The Reputation of Money

To be respected, authority has got to be respectable. – Tom Robbins

September 9, 2018

by Steve Stofka

Most nations create their own money, a super power of the modern state. The politicians and central bankers of each country have the responsibility to maintain the reputation of its money. Each nation is both the creator and net seller of its money, able to lower but not raise its comparative value. To raise that value, each nation depends on others to be net buyers of its money.

Nations carefully study the behavior of each other’s central banks. Argentina cut interest rates in January 2018 even though the country was experiencing high inflation. This action was the opposite of good central banker behavior, and hurt the reputation of the Argentine peso, which has lost half its value since January. Money traders suspected that the Argentine central bank had become captive to political control. Few trusted a politician with money super powers.

The reputation of a nation’s money rests on the steadiness of its tax revenues. As I have noted before, revenue from the sale of nationalized resources acts as a tax. Those commodity revenues do not build a money’s reputation as much as the tax revenues from the economic production of a nation’s people and businesses.

A nation can print its own money at little cost. A greater supply of anything, given a constant demand, lowers the price of that thing. The real cost of printing money is borne by the nation’s people and businesses who use that money for daily exchange. As a money’s value declines, that loss of value acts as a sales tax on each money unit exchanged. Let’s call that the king’s tax. This undeclared tax revenue does not build a money’s reputation.

A nation supports the reputation of its money by using its super powers with restraint. When a nation receives most of its tax revenues from its own internal production, that is a sign of a healthy economy, with a reasonable monetary and fiscal policy. When the king’s tax (inflation) and commodity resource revenues exceed half of a nation’s revenue, the value of its money becomes like two day old bread.

A nation’s money rises in reputation when it is bought, and there are two reasons for buying a nation’s money: 1) buying goods and services from that nation, and 2) loaning money to the governments and businesses of that nation. In 2017, China, the United States and Germany were the top exporters, putting their currencies in demand (Note #2). Loans to borrowers in emerging markets are often priced in U.S. dollars, the current reserve money of the world. If the money in that nation loses its value against the dollar, the borrowers effectively pay a king’s tax as they make their loan payments (Note #1). Typically, a nation will blame the tax on rapacious money dealers.

A nation’s money reputation relies on several factors that a nation can control: inflation, tax revenue and the source of that revenue. A nation is judged on its current and historical behavior with money and debt. Its political structure and the independence of its central bank are important factors as well. On an international stage, its money must compete with other nations in all these categories. Call it the daily beauty contest – no swimsuits.


1. EMB is a basket of emerging market debt priced in USD ( It is off 5% from its high at the beginning of the year and pays a dividend of 4.6%. Its annual return for the past ten years was 6.5%, the same as a long Treasury ETF like TLT. A broad bond index fund like Vanguard’s BND earned 3.8%.

2. Germany uses the Euro, not its own national currency. In 2017, China exported $2.35 trillion, the U.S. $1.55T and Germany $1.45T. Visual Capitalist picture graph. The site is a picture book for curious minds. Here’s one on the biggest employer in each state. For southern states, the answer is Wal-Mart. Universities and health care systems are prominent employers in many states.

Related: The U.S. owes $6.2 trillion to the rest of the world. China’s share of that debt is $1.8 trillion. The U.S. holds $125 billion in foreign reserves, similar to the amount Turkey holds. As the world’s reserve money, the U.S. holds enough foreign reserves to counter any distortions in currency markets.



In a survey of 5000 workers, Gallup found that only 51% had a single full-time job.  36% were gig workers.

Since 1991, real purchase only house prices have gone up 1.7% annually. FRED series HPIPONM226S / PCEPI, index 3/1991 = 100. Real rents and owner equivalent rent (OER) nationally have gone up 8/10ths percent annually. This is about half the rate of home price growth. Urban residents must pay an extra price. In Denver, rental prices have gone up 1.9% annually since 1991. OER has risen 1.7% annually. No doubt, California cities have even higher annual growth rates than national averages. Owner Equivalent Rent is a BLS-calculated rent that a homeowner pays themselves for use of the residence. This includes mortgage, repair and maintenance costs on the home.

