The outlook for the global economy darkened as a stream of data from Europe and Asia suggested growth faltered in the third quarter, hobbled by world-wide supply-chain snarls, sharply accelerating inflation and the impact of the highly contagious Delta variant.
U.S. inflation accelerated last month and remained at its highest rate in over a decade, with price increases from pandemic-related labor and materials shortages rippling through the economy from a year earlier.
The Labor Department said last month’s consumer-price index, which measures what consumers pay for goods and services, rose by 5.4%
The gap between yields on shorter- and longer-term Treasury’s narrowed Wednesday after data showed inflation accelerated slightly in September, fueled by investors’ bets that the Federal Reserve may need to tighten monetary policy sooner than expected. Measures of inflation in China and the U.S. highlight this week’s economic data.
China’s exports, long a growth engine for the country’s economy, are expected to increase 21% from a year earlier in September, according to economists polled by The Wall Street Journal. That is down from a 25.6% gain in August. Meanwhile, inbound shipments are forecast to rise 19.1% from a year earlier, retreating from the 33.1% jump in August.
The International Monetary Fund releases its World Economic Outlook report during annual meetings. The latest forecasts are likely to underscore the relatively quick economic rebound of advanced economies alongside a slower recovery in developing nations with less access to Covid-19 vaccines.
China’s factory-gate prices for September are expected to surge 10.4% from a year earlier, a pace that would surpass its previous peak in 2008, according to economists polled by The Wall Street Journal. Higher commodity costs have led to the rise in producer prices this year, but so far that hasn’t fed through to consumer inflation. Economists forecast the consumer-price index rose only 0.7% from a year earlier in September.
September’s U.S. consumer-price index is expected to show inflation remained elevated as companies passed along higher costs for materials and labor. Rising energy prices likely contributed to the headline CPI, while core prices, which exclude food and energy, might start to reflect climbing shelter costs.
The Federal Reserve releases minutes from its September meeting, potentially offering additional insight on plans to start reducing pandemic-related stimulus.
U.S. jobless claims are forecast to fall for the second consecutive week as employers hold on to workers in a tight labor market. The data on claims, a proxy for layoffs, will cover the week ended Oct. 9.
U.S. retail sales are expected to fall in September. U.S. consumers appear to be in decent financial shape, but Covid-related caution, rising prices and widespread supply-chain disruptions are tamping down purchases. The auto industry has been especially hard hit by a semiconductor shortage—separate data released earlier this month show U.S. vehicle sales in September fell to their lowest level since early in the pandemic.
J. M. Keynes (1936), The General Theory of Employment, Interest and Money, Chapter 12. (New York: Harcourt Brace and Co.).
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Kaufman, George G.; Scott, Kenneth E. (2003). “What Is Systemic Risk, and Do Bank Regulators Retard or Contribute to It?”. The Independent Review. 7 (3): 371–391. JSTOR24562449.
Dorn, N. (1 January 2010). “The Governance of Securities: Ponzi Finance, Regulatory Convergence, Credit Crunch”. British Journal of Criminology. 50 (1): 23–45. doi:10.1093/bjc/azp062.
Nearly 140 countries agreed Friday to the most sweeping overhaul of global tax rules in a century, a move that aims to curtail tax avoidance by multinational corporations and raise additional tax revenue of as much as $150 billion annually.
The reform sets out a global minimum corporate tax of 15%, targeted at preventing companies from exploiting low-tax jurisdictions.
Treasury Secretary Janet Yellen said the floor set by the global minimum tax was a victory for the U.S. and its ability to raise money from companies. She urged Congress to move swiftly to enact the international tax proposals it has been debating, which would help pay for extending the expanded child tax credit and climate-change initiatives, among other policies.
“International tax policy making is a complex issue, but the arcane language of today’s agreement belies how simple and sweeping the stakes are: when this deal is enacted, Americans will find the global economy a much easier place to land a job, earn a living, or scale a business,” Ms. Yellen said.
The agreement among 136 countries also seeks to address the challenges posed by companies, particularly technology giants, that register the intellectual property that drives their profits anywhere in the world. As a result, many of those countries established operations in low-tax countries such as Ireland to reduce their tax bills.
The final deal gained the backing of Ireland, Estonia and Hungary, three members of the European Union that withheld their support for a preliminary agreement in July. But Nigeria, Kenya, Sri Lanka and Pakistan continued to reject the deal.
The new agreement, if implemented, would divide existing tax revenues in a way that favors countries where customers are based. The biggest countries, as well as the low-tax jurisdictions, must implement the agreement in order for it to meaningfully reduce tax avoidance.
Overall, the OECD estimates the new rules could give governments around the world additional revenue of $150 billion annually.
The final deal is expected to receive the backing of leaders from the Group of 20 leading economies when they meet in Rome at the end of this month. Thereafter, the signatories will have to change their national laws and amend international treaties to put the overhaul into practice.
The signatories set 2023 as a target for implementation, which tax experts said was an ambitious goal. And while the agreement would likely survive the failure of a small economy to pass new laws, it would be greatly weakened if a large economy—such as the U.S.—were to fail.
“We are all relying on all the bigger countries being able to move at roughly the same pace together,” said Irish Finance Minister Paschal Donohoe. “Were any big economy not to find itself in a position to implement the agreement, that would matter for the other countries. But that might not become apparent for a while.”
Congress’ work on the deal will be divided into two phases. The first, this year, will be to change the minimum tax on U.S. companies’ foreign income that the U.S. approved in 2017. To comply with the agreement, Democrats intend to raise the rate—the House plan calls for 16.6%—and implement it on a country-by-country basis. Democrats can advance this on their own and they are trying to do so as part of President Biden’s broader policy agenda.
The second phase will be trickier, and the timing is less certain. That is where the U.S. would have to agree to the international deal changing the rules for where income is taxed. Many analysts say that would require a treaty, which would need a two-thirds vote in the Senate and thus some support from Republicans. Ms. Yellen has been more circumspect about the schedule and procedural details of the second phase.
Friction between European countries and the U.S. over the taxation of U.S. tech giants has threatened to trigger a trade war.
In long-running talks about new international tax rules, European officials have argued U.S. tech giants should pay more tax in Europe, and they fought for a system that would reallocate taxing rights on some digital products from countries where the product is produced to where it is consumed.
The U.S., however, resisted. A number of European governments introduced their own taxes on digital services. The U.S. then threatened to respond with new tariffs on imports from Europe.
The compromise was to reallocate taxing rights on all big companies that are above a certain profit threshold.
Under the agreement reached Friday, governments pledged not to introduce any new levies and said they would ultimately withdraw any that are in place. But the timetable for doing that has yet to be settled through bilateral discussions between the U.S. and those countries that have introduced the new levies.
Even though they will likely have to pay more tax after the overhaul, technology companies have long backed efforts to secure an international agreement, which they see as a way to avoid a chaotic network of national levies that threatened to tax the same profit multiple times.
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Do you agree with the global minimum tax on corporations? Why or why not? Join the conversation below.
