Naked Money
Low interest rates help to put more Americans back to work and raise the wages of others. On the other hand, low interest rates punish savers and can, if they are too low for too long, cause inflation.
Page: 5, Location: 62-63
Note: The dilemma of interest rates
money typically refers to assets that can be used immediately to make purchases. Cash is money. So are deposits held in checking accounts or other accounts with check-writing privileges because you can use them to buy things now. On the other hand, a fancy car and a big house are not considered “money”; both have great value and are therefore sources of wealth, but neither is frequently used to conduct commerce.
Page: 8, Location: 114-117
Note: Difference Between money and wealth
Page: 9, Location: 126
Note: Difference between currency and money
Here is the irony: as long as the people using the rice certificates are confident they can redeem them at any time, most will feel no urgency to do so. But it’s also true that if there is even a whiff of doubt about the value of those rice certificates—whether it is justified or not—you are going to have a mob of certificate-wielding people banging on your door and demanding rice. This turns out to be a potentially destabilizing feature not just of commodity-based money but of the broader financial system. Even the most complex financial systems can thrive or fail depending on whether people believe they will thrive or fail.
Page: 15, Location: 220-225
Note: Bank runs
issuing paper certificates against a commodity solves the portability problem.
Page: 21, Location: 311-311
Note: Commodity backed money
In 2010, after Haiti was recovering from the horrible earthquake, the United Nations was working to distribute food aid to the starving population. The distribution system was dangerous and chaotic, in part because workers tossing bags of food from the backs of trucks invited mayhem. Instead, the UN went to a system of coupons—a variation of the rice certificate example. Each coupon could be redeemed for a fifty-five-pound bag of rice. Consumers could store the coupons more safely than the rice; aid agencies could distribute the coupons broadly while storing rice at a smaller number of supervised distribution points. The coupons also became a currency that
Page: 21, Location: 311-316
Note: Anything can become as currency
Fortunately, there is an easy fix for the uncertainty surrounding the supply of any single commodity: a currency backed by a basket of commodities. Suppose each “commodity dollar” could be exchanged for a kilo of rice, a gallon of gasoline, a quart of milk, six songs on iTunes, and so on. The accounting would become a little more difficult, but consumers would grow accustomed to the system as long as the value of the currency remained stable. The holders of these commodity dollars would be insulated against a sudden increase or decrease in the supply of any single commodity. The currency would have real, well-defined purchasing power. The broader the basket of commodities against which the currency is backed, the more stable the value of that currency will be and the more highly correlated it will be with growth in the economy overall.
Page: 25, Location: 371-377
Note: Currency backed by busket of commodities
Hugo Chavez transformed powdered milk into something like a free seat on United: a great deal if you happen to be lucky enough to get it at the artificially low price.
Page: 34, Location: 513-514
Note: Price control
“Inflation occurs when the quantity of money rises appreciably more rapidly than output, and the more rapid the rise in the quantity of money per unit of output, the greater the rate of inflation. There is probably no other proposition in economics that is as well established as this one.”
Page: 34, Location: 518-520
Note: Milton Friedman on inflation
China’s premier Wen Jiabao compared inflation to a tiger: once unleashed, it is very hard to cage again. Karl Otto Pöhl, a former president of Deutsche Bundesbank, the German central bank, described fighting inflation like trying to put toothpaste back in the tube.15 You can choose your metaphor—tigers or toothpaste—but dealing with inflation is like many other life challenges: better
Page: 42, Location: 637-641
Note: Crux of inflation
Falling incomes and falling prices would be fine—just like rising incomes and rising prices—but for one crucial detail: our debts are typically fixed (e.g., your monthly mortgage payment of $2,153.21).
Page: 43, Location: 646-647
Note: Deflation and debt
As in the babysitting co-op, one person’s thrift lowers another person’s income—a phenomenon popularized by the twentieth-century economist John Maynard Keynes as the “paradox of thrift.”
Page: 47, Location: 718-720
Note: Paradox of thrift
When calculating the CPI, each item is weighted based on its share in the basket of goods. If the typical household spends three times as much on fresh chicken as it does on Parmesan cheese, then any change in the price of chicken will affect the CPI three times as much as a change in the price of Parmesan cheese. (In the Christmas Price Index, the annual change in the price of lords a-leaping is weighted ten times as heavily as the price of a partridge in a pear tree, since your true love sends you ten lords a-leaping and only one partridge in a pear tree.) The end product is the most commonly cited inflation measure in the United States: the Consumer Price Index for All Urban Consumers (CPI-U), which captures the spending patterns of about 88 percent of the American population.8 (A related index, the CPI-W, covers Urban Wage Earners and Clerical Workers, which represent 32 percent of the population.) As both names would suggest, this still leaves out rural households, whose basket of goods and shopping options are appreciably different from those of households in metropolitan areas. Nor does it measure regional variations in consumption patterns and prices. The Bureau of Labor Statistics warns, “The CPI frequently is called a cost-of-living index, but it differs in important ways from a complete cost-of-living measure.”
Page: 53, Location: 801-811
Note: Measuring CPI
If our goal is to measure changes in the cost of living, obviously we have to measure changes in prices—but also changes in consumption patterns induced by those higher or lower prices. Yes, my Social Security check ought to get bigger if the stuff I typically buy gets more expensive; however, that bigger check ought to be offset somewhat if I buy less of the stuff that is getting more expensive—fewer oranges and more bananas. Failure to take this behavioral change into account will overstate the true rise in the cost of living.