Trump To The Rescue

by Steve Stofka

December 10, 2017

This blog post goes to what may be a dark place for some readers. The election of Donald J. Trump may have stopped a year-long slide into recession. I didn’t start out with that conclusion. I meant to point out some interesting correlations in the velocity of money. Yeh, yawn. By the time I was done, not yawn.

If I mention the change in the velocity of money, do you groan at the prospect of a wonky economics topic? Take heart. Anyone who has slowed down from 65 MPH on a highway to 15 MPH in rush hour traffic is familiar with a change in velocity.

The velocity of money measures the amount of time that money stays in our pockets. It signals the willingness of buyers and sellers to make transactions. When buyers and sellers can’t agree on price, transactions fall and the change in velocity goes negative. In the chart below, the change in the velocity of money (blue line) often has a similar pattern to the change in real GDP (red line).


Both recent recessions were preceded by declines in GDP growth and the speed of money. Following the financial crisis, the Fed began to inflate the money supply in a series of policies dubbed “QE,” or Quantitative Easing. In 2011, after two rounds of QE, the Fed worried that the recovery might stall out.

Let’s turn to the green square in the chart labelled Operation Twist. Obama and a do-nothing Republican Congress were at odds so there was little chance of Congress enacting any fiscal policy to come to the economic rescue. That task was left – once again – to the Federal Reserve to use its monetary tools.

In Congressional hearings, then Fed Chairman Ben Bernanke advised the Senate Finance Committee that the short term interest rate was already zero and the Fed was out of monetary tools. The Congress should step in with a stimulative fiscal policy. The Committee members somberly hung their heads. We are incompetent, they said, so the Federal Reserve will have to rescue the country.

If it expanded the money supply further, the Fed was concerned that they would spark inflation. In hindsight, that fear was unfounded, but none of us has the luxury of making decisions while looking in the rearview mirror. Economic identities like M*V = P*Q (notes at end) are just that – looking in the rearview mirror.

The Fed resurrected a monetary tool from the 1960s dubbed Operation Twist, after the dance craze the Twist (Fed paper).  Early Boomers will remember Chubby Checker. The Fed began selling the short-term Treasuries they owned and buying long term Treasuries. By increasing the demand for long term Treasuries, the Fed drove down long-term interest rates as an inducement for businesses and consumers to borrow. Despite the low rates, consumers continued to shed debt for another year. How effective was Operation Twist – maybe a little bit (Survey).

As the price of oil declined in late 2014 and the Fed ended yet another round of QE (QE3), there was a real danger of moving into a recession. Notice the decline in GDP growth (red) and money velocity (blue).

The downward trend barely reversed itself in the 3rd quarter of 2016, just before the election, but not by much.


The election of Donald J. Trump and a single party controlling both houses of Congress kindled hope of a looser regulatory environment and tax reform. Only then did the speed of money turn consistently upward. But we are not out of the woods yet. A year later, in late 2017, money velocity is still negative. As I said earlier, buyers and sellers still cannot agree on price. There is a mismatch in confidence and expectations. Until that blue line turns positive, GDP growth will remain tepid or turn negative.


M*V = P*Q is an identity that equates money supply (M) and demand (V) to inflation (P) and output (Q).



Independence is Money

July 5th, 2015

In past weeks I have been digging into a perplexing problem.  Since early 2008, the Federal Reserve has heaped almost $4 trillion of government debt on its books and the supply of money has doubled, yet inflation remains subdued.  Why?

There are several measures of money. For several decades the Federal Reserve branch published Modern Money Mechanics (book or PDF). M1 is a measure of transactional money, and includes cash and money held in checking accounts. This category of money has doubled in the past 7-1/2 years.

Supply of money goes up.  Inflation goes up, right? From the Federal Reserve paper:

Assuming a constant rate of use, if the volume of money grows more rapidly than the rate at which the output of real goods and services increases, prices will rise. This will happen because there will be more money than there will be goods and services to spend it on at prevailing prices. [emphasis added]

If inflation is not going up, then the output of goods and services must be going up as much as the supply of money, right?  It’s not.

Some economists have argued that the various measures of money don’t measure demand for goods and services.  Rather, the money supply measures uncertainty.  Shown in the chart below is the annual percent change in both GDP and the M1 money supply.

