An Idiot's Guide to Central banking - My article for Express Tribune

[AsifAmeer]

[h=1]Global central bankers in the spotlight[/h]http://tribune.com.pk/story/480452/global-central-bankers-in-the-spotlight/

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DALLAS: Recently, there has been a spotlight on the activities of global central bankers who manage the global money supply. Primarily, there are three major active central banks the US Federal Reserve, the European Central Bank and the Bank of Japan. These banks usually collaborate with each other while making changes to their policies.

Of course, there are other central banks, but their issued currencies do not buy oil, settle balance of payments or satisfy international debt. Then, we have the Bank of International Settlement (BIS) in Basel, Switzerland. BIS and the Society for Worldwide Interbank Financial Telecommunication (SWIFT) are supposed to function as a global clearing house for international payment and regulators of the global banking system.

BIS is infamous for manipulating the dollar/euro rates, also affecting Libor rates sort of global banking interest rate.

Money
Some call it the root of all evils. Others call it lubrication for trade. Heres how its generally created. No, the government doesnt simply print money. That job has been outsourced to its central bank. The government borrows cash from primary dealers, the elite commercial banks, and issues them borrowing receipts called treasury bills (T-bills).

The primary dealers buy cash using those T-bills from a special bond market called the repo market. It is in this repo market, the central bank buys those T-bills using newly printed cash or electronic credit. This process of injecting liquidity into the market is called open market operation (OMO) or quantitative easing (QE). So why doesnt the central bank directly lend to the government? They say these steps maintain the banks autonomy. So why doesnt the government simply print the money itself? The unofficial answer is, simplicity and transparency reduces the room for confusion. Complexity breeds confusion and corruption.

Just to be fair, whatever income the central bank gets in interest for the borrowed funds, is deposited back into the government treasury account (minus administrative cost). The primary dealers retain their cut called spread.


Modern money theory
This process of money creation is called chartalism or modern money theory. In this process, value of money is derived from taxation. Here is how this policy is supposed to work in theory. Government can run deficit budgets as long as the total debt remains proportional and manageable compared to the overall GDP. Government should be running surplus during good times and switch to deficits during bad times to pick the slack of the private sector.

But when the deficit starts to get bigger, the central bank is supposed to raise the rates. Since interest income to the central bank is poured back into the treasury, this in turn reduces the deficit gap.

If the central bank gradually continues to increase rates to bring government spending in line with income, it will stabilise the currency and pricing.


Fear the carry trade
Just like price fixing/floors/ceilings cause hoarding, black markets and shortages, fixing interest rates causes mispricing of risk, artificial currency appreciation, accumulation of risk in the financial sector and the buildup of the carry trade tsunami in forex. Reason why countries peg their currency to the dollar is to reduce their borrowing cost in international markets, causing distortions in their economies.


Realities
There is no such thing as an apolitical central bank. Debt, along with implicit backing of central bank through intervention in the repo market, injects moral hazard into government decision-making and the entire banking system.

Dilution of currency shifts wealth from the productive real economy to the government and financial sector. Debasement of currency increases commodity and import prices, squeezing profit margins of the private sector as the cost of raw materials, energy and imports goes up.

This is the reason why low interest rates do not spur real economic growth, but boosts speculative investment. Its true that inflation is a monetary phenomenon but hyper-inflation is a political phenomenon.

The writer is a Dallas-based equity, bonds and derivatives trader

Published in The Express Tribune, December 17[SUP]th[/SUP], 2012.

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COMMENTS: I know this thing is very technical. And its ok if you do not understand everything. But just go thru the "Fear the Carry Trade" and the "Reality" section.

Feel free to ask

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[EniGma90]

@Asif looks like that some 1 is really angry wid u.

Ist comment by Tamaaz khan

"Ridiculous article
The gentleman doesnt seem to have even a cursory understanding of fiscal and monetary policy.
Tribune needs to do a better job of editing and choosing writers.
Just filling a article with financial jargon does not ensure a cogent argument." :P

 

[AsifAmeer]

I call that noise, not because he is calling foul. But because he is calling foul without pointing out anything specific. There is another type of foul you are gonna see in the comment section. They will take my argument, draw a false conclusion and then claim my concept is wrong.

Thats why I call it noise.

