Cmon in, maybe youll learn something the government wont teach you

Discuss

Please prepare yourself for a mind-bending exercise. Put aside everything that you think you know about economics and money. In the next few paragraphs we are going to explore something that many people outside the world of finance may struggle to understand. Nonetheless, bear with me for a few minutes and I think you'll find this information to be enlightening, entertaining, and even disturbing (or some combination of all three reactions).

Here are the facts: on Tuesday, January 10th, the Federal Reserve Bank announced that it made a profit of approximately $79 billion in 2011, and would pay approximately $77 billion of this amount to the U.S. Treasury (it is standard policy for the Fed to return all of its surplus earnings to the Treasury each year). You can view the full text of the press release here. Now to the surprising parts:

With $79 billion in profits, the Federal Reserve made more money in 2011 than ExxonMobil (XOM), Apple (AAPL), and IBM (IBM) - combined.
With a projected federal budget deficit of approximately $1 trillion for the current fiscal year, this contribution from the Federal Reserve's profits will actually decrease our nation's budget deficit by approximately 8% (because the Fed returns all of its profits to the Treasury, it has the effect of reducing our annual budget deficits)
The Federal Reserve System employees 17,000 people, from its Chairman all the way down to part-time administrative staff, and the average salary of a Federal Reserve employee was about $88,000 in 2010 (the most recent year for which Fed payroll data is available). Therefore, with a net profit of $79 billion, this tells us that the Federal Reserve System produced an average profit of $4.6 million per employee!
This is all pretty amazing stuff. If the story ended right there, you might think the following: "Gee whiz, these people are geniuses! These Federal Reserve employees must be the smartest, most productive human beings on earth! They work really hard, make gobs of money, and then give it all back the U.S. Treasury to reduce our budget deficits!" Why can't those folks at Apple and Exxon Mobil figure out how to do a better job?" If you're reading all of this with a puzzled look on your face, you are not alone. The simple explanation is this: The Federal Reserve can make so much money in a given year because it literally has the authority and the power to "make money."

As you know, the Fed's quantitative easing programs have led to large scale purchases of financial assets, primarily U.S. Treasuries as well as government guaranteed mortgage backed securities. At this time, the Federal Reserve holds roughly $3 trillion in fixed income securities, mostly government and agency bonds. Where did the Federal Reserve get the money that it used to buy all of those bonds? It created the money, of course. The Federal Reserve bought trillions of dollars' worth of bonds with the money that it created out of nothing. Now, the Fed is collecting all of the interest payments on those bonds, calling it a "profit," and returning the money to the Treasury to reduce our budget deficits.

Just for fun, let's take this situation to the extreme to see what happens. Let's do a thought experiment and imagine the Fed buying all outstanding Treasury and agency securities. Using rough numbers, the Fed could buy up $10 trillion or so in outstanding government debt, plus $8 trillion or so of securitized agency mortgage debt, for a total of $18 trillion. Assuming an average coupon yield of 3% across this $18 trillion portfolio, we would calculate the Fed's interest income to be about $540 billion per year. The Fed would then claim a profit close to this amount, pay the money to the U.S. Treasury, and the net effect would be a 50% reduction in our government's annual budget deficit.

There are a number of disturbing aspects to this situation and it exposes one of the often-incomprehensible features of paper money systems - also known as "fiat money." Our government, through the U.S. Treasury, can issue debt, while another agency of the same government - the Federal Reserve - can buy that debt, collect the interest payments, and actually return the interest income to…the U.S. Treasury - the same agency that issued the debt in the first place! It's easy for this sort of arrangement to confuse people, because most logical people recognize the obvious circularity of the money transfers. However, since we lack a real-world analogue to this arrangement, it can be hard to get our minds around all the implications the first time we think about it. Feel free to read it again and take it all in, if you need to.