The first thing we notice about the M1 chart above – when the growth in the money supply falls below zero, get worried.  People are too confident in the future.  It would be nice if we could craft a long term trading rule like “Buy stocks when the blue line crosses below the red line” but that has not been a successful strategy.  What does stand out is that money growth, the blue line, crossed above GDP growth, the red line, in the summer of 2008 and has not crossed below.  That is the longest period of time since this money measure began. Clearly, there is a lack of confidence among families and businesses.

In the quote from the Federal Reserve paper above, I passed over a key phrase that began the paragraph.  Yes, very sneaky of me to do that. The phrase is “Assuming a constant rate of use.” I wanted to focus separately on the growth in the money supply and the growth in GDP.  Economists often look at the rate of use of money to produce a given level of GDP.  They call it the velocity of money.  In the chart below, I have included the velocity of money, the ratio of GDP/MONEY (red line in the chart), and the amount of money in the system as a percentage of output, MONEY/GDP (blue line) to show how the two are mirror images of each other.

When economists worry that the velocity of money (red line) continues to fall during this recovery, they are worried that there is simply too much money sitting around for the amount of output in the economy (blue line).  Why are people and businesses holding over 17% of output in readily available money today? We are in a low inflation, low growth economy.  In the 1970s we held the same percentage of money but the ’70s was a high inflation, low growth economy.  The similarity of then and now is low growth.

In these past weeks I have looked at two places to put savings – yesterday’s spending, debt, and tomorrow’s spending, equity.  When people and businesses hold onto more money, which kind of spending are they investing in?  They are concerned about tomorrow’s income.  What does tomorrow’s income pay for?  Both tomorrow’s AND yesterday’s spending.

Next week – if saving is just a form of spending, what is income?



Good job numbers. Not good labor participation numbers.  Bill McBride at Calculated Risk did a good job this week of putting a long term perspective on the job numbers.  Underscores the theme I just touched on.  Low growth.  For 12 years, from 2000 – 2012, there was almost NO job growth and the effect of that does not pass quickly as things improve.  Caution prompts us to hold onto more money just to be on the safe side.

Heaven On Earth

May 31, 2015

Although the unemployment rate has fallen below 5.5%, the labor participation rate is still rather low and wage growth is slow, prompting renewed calls for government stimulus. A 2010 article laid out the justifications for more government borrowing to spur the economy. Let’s review a few points made by these economists.

“Spending by the federal government always creates new money in the system, while taxation destroys it.”

The nature of money and the government’s relationship to money is certainly beyond the scope of a blog post. In short, money in all its forms is a claim. A central bank (called the Federal Reserve in the U.S.) is a government created institution which regulates and administers the supply of money and credit within a country, and manages the reserves of foreign currencies held within that country.  It acts as the government’s banker and is the lender of last resort both to the public and the government.  If the public will not buy all of the debt issued by the Treasury of a government, the central bank steps in and buys it, a practice known as “printing money” although there is no new money printed.

In a fiat (unbacked by any hard metal or asset) money system, a sovereign government has the power to create and destroy money claims at will.  As the 2010 article notes, all taxation is a destruction of money.  A $100 tax voids a taxpayer’s ability to make a $100 claim for some good or service.   A thief takes money with no promises.  A government takes money with some implied promise or threat but no exchange of value at the time of the taking.  Taxation is not an exchange, but a taking, a destroying, like letting a little bit of air out of a balloon.  As long as the government pumps in the same amount of air that it took out, the size of the balloon changes only in proportion to the change in population.

In 1960, two economists, Gurley and Shaw, coined the terms Inside Money and Outside Money to capture this unique license of government (Federal Reserve paper on this subject). Treasury bills and forms of government debt are claims on government, and termed outside money, as in outside the private marketplace. Money exchanges between people and companies in the private sector are termed inside money. Each dollar of inside money represents a debt by someone else within the private sector.  When government spends more than it taxes, it borrows and pumps outside money into the private sector balloon. Many of us might think inflation is the net change in the size of the balloon but it might be more helpful to imagine that the size of the balloon, or volume, is the size of the population and grows slowly and constantly, about 1% in the U.S.  Inflation, then, is a measure of the pressure inside the balloon. (Boyles’ Law  and other fun facts with gases)

Various economists in this article asserted that the government should pump more outside air into the balloon, which will cause the economy, the molecules inside the balloon, to speed up.  Is there any limit to the amount of outside money that a government can pump into the balloon?