Page: 56, Location: 855-859
Note: Consumer substitution bias
In fact, there is a human tendency to prefer getting a raise, even when inflation eats away all the benefit. And we abhor getting a pay cut, even when falling prices might compensate for some or all of the smaller check. Economists describe this tendency to think in nominal terms, rather than real (inflation-adjusted) terms, as “money illusion.”
Page: 68, Location: 1033-1035
Note: Human Psychology of inflation
As one professor, a member of the Stable Money Association, puzzled almost a hundred years ago, “We have standardized every other unit in commerce except the most important and universal unit of all, the unit of purchasing power. What business man would consent for a moment to make a contract in terms of yards of cloth or tons of coal, and leave the size of the yard or the ton to chance?”
Page: 69, Location: 1053-1056
Note: Indexing Inflation in contracts
(Dartmouth economist Doug Irwin points out a clever rule of thumb: with tradables, goods move to the people; with nontradables, the people must move to the services.)
Page: 129, Location: 1966-1967
Note: PPP works mostly with non tradeable goods
(A “hill of beans” is a technical term used by some currency experts to gauge the level of interest in exchange rate movements.)
Page: 132, Location: 2016-2017
Note: TIL
In fact, you can use someone else’s money to do all of that. Money is not just about the bills in your wallet. Our whole financial system is built around a simple but powerful idea: credit. Banks, and the many institutions that function like banks, are intermediaries that match lenders and borrowers (taking a fee, of course, for the service). In that lending process, something remarkable happens: financial institutions create credit, which expands the supply of money.
Page: 3, Location: 36-39
The history of finance is also a history of financial panics.
Page: 4, Location: 48-49
Even stocks and bonds are not money. They are assets that one sells for money, which can then be used to buy things. Thus, all money is wealth, but not all wealth is money. This is how I can safely assert that Warren Buffett may not have more money than I do. Sure, he has billions in stocks and bonds, plus a plane and maybe some hotels. But does he keep more money in his wallet and checking account than I do? Maybe, maybe not. In the same
Page: 8, Location: 118-121
Even stocks and bonds are not money. They are assets that one sells for money, which can then be used to buy things. Thus, all money is wealth, but not all wealth is money. This is how I can safely assert that Warren Buffett may not have more money than I do. Sure, he has billions in stocks and bonds, plus a plane and maybe some hotels. But does he keep more money in his wallet and checking account than I do? Maybe, maybe not.
Page: 8, Location: 118-121
Currency technically comprises the paper notes and coins that circulate—the dollars in your wallet, the coins on your dresser, and so on. Money is a broader concept that includes currency but also other assets that can be used to make purchases or quickly converted to currency, such as checking account deposits. All currency is money, but not all money is currency. That said, a nation’s currency, such as the Japanese yen or the Chinese yuan, typically refers to all its money, not just the bills and coins. The language in this regard has evolved in a sloppy way, but context usually
Page: 8, Location: 122-126
Liquidity, a term that will come up throughout the book, is a measure of how quickly an asset can be turned into cash at a predictable price. Treasury bonds are highly liquid; Vincent van Gogh paintings are not.
Page: 9, Location: 130-131
CHAPTER 1 What Is Money?
Page: 10, Location: 139-140
One cannot pronounce something worthless that has worth. True, the government could try to confiscate all the mackerel, but that’s a different and much more difficult task.
Page: 14, Location: 203-205
The torn Indian rupees are real money, yet you can’t use them to buy a cup of tea. The Somali shillings—and certainly the counterfeit Somali shillings—were not real money, in the absence of a government to declare them legal tender, except that you could use them to buy a cup of tea. Here, the simple becomes the profound: If you can swap something easily and predictably for goods and services, it’s money. If you can’t, it’s not. There is even a continuum in between. Moneychangers across Africa offer better rates for new American bills than for older ones. A 100billsignedbyacurrentTreasurysecretarygetsabetterratethana100 signed by John Snow (Bush administration) or Robert Rubin (Clinton administration). Clean, crisp bills get a better rate than old, dirty bills. And a single 100billismorevaluablethanfive20s.10
Page: 17, Location: 260-266
purposes. First, money serves as a unit of account. People think in terms of a particular monetary unit when placing a value on things.
Page: 18, Location: 274-275
Second, money is a store of value. It gives us a way of accepting payment for something now and using that purchasing power later.
Page: 19, Location: 282-283
Finally, money is used as a medium of exchange, meaning that it can be used to conduct transactions with relative ease. Paper currencies obviously work well in this respect.
Page: 20, Location: 295-297
The important point is that money need not have intrinsic value in order to be valuable; it need only facilitate exchange.
Page: 20, Location: 301-301
The Economist encapsulated this fundamental principle: “Were an extraterrestrial to be shown a room full of gold ingots, a stack of twenty dollar bills or a row of numbers on a computer screen, he might be puzzled as to their function. Our reverence for these objects might seem as bizarre to him as the behavior of the male bowerbird (which decorates its nest with shiny objects to attract a mate) seems to us.” 13 Money is a means to an end; it facilitates specialization and trade, which make us more productive and therefore richer.
