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Economic genius required---to explain these?

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Where does all this money required to bail out these Companies come from---I believe its just printed and isn't actually a "surplus" as such.So wheres it come from?
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It's like a credit card. Get the money now but pay it back in the future. The government gets this money in the future by taxing people more.

Where does this money go ---who gets it---who benefits---how is it used---what actually IS the debt being paid out?
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Assets these failed companies own that depreciated will be purchased at inflated prices. This will put money into the system, increasing liquidity.

OK so now the American government is in deeper and deeper debt---TO WHO? Whats to stop a never ending increase in debt?
How would this debt be paid back? Who would pay it back? If its never paid back then what.
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The debt is mainly from Treasury bonds. The debt will mainly be paid back to Arab and Asian countries.
 
Great questions and contributions so far. My question is: why are they spending so much money to try and sponge up the toxic derivative mess; wouldn't that money be far better utilised in buying up the underlying assets, which would drive up their price?
Say the total derivative value at risk is 500 trillion dollars. This value may be 1,000 times more than the underlying assets on which this pyramid was built.
Wouldn't it be far more effective to try and drive up the price of the underlying assets by 10% for starters?
 
another 2c worth
 
refined silver said:

Chops - hadn't heard or read about that (about Germany).
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I didn't know either until I started reading about it again:

 
tech/a said:
So I need some genius Economic help to these specific questions.
I cant find the answers hopefully here!
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There are some fantastic answers posted so far, but they've been scattered over many many different replies, and mixed in with links, and maybe some answers I don't think is 100% correct. May I take my shot at answering these?

tech/a said:
(1) Where does all this money required to bail out these Companies come from---I believe its just printed and isn't actually a "surplus" as such.So wheres it come from?
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You are correct, the money is just printed. So what it's doing is diluting the value of money already in existance.

So just say I have 10 apples, and there is $10 in existance. If everyone wants an apple, then each apple will sell for $1.

If I print more money so that there is $20 in existance, and everyone still wants an apple, then each apple will find it's new equilibrium at $2 each.

So when the fed prints more money, everyone holding existing USD loses a bit.

tech/a said:
(2) Where does this money go ---who gets it---who benefits---how is it used---what actually IS the debt being paid out?
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The money is used in various different ways. One way is for the government to buy bad debt. Say you're a bank with $100 Billion in sub prime loans. You ask to borrow some money from another bank, and the bank asks for collateral. You put forward your sub prime loan, and they laugh in your face. No loan, you're stuffed. Your creditors get to foreclose and you go under.

But the Fed is saying "We'll give you $85 Billion in T-Bills for those $100 Billion in sub-prime loans, and you can then use the T-Bills to borrow against". The Fed takes the risk of default, but if less than 15% defaults, they win. So it's not money for nothing, but rather putting confidence back in the market. (Figures totally made up. If the Fed paid 85c on the dollar, they're paying way too much IMHO)

In other deals, it's more about the rate of interest. The other bank might say "Yes, we'll loan you 100 Billion, but we're going to lend it to you at 200 basis points over cash, to factor in some extra reward for the risk we're taking". Unfortunately, if you've loaned it out at 150bp above cash, then borrowing it at 200bp above, is a recipe for losing money fast. So the Fed might say "Okay, we'll lend it to you at 100bp above cash, but in return, we're taking 89% of stock holder equity". (Freddie/Fannie)

Another one I won't go into much detail with, is where the Fed will loan against poor quality collateral, without excessive risk premiums.

Who benefits? Not usually the bailed out entity. The Fed has been very careful in avoiding the appearance of creating moral hazard. The people who benefited, are the share holders, who had the stock BEFORE it all started unravelling (and sold before the crash), and executives in multi-million dollar bonuses.

So in the present term, it doesn't figure out anyone benefits. It's like saying you had the party, and now the piper has to be paid. Nobody can, so the piper takes the kids. Everyone loses, except those who attended the party and pissed off.

tech/a said:
(3) OK so these debts are paid out---who owes who for what?
Does the Government now own the companies bailed out? Do they have to pay back the debt---ever?
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So far the Fed have demanded a stake in the companies that they've bailed out. The loan does have to be paid back, where it is clear it is a loan.


tech/a said:
(4) OK so now the American government is in deeper and deeper debt---TO WHO? Whats to stop a never ending increase in debt?
How would this debt be paid back? Who would pay it back? If its never paid back then what.
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The government isn't necessarily deeper in debt. In fact, the money that other countries are holding are worth less, not more, so in real terms, their debt is decreased. However, then people start dumping the USD, and the price of their exports go down (relatively) and the price of their imports go up (relatively).