The Organization for Economic Cooperation and Development, which has been guiding the tax talks, estimates that some $125 billion in existing tax revenues would be divided among countries in a new way.
Those new rules would be applied to companies with global turnover of €20 billion (about $23 billion) or more, and with a profit margin of 10% or more. That group is likely to include around 100 companies. Governments have agreed to reallocate the taxing rights to a quarter of the profits of each of those companies above 10%.
The agreement announced Friday specifies that its revenue and profitability thresholds for reallocating taxing rights could also apply to a part of a larger company if that segment is reported in its financial accounts. Such a provision would apply to Amazon.com Inc.’s cloud division, Amazon Web Services, even though Amazon as a whole isn’t profitable enough to qualify because of its low-margin e-commerce business.
The other part of the agreement sets a minimum tax rate of 15% on the profits made by large companies. Smaller companies, with revenues of less than $750 million, are exempted because they don’t typically have international operations and can’t therefore take advantage of the loopholes that big multinational companies have benefited from.
Low-tax countries such as Ireland will see an overall decline in revenues. Developing countries are least happy with the final deal, having pushed for both a higher minimum tax rate and the reallocation of a greater share of the profits of the largest companies.
—Sam Schechner in Paris contributed to this article.
See. Charles Edward Andrew Lincoln IV, Is Incorporation Really Better Than Central Management and Control for Testing Corporate Residency? An Answer to Corporate Tax Evasion and Inversion, 43 Ohio N.U.L. Rev. 359 (2017).
Nobody likes dropping cash, however Tuesday’s stock-price fall worries me greater than the headline of a 2% fall within the S&P 500 ought to. In itself, 2% is not any biggie: three days this yr had larger falls, and on common we now have had seven worse days a yr since 1964.
What bothers me is that the rise in bond yields that triggered the autumn was actually fairly small, and there may simply be much more to return. The ten-year Treasury yield rose solely 0.05 share level, taking it above 1.5%, and the 30-year rose barely extra to only above 2%. If that is the type of response we should always anticipate, then get out your tin hat. Yields must rise 4 occasions as a lot simply to get again to the place they had been in March.
Why, you would possibly fairly ask, are shares abruptly spooked by bond yields? Within the increase as much as March, shares and yields marched increased collectively, and for the previous 20 years increased yields have typically been higher for shares. The distinction is that investors see the central banks turning hawkish, whilst financial development slows, as a result of they will’t ignore excessive inflation.
As Pascal Blanqué,chief funding officer at French fund supervisor Amundi, places it, the worry is of an increase in charges pushed by inflation alone pushing central banks to behave, somewhat than an increase in charges pushed by financial development pushing central banks round. That is the mind-set that dominated funding till the late Nineteen Nineties. If it sticks, it marks a profound change.
In the long term, it could imply bonds would not present a cushion when inventory costs drop, making portfolios extra unstable. Within the quick time period, if the sharp rise in yields since the Federal Reserve meeting last week is the beginning of a development, then shares are in bother. On the flip aspect, if yields come again down, it is perhaps good for shares—because it was on Friday—somewhat than unhealthy, as has often been the case for a few many years.
To see the risk, suppose again to the spring, when yields had been marching increased. The outlook for inflation is about the identical (buyers are pricing it as excessive however short-term). The outlook for financial development is worse, which gives much less help for shares typically. However central banks have shifted stance from super-easy for just about perpetually to start out speaking about tightening.
That is the improper type of rise in bond yields. When yields had been rising as much as their March excessive of 1.75% for the 10-year Treasury, shares had been on a tear as a result of yields had been being pushed up by the prospect of upper financial development, and so stronger income. Overwhelmed-up worth shares and economically-sensitive sectors soared, whereas Huge Tech and different development shares, plus the dependable earners generally known as high quality shares, went sideways. After March, falling yields boosted development and high quality shares once more, whereas worth and cyclical went sideways.
This time, shares are reacting as they do when yields rise as a consequence of a central financial institution hawkish shift. Huge Tech, other growth stocks and quality suffered the most, as their excessive valuations make them reliant on projected earnings far sooner or later; increased yields make these future earnings much less enticing in contrast with proudly owning tremendous secure bonds. However with out the prospect of upper financial development to spice up earnings, low cost worth and cyclical shares additionally fell when yields rose, albeit by lower than development and high quality.
There’s enormous uncertainty in regards to the potential financial outcomes, so we shouldn’t simply assume that this week’s buying and selling sample will proceed. On the plus aspect, increased capital spending and the pandemic-driven adoption of know-how would possibly enhance productiveness greater than employee shortages push up labor prices. This could damp inflation and speed up development.
A retreat of Covid-19 might ease pressure on manufacturing and change spending again to companies. On the down aspect, hovering power prices and better costs from widespread provide bottlenecks would possibly hit households and weaken the financial system additional, whilst inflation stays excessive—the dreaded stagflation state of affairs.
We ought to be even much less assured about how central banks will react. I see twin triggers for the market’s reassessment. First, Fed coverage makers upped their “dot plot” predictions for rates of interest subsequent yr and the yr after, together with inflation. Second, the Financial institution of England, faced with an energy price crunch and higher-than-forecast inflation, warned of a potential price rise earlier than the tip of this yr. A slew of emerging-market central banks additionally raised charges, as did oil-producer Norway.
If the financial system reacts badly to increased yields, although, the Fed and Financial institution of England would possibly properly shift again to uber-dovishness. The withdrawal of emergency authorities spending measures in a lot of the world may also give the doves a brand new cause to maintain charges low.
Lastly, there’s uncertainty in regards to the market response itself. Possibly Tuesday’s bond strikes had been exacerbated by a mixture of momentum promoting and yields (which transfer in the other way to costs) rising above the brink of 1.5% on the 10-year and a pair of% on the 30-year.It may not be a coincidence that shares did properly on Friday as soon as the 10-year dropped again under 1.5%.
SHARE YOUR THOUGHTS
How involved are you in regards to the late September stock-price fall? Weigh in under. Spherical numbers shouldn’t matter, however typically do, whereas momentum is short-term. Tuesday’s transfer wasn’t pushed by an occasion on the day, so maybe the brand new narrative of hawkishness received stick. In spite of everything, it shouldn’t be that massive a deal to withdraw some financial help when inflation is greater than double the goal and coverage has by no means been simpler.
Given Huge Tech’s outsize share of the general market, buyers within the S&P 500 should be satisfied that if bond yields are going to maintain rising, it is going to be for the great cause of an accelerating financial system, not the unhealthy cause of sticky inflation pushing central banks to behave.
Asian stocks were mixed Tuesday as weaker economic activity in China and the latest escalation in Beijing’s crackdown on private industries overshadowed another record close on Wall Street.
Equities slipped in China, where data signaled that an outbreak of the delta virus variant led to a service-sector contraction for the first time since February last year. Hong Kong slid as Beijing’s stepped-up curbs on video-gaming firms weighed on Chinese technology stocks.