Page: 20, Location: 303-307
2010, after Haiti was recovering from the horrible earthquake, the United Nations was working to
Page: 21, Location: 311-312
In 2010, after Haiti was recovering from the horrible earthquake, the United Nations was working to distribute food aid to the starving population. The distribution system was dangerous and chaotic, in part because workers tossing bags of food from the backs of trucks invited mayhem. Instead, the UN went to a system of coupons—a variation of the rice certificate example. Each coupon could be redeemed for a fifty-five-pound bag of rice. Consumers could store the coupons more safely than the rice; aid agencies could distribute the coupons broadly while storing rice at a smaller number of supervised distribution points. The coupons also became a currency that could be traded for other scarce items.14
Page: 21, Location: 311-316
Most important, money needs to be scarce in a predictable way. Precious metals have been desirable as money across the millennia not only because they have intrinsic beauty but also because they exist in fixed quantities.
Page: 22, Location: 323-324
be produced in unlimited quantities. They are “fiat currencies,” meaning that they have value because the governments that issue them declare them to be legal tender. A century ago, those same countries used commodity money—gold, silver, or some combination of the two.
Page: 22, Location: 331-333
CHAPTER 2 Inflation and Deflation
Page: 27, Location: 405-406
Great Depression.
Page: 29, Location: 440-440
You can’t increase collective wealth without increasing the stock of things with true value, which in this case is the shoebox of cash. The extra chips are just plastic that diminish the purchasing power of the chips already on the table.
Page: 31, Location: 466-468
the chips are fiat money and the cash in the shoebox represents goods and services in the economy. What people care about are cars, food, washing machines, college tuition, and other things that have real value. Money is what we redeem to get those things. If the amount of money rises relative to the quantity of goods and services—because of a Nazi counterfeiting plot, or an autocrat printing $100 trillion bills, or for any other reason—we have to exchange more money to get the same quantity of real stuff.
Page: 31, Location: 475-478
It is most intuitive to think of inflation not as rising prices (though that is clearly happening) but as a fall in the purchasing power of money.
Page: 32, Location: 478-479
But deflation can be worse; even modest deflation can set in motion a cascade of adverse economic responses. Sure, it may seem great that the price of a beer is falling between rounds. If that were the case, your income would probably be falling, too. No tragedy yet—your income is falling and so are the prices of the things you typically buy. But now imagine that your debts are not falling. The bank still expects the same mortgage payment every month, even as your paycheck shrinks steadily. Welcome to the Great Depression.
Page: 29, Location: 436-440
The relationship between the money supply and prices is also affected by the speed with which money circulates in the economy, or the “velocity” of money. Velocity is prone to be higher—a single dollar will circulate quickly through the economy—when consumers and firms have less need or desire to hang on to cash (and assets that approximate cash, such as checking account deposits).
Page: 35, Location: 529-531
Velocity is the crucial link between money supply and prices. Anything that causes individuals and institutions to hang on to money will slow velocity. For example, economic uncertainty prompts banks, firms, and consumers to stockpile cash (and other liquid assets†) because they fear less access to credit in the future. On the other hand, financial innovations that make it easier to convert assets to cash, such as home equity loans, speed up velocity because they enable households to hold less money for a rainy day (or, more accurately, a hurricane that blows off the roof). For all that, short-term fluctuations in velocity can still be puzzling.
Page: 36, Location: 539-544
“nominal” figures, which are not adjusted to account for inflation, and “real” figures, which are.
Page: 37, Location: 557-558
problems of inflation—and then some. Falling
Page: 39, Location: 594-594
Second, deflation creates all the problems of inflation—and then some. Falling prices can cause individuals and firms to do things that are bad for the broader economy, which makes prices fall further, which induces more economically destructive behavior . . . and so on.
Page: 39, Location: 594-596
Prices are supposed to transmit information in a market economy; inflation obscures that mechanism.
Page: 40, Location: 609-609
As the Economist notes, “Inflation of all kinds devalues everything it infects. It obscures information and so distorts behaviour.”
Page: 41, Location: 621-622
summary of the symptoms associated with Fisher’s debt-deflation spiral reads like Stephen King tried his hand at economics writing: “Distress-selling, falling asset prices, rising real interest rates, more distress-selling, falling velocity, declining net worth, rising bankruptcies, bank runs, curtailment of credit, dumping of assets by banks, growing distrust and hoarding.” 17 All that’s missing is a zombie with a chain saw. In particular, falling prices
Page: 44, Location: 661-665
A summary of the symptoms associated with Fisher’s debt-deflation spiral reads like Stephen King tried his hand at economics writing: “Distress-selling, falling asset prices, rising real interest rates, more distress-selling, falling velocity, declining net worth, rising bankruptcies, bank runs, curtailment of credit, dumping of assets by banks, growing distrust and hoarding.” 17 All that’s missing is a zombie with a chain saw.
Page: 44, Location: 661-665
as good for business as Mahmoud Ahmadinejad, the Iranian president from 2005 to 2013
Page: 124, Location: 1894-1895
At the same time, the U.S. dollar is the best form of currency one might conceive. It is widely accepted and has a predictable purchasing power against a broad basket of goods. In that respect, the dollar is better than gold or silver (or mackerel) because it is less prone to swings in value, particularly deflation. A responsible central bank can grow the money supply at whatever rate produces stable prices. In times of economic distress, the right number of clicks on a keyboard at the right time can save jobs and raise incomes.