So the US citizen cops the brunt of it.

Countries have repudiated debt before. I'm not sure if the US has. But those countries basically have their dollar go worthless. They have to trade in another country's currency, or gold. Look at Zimbabwe. In order to reduce their foreign debt, they just kept printing more and more money, to make their debt worth less and less. Even if their debt isn't held in Zimbabwe dollars, they print more money, trade it for USD, pay off some debt, then their dollar falls, their inflation goes through the roof, and the next people buying Zimbabwe dollars is wary.

tech/a said:
(5) I understand that hyper inflation will devalue the monetary system of the country involved.At that point of collapse what happens to start it up again as Germany did?
Whats the process?
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Basically, they stop printing money, put faith back in their currency (usually by taking 9 or 12, or 15 zeros off the end of their notes), and it's a slow and painful process.

Hope this has helped. I might not be 100% correct on all answers, but I am fairly well read, and I have studied economics, and I believe what I say here to be an accurate, if somewhat over simplified answer.

If anyone can contradict me with proof, I'm always keen to learn.

Cheers,

Ken.
 

Doesnt make sence---more money apples MORE EXPENSIVE!
But I see your point
 
tech/a said:
Doesnt make sence---more money apples MORE EXPENSIVE!
But I see your point
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No - apples have the same value - they are not more expensive - the money has less value so you need more of it to exchange for the same amount of apples.

Supply/Demand - more supply of dollars - the more dollars chasing the same number of apples - the price of apples rises.

Value - an important thing to understand to preserve and grow wealth.
Wealth - an accumulation of 'things' that have value.

Price <> Value. Value is what is important.

In an inflationary environment money loses value.

Money is debt - debt is an asset depending on what side of it you are on.
 
Banks are only a supermarket were you csan get money from and they need money to lend out to stay in business and need suckers to be in debt all their life to survive.
As things get worse and people can't make their repayments they feel the pinch up rates to get money in the door.
 
Sunder said:
You are correct, the money is just printed. So what it's doing is diluting the value of money already in existance.
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Thanks for the post Sunder - seems like a pretty good summary of the situation to me. Just a comment on this point (because I'm still not 100% clear on it as well and a comment by Bernanke in response to a question where he stated that the fed has the authority to coin money also got me thinking more).

They could just 'print' the money - i.e. create it out of thin air - as I understand it from the 'coin money' comment I assume the fed does have the authority to this (what bounds there are around it and approvals required is another question). But my understanding is that the more common way they 'print money' is to issue debt - i.e. govt bonds - to foreign governments and private investors. Those investors pay money for the bonds and take on govt debt as a result. One is arguably less inflationary than the other (the direct printing of money without a corresponding debt issue is directly inflationary).

I'd be curious as to anyone's thoughts on the details of this aspect of the 'printing of money' - and also the affects of one approach vs the other.
 
Good discussion guys thanks for the questions / answers

More questions

Looking at out comes whats the implications for Australia?

Do we get Hyperinflation or massive deflation?

What are the signs that one of these is coming or the trend has started?

Which asset classes are the best to hold?
 
T/A,

I will try to explain what I know, which could be very little or wrong, so be gentle with me if I am wrong. Happy to be corrected here.

1) printing paper money will generate something economist called "monetary inflation" - it is much easier to see it if you based the dollar on a fixed sum, say, gold as the basis for its value. Assuming you have 100 tons of gold, based on this 100 tons of gold you are allowed to print 100 million dollars. Effectively this gives each million dollar a value equivalent to 1 ton of gold. Now if for some reason you begin to print more paper money, instead of printing 100 millions, you choose to print 1,000 million - the value of your dollar in this case has declined, to pay for a ton of gold, it now cost you 10 millions dollars.

In short, you can't expand your wealth or your dollar value by printing more paper money because your asset backing, or the value used in measuring the paper value of your dollar has not increased. In this case, the total "treasury value", your gold, has not changed, but the face "value" of your dollar has changed, dropped by 10 times because you have issued 10 times more paper money.