U.S. futures edged up after the S&P 500 hit its 12th all-time high in August and the Nasdaq 100 rose. Treasuries held gains made following Federal Reserve Chair Jerome Powell’s measured comments about a possible reduction in stimulus and any future interest-rate hikes. The dollar dipped.
Oil declined, with traders assessing the prospect of additional OPEC+ production. Aluminum and nickel advanced as Goldman Sachs Group Inc. raise target prices. In cryptocurrencies, Bitcoin fell to about $47,000.
Global stocks overall are set for a seventh monthly advance on strong company profits, expanding vaccinations to underpin economic reopening and supportive Fed policies. At the same time, the decline in Treasury yields from a March peak may partly reflect concerns of a slower recovery ahead on risks such as the impact of the delta strain.
“The bond market is getting a little nervous about the economic outlook,” Priya Misra, head of global interest rate strategy at TD Securities, said on Bloomberg Television. But she added the U.S. economy is “strong” and that “by year end, if the economy holds up, which we forecast it will, that’s when we expect rates — especially in the long end — to start to edge higher.”
In the latest U.S. data, pending home sales fell in July. Traders are awaiting key payrolls figures Friday for further guidance on the economy’s strength.
Here are some key events to watch this week:
OPEC+ meeting on output WednesdayEuro zone manufacturing PMI WednesdayU.S. jobs report Friday
S&P 500 futures climbed 0.2% as of 1:42 p.m. in Tokyo. The S&P 500 rose 0.4%Nasdaq 100 futures increased 0.1%. The Nasdaq 100 rose 1.1%Japan’s Topix index rose 0.7%Australia’s S&P/ASX 200 index rose 0.6%South Korea’s Kospi added 0.8%Hong Kong’s Hang Seng index fell 1.4%China’s Shanghai Composite index retreated 0.8%
The Bloomberg Dollar Spot Index shed 0.1%The euro was at $1.1818The Japanese yen was at 109.88 per dollarThe offshore yuan was at 6.4660 per dollar
The yield on 10-year Treasuries held at 1.28%
West Texas Intermediate crude was at $68.90 a barrel, down 0.5%Gold was at $1,815.12 an ounce, up 0.3%
The latest twists in the seemingly endless saga of the U.S. debt ceiling underscore once again how strange the whole thing is.
The very existence of the debt ceiling is utterly superfluous. Every couple of years members of Congress have to vote to allow borrowing to fund measures that they’ve already approved through individual spending bills. Its main function is political: Whichever party isn’t in power at the time uses it to try to either extract something from, or embarrass, the other side.
On top of that, the limit isn’t really the limit. By invoking the vague catchall of “extraordinary measures,” Uncle Sam can keep on borrowing even after it’s hit the cap—or when the limit has been reinstated following a suspension, as was the case at the end of last month. Given that the alternative is either what’s known as a technical default or a seizing up of everyday government spending, that’s a good thing, even if you’re a fiscal hawk, which is an endangered species these days.
Just because something is mainly theatrical, though, that doesn’t mean it can’t have an impact. This month marks the 10th anniversary of S&P’s decision to strip America of its AAA credit rating, a move that followed one of many bruising Congressional fights over the debt limit. The move by the ratings agency back then sent a shiver through markets and caused a lot of consternation from Wall Street to Washington. But the U.S. has continued to borrow cheaply—indeed, even more cheaply than before.
Right now, the ceiling is at about $28.4 trillion, and the U.S. Treasury’s fancy footwork on accounting should keep U.S. borrowing authority officially intact for a little while. That should allow lawmakers to stitch together enough votes for either an increase or another suspension in the coming months. But what if they don’t?
One subplot of the drama helps put some perspective on this question. With the overall cap for debt back in force as of the start of August, the Treasury has been forced to slash its cash pile—essentially the balance of the government’s main checking account—to around the same level it occupied before the last ceiling suspension. The legislation that governs the ceiling includes a measure to hold things in check; without it, there’d be little to restrain the government from simply issuing tons of debt, while the now-lapsed suspension was still in place, in order to be able to spend the money later.
For quite a long time, some market observers have acted on the assumption that this time around, the cash pile would end up somewhere in the vicinity of $130 billion. In May, though, the Treasury itself said its borrowing plans were premised on the pile amounting to around $450 billion.
Ultimately, the Treasury got down to within around $10 billion of that, which the market appears to accept as close enough. Would it have made much of a difference if they were off by $50 billion or $100 billion—or $500 billion? Would there be any real penalty beyond a bit of political scoring in the never-ending ceiling tussle?
This isn’t a moot point. In its quest to get the cash balance down, the Treasury has affected markets. It has been dialing back its borrowing in T-bills—its shortest-maturity securities—and that, in turn, has been distorting money markets and complicating the Federal Reserve’s management of interest rates.
The issue is that when there’s a shortage of T-bills, they become more expensive, and the yield they offer falls. And because the kinds of people who buy T-bills also invest in a range of other money market instruments, the rates on those come under pressure, too.
That’s not necessarily a concern until it starts pushing the rates on which the Federal Reserve focuses out of its target band. At that point, the Fed needs to pull some other levers. Such a response carries costs while continuing the cycle of distortion.
A further example: On occasion, the imminent approach of a so-called technical default by the world’s largest debtor nation has prompted odd moves in various T-bills as those securities that are most at risk of non-payment become market pariahs. While this is most acutely a problem for investors in those individual issues, it throws out of kilter a market that helps benchmark a huge swath of the world’s borrowing—both government and private.
Nobody can honestly pretend that the ceiling is a mechanism to rein in debt. It causes distortions, and it wastes a lot of time and energy that the denizens of Washington could devote to ensuring the money being borrowed is spent effectively and productively. That’s not to say that debt and deficits don’t matter. But the way the U.S. thinks and legislates on the topic needs to change. —With Alex Harris
Imagine Imagine logging on to your own account with the U.S. Federal Reserve. With your laptop or phone, you could zap cash anywhere instantly. There’d be no middlemen, no fees, no waiting for deposits or payments to clear.
That vision sums up the appeal of the digital dollar, the dream of futurists and the bane of bankers. It’s not the Bitcoin bros and other cryptocurrency fans pushing the disruptive idea but America’s financial and political elite. Fed Chair Jerome Powell promises fresh research and a set of policy questions for Congress to ponder this summer. J. Christopher Giancarlo, a former chairman of the Commodity Futures Trading Commission, is rallying support through the nonprofit Digital Dollar Project, a partnership with consulting giant Accenture Plc. To perpetuate American values such as free enterprise and the rule of law, “we should modernize the dollar,” he recently told a U.S. Senate banking subcommittee.
For now the dollar remains the premier global reserve currency and preferred legal tender for international trade and financial transactions. But a new flavor of cryptocurrency could pose a threat to that dominance, which is part of the reason the Federal Reserve Bank of Boston has been working with the Massachusetts Institute of Technology on developing prototypes for a digital-dollar platform.