Page: 48, Location: 733-737
CHAPTER 3 The Science, Art, Politics, and Psychology of Prices A nickel ain’t worth a dime anymore. —Yogi Berra
Page: 50, Location: 758-761
CHAPTER 3 The Science, Art, Politics, and Psychology of Prices
Page: 50, Location: 758-759
A nickel ain’t worth a dime anymore. —Yogi Berra
Page: 50, Location: 760-761
badly. What to do? The key to making the Consumer Price Index relevant and accurate is identifying the basket of goods most relevant for most American households.7 In this respect, the Bureau of Labor Statistics really is like the CIA. Field agents send raw data back to headquarters where it is analyzed to find meaningful patterns. Specifically, BLS statisticians use expenditure data
Page: 52, Location: 796-799
The key to making the Consumer Price Index relevant and accurate is identifying the basket of goods most relevant for most American households.7 In this respect, the Bureau of Labor Statistics really is like the CIA. Field agents send raw data back to headquarters where it is analyzed to find meaningful patterns. Specifically, BLS statisticians use expenditure data for a representative sample of families to determine the most appropriate basket of goods for the typical American household. At present, that basket consists of more than two hundred categories of goods and services in eight broad groups: food and beverages, housing, apparel, recreation, and so on.
Page: 52, Location: 796-801
In theory, if a car is 7 percent more expensive and also 7 percent “better” (safer or more dependable or more comfortable), the price has not gone up. How exactly does one quantify how much better a car is because it now has antilock brakes and audio controls on the steering wheel? In what the Wall Street Journal has described as “a warren of beige-walled cubicles at the Bureau of Labor Statistics,” some forty commodity specialists make these determinations.
Page: 55, Location: 836-839
income tax brackets are indexed for inflation to prevent “bracket creep,” a phenomenon in which households pay higher tax rates because the numbers on their paychecks are bigger but the real value of those paychecks has not grown.
Page: 58, Location: 880-882
Consumers typically respond to rising prices in three ways, all of which the CPI failed to capture fully. First, they find cheaper places to buy the same product. (This was a particularly salient point because the Boskin Commission report coincided with the spread of outlets and superstores.) They also substitute across products (bananas for apples). And then they substitute within product categories (Gala apples for Red Delicious).
Page: 59, Location: 897-900
There is also agreement that deflation should never have to happen, as every modern economy has a fiat currency that can be printed on demand. Ben Bernanke once famously suggested that falling prices in Japan could be fixed easily by dropping money out of helicopters. (This was a metaphor, not a literal policy suggestion.) Deflation is like a disease that can be cured by eating pizza and ice cream while watching TV on the couch; we would not expect it to afflict the country for a long time.
Page: 65, Location: 988-992
For as long as there have been creditors and debtors—which is a darn long time—creditors have tried to protect the value of the currency and debtors have sought to devalue it.
Page: 66, Location: 1001-1002
Governments tend to be huge borrowers; for that reason, they tend to benefit from inflation, too, assuming their debts are not indexed for rising prices.
Page: 66, Location: 1003-1004
Printing more money diminishes the value of the money already in circulation, which is effectively a tax on that currency. Economists refer to this phenomenon as “seignorage,” which reflects the difference between the cost of producing money (essentially zero in the modern era) and the value of that new money. Seignorage is like the host of the poker game who reaches into the closet to get more plastic chips for himself without putting any more cash in the shoebox. He gets richer at the expense of everyone else holding chips.
Page: 67, Location: 1017-1021
to paraphrase Milton Friedman, inflation is everywhere and always a political phenomenon.
Page: 67, Location: 1026-1027
Inflation is bad. Deflation is worse. Hyperinflation is worst of all.
Page: 71, Location: 1078-1079
CHAPTER 4 Credit and Crashes
Page: 72, Location: 1101-1102
Financial institutions often “borrow short and lend long,” meaning that if a high proportion of depositors (or other investors) suddenly want their money back, the funds are likely to be tied up in loans or other investments that cannot easily be converted to cash.
Page: 75, Location: 1147-1149
As the Economist has noted, “The old saw about bankers—that they believe in capitalism when it comes to pocketing the profits and socialism when it comes to paying for the losses—is too true for comfort.” 8 The relevant policy question is if and how the government ought to intervene to reduce the likelihood of financial crises and to lessen the damage of those that do happen. Always has been, always will be.
Page: 77, Location: 1174-1177
Banks generate credit, and credit is new money. Even with a gold standard. Or
Page: 81, Location: 1240-1241
The money I deposit in the bank counts as my money, and when it gets loaned out, it counts as someone else’s money, too.† Banks generate credit, and credit is new money. Even with a gold standard. Or rice.
Page: 81, Location: 1239-1241
any other institution that generates credit can create money, too.
Page: 81, Location: 1242-1243
The financial system amplifies booms and busts, primarily because of the “procyclical” nature of credit. Banks lend most aggressively when times are good and most cautiously when times are bad—which makes the good times better and the bad times worse. When a party gets going, credit has the effect of turning up the music and adding grain alcohol to the punch. When that party starts to falter—for any reason, real or imagined—credit becomes scarcer, which is like dumping out the punch and turning on the lights.