@Asif looks like that some 1 is really angry wid u.

Ist comment by Tamaaz khan

"Ridiculous article…
The gentleman doesn’t seem to have even a cursory understanding of fiscal and monetary policy.
Tribune needs to do a better job of editing and choosing writers.
Just filling a article with financial jargon does not ensure a cogent argument." :P

 

[islamabadi6]

In case you havent noticed munna this is siasat.pk not siasat.USA...so stop clining onto whatever little Pakistaniyat you have left in you by coming onto Pakistani newspapers and sites and making yourself feel useful to us Pakistani.s Go worry about Obama politics

 

[guest]

mr asif i object to your modern money theory. in many ways the fundamental importance that you give to deficits is contradictory to the way capitalism is organized in the world. deficits and surplus go together, so if US is running huge deficits, others have to by definition be running huge surpluses to fnd these deficits (china, japa, saudi etc). thus in a world where the US acts as a Keynesian customer of last resort, and others either act as providers of resources (saudi etc) or production units of the world (china, south asia, vietnam etc), there is no option but to have US running huge trade/budget deficits and everyone else run huge surpluses and fund the US deficits. it is structurally impossible to have any other outcome. you have to present analysis for the whole world, rather then one region, as capitalism today is about global dynamics of capital, labour and resources.

I also object to the money creation theory that you accept as an axiom. i suggest you listen to an economist called steve keen and his critique of the money creation theory. his is a much more comprehensive idea of money. first of all when you say money, you have to have to include credit creation in it, as it forms a much larger chunk of the fungible. once you do that, you will realise that due to structure of banks in OECD nations, private money creation is much larger and important than government money creation.

 

[AsifAmeer]

I WISH this stuff were Textbook material in Unis. Its not. I had to get in touch with senior traders at Major banks and IMF to understand the complexities. Had to buy 10s of books, get in touch with their authors like get understand the issues.

Gotti, Maybe you can elaborate Khan's concerns too. Criticism lacking specifics is noise. You dont wanna sound noisy.. do you?

I call that noise, not because he is calling foul. But because he is calling foul without pointing out anything specific. There is another type of foul you are gonna see in the comment section. They will take my argument, draw a false conclusion and then claim my concept is wrong.

Thats why I call it noise.

I agree with Mr. Khan because this is just a textbook excerpt on Fiscal and Monetary policy and something kids are taught in introductory courses on Economics, Macroeconomics, Money, and other relevant concepts, which does not need to be published as a "journalistic" article.

Therefore, the Tribune, associated with names such as the IHT and NYT, needs to, as Mr. Khan states "do a better job of editing and choosing writers"

Why? well, because, as he says "Just filling a article with financial jargon does not ensure a cogent argument."

Those who want to be taught economics, will pick up a book, not visit websites that are purportedly presenting "news" on the economy.

Also, being a day-trader has absolutely no impact on how one understands the economy and those who have no understanding of the financial world, might buy this argument but the reality is that Warren Buffet's advice to the Fed will be sh@t on from such a height that he'll think Ben Bernanke did it from the tip of the Empire State building.

Stocks have no impact on a nation's GDP and neither do they reflect on how intellectual someone is with respect to their understanding of macroeconomic principles.

No disrespect or offense intended as only the right to exercise free speech is what has occurred in this post and nothing else.

I appreciate something if it is worthy of appreciation even if it is from people I can't stand, at all, and the example would be of @sherkhan314 whose piece was wonderfully written and very eloquent in nature despite my utter hatred for PTI, Imran Khan and even him (bigsmile)

Therefore, this is not personal but just a statement of fact, or even opinion (depending on how one perceives what I wrote).

BTW, it was going to happen, eventually - I was only waiting when - I had started to wonder if I was the only one who thought the way I did but no, I am not someone extremely intelligent or unique in my way of thinking.

There are a lot of people out there who are far superior in their intellect and they have now started to become vocal against idiocy just as Mr. Khan did in his comment.

The Tribune, who has decent traffic and online tools to make money will eventually take note of Mr. Khan's comments and other intelligent folks who, if they read this non-sense, will follow suit, and make comments similar to those of Mr. Khan.

This is only important for the betterment of journalism and the flow of information for Pakistanis, not for individuals, their glory or hatred against them, etc.

