Saturday, November 6, 2010

A Critique from a " a pretty successful economic advisor for a major investment firm"

Eric sends the following email. (My responses are in blue):

I read your article (Fed Gone Mad: Total Supermoney Through Second Quarter of 2011 could be as Much as $900 Billion) and forwarded it onto a friend of mine who is a pretty successful economic advisor for a major investment firm. Could you help clear up a few items he raised? I am copying his response to your article:
I didn't know there were any " pretty successful" economic advisors at any major investment firms.  Did he call the real estate bust, the September 2008 collapse? Was he in gold at $300 an ounce?

"The analysis is unsubstantiated. The author is speculating on a 2-3x multiplier and doesnt [sic] show how he got there. What are his assumptions? What is his math based on? How does he get to "high double digit inflation rates"?
This guy can't even read what I wrote. I didn't say the multiplier was going to be 2-3x. I said it was a possibility, given that high-powered money has a tendency to result in a multiple at the M2 money supply level. As for how "the math"  works. It's pretty basic stuff that even Mankiw and Nordhaus/Samuelson probably have in their money discussions in their macro 101 texts.

Look, Eric, I understand what your driving at, conceptually. I dont [sic] disagree with the concern. But the math has not added up yet and this guys rantings dont [sic] support an academic argument. For the most part, the talk has been rhetorical and the price action has been speculative.

Until we see rapidly growing leverage in the system, we wont see expansion of money supply. To his point a "conservative 2-3x multiplier", the multiplier continues to fall from the 10x he referenced. This, of course, is after QE1, which you Austrians all freaked out about."
I didn't freak out about QE1. I consistently warned that money in the monetary base is not necessarily in the system and I was one of the first to focus on the "excess reserves" and the fact that this money was not in the system. He must have me confused with a fogged up picture of himself in the mirror.

When he writes, "I understand what your driving at, conceptually. I dont [sic] disagree with the concern." He sounds like Alan Greenspan, who, when he was Fed chairman, was "theoretically" in favor of the gold standard--while he printed billions of paper dollars. How do you understand "conceptually" but don't see double digit inflation and position yourself for such? WTF could "conceptually" possibly mean under those conditions?

As for why QE1 didn't result in the multiplier effect, as I have explained many times, it has to do with the fact there were unique circumstances that caused excess reserves last time, and then impacted the multiplier. The non-multiplier impact of QE1 was a special situation that is unlikely to be repeated. If he is still too dense to understand how all this played out with QE1, I am willing to explain it to him personally at my regular consulting fee rates.

When he writes this: "Until we see rapidly growing leverage in the system, we wont see expansion of money supply". It shows he doesn't understand money creation at all. "Growing leverage in the system" is money creation. It's like saying, we won't see rain until we start to see puddles of rain water. No shit.

Eric then writes:
Please help me out here as I am trying to understand what the disagreement is...


Bottom line. This guy doesn't sound like he has ever had an original idea in his head, ever. He parrots whatever he hears around him. He is very dangerous to follow, since he is parroting trend followers and will never catch the major turns.

Further, if he doesn't see how I get to "high double digit" inflation rates, if the multiplier kicks in at a 2 to 3x, given what commodities are doing now, he is blind to the obvious.


  1. Wenzel,

    For those of us who aren't "pretty successful economic advisors" and therefore hopefully haven't earned your wrath and distaste, can you please explain what some catalysts might be that would cause the multiplier to "kick in" at a rate of 2-3x, this time?

    Don't say, "because they're buying from retail holders", because you still need to explain what conditions and circumstances would lead to those retail holders spending that money instead of putting it in a bank which would hold it as excess reserves. That is the key problem here-- the money is always going to come back to a bank, at some stage; what will lead the banks to suddenly start lending rather than sequestering the multiplier by holding the money as excess reserves?

  2. Round one entering the system is pretty much a given. Why else would someone sell a Treasury security that is paying interest? To put it in a lower yielding bank checking account? Not going to happen. Anyone selling the securities has a plan for the money.

    Once it gets to the banks, it will generally be a different set of banks then the elite banks that put funds on deposit as excess reserves.

    The question that should be asked is why the banks put the money in excess reserves (even though there was only a low rate to earn), when that never happened before.

    With commodity prices soaring (and stocks), there are going to be a lot of people bidding up for that money in competition with excess reserve interest.

    There is no economic law that says it must be loaned out, but the likelihood is very strong.

  3. Haha, slam dunk in the world of ideas.

    How about your friend getting the advisor's portfolio's performance last week? Not including rental real estate, my family was up over 6% in terms of USD, up 3.5% in gold terms.