Page: 82, Location: 1252-1256
In a crisis, the distinction between these concepts is crucial. Liquidity is a measure of the ease and predictability with which an asset can be converted to cash. Cash is the most liquid asset, because it is already cash.
Page: 86, Location: 1313-1315
Aside from actual dollars, which are impractical for holding large sums, U.S. Treasury securities are the world’s most liquid asset. Roughly half a trillion dollars’ worth of Treasury bonds are bought and sold every day.18 Liquidity is a continuum, with cash on one end and unique assets, such as fine art, on the other. Every Rembrandt painting is unique; the number of potential buyers is small. It takes time to arrange such a sale, and the commission for selling such a work tends to be high. If you need to raise a large amount of cash in the next fifteen minutes, selling Treasuries is a perfectly viable option—selling a Swiss ski chalet or a vintage baseball card collection less so.§
Page: 86, Location: 1315-1321
Solvency, on the other hand, is a binary concept. An entity is solvent if its assets exceed its liabilities; it is insolvent (broke, bankrupt) if its liabilities are more than its assets. Even if all the assets can be liquidated quickly and easily, the revenue generated is not sufficient to pay off all the creditors. But here’s the thing: assets that are liquid in normal times are not liquid in a crisis because so many people are trying to sell the same thing at the same time. Even if your balance sheet is healthy, assuming that you can sell assets to survive a financial panic is like assuming you can run to the grocery store to get water during a hurricane. It doesn’t work if everyone else is rushing to do the same thing.
Page: 87, Location: 1321-1326
Bagehot wrote, “The ultimate banking reserve of a country (by whomsoever it is kept) is not kept out of show, but for certain essential purposes, and one of those purposes is the meeting a demand for cash caused by an alarm within the country.” 19 Bagehot’s admonition remains the mantra of central bankers to this day: lend freely against all good collateral at a punitive
Page: 87, Location: 1332-1335
Bagehot wrote, “The ultimate banking reserve of a country (by whomsoever it is kept) is not kept out of show, but for certain essential purposes, and one of those purposes is the meeting a demand for cash caused by an alarm within the country.” 19 Bagehot’s admonition remains the mantra of central bankers to this day: lend freely against all good collateral at a punitive rate.
Page: 87, Location: 1332-1335
The Economist has described these collective institutions as an “economic time machine, helping savers transport today’s surplus income into the future, or giving borrowers access to future earnings now.”
Page: 91, Location: 1391-1392
Moneylending is the good part of banking. The whole point is to put idle capital into the hands of those who can make productive use of it; anyone who facilitates such a deal is performing a valuable service and should be paid as such. The problem is when moneylending goes wrong—namely when depositors rush the temple and the moneylenders don’t have the money. If Jesus were a central banker, that would be his concern. ____ * Technically the Building & Loan was not a bank or the Federal Deposit Insurance Corporation would have insured the accounts.
Page: 93, Location: 1420-1425
Moneylending is the good part of banking. The whole point is to put idle capital into the hands of those who can make productive use of it; anyone who facilitates such a deal is performing a valuable service and should be paid as such. The problem is when moneylending goes wrong—namely when depositors rush the temple and the moneylenders don’t have the money. If Jesus were a central banker, that would be his concern.
Page: 93, Location: 1420-1423
CHAPTER 5 Central Banking
Page: 95, Location: 1456-1457
The role of a central bank is typically threefold: to manage the money supply; to act as a lender of last resort; and to regulate the financial industry. (The regulatory responsibility is often shared with other arms of government.)
Page: 102, Location: 1554-1556
central banks can also commit monetary malpractice. Zimbabwe’s central bank wrecked the economy with too much money; in the United States during the 1930s, the relatively young Federal Reserve allowed the money supply to shrink precipitously, turning what might have been a routine economic downturn into the Great Depression. Yes, a doctor can cure cancer; he can also amputate the wrong limb. So it is with central bankers.
Page: 102, Location: 1559-1562
All else being equal, lowering the reserve requirement expands the money supply; raising it does the opposite. As noted earlier,
Page: 104, Location: 1586-1587
A central bank can also loan funds directly to the banking system through a mechanism called the “discount window.” The Fed is the lender of last resort; as the name would suggest, banks are encouraged to go elsewhere first. The interest rate at which the Fed will loan funds directly to banks, the discount rate, is typically set slightly above the market rate at which banks borrow from one another.‡ Historically there has been not only a small pecuniary penalty for borrowing from the central bank but also a stigma. Borrowing from the Fed is like borrowing money from your parents once you are over thirty. You can do it, but everyone involved would prefer that you found the funds somewhere else. The Fed’s discount lending adheres to Walter Bagehot’s admonition that a lender of last resort ought to lend freely at a punitive rate. At the height of the financial crisis, both Morgan Stanley and Goldman Sachs, two of America’s preeminent investment banks, legally converted themselves into traditional bank holding companies in part so that they would have access to emergency lending from the Fed.
Page: 104, Location: 1591-1598
The Fed changes the supply of money in order to raise or lower the price of credit, which is a more intuitive way of describing the interest rate.