 

[gazoomartian]

Too long and too financial. I refuse to read it

 

[AsifAmeer]

I truly appreciate your argument. And this is the very argument we hear everywhere in the policy making circles.

Do this, for a minute forget about everything you know. Lets just use simple thought processes. Lets try to negate to the conclusion.

Suppose Russia were supposed to run these huge trade deficits US is running. What would happen? Two things
1. Currency devaluation of Ruble
2. Inflation in Russian Economy.

So far so good? So why is the US able to run the deificts? I hinted to that in the 1st para.
1. Dollar denominated Oil
2. Dollar denominated International debt
3. Dollar liquidity

Now read this report
http://www.sprott.com/markets-at-a-glance/the-greatest-trade-of-all-time/


What I share here is not something new. Its just not covered in textbooks. Its even got a term coined after it called the "Triffin Dilema" back in the 60s.

In a free floating currency model, you cant have a reserve currency. Otherwise every other currency will start to depreciate, causing the reserve currency's economy to run trade deficits. Currency War is the natural consequence of this Reserve currency model outcome.

I wrote about this very thing in
http://blogs.tribune.com.pk/story/10374/how-the-mighty-dollar-weakens-the-rupee/

These ideas not are very common in policy cirlces, but actually looked down upon.

I'd rather speak the truth than be respected...

mr asif i object to your modern money theory. in many ways the fundamental importance that you give to deficits is contradictory to the way capitalism is organized in the world. deficits and surplus go together, so if US is running huge deficits, others have to by definition be running huge surpluses to fnd these deficits (china, japa, saudi etc). thus in a world where the US acts as a Keynesian customer of last resort, and others either act as providers of resources (saudi etc) or production units of the world (china, south asia, vietnam etc), there is no option but to have US running huge trade/budget deficits and everyone else run huge surpluses and fund the US deficits. it is structurally impossible to have any other outcome. you have to present analysis for the whole world, rather then one region, as capitalism today is about global dynamics of capital, labour and resources.

 

[Keepinformed]

The article I agree with as part of few pieces of the larger pie we call the modern financial system.

Its more complex.

I am seeing that you have finally entered into publishing. It would be better to see your article posted on SeekingAlpha.com or BusinessInsider.com type blogs. Either way G L.

 

[guest]

Too long and too financial. I refuse to read it

typical muslim of today are you. i agree, so much easier to blame the jews and/or hindus. who will take the time to read and investigate real issues. just demagogue your way to glory. (clap)

 

[Keepinformed]

typical muslim of today are you. i agree, so much easier to blame the jews and/or hindus. who will take the time to read and investigate real issues. just demagogue your way to glory. (clap)

Demagoguing requires creative skills. Not everyone can become Sheikh Rasheed.

 

[guest]

Asif you are still not recognizing my key point. the dollar denominated trade is not an accident. no other country other than the US can have its currency forced down on others as a trading currency. capitalism is itself structured to have the US as a customer of first and last resort. i ask you a simple question. if equilibrium is what drives economics, we all know such huge deficits year after year are far far from equilibrium. why then is not the US economy completely falling to pieces? the ron pauls and peter schiffs have for years been saying this, but it never happens.


also if US collapses, who is going to become consumer of last resort? who will gulf sell oil to? who will china sell manufactured goods to? thats why i am saying that we have a global structural problem, which probably has no reasonable solution. you cannot have the present system of capitalism the way it is run, and yet correct global trade and capital imbalances. and let me be clear, when i say present system of capitalism what i mean is the capitalism where nation states have no meaning. global capital freely flows from tokyo to london to NY without anyone stopping it. nation states have no power here. thats why HSBC and Deutch bank and Credit suisse etc can get bailout money from US Fed and avoid prosecution from financial crimes by US regulators. the capitalism of today is not beholden to nation states, and so it has decided for all of us that US will be the consumer of last resort and the third world will be dominions of resource or production.

I truly appreciate your argument. And this is the very argument we hear everywhere in the policy making circles.

Do this, for a minute forget about everything you know. Lets just use simple thought processes. Lets try to negate to the conclusion.

Suppose Russia were supposed to run these huge trade deficits US is running. What would happen? Two things
1. Currency devaluation of Ruble
2. Inflation in Russian Economy.