Other governments, notably China’s, are ahead in digitizing their currencies. In these nations, regulators worry that the possibilities for fraud are multiplying as more individuals embrace cryptocurrency. Steven Mnuchin, former President Donald Trump’s treasury secretary, said he saw no immediate need for a digital dollar. His successor, Janet Yellen, has expressed interest in studying it. Support for a virtual greenback cuts across party lines in Congress, which will have a say on whether it becomes reality.
At a hearing in June, Senators Elizabeth Warren, a Massachusetts Democrat, and John Kennedy, a Louisiana Republican, signaled openness to the idea. Warren and other Democrats stressed the potential of the digital dollar to offer free services to low-income families who now pay high banking fees or are shut out of the system altogether.
Kennedy and fellow Republicans see a financial equivalent of the space race that pitted the U.S. against the Soviet Union—a battle for prestige, power, and first-mover advantage. This time the adversary is China, which announced this month that more than 10 million citizens are now eligible to participate in ongoing trials.
The strongest opposition to a virtual dollar will come from U.S. banks. They rely on $17 trillion in deposits to fund much of their core business, profiting from the difference between what they pay in interest to account holders and what they charge for loans. Banks also earn billions of dollars annually from overdraft, ATM, and account maintenance fees. By creating a digital currency, the Federal Reserve would in effect be competing with banks for customers.
In a recent blog post, Greg Baer, president of the Bank Policy Institute, which represents the industry, warned that homebuyers, businesses, and other customers would find it harder and more expensive to borrow money if the Fed were to infringe on the private sector’s historical central role in finance. “The Federal Reserve would gain extraordinary power,” wrote Baer, a former assistant treasury secretary in the Clinton administration.
Some economists warn that a digital dollar could destabilize the banking system. The federal government offers bank depositors $250,0000 in insurance, a program that’s successfully prevented bank runs since the Great Depression. But in a 2008-style financial panic, depositors might with a single click pull all their savings out of banks and convert them into direct obligations of the U.S. government.
“In a crisis, this may actually make matters worse,” says Eswar Prasad, a professor at Cornell University and the author of a book on digital currencies that will be published in September. Whether a virtual dollar is even necessary remains up for debate. For large companies, cross-border interbank payments are already fast, limiting the appeal of digital currencies. Early adopters of Bitcoin may have won an investment windfall as its value soared, but its volatility makes it a poor substitute for a reliable government-backed currency such as the dollar.
Yet there’s a new kind of crypto, called stablecoin, that could pose a threat to the dollar’s dominance. Similar to the other digital currencies, it’s essentially a string of code tracked and authenticated via an online ledger. But it has a crucial difference from Bitcoin and its ilk: Its value is pegged to a sovereign currency like the dollar, so it offers stability as well as privacy.
In June 2019, Facebook Inc. announced it was developing a stablecoin called Libra ( since renamed Diem). The social media giant’s 2.85 billion active users worldwide represent a huge test market. “That was a game changer,” Prasad says. “That served as a catalyst for a lot of central banks.”
Regulators also have concerns about consumer protection. Stablecoin is only as stable as the network of private participants who manage it on the web. Should something go wrong, holders could find themselves empty-handed. That prospect places pressure on governments to come up with their own alternatives.
Although the Fed has been studying the idea of a digital dollar since at least 2017, crucial details, including what role private institutions will play, remain unresolved. In the Bahamas, the only country with a central bank digital currency, authorized financial institutions are allowed to offer e-wallets for handling sand dollars, the virtual counterpart to the Bahamian dollar.
If depositors flocked to the virtual dollar, banks would need to find another way to fund their loans. Advocates of a digital dollar float the possibility of the Fed lending to banks so they could write loans. To help banks preserve deposits, the government could also set a ceiling on how much digital currency citizens can hold. In the Bahamas the amount is capped at $8,000.
Lev Menand, an Obama administration treasury adviser, cautions against such compromises, saying the priority should be offering unfettered access to a central bank digital currency, or CBDC. Menand, who now lectures at Columbia Law School, says that because this idea would likely require the passage of legislation, Congress faces a big decision: to create “a robust CBDC or a skim milk sort of product that has been watered down as a favor to big banks.”
Wall Street is warming up to the idea that the next big disruptive force on the horizon is central bank digital currencies, even though the Federal Reserve likely remains a few years away from developing its own.
Led by countries as large as China and as small as the Bahamas, digital money is drawing stronger interest as the future of an increasingly cashless society. A digital dollar would resemble cryptocurrencies such as bitcoin or ethereum in some limited respects, but differ in important ways.
Rather than be a tradable asset with wildly fluctuating prices and limited use, the central bank digital currency would function more like dollars and have widespread acceptance. It also would be fully regulated and under a central authority.
Myriad questions remain before an institution as large as the Fed will wade in. But the momentum is building around the world. As the Fed and other central banks work through those logistical issues, Wall Street is growing in anticipation over what the future will hold.
“The race towards Digital Money 2.0 is on,” Citigroup said in a report. “Some have framed it as a new Space Race or Digital Currency Cold War. In our view, it doesn’t have to be a zero sum game — there’s a lot of room for the overall digital pie to grow.”
There, however, has been at least the semblance of a race, and China is perceived as taking the early lead. With the launch of a digital yuan last year, some fear that the edge China has ultimately could undermine the dollar’s status as the world’s reserve currency. Though China said that is not its objective, a Bank of America report notes that issuing digital dollars would let the U.S. currency “remain highly competitive … relative to other currencies.”
The pace of U.S. hiring accelerated in June, with payrolls increasing by the most in 10 months, suggesting firms are having greater success recruiting workers to keep pace with the economy’s reopening.
Nonfarm payrolls jumped by 850,000 last month, bolstered by strong job gains in leisure and hospitality, a Labor Department report showed Friday. The unemployment rate edged up to 5.9% because more people voluntarily left their jobs and the number of job seekers rose.
The median estimate in a Bloomberg survey of economists was for a 720,000 rise in June payrolls. “Things are picking up,” said Nick Bunker, an economist at the job-search company Indeed. “While labor supply may not be as responsive as some employers might like, they are adding jobs at an increasing rate.”
The gain in payrolls, while well above expectations, doesn’t markedly raise pressure on the Federal Reserve to pare monetary policy support for the economy. Even with the latest advance, U.S. payrolls are still 6.76 million below their pre-pandemic level.
Demand for labor remains robust as employers strive to keep pace with a firming economy, fueled by the lifting of restrictions on business and social activity, mass vaccinations and trillions of dollars in federal relief.
At the same time, a limited supply of labor continues to beleaguer employers, with the number of Americans on payrolls still well below pre-pandemic levels.
Coronavirus concerns, child-care responsibilities and expanded unemployment benefits are all likely contributing to the record number of unfilled positions. Those factors should abate in the coming months though, supporting future hiring.
Wage growth is also picking up as businesses raise pay to attract candidates. The June jobs report showed a hefty 2.3% month-over-month increase in non-supervisory workers’ average hourly earnings in the leisure and hospitality industry. Overall average earnings rose 0.3% last month.
