Mystery Donor Pays Off $2.2M of National Debt

[Jacob Martin]

18 Trillion debt > Any wealth stashed in USA

America's problems are social and structural, not financial.

Housing in USA the property value will crumble to match that of third world country due financial crisis , most people 30-40% in USA don't have saving accounts they invest in their homes , when home prices will crash their capacity to take out loans under their Home would also reduce greatly

The cause was consumer debt, not the national debt. This was and is America's big economic problem. If the banks had gone out of business, it would have been a great thing for the US, because then we would have the opportunity to restructure the economy the way it should be.

I am responding to these posts together, as I wish to point out a common theme which is being missed out here.

To explain how both debt and assets are notional in nature, let me point this out. If you think that all the notional assets and liabilities on the world's spreadsheets are gospel, then try explaining this. In 2014, the top 25 banks in the US had roughly 237 trillion dollars of exposure to derivatives. This includes:

JPMorgan Chase Total Assets: $1,945,467,000,000 (nearly 2 trillion dollars) Total Exposure To Derivatives: $70,088,625,000,000 (more than 70 trillion dollars)
Citibank Total Assets: $1,346,747,000,000 (a bit more than 1.3 trillion dollars) Total Exposure To Derivatives: $62,247,698,000,000 (more than 62 trillion dollars)
Bank Of America Total Assets: $1,433,716,000,000 (a bit more than 1.4 trillion dollars) Total Exposure To Derivatives: $38,850,900,000,000 (more than 38 trillion dollars)
Goldman Sachs Total Assets: $105,616,000,000 (just a shade over 105 billion dollars) Total Exposure To Derivatives: $48,611,684,000,000 (more than 48 trillion dollars)

http://www.occ.gov/topics/capital-markets/financial-markets/trading/derivatives/dq413.pdf

So if all debt is real, then all assets should also be treated as such. By that reasoning, the top American Banks had created 237 trillion dollars in assets spread out over a variety of OTC derivatives such as forex, commodities, equity-linked, CDS and interest rate.

The global financial system is much more complex, and dangerous, than we imagine. The primary concern during the 2008 financial crisis was that so much notional wealth had been leveraged through toxic financial instruments, that when the underlying assets would lose value, the financial system would go under.

Let me briefly try explaining how derivatives work by giving an example. We all know that American banks were competing with each other to give housing loans to people who couldn't possibly pay them back. The question is - why would banks line up to lend where the chances of repayment are slim? This seems like an insane proposition. Except that for the Banks themselves, it wasn't so. Over time, financial contracts have become so complex that very few people can make sense of them. Wall Street has engineered hundreds of neat little tricks to make more and more money for itself. Some of these involve making contracts based upon the value of underlying assets.

The Banks lent money. This loan thereby became an asset in their accounts. After this, the banks were free to make various derivatives based on the underlying asset value of these loans. These derivatives were then further chopped up into even more complex and toxic financial instruments, and at each level, the supporting base of assets backing these instruments became smaller and smaller. The banks then traded these derivatives to investors - rich people, pension funds, City Corporations, etc. These investors were told that since the value of the underlying asset (in this case real estate) would only go up, their investments were safe. Neither did these people understand the nature of the instruments they were investing in, nor did they question the fundamental assumption of perpetual appreciation in underlying asset value.

Meanwhile, the banks, knowing fully well the nature of the Ponzi scheme they were running, would then re-trade a part of these derivatives for real money, and thereby award themselves those eye-popping bonuses for which Wall Street is so famous. So they were creating fictitious assets, selling them to investors, who were paying real money for these toxic instruments, and then rewarding themselves lavishly for their efforts. Talk about being scumbags!

All this lending led to a real estate bubble, where prices reached unsustainable levels. When the bubble burst, prices started falling or stagnating. Loan defaults started increasing as well. This meant that the toxic instruments that had been concocted on the basis of underlying valuation of loan assets started losing value. Suddenly, pension funds were bleeding. City Corporations were becoming bankrupt. All because they had trusted these banks to know what they are doing.