So far so good? So why is the US able to run the deificts? I hinted to that in the 1st para.
1. Dollar denominated Oil
2. Dollar denominated International debt
3. Dollar liquidity

Now read this report
http://www.sprott.com/markets-at-a-glance/the-greatest-trade-of-all-time/


What I share here is not something new. Its just not covered in textbooks. Its even got a term coined after it called the "Triffin Dilema" back in the 60s.

In a free floating currency model, you cant have a reserve currency. Otherwise every other currency will start to depreciate, causing the reserve currency's economy to run trade deficits. Currency War is the natural consequence of this Reserve currency model outcome.

I wrote about this very thing in
http://blogs.tribune.com.pk/story/10374/how-the-mighty-dollar-weakens-the-rupee/

These ideas not are very common in policy cirlces, but actually looked down upon.

I'd rather speak the truth than be respected...

 

[sherkhan314]

I agree with Mr. Khan because this is just a textbook excerpt on Fiscal and Monetary policy and something kids are taught in introductory courses on Economics, Macroeconomics, Money, and other relevant concepts, which does not need to be published as a "journalistic" article.

Therefore, the Tribune, associated with names such as the IHT and NYT, needs to, as Mr. Khan states "do a better job of editing and choosing writers"

Why? well, because, as he says "Just filling a article with financial jargon does not ensure a cogent argument."

Those who want to be taught economics, will pick up a book, not visit websites that are purportedly presenting "news" on the economy.

Also, being a day-trader has absolutely no impact on how one understands the economy and those who have no understanding of the financial world, might buy this argument but the reality is that Warren Buffet's advice to the Fed will be sh@t on from such a height that he'll think Ben Bernanke did it from the tip of the Empire State building.

Stocks have no impact on a nation's GDP and neither do they reflect on how intellectual someone is with respect to their understanding of macroeconomic principles.

No disrespect or offense intended as only the right to exercise free speech is what has occurred in this post and nothing else.

I appreciate something if it is worthy of appreciation even if it is from people I can't stand, at all, and the example would be of @sherkhan314 whose piece was wonderfully written and very eloquent in nature despite my utter hatred for PTI, Imran Khan and even him (bigsmile)

Therefore, this is not personal but just a statement of fact, or even opinion (depending on how one perceives what I wrote).

BTW, it was going to happen, eventually - I was only waiting when - I had started to wonder if I was the only one who thought the way I did but no, I am not someone extremely intelligent or unique in my way of thinking.

There are a lot of people out there who are far superior in their intellect and they have now started to become vocal against idiocy just as Mr. Khan did in his comment.

The Tribune, who has decent traffic and online tools to make money will eventually take note of Mr. Khan's comments and other intelligent folks who, if they read this non-sense, will follow suit, and make comments similar to those of Mr. Khan.

This is only important for the betterment of journalism and the flow of information for Pakistanis, not for individuals, their glory or hatred against them, etc.

lol. tu baaz nahi aye ga :P

 

[AsifAmeer]

You are 100% correct in terms of money creation. Most of the "credit creation" is done via private banks.

I have gone thru Steve Keen's material, including his Minsky Model. Also gone thru his book - debunking economics, which is excellent.

My argument is, just by debasement and fixing interest rates, Central banks are giving preference to financial capital over labor and economic resource. Thats the central argument i place. That is why I said low interest rates do not spur real growth but financial speculation which then spills over into some growth but the debt makes the economy fragile to economic shocks.

I also object to the money creation theory that you accept as an axiom. i suggest you listen to an economist called steve keen and his critique of the money creation theory. his is a much more comprehensive idea of money. first of all when you say money, you have to have to include credit creation in it, as it forms a much larger chunk of the fungible. once you do that, you will realise that due to structure of banks in OECD nations, private money creation is much larger and important than government money creation.

 

[AsifAmeer]

I get 700 words to put my views in. Not alot when you are trying to explain International Monetary System.

Those websites like seekingalpha or businessinder have some amazing amazing writers. There is absolutely no need for me to write for them. I would consider myself as a noise. There are many very geniune point of views in the Western economic community which I have yet alot to learn from.

The reason why I am writing for Pakistani news is because of the vacuum in the Pakistani financial media reporting. I have been helping few senior columnist for Pakistan in shredding data from the monetary policy. Hopefully something good will come out of it..