“The strength of our recovery is helping us flip the script,” Biden said in remarks Friday. “Instead of workers competing with each other for jobs that are scarce, employers are competing with each other to attract workers.”
The Labor Department’s figures showed a 343,000 increase in leisure and hospitality payrolls, a sector that’s taking longer to recover because of the pandemic.
Job growth last month was also bolstered by a 188,000 gain in government payrolls. State and local government education employment rose about 230,000, boosted by seasonal adjustments to offset the typical declines seen at the end of the school year.
Hiring was relatively broad-based in June, including other notable gains in business services and retail trade. However, construction payrolls dropped for a third straight month and manufacturing employment rose less than forecast.
“Most of the new jobs now being created are in sectors that were slammed by the pandemic, while companies in other industries are struggling to find available workers,” Sal Guatieri, senior economist at BMO Capital Markets, said in a note.
The overall participation rate held steady and remained well short of pre-pandemic levels. The employment population ratio, or the share of the population that’s currently working, was also unchanged.
Average weekly hours decreased to 34.7 hours from 34.8
The participation rate for women age 25 to 54 rose by 0.4 percentage point; the rate among men in that age group also climbed
The number of Americans classified as long-term unemployed, or those who have been unemployed for 27 weeks or more, increased by the most since November
The U-6 rate, also known as the underemployment rate, fell to a pandemic low of 9.8%. The broad measure includes those who are employed part-time for economic reasons and those who have stopped looking for a job because they are discouraged about their job prospects
The labor force is the actual number of people available for work and is the sum of the employed and the unemployed. The U.S. labor force reached a high of 164.6 million persons in February 2020, just at the start of the COVID-19 pandemic in the United States. The U.S. labor force has risen each year since 1960, with the exception of the period following the Great Recession, when it remained below 2008 levels from 2009-2011.
The labor force participation rate, LFPR (or economic activity rate, EAR), is the ratio between the labor force and the overall size of their cohort (national population of the same age range). Much as in other countries in the West, the labor force participation rate in the U.S. increased significantly during the later half of the 20th century, largely because of women entering the workplace in increasing numbers. Labor force participation has declined steadily since 2000, primarily because of the aging and retirement of the Baby Boom generation.
Analyzing labor force participation trends in the prime working age (25-54) cohort helps separate the impact of an aging population from other demographic factors (e.g., gender, race, and education) and government policies. The Congressional Budget Office explained in 2018 that higher educational attainment is correlated with higher labor force participation for workers aged 25–54. Prime-aged men tend to be out of the labor force because of disability, while a key reason for women is caring for family members.
The Congressional Budget Office explained in 2018 higher educational attainment is correlated with higher labor force participation. Prime-aged men tend to be out of the labor force due to disability, while a key reason for women is caring for family members. To the extent an aging population requires the assistance of prime-aged family members at home, this also presents a downward pressure on this cohort’s participation.
China’s economy had a great 12 months, leading the globe out of the Covid-19 era. Yet the last year has damaged something equally important: Beijing’s soft power.
Beijing’s handling of questions about what happened in Wuhan—and why officials were so slow to warn the world about a coming pandemic—boggles the mind. If China’s handling of the initial outbreak was indeed the “decisive victory” that it claims, why overreact to Australia’s call for a probe?
Harvard Kennedy School students might one day take classes recounting how China’s leaders squandered the Donald Trump era. As the U.S. president was undermining alliances, upending supply chains, losing allies, and playing down the pandemic, Beijing had a once-in-a-lifetime opportunity to increase the country’s influence at Washington’s expense.
And now, many in Beijing appear to understand the extent to which they blew it. Earlier this month, Xi Jinping urged the Communist Party to cultivate a “trustworthy, lovable and respectable” image globally. It’s the clearest indication yet that the “wolf warrior” ethos espoused in recent times by Chinese diplomats was too Trump-like for comfort—and backfiring.
The remedy here is obvious: being the reliable economic engine leaders from the East to West desire.
The Trump administration’s policies had a vaguely developing-nation thrust—favoring a weaker currency, banning companies, tariffs of the kind that might’ve worked in 1985, assaulting government institutions. They shook faith in America’s ability to anchor global finance. The last four years saw a bull market in chatter about replacing the dollar as reserve currency and the centrality of U.S. Treasury debt.
China is enjoying a burst of good press for its gross domestic product trends. Not just for the pace of GDP, but the way Xi’s team appears to be seeking a more balanced and sustainable mix of growth sources. Though some pundits were disappointed by news that industrial production rose just 6.6% in May on a two-year average basis, it essentially gets Asia’s biggest back to where it was pre-Covid-19.
Fixed-asset investment—in, say, property and land—expanded 4.2% on the same basis in the five months to May. Retail sales, meantime, is up a less impressive 4.5%, which is roughly half what we saw in 2019.
China is getting there, slowly but surely. Far from disappointing, though, data suggest Xi’s party learned valuable lessons from the myriad boom/bust cycles that put China in global headlines since 2008. That was the year the “Lehman shock” devastated world markets and threatened to interrupt China’s meteoric rise.
Instead, Beijing bent economic reality to its benefit. Yet the untold trillions of dollars of stimulus that then-President Hu Jintao’s team threw at the economy caused as many long-term headaches as short-term gains. It financed an unproductive infrastructure boom—one prioritizing the quantity of growth over quality—that fueled bubbles. It generated a moral-hazard dynamic that encouraged greater risk and leverage.
Unfortunately, Xi’s government doubled down on the approach in 2015, when Shanghai stocks went into freefall. The impulse then, as in the 2008-2009 period, was to throw even more cash at the problem—treating the symptoms, not the underlying ailments.
The ways in which Team Xi restored calm—bailouts, loosening leverage and reserve requirement protocols, halting initial public offerings and suspending trading in thousands of companies—did little to build a more nimble and transparent system. The message to punters was, no worries, the Communist Party and People’s Bank of China have your backs. Always.
Yet things appear to be changing. In 2020, while the U.S., Europe and Japan went wild with new stimulus schemes, Beijing took a targeted and minimalist approach. Japan alone threw $2.2 trillion, 40% of GDP, at its cratering economy. The Federal Reserve went on an asset-buying tear.
The PBOC, by sharp contrast, resisted the urge to go the quantitative easing route. That is helping Xi in his quest to deleverage the economy. It’s a very difficult balancing act, of course. The will-they-or-won’t-they-default drama unfolding at China Huarong Asset Management demonstrates the risks of hitting the stimulus brakes too hard.
The good news is that so far China seems to be pursuing a stable and lasting 2021 recovery, not the overwhelming force of previous efforts. And that’s just what the world needs. A 6% growth rate year after year will win China more soft-power points than the GDP extremes. So will China accelerating its transition from exports to an innovation-and-services-based power.
It’s grand that President Joe Biden rapidly raised America’s vaccination game. That means the two biggest economies are recovering simultaneously, reinforcing each other.