“[A] government cannot become insolvent with respect to obligations in its own currency.”

If a government can make up money out of thin air, why not just give $100K to each of the 300 million citizens in the U.S.?  People who couldn’t afford a newer car could buy one, which would boost the sales of car manufacturers. New homes, new appliances, vacation trips – a shot in the arm for so many industries. Unemployment would practically vanish. Imported goods into the U.S. would soar, helping the workers and businesses in other countries.  People could pay off their credit card and student loan debts but banks might suffer because not as many people would want loans.  Stock prices would soar in value as families searched for a place to invest some of their windfall.  People who had already owned stocks and other assets before the boon would see their net worth increase exponentially.  Housing prices would climb as more people could afford to buy a house.

What about inflation?  Well, the government has already pumped in $8 trillion since the recession started in late 2007.

$8 trillion divided by a 300 million population is almost $27,000 per person.  Contrary to predictions of runaway inflation, it has been moderate or below the 2% target rate.  In fact, if we use the method of calculating inflation used in the Eurozone, we have had deflation in the first quarter of this year.   So any inflationary effect from a one time $100K boon would be less than disastrous.  Even if inflation climbed to a 1990s level, about 4 – 5%, what is the harm?

Most of us instinctively look at this scheme, furrow our brow, and get suspicious.  But why?  Why can’t a government with a fiat money system simply create heaven on earth?

Stay tuned till next week….

The Talk

November 23, 2014

A strong wind from the southwest blew into town, chasing the cold weather out onto the great plains east of Denver.  Most of the trees had given up their leaves as the days grew shorter but the elm trees had stubbornly held onto their leaves, still green far into November.  The turning of color began during the cold snap of the previous week and now the great gnarly giants began to release their leaves to the winds.  Busy at work for many years, George had hired out the autumn cleanup.  Now that he was retired, he was becoming more attuned to the daily and seasonal rhythms of the plants and animals in the neighborhood.

“Leave me a small bag of leaves, dear,” Mabel asked.  She would dry them out, then arrange them into an autumn harvest theme.  George knew he needed to bring up the renewal of the CD with Mabel before her attention became entirely focused on the holidays.  She would set up the card table in the dining room and the season’s decorating would begin.

George had spent a lifetime assessing risk for the insurance of commercial buildings, which are dependent on the municipal services available to them – the fire, police, utilities, transportation, communications, and medical facilities that reduce either the risk or cost of damage.  George had given too many presentations at city council meetings or at the city planning board, outlining the cost benefits of municipal improvements.  Unlike the federal government with its seemingly limitless ability to borrow money, state and local governments had to live with real budget constraints.

George categorized himself as a prudent judge of risk.  However, he knew that most people he had met in his line of work thought they were prudent.  If asked, “Do you think you are more or less prudent than average?” most would answer that they are above average.  It was the Lake Wobegon effect, where everyone’s child was above average.  We couldn’t all be above average.

Mabel’s experience as a school principal had given her a firm grounding in budgets and accounting, but she was reluctant to take much risk with their personal savings, preferring CDs and savings accounts. She was not alone. In a recent Wall St. Journal blog was a study showing that 1/3 of IRA accounts had no stock exposure.

Fifty-six percent of IRA owners had either all their IRA money in stocks or absolutely none of that money in stocks in both 2010 and 2012, according to a study by the Employee Benefit Research Institute of data on 25.3 million accounts. (It was 33.2% at the no-equity end of the spectrum and 22.5% at the all-equity end.)

 In today’s low interest environment these accounts paid little interest but their value was secure.  If the 2008 financial crisis had happened when he and Mabel were in their thirties and had little in savings and several decades of paychecks to come,  the emotional effect probably would have lessened with time.  Coming as it did right before their retirement, the crisis had shaken their faith in anything whose principal was not guaranteed.  Their losses during the crisis had been lessened simply because Mabel had been so insistent on selling what stocks and bonds they had in September of 2008.

She had blamed the crisis on Bush, whom she thought to be one of the worst presidents in U.S. history.  George, who followed the markets and financial news more closely, made several attempts to give Mabel a more balanced assessment but she was adamant.  “No rules!  No regulations!  This dummy for a president is finding out what happens when there are no rules or regulations!  It’s like high school with no one in charge!”  As stock prices continued to sink over that winter, George was thankful that they had avoided any additional losses.  On the other hand, they had avoided most of the subsequent gains in the past seven years.