This situation also illuminates the central reason why many people are buying physical resources - gold, oil, farmland, etc. The Federal Reserve's actions clearly demonstrate the counterfeiting nature of central monetary authorities who have, throughout history, enabled fiscally-malfeasant nations to run unsustainable budget deficits and inflate their currencies to the point of being worthless. Some people have a hard time understanding the value of gold or the rationale for owning the yellow metal, and I'll confess that I am sympathetic to their dilemma; there was a time when I used to ask myself these questions. If you are such a person, I suggest that you ask yourself a different question: what is the value of paper money, which can be created from nothing, in infinite quantities? When you begin to explore this question, the rationale for ownership of gold and other physical resources becomes a foregone conclusion.

http://seekingalpha.com/article/318993-the-most-profitable-bank-in-the-world?source=email_cfa_daily&ifp=1

The value of paper money in the economy is the productivity of the economy.
I am not too worried about hyperinflation and dollar becoming worthless because there is a lot of productivity in the US economy.

When inflation rises, the government will raise taxes, cut subsidy spending and bring the aggregate demand under control until equilibrium. You guys are making much ado about nothing.

kiranr wrote:
The value of paper money in the economy is the productivity of the economy.
I am not too worried about hyperinflation and dollar becoming worthless because there is a lot of productivity in the US economy.

When inflation rises, the government will raise taxes, cut subsidy spending and bring the aggregate demand under control until equilibrium. You guys are making much ado about nothing.

I shouldnt have put that article here, the effects of discretionary money printing are enormous and long lasting both economically, culturally and politically. There is a reason why the germans and the ECB are very wary of doing it.

The video talks about the fractional reserve system and its effect on the economy, did you watch it kiranr?

Not yet Yuri, but i will.

And yes, discretionary money printing will lead to inflation, a culture of entitlement and many other negative effects. But, i feel, if it is done in a way that can boost the productivity of an economy, then it is a good thing right?

They way the US has done it is not right at all though..

you should write about Engish economy so i can write that in my exam

The US economy is the most in debt economy in the history of man kind. Now there are a few ways the US can pay its debt, 1 is by increasing productivity to raise more cash and actually pay off that debt, and 2 is by depreciating the value of their currency and automatically reducing the value of their debt.

The debt is in the form of treasury bonds and those are issued in the American dollar. Now last semester my finance professor, explaining the meaning of risk free investments, said that T Bonds are risk free since the government can literally print the money to pay you back and it looks like this is exactly what's happening

And its not just about debt. China is keeping it's currency undervalued to make its exports more competitive and there's nothing the United States can do about it except do what the Chinese are doing. Remember, China is the US's biggest creditor so it's their money that is losing value, and they're the US's the biggest "trade partner" so its their products that are becoming more expensive

but of course this could backfire bla bla bla inflation bla bla bla so we'll see about that

As long as the US dollar remains the reserve currency, US are pretty much immune.

@ RG, i would definitely get you failed.

The very existence of banks is a slap in the face to everyone on earth. Imagine if a bank lent out one earth (one dollar). Now the interest is 0.1 earth (10 cents). So in essence, the debtor must pay back 1.1 earths (one dollar ten cents). But hang on, there's only one earth to begin with (there's only one dollar in circulation in the economy). So how the f*ck do you pay that extra 0.1 earth (10 cents) back?

Easy, produce a 0.1 earth (10 cents) out of nothing. The result? Inflation sets in. Granted, inflation is necessary to maintain a fractional reserve banking system, but at the end of the day, the standard of living of all the average folk out there slowly but inevitably decreases. This is based on the fact that there's one constant in this system- the bank makes profits.

Although my analogy was extremely simplified, the underlying premise of this idea is still clear.

Your analysis is valid only if the output or the productivity does not increase when 10 cents is created out of nothing as you say.

As they say, the economic pie is not constant, it keeps increasing. It has to.

well productivity has its limitations as well and it simply cant keep up with compounded interest. Anyway we're working with a finite number of resources so no matter how much our productivity increases Interest rates will always create Inflation

It is eventually unsustainable if we keep depending on these finite resources. But as long as our productivity keeps increasing, the standard of living will not fall.