China’s revival could have an even bigger impact. Look at how China’s growth in recent months is lifting so many boats in Asia. In May alone, Japan enjoyed a 23.6% surge in shipments to China. Mainland demand for everything from motor vehicles to semiconductor machinery to paper products is helping Japan recover from its worst downturn in decades. South Korea, too.
The best thing Xi can do to boost China’s soft power is to lean into this recovery, and provide the stability that the rest of the globe needs. Xi should let China’s GDP power do the talking for him.
I am a Tokyo-based journalist, former columnist for Barron’s and Bloomberg and author of “Japanization: What the World Can Learn from Japan’s Lost Decades.” My journalism awards include the 2010 Society of American Business Editors and Writers prize for commentary.
State-owned enterprises accounted for over 60% of China’s market capitalization in 2019 and generated 40% of China’s GDP of US$15.66trillion in 2020, with domestic and foreign private businesses and investment accounting for the remaining 60%. As of the end of 2019, the total assets of all China’s SOEs, including those operating in the financial sector, reached US$78.08trillion. Ninety-one (91) of these SOEs belong to the 2020 Fortune Global 500 companies.
The crackdown on monopolies by tech giants and internet companies follows with recent calls by the Politburo against monopolistic practices by commercial retail giants like Alibaba. Comparisons have been made with similar probes into Amazon in the United States.
Money is the engine of the economy. It is the facilitator of trade and specialization. However, few people ask themselves: where does our money come from? This article discusses the process of money creation at banks and central banks. The analysis is based on the respective balance sheet.
How the Federal Reserve creates money out of thin air — a balance sheet analysis
This section shows how money is created at the Federal Reserve (Fed), the central bank of the United States. The Fed acts as the bank for the government and as bank for other commercial banks. The Federal Reserve is known to be the “lender of last resort” with the ability to bail out commercial banks. The following analysis is based on the balance sheet of all Federal Reserve Banks combined as published in the annual report 2019 by the Federal Reserve.
The balance sheet of the Fed consists of assets on the one side and liabilities on the other side — just as any company’s balance sheet. The sum of all assets must always be equal to the sum of all liabilities. This is based on the concept of double entry bookkeeping which requires two entries in the balance sheet for every transaction. Assume you are keeping a balance sheet for your personal finances. When you go shopping and pay with cash for food, then there are two entries: a reduction in cash and an increase in food. This fact of every transaction requiring two entries will be important in the further analysis.
Treasury securities and the general account of the treasury
First, we discuss the entries of the Fed’s balance sheet relating to treasury. On the asset side there are „Treasury securities“. On the liability side there is the entry „Treasury, general account“. Treasury securities are bonds issued by the government with varying length and interest rate. The Federal Reserve Bank bought more and more of these government bonds over time thereby providing funding to the government. In 2019, the Fed has claims on the government of more than USD 2.4 trillion. The government is expected to pay this sum with future tax payments by the people since this is the major revenue stream of governments.
But how did the Federal Reserve fund the money for buying government bonds? By creating it out of thin air. Here comes the double entry bookkeeping into play. On the liabilities side, we find the operational account of the treasury which sums up to USD 403 billion. We see that the Fed can easily create new money by expanding the credit sheet. The book value of the government bonds is placed under „treasury securities“ as assets . This process involves an intermediary bank that buys the government bond from the government which is then sold to the Federal Reserve. Thus, the process is in fact even more complex. An illustration of the process can be found in the end of the article.
The central bank also creates money by issuing a credit to banks. The value of the loan is noted on the asset side of the central bank and the money loaned is added to the deposit account of the bank on the liabilities side.The process is explained in the figure below.
The government may issue unlimited amounts of government debt and thereby finance its activities. The Fed may infinitely buy government bonds thereby closely collaborating with the government. The annual report states that any surplus of the Fed’s income is transferred to the Treasury which clearly lines out that the Fed works for the government (see screenshot below). In contrast, any company who takes on more and more debt would face higher interest rates due to increased risk. At a certain stage, the company would not be able to take on more debt. On the other side, the government can loan money infinitely through collusion with the Fed who buys treasury securities to the lowest interest rate.
Federal Reserve Notes
Printing new money can be either exercised through book money or by literally printing new money, i.e. Federal Reserve notes. The annual report of the Fed says that “Federal Reserve notes are obligations of the United States government“ which means that by holding a Federal Reserve note one owns a claim on future tax payments — this concept lies at the heart of government backed money. Essentially, the taxpayer is the collateral for Federal Reserve notes. In 2019, the Federal Reserve notes outstanding accumulate to more than USD 1.7 trillion.
Mortgage-backed securities in the Federal Reserve balance sheet
We have discussed the most important entry on the balance sheet of the Federal Reserve which is the claim on the government bonds on the asset side and the general account of the treasury on the liability side. The Federal Reserve, however, does not only hold government bonds as collateral for the Federal Reserve notes. The second largest entry on the assets side of the Fed’s balance sheet are mortgage-backed securities. The entry „Federal Agency and Government-Sponsored Enterprise Mortgage-Backed Securities“ comprises purchases of mortgage-backed securities from “government-sponsored enterprises” such as the Federal National Mortgage Association (Fannie Mae) & Federal Home Loan Mortgage Corporation (Freddie Mac). This means that the Fed owns the claims on house owners’ debt obligations. In general, the buyer of a mortgage-backed security (MBS) has a claim on the real estate in case of credit default. So in case of defaulting MBS, the ownership of the real estate is transferred to the Federal Reserve Bank.
But where did the Federal Reserve receive the funds for buying MBS? The central bank may simply create the money to buy assets as discussed in an article from the Bank of England. The central bank does so by adding the value of the assets on the asset side of the balance sheet and by inserting the funds for the assets to the seller’s bank account. Quantitative Easing works according to the same principle: The central bank buys government bonds from other banks thereby creating the funds out of thin air. The bank accounts can be found in the row “Depository institutions“ which is further explained in the next section.
Bank accounts at the Fed and the reserve requirement
Banks are obliged to hold a certain percentage of their liabilities as reserve at the central bank called “reserve requirement”. The reserve requirement of all banks combined is noted in the row “Depository institutions” on the liability side of the central bank. The central bank primarily holds government bonds and MBS as a reserve for the banks’ deposits. This means that the people’s savings are not more secure with higher reserve requirements since these savings are backed by not necessarily “safer” investments. Essentially, savings can be only considered “safe” when assuming unlimited bank bailouts.
In 2019, the total sum of bank deposits at the Fed accounted for more than USD 1.5 trillion. The percentage of reserves banks need to hold in reserve at central banks is set by central banks. In March 26, 2020 this percentage was set to zero. This means that banks are not required to hold any money in reserves for the debt they give out. However, for being able to serve the claims of customers, they should hold a certain amount of money as reserve. The amount of money which banks hold at central banks that exceed the minimum reserve is called “excess reserve”. The Fed has not charged negative interest rate for excess reserves yet but the ECB has already started to do so. This means that banks holding money at the ECB have to pay for doing so. This puts great strain on banks so they have an incentive to give out more debt to make money from the debt related interest.