If we broadly based the value of the US$ on its GDP, which is estimated to be at 14.5 trillion dollars, then, in theory, the USA can only print a corresponding amount of paper money based on the incremental value of its GDP (new wealth). If its GDP last year was growing at 1%, then, in theory, the USA could only print 1% of 14.5 trn paper money at most. That is assuming she has no deficit of any form, ie, she doesn't owe anyone any debt, no inflation, etc. But in reality, the USA has been borrowing heavily, and she is in no position to print any money at all because, if she has been a responsible debtor, she would have used the 1% GDP productivity gain in wealth to pay off her debt, reducing the overall interests she owes others. In this case, it is not happening, instead of tightening belt, she continues her borrowing by issuing more bonds (govt IOUs), providing cheap credits to encourage consumption (buying from China for example) to promote economic growth, in the process, increasing her debt by issuing more US$ to pay for the goods imported (mainly from China), which she has no additional wealth to back up (the increase in paper money) thereby reducing the value of its paper dollar. As a result, a bar of soap that used to cost 1 dollar to exchange has now cost more because the face value of the US$ has declined. The net effect here is inflation, generated by printing excessive paper money.

To answer your questions:

1) gold and oil and commodities in general are tangible "fixed" assets. In theory, their value doesn't change much due to their tangible value. It's like your real property, if the house were to cost 100K to build 10 years ago, chances are it will cost 100K or more to build now. It's value would only increase partly due to demand and partly due to inflation.

If the value of the US$ is declining, the value of gold and oil would usually move in an opposite way because of the investors' belief, say in gold's value as a form of universal currency because of its past. They use gold as a hedge for inflation. Oil goes up because of the belief that the demand will increase and the future supply is limited, this is probably has a bit to do with speculation, based on market economics. In addition, as a result of the declining US$, it has cost more to extract oil from the ground partly due to rise in cost and partly due to scarcity of easy oil suppy, hence, it is only logical to assume its price could only go up. This is the belief of many oil speculators.

2) Yes. There is a good chance that the US$ will decline. But the commodities will not decline in sync with the US$ though because as pointed out earlier, it would cost more to get them out in the first place. It is logical to assume most miners will not sell their commodity below cost. It is also logical to assume most commodities will go up in price if measured in US$, but still they are subjected to market forces such as supply vs demand.

For other currencies such as the Chinese RMB, if it is not arbitrarily pegged at a low exchange rate against the US$, it will probably behave like gold, going up in reverse to the US$.

3) Yes. The USA eventually will become so cheap that it is turning into a buyer's heaven. For example, the properties over there will be really good buys in a year's time. The cheap US$ will make US goods and exports very competitive, hopefully, through export growth and belt tightening, they can save and rebuild their economy. It will take a while to rebuild their credit worthiness in the world community though, when that happens, you will see the US$ rising strongly.

4) Yes. Australia is a major player currently because of our supplies of minerals and raw materials to the developing economies, countries such as China and India. But because of our size, we tend to be a trend follower rather than a trend leader.

A new economy order? Could be, but not so fast and not so easy. You can read up the history of US$ here: http://atimes.com/atimes/China_Business/JI26Cb01.html


Cheers.
 
T/A,

This is the second set of answers to your questions (the system won't allow me to combine both since they exceeded 10,000 chars):

2) the govt will use the 700bln to buy over the "bad assets" (bought at overly inflated price, but now there's no market for them) from the banks. The banks are unwilling to sell these bad assets because of their fear of being forced to grossly marking down these asset prices (mark to market), eroding their capital (which is crucial for the operation of the bank) - as a result of the sales.

Because of this fear, the banks are reluctant to sell these high value bad assets, instead, they are holding them in their books, in the process tying up their capital. What Paulson and Bernanke want to do is to buy over these bad assets at "a price" from these banks to relieve them of this burden and the tied up capital so they can go back to normal operation. Effectively this bailout is their attempt to create a market for all these bad assets, allowing the banks to pass the burden to a govt holding, hopefully say in a few years time when the economy improves, these assets can be sold at a much better price than the current market.

3) once the buyout has happened, the govt/people will own these assets. They will also own a percentage of the banks. Details not sure at this point. The banks will not have to pay back anything, since in this case they have sold the assets to the people. The people/govt own these assets until such time they can be sold. Some projections are saying out of the 700bln bailout, the govt can probably get back at least 500bln, costing a net about 200bln to the people in bailing out all these banks. The variables in this estimate however are quite many as it depends on: a) the purchase price; b) the future sales price; c) the state of the economy.