In 2005 an ounce of gold was being sold for around $400. Now its for 1600 something. Did your income increase 4 folds in the last 7 years ? coz if it didnt you're in big trouble. Remember, the value of money has an inverse relationship with the prices of gold

That is true Zizzle. But is it a perfect correlation? If you examine the data of these past few years, you will find it is not. I dont think even India, which has the worst inflation among the BRICS, has seen prices jump 4-fold in the past 7 years.

I get your point in general Zizzle. But banks should be allowed to operate and it should be done with a lot lesser restriction on it, which obviously means no bailouts either.

Banks provide financing which is an invaluable part of our economy. Hence, there should be an incentive for people to get into banking and earn profits. As the money borrowed by people is used to improve the productivity of the economy, our standard of living will keep increase and our real wealth will also increase.

The current policies being followed by almost all governments are flawed and this is the reason why we are seeing such tough times. But that is what you get with politics. All i can hope is sense prevails sooner than later.

Yuri Yukuv wrote:

kiranr wrote:
The value of paper money in the economy is the productivity of the economy.
I am not too worried about hyperinflation and dollar becoming worthless because there is a lot of productivity in the US economy.

When inflation rises, the government will raise taxes, cut subsidy spending and bring the aggregate demand under control until equilibrium. You guys are making much ado about nothing.

I shouldnt have put that article here, the effects of discretionary money printing are enormous and long lasting both economically, culturally and politically. There is a reason why the germans and the ECB are very wary of doing it.

The video talks about the fractional reserve system and its effect on the economy, did you watch it kiranr?

....the ECB is largely responsible for the mess in Europe and would definitely not be a central bank I look at with admiration right now. Then again it is flawed by design.

kiranr wrote:
Your analysis is valid only if the output or the productivity does not increase when 10 cents is created out of nothing as you say.

As they say, the economic pie is not constant, it keeps increasing. It has to.

What I was trying to get at is, you cannot create 0.1 earth out of nothing. There is no 0.1 earth floating around, waiting to be used (circulated into the economy).
Eventually, printing more money to pay back the interest will become impossible. We're currently heading towards that point right now.

In regards to output and productivity, well, zizzle summed it up well.

However, speaking in terms of inflation, ideologically, the standard of living for the populace will not fall. But, come on, when was the last time wages for the average folk kept up with the increase in prices for goods and services?

This deficit is going to the banks.

I agree Keva. But that is more down to the useless policies of the governments and their propensity to keep interfering in the economy and trying control it. That results in the non-equitable sharing of the wealth.

If the governments rise above politics, then banking will actually do good rather than be the bad person that they are being shown as now!

kiranr wrote:I agree Keva. But that is more down to the useless policies of the governments and their propensity to keep interfering in the economy and trying control it. That results in the non-equitable sharing of the wealth.

If the governments rise above politics, then banking will actually do good rather than be the bad person that they are being shown as now!

Well, the lesson learnt from the Great Depression is... don't let the banks fail and don't believe that the free market can naturally sort things about.

Obama genuinely tried to learn from history. He believed that the government had to make drastic moves and that the banks had to be bailed out. But, the execution of his plan was absolutely shocking.

How much money did the average folk end up getting? Did ALL the money go to the right places? What happened behind doors?

The fact of the matter is, we live in a society that is financially unfeasible in the long term. We should be heading towards a resource- based economy, instead of our current one.

There are many solutions in place with our current model which is with fiat currency Keva. We dont need to go to a resource-based economy ( I have a slight idea, but could you elaborate on this?).

The current model is the most flexible one and it can be improved upon with many reforms to the monetary system. There are a lot of people working towards it, even from the govt. I am hopeful, to say the least.

kiranr wrote:
That is true Zizzle. But is it a perfect correlation? If you examine the data of these past few years, you will find it is not. I dont think even India, which has the worst inflation among the BRICS, has seen prices jump 4-fold in the past 7 years.

I get your point in general Zizzle. But banks should be allowed to operate and it should be done with a lot lesser restriction on it, which obviously means no bailouts either.

Banks provide financing which is an invaluable part of our economy. Hence, there should be an incentive for people to get into banking and earn profits. As the money borrowed by people is used to improve the productivity of the economy, our standard of living will keep increase and our real wealth will also increase.