Can commercial banks create money individually out of thin air?
There is an ongoing discussion on whether commercial banks may create money individually out of thin air in the process of credit creation. This section first discusses the theoretical background followed by empirical evidence supporting the hypothesis that commercial banks create money out of thin air. It also reflects the view of central banks, which clearly shows that banks can create money from nothing.
Banks as custody providers and investment vehicles
The theoretical part refers to Rothbard’s analysis on money creation in his book „Man, Economy, and State with Power and Market“ first published in 1962, page 801 forth following. Rothbard started his argumentation with banks acting as custody providers during the gold standard which means that gold was used as a currency (in contrast to government-backed fiat money which is essentially backed by future tax payments).
Rothbard explains the concept of money creation with the hypothetical example of the „Star Bank“ offering custody services to the public. For storing 5000 ounces of gold, the bank issued warehouse receipts covering exactly 5000 ounces.
Now the bank decided to perform investments with their clients’ money to increase their revenue. The bank lends out the saver’s money to others, in turn the bank offers an interest rate to their customers. The bank now acts as an investment vehicle. Since the savers want to withdraw their money every now and then, the bank holds some gold in reserve. This gold in reserve is not used for investment purposes. So the bank acts as both: custody provider and investment vehicle.
If more people want to withdraw their money than the bank has reserves, then the bank goes bankrupt. This happened in the past in so-called „bank runs“. This problem could have been mitigated by the bank clearly separating their business as investment vehicle and as custody provider. In such a scenario, the customer can decide which portion of his money he aims to invest and get interest for and which portion of the money he aims to place in custody where he needs to pay custody fees for the service. Also, the bank should be required to be transparent about which investments the people’s money flows to, which is not the case in the current financial system.
The process of money creation through credit creation at commercial banks
In the process of credit creation, an entry on the asset side of the balance sheet is created depicting the claim of the bank on the debtor. Since the system is based upon double entry bookkeeping, a corresponding entry is required. This means that the money that is lent out has to come from somewhere.
The process of credit creation is explained with another example of the Star Bank illustrated in the screenshot below. The asset side shows that 5000 ounces are kept in custody and 1000 ounces of gold were given out to debtors (I.O.U’s from Debtors — I.O.U. refers to “I owe you”). The liability side shows that warehouse receipts worth 6000 ounces of gold were given out. We assume that exactly 1000 ounces more gold were inserted by customers which was then lent out. This means that the debt money originates from the savers depositing their money in the bank. So, the money was merely shifted from saver to debtor where the bank acts as financial intermediary.
This is no problem when the bank first asks their customers whether they agree with this particular investment because in the end, these customers bear the risk of default. The bank becomes the investment vehicle and intermediary for this particular transaction.
But what if the bank creates more warehouse receipts than the total sum of the gold the bank holds in custody and the gold lent out? This is „the creation of new money out of thin air, by issuing receipts for nonexistent gold“ which is called „monetization of debt“ (Rothbard, 1962, p. 809). We use the example above, however, now assuming that the bank created 1000 pseudo warehouse receipts that are not covered by gold. In fact there are only 5000 ounces of gold but the bank acts as if there were 6000 ounces of gold by giving out 6000 pseudo warehouse receipts. In the process of lending out money, 1000 new warehouse receipts were created which are not covered by gold. These are fake money certificates created in the process of debt issuance. So essentially, the bank has issued more money certificates than it can actually redeem. If more customers claim their gold than the bank holds in custody, then the bank goes bankrupt if it is not bailed out.
According to Rothbard „It is, in fact, difficult to see the economic or moral difference between the issuance of pseudo receipts and the appropriation of someone else’s property or outright embezzlement or, more directly, counterfeiting. Most present legal systems do not outlaw this practice; in fact, it is considered basic banking procedure.“ (Rothbard, 1962, p. 809)
When banks engage in fraudulent behavior, they would normally lose customers. Also, other banks would stop lending money to the fraudulent bank. This allows sound checks between banks on their risk and credibility. This was stopped through the nationwide check-clearing system called „Federal Reserve“ which can bail out even the most fraudulent bank. The Federal Reserve published a document explaining its purposes and functions which says the following:
„By creating the Federal Reserve System, Congress intended to eliminate the severe financial crises that had periodically swept the nation, especially the sort of financial panic that occurred in 1907. During that episode, payments were disrupted throughout the country because many banks and clearinghouses refused to clear checks drawn on certain other banks, a practice that contributed to the failure of otherwise solvent banks [Note author: if the banks were solvent they would not need a bailout]. To address these problems, Congress gave the Federal Reserve System the authority to establish a nationwide check-clearing system.“ (Source: Federal Reserve System Publication, Purposes and Functions)
For evidence on whether commercial banks may individually create money out of thin air, we may either look into the source code of the banking system or we look at empirical data. The source code is unfortunately undisclosed. So we may only look at empirical data.
Empirical study on whether commercial banks may create money out of thin air
This section refers to the study “Can banks individually create money out of nothing? — The theories and the empirical evidence“ by Professor Richard Werner. In this study, the cooperating bank granted a loan of 200 000 EUR of maturity under 4 years to Richard Werner. A snapshot of the balance sheet was taken before the transfer and on the next day when the transaction was completed. The study showed the following balance sheet movements of the „Raiffeisenbank”:
We see an increase of around 170 000 EUR on the liability side in the entry „claims by customers“. This entry corresponds to the „pseudo warehouse receipts“ in the analysis of Rothbard. It is quite unlikely that customers inserted so much money as savings on the day regarded. But what else could have moved this entry so much? Let’s remember the mechanism of how central banks created new money — maybe a similar mechanism is applied with commercial banks. Central banks create new money by recording the issued loan as an asset on the asset side and by entering the corresponding money into the banks’ accounts. Commercial banks could make use of the same principle: They can note the loan amount on the asset side and insert this money in the bank account of the debtor. In this process, the credit sum would be added to both sides of the balance sheet: the “claims on customers” on the asset side (the debt) and the “claims by customers” on the liability side of the bank (the loaned money).
A snapshot directly before and after the transaction would have given us more clarity but this is the best to work with for now. The 170 000 EUR of increase in claims by customers is close to the credit sum but does not cover it entirely. So let’s have a look at the other major movements on the balance sheet. Apart from the increase in the claims by customers, we see an increase in cash on the asset side and a decrease in „claims on financial institutions“. This indicates that other banks paid the debt they had with the „Raiffeisenbank“. Since we do not have the balance sheet of all customers and debtors of the Raiffeisenbank, it is not possible to say with absolute clarity which transaction was a pseudo transaction and which was not. But we can have a look at what the central authorities say on Money creation.
Central banks’ view on money creation in the banking system
Both articles have found that banks and central banks create money by issuing debt. More precisely, the debt is noted on the asset side as a claim on the debtor and the related money is inserted in the deposit account of the debtor. This fits very well to what was explained above.