The article I agree with as part of few pieces of the larger pie we call the modern financial system.

Its more complex.

I am seeing that you have finally entered into publishing. It would be better to see your article posted on SeekingAlpha.com or BusinessInsider.com type blogs. Either way G L.

 

[Unicorn]

Asif you are still not recognizing my key point. the dollar denominated trade is not an accident. no other country other than the US can have its currency forced down on others as a trading currency. capitalism is itself structured to have the US as a customer of first and last resort. i ask you a simple question. if equilibrium is what drives economics, we all know such huge deficits year after year are far far from equilibrium. why then is not the US economy completely falling to pieces? the ron pauls and peter schiffs have for years been saying this, but it never happens.

also if US collapses, who is going to become consumer of last resort? who will gulf sell oil to? who will china sell manufactured goods to? thats why i am saying that we have a global structural problem, which probably has no reasonable solution. you cannot have the present system of capitalism the way it is run, and yet correct global trade and capital imbalances. and let me be clear, when i say present system of capitalism what i mean is the capitalism where nation states have no meaning. global capital freely flows from tokyo to london to NY without anyone stopping it. nation states have no power here. thats why HSBC and Deutch bank and Credit suisse etc can get bailout money from US Fed and avoid prosecution from financial crimes by US regulators. the capitalism of today is not beholden to nation states, and so it has decided for all of us that US will be the consumer of last resort and the third world will be dominions of resource or production.

I just want to know how US is forcing anyone to trade in their currency? Every country can choose how or what medium to use as trade. Before US dollar people traded with British pounds and gold. When did US force anyone to trade in their currency?

 

[AsifAmeer]

I think I agree with almost everything you just said.. except this "capitalism is itself structured to have the US as a customer"

For some reason I find that a bit offensive.. lol. How can free market prefer 1 country over the other? Think about it... The reason is not an economic law but a political one. US controls Oil. It controls International trade. It controls the Global Banking sector. Now when I say US, I do not mean the US congress or the American people. I mean the US primary dealer banks and its board.

Now to your question of if US doesnt remain the consumer of last resort, who will.. The answer is - the producing economies! Let the Chinese play with the toys they make. Let the pakistani taste the rice he grows. Let the indian wear that shirt he stitches. But how? By restoring purchase power their their respective currencies but settling their exports in their local currencies.


Did you read my article on Rupee vs the Dollar? Do you see my point? Did you look up the Triffin's dilema?

Asif you are still not recognizing my key point. the dollar denominated trade is not an accident. no other country other than the US can have its currency forced down on others as a trading currency. capitalism is itself structured to have the US as a customer of first and last resort. i ask you a simple question. if equilibrium is what drives economics, we all know such huge deficits year after year are far far from equilibrium. why then is not the US economy completely falling to pieces? the ron pauls and peter schiffs have for years been saying this, but it never happens.


also if US collapses, who is going to become consumer of last resort? who will gulf sell oil to? who will china sell manufactured goods to? thats why i am saying that we have a global structural problem, which probably has no reasonable solution. you cannot have the present system of capitalism the way it is run, and yet correct global trade and capital imbalances. and let me be clear, when i say present system of capitalism what i mean is the capitalism where nation states have no meaning. global capital freely flows from tokyo to london to NY without anyone stopping it. nation states have no power here. thats why HSBC and Deutch bank and Credit suisse etc can get bailout money from US Fed and avoid prosecution from financial crimes by US regulators. the capitalism of today is not beholden to nation states, and so it has decided for all of us that US will be the consumer of last resort and the third world will be dominions of resource or production.

I just want to know how US is forcing anyone to trade in their currency? Every country can choose how or what medium to use as trade. Before US dollar people traded with British pounds and gold. When did US force anyone to trade in their currency?

 

[Unicorn]

I think I agree with almost everything you just said.. except this "capitalism is itself structured to have the US as a customer"

For some reason I find that a bit offensive.. lol. How can free market prefer 1 country over the other? Think about it... The reason is not an economic law but a political one. US controls Oil. It controls International trade. It controls the Global Banking sector. Now when I say US, I do not mean the US congress or the American people. I mean the US primary dealer banks and its board.