Page: 106, Location: 1617-1618
The federal funds rate is the thermostat for the credit market. The FOMC sets the thermostat and then conducts open market operations until the target interest rate is achieved. You should recognize that the Fed is not creating new wealth, only new money. Unlike dropping money from helicopters or randomly depositing new money at banks, no one is getting richer when the Fed injects new money into the system (or poorer when the funds are withdrawn). This is all about
Page: 107, Location: 1636-1639
The federal funds rate is the thermostat for the credit market. The FOMC sets the thermostat and then conducts open market operations until the target interest rate is achieved. You should recognize that the Fed is not creating new wealth, only new money. Unlike dropping money from helicopters or randomly depositing new money at banks, no one is getting richer when the Fed injects new money into the system (or poorer when the funds are withdrawn). This is all about liquidity.
Page: 107, Location: 1636-1639
The Fed does not respond to where prices are; they respond to where they think prices are going.
Page: 110, Location: 1686-1686
Just about everything related to monetary policy happens with a lag, meaning that some time elapses between cause and effect. If the corn crop is lousy in the Midwest this summer, food prices might be higher this fall, or next year, or some combination of both.
Page: 110, Location: 1686-1688
Cowen wrote in 2012, “The modern bank run means a rush to withdraw from money market funds, the disappearance of reliable collateral for overnight loans between banks or the sudden pulling of short-term credit to a troubled financial institution.”
Page: 113, Location: 1733-1735
the Basel Accords—Basel I, Basel II, and Basel III—are a set of voluntary international standards related to the amount of capital that banks should hold to protect against bad loans. (The agreements are named for the Swiss city where the Basel Committee on Banking Supervision meets to make the recommendations.) Under Basel III, banks with a significant role in the global financial system should hold capital equal to 7 percent of their assets (as of 2010). This capital is their own money that can be used to make up for losses, if necessary. The Basel recommendations do not have the force of law, but they tend to be the basis for regulations imposed
Page: 117, Location: 1781-1785
the Basel Accords—Basel I, Basel II, and Basel III—are a set of voluntary international standards related to the amount of capital that banks should hold to protect against bad loans. (The agreements are named for the Swiss city where the Basel Committee on Banking Supervision meets to make the recommendations.) Under Basel III, banks with a significant role in the global financial system should hold capital equal to 7 percent of their assets (as of 2010). This capital is their own money that can be used to make up for losses, if necessary. The Basel recommendations do not have the force of law, but they tend to be the basis for regulations imposed by national governments.
Page: 117, Location: 1781-1785
History suggests that changing reckless behavior is much harder than trying to change reckless behavior.
Page: 118, Location: 1805-1806
As the Economist explains, “Societies give unelected technocrats power over monetary policy because they think they will do a better job than politicians with an eye on the next election.”
Page: 120, Location: 1835-1837
CHAPTER 6 Exchange Rates and the Global Financial System
Page: 123, Location: 1881-1882
One currency can be swapped for another at whatever rate two parties are willing to make a voluntary trade. How much is my 2001 Volvo worth? Whatever someone is willing to pay for it. Currencies are no different, paper or not.
Page: 125, Location: 1911-1912
currency transactions are voluntary trades. The exchange rate between two currencies will reflect the price at which reasonable people find it advantageous to swap one currency for the other.
Page: 125, Location: 1917-1918
In the aggregate, the exchange rate between two currencies—the price at which one currency can be exchanged for another—will reflect supply and demand. If a huge number of Americans (holding dollars) suddenly want more Mexican pesos, the demand for pesos relative to dollars will go up, meaning that the “price” of pesos in dollars will climb. An economist would say that the peso has appreciated relative to the dollar, but really the price of that currency has gone up for the same reason roses are more expensive on Valentine’s Day: people are willing to give up more dollars to get them. If you want to sound fancy about it, you can say roses have appreciated relative to dollars.
Page: 126, Location: 1927-1931
PPP is an extremely useful benchmark for evaluating the relative value of currencies. Currencies that are worth more than PPP would suggest are typically described as overvalued.
Page: 129, Location: 1968-1970
dollar). When economic indicators are compared across countries, they are often converted into dollars using PPP rather than market exchange rates.
Page: 130, Location: 1985-1987
When economic indicators are compared across countries, they are often converted into dollars using PPP rather than market exchange rates.
Page: 130, Location: 1986-1987
all other things being equal, a weak currency is good for exports and bad for imports. A strong currency does the opposite: exports become more expensive and imports cheaper. This concept is so crucial to international economics, and therefore to global politics, that it deserves a simple numerical example.
Page: 131, Location: 2004-2006
all other things being equal, a weak currency is good for exports and bad for imports. A strong currency does the opposite: exports become more expensive and imports cheaper. This concept is so crucial to international economics, and therefore to global politics,
Page: 131, Location: 2004-2006
So which is better: a strong currency or a weak one? Any currency that is wildly out of sync with PPP will unfairly reward one group of citizens at the expense of another.
Page: 135, Location: 2057-2058
The authors write, “There is no ‘fail-safe’ method in estimating the proper value of an economy’s foreign exchange rate or in establishing a precise measure of over- or under-valuation.” 9 As with other policies related
Page: 136, Location: 2072-2075
The authors write, “There is no ‘fail-safe’ method in estimating the proper value of an economy’s foreign exchange rate or in establishing a precise measure of over- or under-valuation.”