Both articles have found another mean for money creation namely in the process of buying assets. When a bank or central bank buys an asset, the asset is placed on the asset side of the balance sheet and the related money is placed in the account of the seller of the asset on the liability side.
Concluding, we have great evidence that both banks and central banks create money out of thin air in the process of credit creation and also in the process of asset purchases.
Next, we look at the occurrence of pseudo receipts in history.
Pseudo receipts in the history of money
The most prominent case of pseudo receipts happened during the Bretton Woods System which was in place from 1944 to 1971. In this time period, the US dollar was fixed to gold at USD 35 per ounce of gold. All other currencies were in turn fixed to the US Dollar. The Federal Reserve held the gold in reserve to which the US dollar was pegged to. This means that the Federal Reserve was the only custody provider that held the gold in reserve which is an extreme centralization of trust. Everyone trusted that the Federal Reserve does not create pseudo warehouse receipts, i.e. more US dollars than are covered by the gold reserves. In the 1960s, the first speculators did not trust the Fed anymore and assumed that more US dollars were created than there were gold reserves. This has led to a revaluation of currencies and eventually to the collapse of the Bretton Wood System. Now, the US dollar is pegged to nothing and the Fed may print infinitely.
Note: Here you find one source on Bretton Woods (notice the framing „speculative attacks“ and „confidence problem“ by the public instead of „deception“ and „fraud“ committed by the Fed).
Money alternatives that cannot be created out of thin air
We learned that depositing one’s money in service custody allows the custody provider to easily instigate fraudulent behavior by issuing fake warehouse receipts. We can prevent this by holding our assets in self-custody. But which alternative money is most suitable for self-custody? In the following, Bitcoin and gold are compared as money alternatives.
Bitcoin can be sent over distance almost immediately without a third party. Gold either requires physical shipping which is very slow and comes with a great risk of losing the funds or the gold is held in service custody and merely the ownership is shifted. Storing one’s money in custody requires trust in the custody provider to not issue pseudo receipts. Bitcoin in turn can be held by the individual and can be sent over distance directly to the recipient. Bitcoin does not depend on a trusted centralized authority — Bitcoin is trustless. Moreover, if bitcoin are stored at a custody provider who gives every customer a separate Bitcoin address, then the customer may verify whether the bitcoins are still there 24/7 over the network. This is why Bitcoin is superior over gold even in the situation of custody.
According to Bloomberg, central banks have bought more and more gold just recently. Some people are arguing that the government may introduce a new coin that is backed by gold when the fiat system crashes. But wait! Didn’t the central banks create more US dollars than there was gold in reserve during the Bretton Woods System? Yes. If your government says that a new fiat is issued which is backed by gold where gold is stored in a centralized custody, why should you trust them not to create pseudo receipts if they did so in the past?
Bitcoin is the way out.
I would like to thank Murray Rothbard for his extraordinary logic in laying out the concept of money and its creation. I also thank Professor Richard Werner for conducting the empirical study on money creation at commercial banks. Great thanks to my proofreaders Ben Kaufman, Keyvan Davani and Márton Csernai. I highly appreciate your support in improving this article. Any feedback from subsequent readers is highly welcome!
Note on fractional reserve banking
It is important to differentiate between two different definitions of fractional reserve banking:
Reserve refers to the percentage of money held in custody which is not lent out. So, a portion of the savers money is held in custody (reserve) and the rest is invested.
Reserve refers to the percentage of money actually covered by the underlying asset. Gold standard: Only a portion of the money certificates is backed with the underlying asset, the rest are pseudo warehouse receipts. Fiat system: The bank may create money in the process of debt issuance.
Note that with fiat money, it is difficult to differentiate money and money substitutes because both are based on nothing and essentially fake. This is why the definition “money may be created in the debt issuance process” is used.
In a monetary system where money cannot be created through accounting fraud in the process of debt issuance, debt and credit simply show the obligations between people. In such a system, money would be distributed from e.g. the savers account to the debtors account where the bank acts as financial intermediary (see first example by Rothbard in this article). So, fractional reserve banking as per the first definition does not lead to more money created. However, money in custody and money invested should be clearly separated thereby laying on a sound monetary system that is scarce. Bitcoin enables this.
The implications of the second system where money may be created out of thin air by banks and central banks have found deep consideration in the article. We have strong evidence that banks and in particular central banks create new money in the process of debt issuance through accounting fraud. Even the reserves behind the central bank money, which among other things consists of the banks’ minimum reserves, can be used by the central banks for risky investments, which makes the whole concept of minimum reserves ad absurdum. We may conclude that both definitions of Fractional Reserve Banking hold in the current system. The first concept of Fractional Reserve Banking is organic to a sound monetary system. The latter is inorganic and can be only facilitated with fraud or unsound money coming with great distortions to the economy.
Note on whether fiat money is debt or money
Emil Sandstedt brought up the very interesting question on whether fiat money is money or debt during our Podcast with Keyvan Davani. I would consider fiat money as both: debt and money and I lay out why in the following.
Federal Reserve notes are per definition part of the “monetary base” which is the most superior money. Money is in fact differentiated into certain categories (monetary base, M1, M2, M3). So, Federal Reserve notes are money in the narrow sense. In general, the longer the deposit maturity of a savings deposit, the lower its rank in the monetary hierarchy per definition. However, Federal Reserve notes are a claim on future tax payments (see chapter Federal Reserve Notes). Since future tax payments are a form of debt, Federal Reserve Notes can be considered both: money and debt.
Per definition, the other forms of debt generated through credit creation are not considered money in the fiat system but rather as a “counterpart of M3”. On the other side, one can buy things with the money that one received through the credit. So this money can be used as a medium of exchange. This is a reason why this debt can be considered “money”.
This article has not focused on this differentiation for reasons of simplicity. In the end, what one calls calls “money” is based on definitions. Since money created through debt issuance can be used for payments, it is valid to consider it as money as it was done in this article. But also, it is justified to call central bank money as debt since these are a claims on future tax payments — claims on debt. Therefore, I like the term “debt money” implicating that the fiat system is based on debt and that this money is used as a medium of exchange.
Interesting side note: Only central bank money is considered money by government decree.
Illustration of quantitative easing
Quantitative easing involves the purchase of government bonds by the central bank. But the treasuries are first sold to the secondary market. In the process below the treasury is first bought by a pension fund, then by a bank called “Citibank” and then by the Federal Reserve. Alexander Bechtel explains this process very well in this video.
By Stefanie von Jan / Freedom and truth seeker, economist for a free market for money, deep into Austrian Economics and Bitcoin, advocate for safe and beneficial technologies
A brief look at how money has evolved over time from being printed on valuable substances (commodity money), to merely representing those valuable substances (commodity-backed money), to not representing anything at all (fiat money). Created by Grant Sanderson. View more lessons or practice this subject at http://www.khanacademy.org/economics-… AP Macroeconomics on Khan Academy: Welcome to Economics! In this lesson we’ll define Economic and introduce some of the fundamental tools and perspectives economists use to understand the world around us!
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