Now to your question of if US doesnt remain the consumer of last resort, who will.. The answer is - the producing economies! Let the Chinese play with the toys they make. Let the pakistani taste the rice he grows. Let the indian wear that shirt he stitches. But how? My restoring purchase power their their respective currencies but settling their exports in their locoal currencies.


Did you read my article on Rupee vs the Dollar? Do you see my point? Did you look up the Triffin's dilema? These view

If you agree with every thing he said than you explain how US is forcing every one to trade in their currency. I also disagree like you with the statement in bold. Capitalism has been around for thousands of years before US so it would be an impossibility to " Structure " capitalism to have US as a customer thousands of years ago, I rest my case.

 

[guest]

@AsifAmeer and @Unicorn on the contrary i am arguing that nation states of today are powerless against globalized capital as represented thru the banks and MNC's. the US is not forcing anyone. The international capital (as represented by ...) has decided for all of us that this is the way things should function. this is not a direct coercion, but if you refuse to play ball (like say iran does), you are treated like a pariah state and your participation in global trade is severely limited. if what you are saying is true (that nation states have control on how to participate in the global capitalistic system), then why is there not one significant country which has abandoned the dollar. it is easy to say that the chinese should restore their people's purchasing power. but for that to happen, they will have to throw the US debt back on the face of the US or atleast stop investing in US debt from now onwards. but if they do that, it will case a massive shock in the global economic system and the controlling capitalists will bear down upon the US and china to come to some agreement so as to not upturn the applecart.

this is why i hate these equilibrium and free will based arguments. if these aruments were correct, long back the china or the Russia would have diversified out of US dollar denominated trading, as they have powerfull enuff militaries that the US cannot attack them. it is not as simple as that and it will never happen, unless the people in control decide to move towards a different inequilibrium point, or there is revolution against these people and they are replaced by a different set of capitalist ideas.

similarly i ask you, why are the EU guys hell bent on having Greece and the PIGS within the european union. the greeks dont want it, the german dont want it. but their is this overreigning group represented by the EU (but actually who themselves represent the capitalists of today) who want to keep the show going. you cannot use equilibrium arguments to explain this. Unicorn will ask why dont the greeks themselves get out of the union. well there are a few political parties within greece who say that. but there is massive propoganda against them before elections which keeps them out of power. even if they came to power and tried to get out of euro, the IMF, the WB, the European central bank and the rest will fall on them like a ton of bricks. in my opinion, the only country where this idea worked was iceland who went their own merry way, but they also got away mainly because they are to small an economy.

I just want to know how US is forcing anyone to trade in their currency? Every country can choose how or what medium to use as trade. Before US dollar people traded with British pounds and gold. When did US force anyone to trade in their currency?

 

[guest]

If you agree with every thing he said than you explain how US is forcing every one to trade in their currency. I also disagree like you with the statement in bold. Capitalism has been around for thousands of years before US so it would be an impossibility to " Structure " capitalism to have US as a customer thousands of years ago, I rest my case.

capitalism has been around for a while, agreed. but never has capitalism been this global and this fluid. never could money from macau be invested in the forex market of NY in the morning and then later in the afternoon move on to get invested in oil bourse at london and evening spend its last hours of the day sitting in the US bond market. so its a false comparison.

let me give a poor yet effective analogy which expolits the idea of the fluidity of todays capitalistic system as against anything before the WW2. if older version of capitaism was like honey (a very slow moving and dense fluid), todays capitalism is like a gas. like in physics you may model flow of honey by say stokes flow, while gas would have to be modelled by gas dynamics equations. totally different physics with different laws, though both are fluids and are fundamentally (asbtractly) derived from the same set of abstract equations.

US was made the cosutomer of last resort when the 2nd bretton woods agreement was dumped in favour of dollar free float by nixon and further soidified after the OPEC Oil crisis when dollar was used to trade oil. these agreements were not in favour of any nation state. on the face of it, they benefited the US, but they laid the foundation for the destruction of the american working class, as the well paying production jobs were permanently moved away from US. and its for this reason that the median income in US has stagnated since roughly the same time. so your analysis based on nation states is wrong. It harmed large sections of the US population in a massive way. Yet it benefited the banks and MNC's operating out of USA massively as corporate profits went thru the roof since that time and corporate taxes went down the drain.