The current policies being followed by almost all governments are flawed and this is the reason why we are seeing such tough times. But that is what you get with politics. All i can hope is sense prevails sooner than later.

I agree with alot of what you said but to me the problem with the free market economy is not a problem of execution and/or corruption but rather a problem of philosophy. Like Kev said this 0.1 has to come from somewhere but in our world it doest.

Remember if your wealth increased that means someone else got poorer, there's no other way around it, but the current system gives us the illusion that we can all become rich and that's simply impossible. If anything we need a system that insures an equal distribution of wealth but the free market economy does exactly the opposite

zizzle wrote:Remember if your wealth increased that means someone else got poorer, there's no other way around it, but the current system gives us the illusion that we can all become rich and that's simply impossible.

I dont agree with this Zizzle. The very nature of investment is to generate new streams of income which if invested again can further generate new streams of income and it keeps looping like this which increases our economic pie.

As productivity increases, more real goods and services are launched, which puts more money into people's pockets and hence every one is richer than before. Some will be more richer than others, but no one gets poorer Zizzle.

If policies are flawed that will distort the economy and remove incentives to increase productivity and that will lead to people getting poorer. Free market economy is the way to go. Dont let a down cycle make you think otherwise.

Kevacious wrote:The very existence of banks is a slap in the face to everyone on earth. Imagine if a bank lent out one earth (one dollar). Now the interest is 0.1 earth (10 cents). So in essence, the debtor must pay back 1.1 earths (one dollar ten cents). But hang on, there's only one earth to begin with (there's only one dollar in circulation in the economy). So how the f*ck do you pay that extra 0.1 earth (10 cents) back?

Easy, produce a 0.1 earth (10 cents) out of nothing. The result? Inflation sets in. Granted, inflation is necessary to maintain a fractional reserve banking system, but at the end of the day, the standard of living of all the average folk out there slowly but inevitably decreases. This is based on the fact that there's one constant in this system- the bank makes profits.

Although my analogy was extremely simplified, the underlying premise of this idea is still clear.

What the....

Kevacious wrote:The fact of the matter is, we live in a society that is financially unfeasible in the long term. We should be heading towards a resource- based economy, instead of our current one.

Oh come on now...

kiranr wrote:

zizzle wrote:Remember if your wealth increased that means someone else got poorer, there's no other way around it, but the current system gives us the illusion that we can all become rich and that's simply impossible.

I dont agree with this Zizzle. The very nature of investment is to generate new streams of income which if invested again can further generate new streams of income and it keeps looping like this which increases our economic pie.

As productivity increases, more real goods and services are launched, which puts more money into people's pockets and hence every one is richer than before. Some will be more richer than others, but no one gets poorer Zizzle.

If policies are flawed that will distort the economy and remove incentives to increase productivity and that will lead to people getting poorer. Free market economy is the way to go. Dont let a down cycle make you think otherwise.

you need to look at the bigger picture here. We already agree that the resources of earth finite, so lets say you control %50 of these resources and i control the other half, in that case, there is no way id get wealthier unless i take a part of your %50 (which would make you poorer)

what you're talking about is the increase in VALUE. The demand for a product/service/currency/whatever creates this added value, but the reformation of a product neither increases or decreases wealth. You can turn dirt into a work of art (production) but as long as 1) i have the skill and the resources to replicate your work or 2) i have no interest whatsoever in your work, the value of your master piece will be exactly the value of its ingredients, or literally dirt cheap. Thats why value is subjective and thus an increase in value is temporary and does not mean an increase in wealth on the long run

kiranr wrote:There are many solutions in place with our current model which is with fiat currency Keva. We dont need to go to a resource-based economy ( I have a slight idea, but could you elaborate on this?).

The current model is the most flexible one and it can be improved upon with many reforms to the monetary system. There are a lot of people working towards it, even from the govt. I am hopeful, to say the least.

Congrats Kiranr on the Indian market opening up, this should be a significant move for the indian financial industry and your career