As for the point about whether it would have been better to let these banks fail - it would have nuked the world financial system. These banks are greedy and they ought to have been punished for it. But the punishment could only be in the form of hefty fines and prison terms for the executives involved. That this was never done points to the structural and regulatory problems that America faces, as rightly pointed out by @Aestu. What justice can be expected when the US Treasury, SEC, Federal Reserve and CFTC are manned by ex-Goldman Sachs employees? I can fully understand any anger directed at the banks.

Yet, allowing them to fail would have placed a panic call on the vast pyramid of toxic instruments that they had created. In 2010, the total global derivative market was estimated at 1.2 quadrillion dollars (1,200 trillion dollars). Imagine what would have happened had there been a global panic and these derivatives had collapsed. The financial markets as we know them would have ended. A majority of the investments would have become worthless, bankrupting individuals, banks, corporations, cities and nations.

Big Risk: $1.2 Quadrillion Derivatives Market Dwarfs World GDP - DailyFinance

This is actually the gravest challenge facing the financial world - how to rationalize / dismantle this mountain of toxic instruments that can nuke the financial world any day.

@Nilgiri

 

[Aestu]

Oh, it would have been much more painful than implied by my laconic remark, no question about it. Obama decided it wasn't worth it. You can call that prudent or cowardly or whatever you like, but for now, the US (and also Japan) don't have the stomach for that kind of upheaval.

The tangibles are there but the distributive system blows. Arguably the last days of Capitalism have much in common with the last days of Communism: a handful of unelected jerks who control all the wealth leading us down the road to nowhere.

 

[Faiez]

The government budget constraint (GBC) framework identifies three sources of public finance: a) taxes and other receipts; b) interest-bearing bonds, c) non-interest bearing money. The standard assumption is that since issuing of debt will soak up money from the private sector and printing money will cause inflation, so government spending should desirably be funded through taxes.

The standard assumption is correct.

From that, we derive the understanding that unless the government wants to print money and cause inflation it has to raise taxes or sell bonds to get money in order to spend. But the understanding that taxation and bond sales provide money for the government spending is erroneous. The government is not a household. The user of currency has to finance their spending before-hand, but the issuer of currency faces no such constraint. In fact, it is just the reverse. The Government necessarily must spend first (credit private bank accounts) before it can subsequently debit private accounts, should it so desire. The government is the source of the funds the private sector requires to pay its taxes and to net save (including the need to maintain transaction balances). Therefore, the government is always solvent in terms of its own currency of issue.

No, that understanding is not erroneous.

Insofar as the claim that infusion of high power “printed” money into the system creates inflation and a run on the currency, for that we need to understand debt monetization. Governments borrow most of their money not from other governments, general public or financial institutions. Most of the money spent by the government is in fact borrowed from the Central Bank. The government issues bonds and asks the central bank to buy them. The central bank then pays the government with money it creates, and the government in turn uses that money to finance the deficit. This process is called debt monetization.

If they were to simply borrow, that would cause no inflation. Debt monetization is what causes inflation. If the gov. were to simply borrow from the central bank and then pay it back all from raising taxes (and so create absolutely no new money), inflation would not occur. Increasing money supply (excessively) is what causes inflation.

However, as I had explained in the earlier post, most of the money created in this manner is not handed over to the public for consumption. The standard conditions for inflation – too much money chasing too few goods, is not met. Please try and understand that firstly, the government uses debt monetization AFTER having already spent the money. That money is notionally already in the economy. If it had to cause inflation, then its work is already done. And secondly, let us look at the type of situations where the government uses debt monetization. What was the purpose of the stimulus package from the American government? Jump-staring demand in the economy, right? So the Federal Reserve issued money which was handed over to selected entities so that demand could be stimulated.

Yes I know that. It's the act of spending more money than you can get out of the existing money supply that causes inflation. It's creating new money and spending it that causes inflation. So as soon as new money is created by central bank and handed over to gov., that is wealth being transferred from everyone else to the government. Now the gov. could pay back this debt by taking away wealth (that it spent) back from the people through taxes OR simply ask central bank to write it off.

When the government erases that deficit by debt monetization, it has no further affect on the economy. Whether the measure fails or succeeds, its effect has already played out. The final act of cancelling that debt will not have any impact on the economy, as the government will only take that step when it needs to make fresh expenditure, and not otherwise.