He mentally rehearsed his presentation.  The $50,000 CD was coming up next week.  It had paid a paltry 1.1%.  He checked one year CD rates.  Chase was offering 1/100th of 1%, Wells Fargo 5/100ths.  Had George read that right?  He checked the decimal points.  Sure enough, .01% and .05%.  In short, “We don’t want your money!”  A savings deposit or CD was essentially a loan to the bank, so why would any bank want money from Ma and Pa Liscomb when they could get it for almost free from the U.S. government?  So, he would start off telling  Mabel about the low interest rates.

The next part of his presentation would be a cautionary tone of risk and reward.  He would tell Mabel that the stock market was like a wagon train.  Well, maybe that was too poetic.  She might give him her “gimme a break” look.  He would hold up his hand and ask for some patience.  Different wagon trains take different paths across the country. The bond wagon train takes the southern route.  The terrain is flatter but the distance is longer.  The stock wagon train takes the more direct route across the mountains and valleys.  He’d show her the chart of the SP500 as it went up and down the hills and valleys.

“Yeh,” she would say, “what I don’t like are the steep valleys.”  That’s when he would show her his zig-zag chart.  Do you see how bonds zig when stocks zag? he would say.  This way, bonds counterbalance some of the risks in the stock market.

“So what happened in 2008?” she would say with a healthy dose of skepticism in her voice.  “Well, that was unusual,” he would say.  “Everything fell.  Even it did happen again, it is unlikely to stay that way for more than a few months or at most a few years.  If a crisis like that happened again and stayed that way for several years, we’d be more worried about getting food and gas, not about paying for it,” he’d say.  Ok, maybe that would be an overstatement, but maybe not.

“But stocks have already gone up for the past few years,” she might say.  “Some people are saying that it’s a bubble.”  Then he’d mention all the good economic signs.  Manufacturing and services were both strong.  Industrial Production continued to rise and has been above 2007 levels for more than a year.

Sure, there were signs of weak consumer demand. The Consumer Price Index had risen only 1.7% over the past year.  Falling gas prices had helped keep a lid on raises in the CPI and was putting extra money in consumers’ pockets.  It was not only lifting airline profits but contributing to lower costs for a lot of companies.  The Homebuilders association was reporting strong confidence among their members and existing home sales were at a stable level.

George wouldn’t tell her one thing that concerned him.  It was a long term phenomenon, a growing caution that George attributed to the aging of the population.  People put money in safe money accounts like savings, CDs, money markets, and checking when they were less confident about the future or anticipated a short term need for  cash.  On the second point, it was true that as people got older, they prudently put more money in safe accounts.  Retired people in particular were encouraged to keep five years of anticipated withdrawals in a safe place, not the stock market.  The Federal Reserve tracked the amount of these safe money accounts, known as the M2 money supply.  Occasionally, George would look at this amount as a percent of GDP.  Over the past decade the percentage of M2 to GDP had been growing.

This could be a natural trend of an aging population but there was another metric that concerned George.  Over the past thirty years, people were keeping twice the amount of money in safe accounts.  In the early 1980s, it had been about $8000.  After accounting for inflation over the past thirty years, the per capita average was $15000.

George guessed that this cautious move to safety would contribute to slowing economic growth for years to come.  But he wouldn’t tell Mabel that.  He was also keeping a wary eye on small cap stocks.

If the index continued to break down below the neckline, George expected further weakness, perhaps another 10% drop as investors lost confidence in small cap stocks.  Falling oil prices and low gas prices helped small caps but the strong dollar and continued weakness in the European countries and Japan would curtail export growth.

Armed with a mental outline of his presentation, George sat down next to Mabel in the living room.  “Whatcha reading?” he asked.  If she was in the middle of a whodunit, this wouldn’t be a good time.  “It’s a series of papers, mostly statistical studies on student scores,” she said.  “Teaching models, and correlations with their socioeconomic backgrounds, their race.  Lorraine lent me her copy.  It’s very interesting but reminds me that I need to brush up on some terms.”