Page: 136, Location: 2072-2074
better.” In other words, that depends, too. A strong currency does not necessarily reflect a strong economy. The dollar was strong in the 1990s when the economy was robust and capital from around the world was rushing to Silicon Valley. The dollar was also strong in the 1980s when capital was flowing to the United States because high government deficits forced us to borrow from the rest of the world.
Page: 136, Location: 2078-2082
A strong currency does not necessarily reflect a strong economy. The dollar was strong in the 1990s when the economy was robust and capital from around the world was rushing to Silicon Valley. The dollar was also strong in the 1980s when capital was flowing to the United States because high government deficits forced us to borrow from the rest of the world.
Page: 136, Location: 2079-2082
world. As the Economist observed, “Once upon a time, nations took pride in their strong currencies, seeing them
Page: 138, Location: 2101-2102
As the Economist observed, “Once upon a time, nations took pride in their strong currencies, seeing them as symbols of economic and political power. Nowadays it seems as if the foreign-exchange markets are home to a bunch of Charles Atlas’s 97-pound weaklings, all of them eager to have sand kicked in their faces.”
Page: 138, Location: 2101-2103
Other things being equal, lower interest rates make a country a less attractive place to invest. When investors sell the local currency to take advantage of more attractive investments elsewhere in the world, the exchange rate weakens.
Page: 138, Location: 2106-2108
It’s mathematically impossible for all currencies to get weaker at the same time. It’s like standing up at a football game to get a better view—a great strategy until everyone else does same thing. As the Economist has described (in the context of British football matches and currency depreciations), “No one’s view has improved but everyone is a lot less comfortable.”
Page: 138, Location: 2115-2117
A decade later, investors fearing economic disruption in the eurozone fled to the relative stability of Switzerland. In just eighteen months—between the beginning of 2010 and August 2011—the Swiss franc appreciated 43 percent relative to the euro. (This helps to explain why the Swiss franc was so overvalued according to the Big Mac Index.)
Page: 141, Location: 2157-2160
A currency intervention is often like trying to warm a cold bathtub with spoonfuls of hot water—especially while other market participants are dumping in buckets of cold water at the same time.
Page: 142, Location: 2163-2164
This phenomenon, when natural resource exports cause the exchange rate to appreciate to the point that it chokes the competitiveness of manufactured goods, is known as “Dutch disease.” Dutch gas exports in the 1970s had such an effect, as have oil exports in many countries ever since.
Page: 142, Location: 2174-2176
In fact, the gold standard is awesome—until it wrecks the global economy and imperils humanity. The major drawback of the gold standard follows naturally from the simple analysis in the last paragraph: gold flows around the globe in response to economic circumstances.
Page: 144, Location: 2200-2201
The gold standard, or any regime of rigidly fixed exchange rates, forces a nation to subvert its domestic economic interests to maintain the exchange rate.
Page: 145, Location: 2209-2210
The bigger point is that fixed exchange rates are only as credible as the governments defending them. Even a hint of weakness in government resolve can bring things crashing down.
Page: 146, Location: 2237-2238
two fundamental policy questions: What is the best exchange rate regime for an individual country? And how can currency values around the world be coordinated in a way that best promotes global stability and economic success?
Page: 149, Location: 2281-2282
the “trilemma” of international finance: no country can simultaneously allow free flow of international capital flow; use monetary policy to serve domestic economic needs; and maintain a fixed exchange rate. The term “trilemma” is a clever play on the policy dilemma here—policymakers can control any two of these two policy levers, but that requires letting go of the third.
Page: 149, Location: 2285-2288
CHAPTER 7 Gold
Page: 156, Location: 2385-2386
Keynes, a fierce critic of the gold standard in general, eloquently stated the logical result: “Gold is liable to be either too dear or too cheap. In either case, it is too much to expect that a succession of accidents will keep the metal steady.”
Page: 158, Location: 2417-2419
Yes, gold exists in finite supply, but that in no way guarantees stable prices. If the quantity of gold coming out of the ground grows faster than the rest of the economy, prices (in gold) will typically rise. If growth in the supply of gold lags behind the rest of the economy, gold will become relatively more valuable and prices will fall. This was Keynes’s critique—though really it is just basic supply and demand.
Page: 164, Location: 2502-2505
Bad governments cause bad money, not the other way around.
Page: 166, Location: 2534-2535
Peter Bernstein tells the impressive story of Dionysius of Syracuse (430–367 BC) who was heavily indebted to his citizens and had insufficient income to pay them back. “[Dionysius] ordered all coins in the city brought to him, under penalty of death. He restamped the coins so that each drachma coin now read two drachmas. After that, paying off his debts was easy.”
Page: 166, Location: 2543-2546
lesson: a currency is as good as gold—until the government says it is not.
Page: 168, Location: 2563-2563
CHAPTER 8 A Quick Tour of American Monetary History
Page: 175, Location: 2678-2679
money. In 1690, the Massachusetts Bay Colony became the first government in the Americas to issue paper
Page: 180, Location: 2759-2760
In 1690, the Massachusetts Bay Colony became the first government in the Americas to issue paper money.
Page: 180, Location: 2759-2760
In 1764, the perfidious British rendered the paper money debate temporarily moot by passing the Currency Act, which outlawed all of the paper money issued by the colonies.
Page: 181, Location: 2772-2773
Congress soon took advantage of its monetary prerogative, passing the Coinage Act of 1792.26 The law sanctioned the construction of the first federal building, a United States Mint in Philadelphia.
