Economics

[WneverLOSE]

Hi, I have lots of questions I would like to ask about economics so I thought I would just make a thread and ask them all combined.

 

I would like to start by asking how come the world has less money than the value of its assets ? by what I understand even if I had all the money in the world I still wouldn't be able to buy half of the real estate in the united states, is this true ?

[rb]

Well first of all if you had all the money in the world you would be able to buy all the real estate in the US. The global money supply I think is about 80 trillion and the real estate in the US is worth maybe around 50 trillion. But that doesn't matter that much.

 

I think you are confusing money with wealth. Think of wealth as what you got. Think of money as an artifact created to facilitate transactions. Since only a small amount of the wealth stock transacts at any time you don't need that much money. To stick with real estate think of a city. That city has a lot of houses that combined are worth a lot. But only maybe 3-5% of that housing stock transacts in a year. You only need enough money to facilitate those transactions.

 

I hope this makes sense.

[John Hjorth]

WneverLOSE,

 

Your question is actually so fascinating, because if one tries to answer it, the answer will basically have no end. [: - ) ]

 

The Wikipedia article about Money is a good place to start.

 

The concept of money is also closely related the very fascinating history of and the existense of banks, that popped up all over the world in the  mid/late 1800s.

[WneverLOSE]

rb you are right, I accidentally looked at the global real estate worth.

After reading your answers, looking at some Wikipedia articles and doing some thinking it makes sense.

 

I have a bit more difficult question now, how is it that the money supply grew so fast after 2008 but we didn't see inflation ? It would make sense if the total credit in the economy would fall to offset the rise in the money supply but I can't find any data point showing that it is infect the case.

[rb]

rb you are right, I accidentally looked at the global real estate worth.

After reading your answers, looking at some Wikipedia articles and doing some thinking it makes sense.

 

I have a bit more difficult question now, how is it that the money supply grew so fast after 2008 but we didn't see inflation ? It would make sense if the total credit in the economy would fall to offset the rise in the money supply but I can't find any data point showing that it is infect the case.

Well first of all the money supply didn't grow as fast as you think. At the end of 2007 M2 money supply was $7.5T at the end of 2017 it was $13.8T. An 84% increase. Looking at the previous period, at the end of 1997 M2 was $4T. So from 97-07 it went up 88%. pretty comparable.

 

What did go up was the monetary base. At the end of 07 it was $848B at the end of 17 it was $3,748B a 342% increase. In the previous 10 year period it went up by only 66%. More on this later on.

 

Now you have to understand inflation. Because it doesn't just happen. There's some mechanisms that cause it to happen. There are 2 kinds of inflation. Demand inflation and supply inflation. Supply inflation happens when for some reason you get a shock the lowers your aggregate supply causing prices to rise. Most common one have to do with commodities. Think 1970 oil shock and stagflation.

 

Then there's demand inflation. This is the classic case where too much money chases not enough goods. To have this you need to have strong demand and a supply constrained economy. Basically people are a bunch of spendy buggers. They have money in their hands and want to get stuff. However the economy is supply constrained. It already produces as much stuff as it can. So then prices go up to bring everything into balance. This is the instance where printing money leads to inflation. Because if you give people more money prices will just go up more because the economy cannot produce the goods. But as you can see it's not an automated thing - money supply up then inflation up. You need to be supply constrained otherwise the economy will expand and produce the goods people want and no inflation.

 

Now, how do you make money. The fed creates monetary base and pushes that into the banking system. Then the banks lend that money out to people because lending is a profitable business. People take those loans because they're a bunch of spendy buggers and want stuff. There's a multiplier effect here. A $1 increase in the monetary base will increase money supply by 1/R, where R is the reserve ratio of the banks. So if banks keep 10% reserves for loans. A $1 increase in the monetary base will lead to a $10 increase in the money supply. This is where the term fractional reserve comes from.

 

Now let's get to 2008. You get a massive demand shock and the economy crashed. You have tons of excess capacity so you're nowhere near supply constrained. But that's not so important. What's important is how that demand shock came to be. Basically one day people woke up and realized that they have way more debt than they're comfortable with and they want to pay it down (all of them, all at the same time). This creates the demand shock because they're not spending the money they use to pay down debt. So people stopped being spendy buggers. The Fed pushes some monetary base to the banks the banks then go to the people and say "Hey man you want a loan" and the people say "No thanks, I'm trying to pay down debt". So then the banks turn around and give that money right back to the Fed in the form of reserve deposits and you get this:

 

https://fred.stlouisfed.org/series/WRESBAL

 

Basically, long story short, you don't get that too much money chasing not enough goods that's required to create inflation.

[WneverLOSE]

wow thanks for the detailed answer this helps a lot !  :)

 

no more questions for now, I think I got it.

[Rainforesthiker]

rb you are right, I accidentally looked at the global real estate worth.

After reading your answers, looking at some Wikipedia articles and doing some thinking it makes sense.

 

I have a bit more difficult question now, how is it that the money supply grew so fast after 2008 but we didn't see inflation ? It would make sense if the total credit in the economy would fall to offset the rise in the money supply but I can't find any data point showing that it is infect the case.

 

Growth in the money supply is certainly inflationary. But there have been huge deflationary pressures at the same time to offset this, primarily the hundreds of millions of people entering the middle class in the last 30 years (mostly in China) and generating wealth, and all producing goods and services at a lower cost than those in the West would have.  These deflationary pressures will eventually ease, and then I think we will be in for a bit of inflation.

[Cigarbutt]

Interestingly, the Globe and Mail had a small commentary about this topic yesterday with a reference to an article written by a hedge fund manager who used to be government economist. Is that what they mean when they say that some people are reaching for yield?

https://www.theglobeandmail.com/globe-investor/investment-ideas/gi-newsletter/article37632557/

https://behavioralmacro.com/there-is-zero-correlation-between-the-fed-printing-and-the-money-supply-deal-with-it/

 

The gist of the article would tend to go along what rb describes in relation to the multiplier effect and velocity of circulation. The actual transmission mechanism does seem to rely on animal spirits.

 

I like also the way Rainforesthiker describes the forces which are multi-factorial and often opposing.

It must be a challenge these days to manage a bond portfolio, especially if your goal is to earn more than the benchmark. :)