This was good, George thought.  Her brain was in analytical mode already.  “Hey, hon, I wanted to talk to you about that CD coming up next week,” he started.  “Oh, yeh,” Mabel responded.  “I was at the bank the other day and couldn’t believe how low the rates are now.  Why do they insult their customers by posting the rates?” she mused.

“I was thinking about that,” George stepped in.  God, she was making this easy, he thought.  “What do you think,” she continued, “maybe move that money into one of those bond index funds?” she asked.  “Uh, yeh,” George said, a bit befuddled. She was making it too easy after all the time he’d spent planning his presentation, her objections, and his persuasive responses.  “You had said you wanted to keep everything totally safe, so I thought…,” George’s voice trailed off.  “Well, I do, but this is ridiculous,” Mabel said.  “Obviously, we are going to have to take some risk.”  “And I’ve got the time to watch it,” George reassured her.  “I’ve noticed that,” she said. “I don’t have the interest to watch it.  I guess I always thought that investing was a ‘set it and forget it’ proposition.  Maybe it was never that way.  But, after 2008, I’m…” and she gave a rock-the-boat gesture with her hand.  “Ok,” George said and stood up. “I’ll have the bank close out the CD, then transfer the money.”


No, it’s not the Queen Elizabeth, either the person or the ship.  It’s Quantitative Easing, a label for the Federal Reserve’s program to print money.  Matt sent me a link to a funny – and ironically sad – video that explains this phenomenon.

The Big Picture

Or maybe the title of this post should be “The Big Pitcher”.  No, it’s not about a tall baseball pitcher, but the glass pitchers that central banks around the world hold.  What comes out of the pitcher when the central banks start pouring?  Money.  How do they do that?  It’s magic.  Don’t you wish you had a money pitcher?

Jerry forwarded me an article by someone at Matterhorn Asset Management, a Swiss asset management company that invests primarily in metals as a wealth preservation model so they will have a predisposition to a gloomy outlook because investors’ fears will bring more business to the company.  That said, the article presents a 200 year review and outlook on the mechanics of inflation and rather dire long term predictions for the world economy.

Featuring a 150 year chart on the Consumer Price Index and another one of US Debt to GDP ratio, this 6 page article definitely takes a long view of events in the past in making prognostications of the future. 

A comparison of the 19th and early 20th century with the latter part of the 20th century has to be put in a bit more perspective than this article does.  Electricity is something we take for granted but its effect on our lives has been as profound as the discovery of fire and the invention of cooking.  It is an energy that is readily available to most people in developed countries.  This ready source of energy has radically transformed our society, our productive capacity and our demand for products that use this energy.

In the 1920s, the new industry of radio telecommunications kicked off a bubble in the stock market.  Some predicted that we would walk around with communication devices that we wore on our wrists.  Information would be readily available to all with these cheap and portable two way radios.  It would be another 70 years before this dream would become a reality with the internet and the dawning of the cell phone age.  That in turn prompted another stock bubble in the late nineties.

When countries around the world abandoned the gold standard in the past century, they did so because the supply of gold could not keep up with the rapid expansion of production and demand that accompanied the energy and communication age.  How profound has this expansion been?  Several historians have noted that a person living in Boston in 1780 would have felt familiar with most of what surrounded him in that same city in 1900.  Jump ahead another 50 years to 1950 and that same person would be totally disoriented in a city with electricity, flashing lights, automobiles, subways, TVs, radios and the sheer growth in the population of the city.

The gold standard simply could not accommodate this rapid expansion of economic activity.  However, the gold standard put brakes on the centuries old tendency of sovereign countries to print money or debase the currency.  After abandoning the automatic regulatory mechanism of the gold standard, we have found nothing comparable to provide some restraint on central bankers other than a trust in the wisdom and foresight of those like Ben Bernanke, Chairman of the Federal Reserve.  An entire world of billions of people depends on the wisdom of several hundred individuals making decisions at central banks around the world.  It is a daunting and vulnerable position we find ourselves in.

The Dough Rises

Where’s the dough?

The Market Beat column in the WSJ 3/31/09 noted that U.S. Banks traditionally carry about $300B in cash. As of March 18th, they had $976B, more than triple the usual level. The M2 money supply – checking deposits, savings accounts other than IRA saving accounts, money market funds – are up 10% this year.

Americans are saving. The banks just aren’t lending out those deposits as quickly as they are received.