Yes, it has no FURTHER effect. The entire effect happened when it spent the newly created money. So created new money does almost inarguably cause inflation.

But USA is different since it has a hard currency. Not all of the new money that they create stays in USA. It "spills" over into the rest of the world due to its global currency status and the demand for USD outside of USA is ever increasing. That is why even with such huge increases in money supply, they haven't had the inflation they should have like other countries (with soft currencies) experience.

 

[Jacob Martin]

No, that understanding is not erroneous.

It is erroneous, insofar as seeing the person issuing money as needing it to spend. If I issue the money, I don't need to mop it up to spend. I give it to others. Taxation is the system whereby people contribute their share of productivity in the form of goods and services. Taxation cannot fund the entity that created the money in the first place. It is logically incongruent to assume that I would issue money to you and then expect you to part with some of it so that I can make ends meet. You are not able to comprehend it because you are assuming that YOU, as a citizen, are creating money. You are not. You might be creating wealth, but wealth is NOT money. Money is created by the Central Bank, in effect the government.

If they were to simply borrow, that would cause no inflation. Debt monetization is what causes inflation. If the gov. were to simply borrow from the central bank and then pay it back all from raising taxes (and so create absolutely no new money), inflation would not occur. Increasing money supply (excessively) is what causes inflation.

The debt that accumulates stays on the governments books. The government DOES NOT take the money it gets through debt monetization and flood the market. The money could be for paying existing liabilities such as government salaries, supplying utilities, etc. You are assuming that the money is handed to commercial bank who then lend it to people for consumption, thereby leading to inflation. That is not the case. What you are referring to as debt monetization is actually quantitative easing, which is not the same thing. Quantitative easing is a whole different area of government activity, which can be discussed separately. You are mixing up what the government does on a daily basis with what it may decide to do once a decade.

existing money supply

There is no existing money supply except what the central bank decides. Quantitative easing saved the American economy post 2008. Try explaining yourself to those who gratefully accepted government stimulus spending that they were causing inflation. Many of them were the same rich people who decry government spending in the name of fiscal balance mumbo-jumbo every other day of the week, except the day when they are taking the government handout.

that is wealth being transferred from everyone else to the government.

It would be if the government was selling interest-bearing bonds to the public. In that case, it is mopping up money from the public, In the present situation, the public does not invest in the government, the central bank does. It does not change the money in the hands of the public by one dollar.

So created new money does almost inarguably cause inflation.

I am afraid you are not keeping perspective on how money is created. When you work the entire week, and are due to be paid, it is not that a fresh order for crisp bank notes is placed, which are then printed and handed over to the bank, which in turn credits your account. The money you receive had already been in the system, your working to earn it has only re-allocated resources to you by money-circulation. You do not create the money. If money creation leads to inflation as you say, then don't ever work in the first place to save the day.

But USA is different since it has a hard currency. Not all of the new money that they create stays in USA. It "spills" over into the rest of the world due to its global currency status and the demand for USD outside of USA is ever increasing. That is why even with such huge increases in money supply, they haven't had the inflation they should have like other countries (with soft currencies) experience.

This same experience has been repeated in every country in the world. The hard currency status of the US has no bearing on this. Japan has done this for 4 decades now. China has done it for 15 years to allocate resources for building manufacturing capability and in the past 5 years for building infrastructure. Your assumption that money is only used for consumer consumption is unsustainable. Without demand, industry will collapse, markets will collapse.

 

[RabzonKhan]

I know it was an off-topic part of the whole comment but still, personally,
I stopped having any thoughts about answering after reading the above.
Azad's view not being correlated to American reality makes it useless, IMHoO.

Just saying' Azad, all factual & no disrespect intended, Tay.

Well said Sir, I myself was thinking from where the hell is that coming from.

 

[Jacob Martin]

Looking forward to part II: China when you got time of course.

Let us now look at China’s recent monetary expansion, the debt it has created, and how it plans to deal with it.