There will be a cost to the people, that is for sure. But this is unavoidable because without govt intervention, the banks will be "hiding" their bad assets for as long as they can, until they run out of options or capital, which by then, they will either have to declare bankrupt or be sold like WAMU - this scenario is more damaging to the investors, the bank customers and the economy as whole. A direct result of not doing anything is to see the freezing up of credit/lending by the banks because: a) they need to keep as much capital as possible, b) they don't trust other banks for fear they are in a worse condition.

To Paulson and Bernanke, it's a no choice scenario. The current situation will only get worse if they don't act now, or act fast. In a bigger picture, they fear the vulnerability of the US$ will be make worse by this freezing up, since every bankruptcy of a bank is a vote of no confidence in the USA and in the US$. They fear creditor countries such as China would react by dumping their US$ holding to reduce their wealth erosion.

4) to pay for all these debt, the US govt will issue bonds, basically they are IOUs to other countries. In this case, they are expecting countries such as China, the petro-nations, Japan to buy these bonds and extend credit to the USA. According to news, the FED itself has about 850bln (not sure) worth of credit, which is their very last reserve, so, in a way they don't have to issue any bond for the bailout, but they probably would want to keep some reserve for emergency, hence they are more than likely to issue more bonds. To issue IOU, they need buyers, which in this case, they need to get the ok from their potential buyers first, hence George Bush called President Hu not too long ago to seek out the Chinese reaction in their bailout. This is my speculation though.

To pay back the debts, the Americans will have to work very hard, produce more, export more, basically earn more money to pay more taxes to their govt so they can have a surplus to pay off these debts. Basically they need to grow their economy, make it stronger to generate more income for the whole country.This can take many years.

If they refuse to pay back these debts then the USA will end up something like Zimbabwe, a pariah in the international community. It will lose all its prestige and will cease to be a leading nation. It's currency will drop, hyperinflation will set in; and depending on what they have been importing, their people may starve if they have been relying on food import all these years.

In short, non-payment is not a very good idea.

5) for a large country such as the USA, hyperinflation will mean many of her citizens will be starving, some may even die in the extreme scenario. Less serious will see her people going through the kind of suffering the people in Zimbabwe are going through now. Shortage of goods, services, fuel, etc. Not a good life for sure.

To curb hyperinflation - simplistic view here is to devalue their currency immediately, cut back the circulation of paper money, or issue new notes, which is much simpler. After that, they need to rebuild their economy. To rebuild, it will need to do a lot of thing - cut back consumption, improve productivity, raise taxes, cut back social services, etc, basically they need to fix their books to make sure they are not over spending and they have surplus to rebuild their treasury. Long story.


Cheers.
 
Thanks Haunting for your interesting reply.

Sunder

I now see the apples scenario!

Many are concerned about their wealth protection.
I'm intersted in the view of those here as to how best to---

(1) Protect that which we have--super and various other investments.

(2) Best grow our wealth heading toward later life.(I hate the idea of retirement---I get bored easily--and understand that inflation means my $$$s today will be worth very little in 30 yrs time!---so in my personal view having an income stream permanently is my own desire and design.

Of course I have a personal interest as I have 2 companies both involved in the Building industry---a SMSF---and numerous IP's---the usual things one does in pursuit of financial freedom.Oh and I got caught in the 18% interest blowout in the early 80s which cost me a lot more than $$s.

My own personal suggestions thus far to myself are.
Business.
Reduce or eliminate non productive debt that cant be locked down and quantified.Leases are OK.
Dominate my field of expertise---in times of uncertainty clients tend to go with larger more secure operators for larger $ items--which we specialise in.
Broaden market share and seek strong alliances.
Run lean and mean.
Look after key personel.

IPs
Decrease gearing to 20%
Keep rent roll to market levels.
Expecting some inflation in the coming years but not to the extent of the US.

SMSF
Invest in gold(Many ways from bullion/futures to stock) and oil.
Have cash working in areas of demand rather than sitting there eroding.

I'm interested in others views and ideas.
Thanks to everyone for their input.
 

Good point Cuttlefish.

It appears to me that the government is the only organisation that is not allowed to create money.

Private banks can create money through fractional reserve banking. This is blantantly obvious by the fact that cold hard cash represents less than 10% of the total money supply. Private banks have created the other 90% as paper entries.

The fact that our bank balances are not represented by real cash does worry me.
 
