Monday, November 29, 2010

Who Really Benefits From Quantitative Easing?

So the world is finally learning the truth about $USA, Yuans, Euros, $Cdn,Francs, Lira, Yen, Pesos, etc. Currencies are merely empty promises by governments to pay their currency promises with currency promises. They even eliminated their old promise on currencies to pay the bearer an equivalent amount in silver or gold. Now currencies are merely described as "legal tender", meaning they can be used to pay off debts.
(For those of you who are new readers of Bob the Beaver's commentaries, you should know that Bob uses plain, beaver on the pond, language and terminology as much as possible.)
Thus, countries in debt can just print legal tender, or create more electronic records of legal tender in computer databases, and use this extra supply of money to pay off existing debts.
Of course, if the creditors, public or the media saw what was happening they would slap their beaver tails in warning. But governments obscure what they are doing by selling new money at a discount to banks who can borrow cheaper than anyone else and lend it out at a profit or buy interest earning debts to make more profits.
The problem is that by loaning the banks all this cheap new money, the banks are borrowing more money than ever before. In fact, their deposits have dropped from 10% of their borrowings to less than 2.5% in the USA and many other countries and 3.2% in Canadian banks. This leverage of 31:1 and over 40:1 is way beyong the 14:1 ratio between loans and deposits considered sustainable for the past 70 years.
In ordinary beaver family terms it is equivalent to owning a $500,000 home with only a $7500 downpayment, (2.5%). Such a family would likley have their house foreclosed if the value dropped to $492,500. Any business with only 2.5% equity or collateral would be put into receivership the next day. In basic language the banks have drowned and only artificial respiration can save them. (No beaver would ever give them "mouth to mouth" resucitation - especially in Canada where they have free health care if they can tread water long enough to get treated.)
So the bottom of the pond is that governments are printing money for banks faster than Mexicans can grow pot, Afghanis can grow poppies or Canadian Beavers can chug-a-lug beers.
All this extra supply of national "yingos" means that by 2011, imports are going to cost these countries more "yingos". But the big problem will be that the average beaver will have to pay more for his needs when he isn't receiving more of these new "yingos" in his paycheck. In fact, he will have to either borrow extra "yingos" or cut back his consumption of goods and services. This causes a recessionary whirlpool.
However, the fact is that China, India and other developing countries have billions of people who want a middle class lifestyle. These countries have acquired the new technologies of the past 40 years from the developed economies and are creating the next generation of technologies for themselves.
The economic and social momentum they have begun will be impossible to stop. They will still need the goods, services and commodities produced by the countries with decreased value currencies. What is happening is that they are transiting from net exporters to net importers.
As the education and skills and technology of a middle-class workforce increases the cost of their domestic products and exports, other countries will find them to be less affordable. Similarly, as the new middle class prospers, imports will increase and thus lead to trade deficits.
It was this process that occurred in the developed economies during the past 60 years and that will likley occur in the developing economies during the next 40 years.
Financing this economic cycle during the past century was strongly influenced by monetary policies designed to remedy major recurrent financial crises. There was no real global monetary plan or perspective so financial markets were relatively free to do the expedient in an increasingly liberallized financial environment.
But the underlying problem throughout this period was a lack of capital and cash to meet the needs of an increasingly democraticed world. Inflationary fears kept monetary supplies tight for most of these years. Thus, the financial sector had to find new ways to leverage sparse financial resources. The financial crises of 2007 through 2015 have been brought about by the excess leveraging of capital which was caused by a lack of financial liquidity in a rapidly developing world.
Thus, the hope and expectation of quantitative easing is to increase financial liquidity and reduce capital leverage in the near term. In other words, by expanding the size of the financial pond it will enable more beavers to become middle class citizens.
During this transition, wealthy beavers want to hold onto their proportionate share of the pond so that they can remain big beavers in a small pond. In the past they could control the flow of capital and size of the pond. In fact, there is evidence that they are redirecting the growing flow of new funds into their share of the pond that they have damned up.
But the good news is that the pond will be bigger sooner than later and the little beavers may soon swim in the new pond of economic order. How this will take place is the subject of another commentary.
Keep your teeth sharp!
Bob the Beaver

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