Back in 2008, the Chinese had already started preparing for the global financial crisis. The Chinese response included both fiscal as well as monetary measures. The fiscal stimulus included a stimulus package of RMB 4 trillion for real estate and infrastructure projects for 2009-10. The package was basically a Keynesian intervention intended to beat the global downturn by stirring up growth through pump pimping real sector projects with fiscal funds.

At the same time, China’s monetary policy became expansionary as well. On 16 September, one day after Lehman Brothers declared bankruptcy, China reduced interest rate which started a series of rate cuts aimed at increasing lending and spending activity. The People’s Bank of China (PBOC), China’s central bank, first scaled back the sterilization operation on the open market in June 2008. Sterilization is basically the process by which foreign currency is purchased by the Central Bank and then introduced as interest-yielding instruments. The interest rate of the central bank bills at issuance was also reduced in a measured way. These actions were designed mainly to enhance supply of liquidity to the circulation.

As a result of these actions, new loans increased dramatically from 181.9 billion Yuan in October 2008 to reach 740 billion Yuan in December. New lending made a record in January 2009 to reach 1.62 trillion Yuan, doubling the highest monthly level in history. This trend continued for quite a while. So in essence, China’s response to the global financial crisis was to massively increase money supply, in the hope that investment would create jobs and spur demand as well.

This trend of massive increase in money supply as well as debt continues to this day. The PBOC has now launched a program to lend money to China Securities Finance Corp (CSFC) to fund stock purchases from investors, which will have the same effect of expanding the money supply even further. In 2008, when the demand for toxic derivatives had collapsed in the US, the Federal Reserve had similarly allowed Banks to mortgage these derivatives which no one wanted to raise money. Now China is doing the same with shares of Chinese companies.

I am not going into the debate about what all these measures indicate about the health of the Chinese economy – people are free to draw their own conclusions on that. The topic under discussion is whether a debt mountain threatens countries. I am merely looking at other countries apart from the US that have run up a huge mountain of debt, such as China has. China’s total debt is massive, and at 282%, is higher than America’s 269%.

Debt and (not much) deleveraging | McKinsey & Company

Officially, government debt makes up a very less percentage of this. But in reality, all of the debt accumulated by financial institutions and most of the debt attributed to other entities is actually public debt, because the government is ultimately responsible for paying it. So what could be the possible game plan for handling this debt mountain? We can get an idea from a few events. In 1999, Chinese Banks were facing a serious NPA situation arising out of real estate exposure. This was to the tune of a massive 30% - whereas NPA of even 10% would be considered catastrophic in a Western Bank. The government simply re-capitalized the banks by transferring the nonperforming loans to asset management companies at book value, thereby effectively extinguishing the bad debt. Chinese banks rolled on as if NOTHING had happened.

This year, China is bailing out the nation’s heavily indebted local governments. Local administrations have accumulated some 18 trillion yuan in bank loans and bonds to fund risky land and property deals – equivalent to a third of China’s economy. As the real-estate market slows, state-owned banks that did much of the lending are in the dock. So Beijing is permitting provinces to refinance their debt by issuing at least 2.6 trillion yuan ($419 billion) in bonds in 2015. This will convert the high interest bearing loans to low interest bearing bonds, thereby giving the government the freedom to cancel the NPAs accumulated by the banks – just like it did in 1999. This is being done on an experimental basis. Gradually, China will try to write off more and more bad debt in this manner.

I do believe there will be consequences to what China has done by chronic over-investment in infrastructure and industrial capacity. No amount of pivoting to a consumption economy can change the fact that return on investment will be either negligible or negative. The production capacity will need to stagnate while demand once again reaches upto the required level. But the worst-case scenario for China will be a Japan-type “lost decade”, where growth will slump, some major PSEs will be forced to shut down, and they might have to battle deflation.

But that’s about it. The NPAs are not going to cause a banking collapse or major apocalyptic scenarios. The government will gradually write off the debt thus accumulated and the world will not even notice, just as we haven’t noticed in the case of the US and Japan. The point I am trying to make is that people fear the word debt too much. Debt for governments does not mean the same thing as it does for households and corporations. Only a really incompetent government, such as Venezuela, or a government that is no longer sovereign, such as Greece, can go bankrupt in the present scenario.