Page: 183, Location: 2806-2808
A 10goldcoincontained17.5gramsofgold;a1 silver coin contained 27 grams of silver. Of course, this “bimetal” standard also fixed the value of gold and silver to each other (at a ratio of 15 to 1). The United States would operate on this bimetallic regime for the better part of a century.
Page: 184, Location: 2811-2813
When gold was discovered at Sutter’s Mill in California in 1848, it helped propel the country to a decade of rapid monetary expansion and rapid growth. It was, in the words of economic historian Glyn Davies, “one of the clearest examples in history of the stimulative power of good-quality money.”
Page: 187, Location: 2866-2868
CHAPTER 9 1929 and 2008
Page: 206, Location: 3146-3147
actors). Let’s start at the bottom: too many people borrowed too much money to buy real estate.
Page: 219, Location: 3355-3356
Let’s start at the bottom: too many people borrowed too much money to buy real estate.
Page: 219, Location: 3355-3356
The reality is that the real estate bubble inspired people and businesses to borrow heavily to buy properties they erroneously believed would not fall significantly in value. Without that fundamental error in judgment, the rest of the crisis could not have happened. The typical real estate purchase was far more leveraged than the stocks purchased on margin in the run up to the 1929 crash. Putting 5 percent down on a house means the other 95 percent is borrowed. (And by the time the party was really going, 5 percent down was old-fashioned.)
Page: 219, Location: 3356-3360
Your condo loan might be packaged with 999 other mortgages and sold off to an investor who wanted to receive the steady stream of income as those mortgages were (hopefully) paid off.
Page: 220, Location: 3369-3370
hundreds more.” 28 The ratings agencies come next in our chain of avarice and incompetence: Moody’s, Standard & Poor’s, and Fitch. If this whole crisis were a massive car wreck, the ratings agencies would be the ones who gave the keys to the drunk driver and helped ease him into the driver’s seat. There is nothing inherently wrong with securitizing mortgages as long as investors understand the quality of the assets that have been bundled into the security.
Page: 221, Location: 3379-3383
The ratings agencies come next in our chain of avarice and incompetence: Moody’s, Standard & Poor’s, and Fitch. If this whole crisis were a massive car wreck, the ratings agencies would be the ones who gave the keys to the drunk driver and helped ease him into the driver’s seat. There is nothing inherently wrong with securitizing mortgages as long as investors understand the quality of the assets that have been bundled into the security.
Page: 221, Location: 3380-3383
The two firms, known as government-sponsored enterprises, or GSEs, combined the worst of both worlds: the private sector hunt for profits with an implicit government guarantee if things went wrong. In 2005, Fannie and Freddie began buying and holding bundles of subprime mortgages—almost exactly at the peak of the real estate market. Suffice it to say, this turned out badly. In September 2008, the federal government took over both Fannie Mae and Freddie Mac after huge losses threatened to bankrupt them.
Page: 222, Location: 3402-3406
Last but not least, the firm AIG (American International Group) put the frosting on this poop cake by insuring some of the most exotic mortgage-related securities. Technically, AIG offered “credit default swaps,” which are promises to pay compensation in the event the issuer of a security defaults or misses a payment. Unlike regular forms of insurance, however, AIG was not required to set aside reserves against potential losses. When real estate prices were rising steadily, this was a great business—like writing hurricane insurance in Florida when it’s not hurricane season. What’s not to like about the steady flow of checks? But when the hurricane season arrived—the collapse of the real estate market—AIG was not able to make good on its promises. This, too, ended badly. In September 2008, the federal government seized control of AIG, providing $85 billion in new capital to keep it afloat.
Page: 223, Location: 3406-3412
insurance.) The repo market was essentially a bank. Firms lending into the repo market are like depositors. They can get their money whenever they want it. But rather than rushing to the bank to make a withdrawal, they just stop renewing the overnight loans (or they demand much more collateral). This is when borrowing 100millionfortenyearsstartstofeelverydifferentthanborrowing100 million every day over
Page: 225, Location: 3447-3450
The repo market was essentially a bank. Firms lending into the repo market are like depositors. They can get their money whenever they want it. But rather than rushing to the bank to make a withdrawal, they just stop renewing the overnight loans (or they demand much more collateral). This is when borrowing 100millionfortenyearsstartstofeelverydifferentthanborrowing100 million every day over and over again. Firms like Bear Stearns and Lehman Brothers were borrowing short-term in the repo market to finance long-term operations. It would be like paying off your house by refinancing the mortgage every evening; if the value of the property drops, that refinancing gets a lot harder.
Page: 225, Location: 3447-3452
Nobody wanted to be holding the contaminated ground beef, or lending to anyone holding contaminated ground beef, or entering into trades with firms that might have exposure to contaminated ground beef.
Page: 226, Location: 3462-3463
Yes, irresponsible lending and the securitization of bad loans amplified and spread the problem. But at the end of the day, this was an old-fashioned financial panic. Customers were not lined up outside of banks; instead firms and institutional investors were demanding their cash back from financial firms like Bear Stearns, Lehman Brothers, Citibank, and the other names you’ve seen in the news. As one witness told the Financial Crisis Inquiry Commission, “The repo market, I mean it functioned fine up until one day it just didn’t function.”
Page: 226, Location: 3465-3468