to the market being less economically efficient than money used for consumption:

Notice that in your investor A to investor B transaction, there is a share of stock being sold for every share being bought, so the same amount of cash is available for consumption before and after every transaction. It may be person A or it may be person B holding the cash afterwards, but someone's gonna have it. Therefore, end total consumption won't actually change, until we run into an Investor/Investee transaction.

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Kerostasis

I realized what struck me wrong about this example. Your description of how money supply is created is pretty much accurate. But your conclusion about inflation is way off base.

In the starting scenario, with $1000 of money supply available, what value does that represent? So far nothing, but for the sake of example lets assume the bank sold $1000 worth of furniture yesterday to generate that capital. (Unlikely? Sure, but it prevents us from dividing by 0 later on, so lets go with it.) So the $1000 in the bank represents the ability to acquire Bank Furniture.

Now you take out the loan and buy "Home Improvements". These Home Improvements do not actually exist yet, but you have paid the contractor to create them. He creates $1000 worth of Home Improvements on your house, and takes your cash back to the bank.

Now I take out a loan and buy "Car". That car wouldn't have been made at all if they weren't going to be able to sell it to me, but since I have the loan handy the dealership acquires a cheap car, sells it to me, and deposits $1000 at the bank.

Ok, lets look at our money situation and see if we have inflation: How much money is available to this micro-economy? The bank still has $1000, and the dealer and the contractor each have a $1000 account, for a total of $3000 in the economy. So what value does that $3000 represent? At the start of the day we just had $1000 worth of furniture, but now we have $1000 of furniture, $1000 of Home Improvements, and a $1000 Car. The money supply has increased to match the increased value of our goods. So there has been no inflation at all!

By contrast, if the bank was unable to make those loans, we would either have severe deflation, with $1000 of cash trying to make up for $3000 of goods, or some of those goods wouldn't have been produced at all, leading to a slower economy.

In short, expansion of the money supply is not inherently bad. It just needs to be controlled to expand at about the same rate as the economy.

(Note -- the example works much better under the assumption that the micro-economy is closed and doesn't need to purchase materials from outside, ie, the most significant business cost is cost-of-labor. The Dealership will violate this principle because they are most likely purchasing the car ready-made from a Car Manufacturer that isn't included in our micro-economy, but its too complicated to follow the cost of the car all the way back to the iron mine that gave us the raw metal -- so for sake of example we're just including the dealer.)

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