In Layman's terms it comes down to devaluing the currency.

So, the debts valued at $x are paid at face value. It's just that the Dollars they are paid with won't be worth much in terms of purchasing power.

In short, that's inflation.

Let's say you lend me $100,000 which is 2 years' average earnings (using round figures here). Then we get massive inflation. Then I repay your $100,000.

It all sounds fine until you realise that the $100,000 I've repaid you is no longer 2 years' earnings but it's now the cost of a bus ticket. You got your $100,000 - no doubt about that. But the money is worthless. You, the lender, just got shafted big time.

That's very simplified but it's basically what's happening to my understanding. China, Saudi Arabia etc will get their money, paid in US Dollars. It's just that those US Dollars will become just about worthless.

My greatest fear in all of this, and one that I do think will happen, is that other countries follow the US and devalue their currencies. That is, we won't see the Aussie Dollar buying 10 US Dollars. Instead, we'll see Australia and others similarly devalue their currencies in a race to the bottom in order to try and remain competitive with exports etc.
 

Tech/A, in your position and with a plan like that, if you can't weather any potential financial storm, then their is no hope for the rest of us.
 
cuttlefish said:
I've never properly understood which way around people express gearing - by 20% gearing do you mean that you own 80% and the bank is owed for the other 20%? (i.e. 20% LVR).
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C/F
Gearing is normally expressed in % geared (on loan).
20% in this case is other peoples money.

But Smurfie raises a very good point.One which has me thinking.
If I have $100,000 of the banks money today buying $100,000 worth of X today and in 5 yrs time I pay back that $100,000 which in terms of value in 5 yrs time is worth $50,000 (Say) then I'm better off having that money working for me in times of inflation.---Rather than paying it back as its worth today is less in BUYING terms than it is today.

My base asset say property in times of inflation will grow and the value of the loan in terms of buying power will decrease all due to the increase in costs of materials and construction!

Perhaps my plan above is best placed in times of Recession than times of inflation! Provided of course I can service debt!

Comments?
 

That's true, but just remember that interest rates is usually tied to inflation. So if inflation is 4% as it is at the moment, the cash rate is 7%. When inflation was 1%, interest rates were only 4%.

So while borrowing money and putting it in inflation proof assets is a good hedge, that's all it is - a hedge, it's not a money maker.
 
An example.

You buy a house for $500K with 100% mortgage at 8%. In today's money that's 10 years average earnings to pay for that house. On top of that you have to pay interest on the loan.

Then we get a bit of inflation and income doubles. Now it's 5 years of average earnings to pay off the house. The downside is interest rates would likely have increased but you could protect against this with a fixed rate loan.

In short, inflation erodes the true value of debt measured in hours of work or anything else tangible. Hence it makes debt easier to repay in most circumstances provided that you don't get screwed by a spike in variable interest rates.

So buying houses (or anything else tangible and better still something that also produces income (rent, dividends)) ought to work well provided that you can ride out the storm and meet the loan repayments during a period of general economic trouble. Many can, those who lose their jobs or see business profits tumble could easily lose the lot due to being unable to meet loan repayments.

The one big downside I can see is that house prices are significantly influenced by buyers' ability to borrow. If inflation and interest rates spike then even with an increase in income, it doesn't necessarily increase the amount someone can borrow. House prices thus may not increase to the same extent as wages or general costs - people simply can not spend money they can't get hold of (in practice, borrow). Buyers in general would thus tend to not increase their bid prices to the same extent that general costs have increased.

All that changes once interest rates peak however. Then we should still have reasonably high inflation (since it's just after the peak) but with falling interest rates, the amount that can be borrowed rises. A bit of a time lag perhaps (measured in years), but there are the seeds of the next boom.

Another one that works well with high inflation is renewable energy. Apart from wind and biomass, most (in the order of 95%) of total life cycle costs are the upfront construction costs. Build it today and borrow the money at fixed rates. Then sit back as production continues at very low ongoing cost whilst energy prices rise with inflation.

If you look at some of the older hydro schemes (there aren't any old solar etc) then they now produce over 100% per annum income return on the original capital investment even though they were financially marginal (at best) when originally built. Inflation is, ultimately, the only thing that has made most of them financially viable at all.

So, anything tangible that generates an income (preferable without significant ongoing expenditure) ought to offer at least some profit from inflation as long as you can withstand high interest rates and general financial turmoil in the meantime.
 
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