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Thursday, March 21, 2013

Cyprus


As part of a bailout package for Cyprus it was proposed that the government confiscate money from private bank accounts to finance the bailout package.  To say that the citizens of Cyprus were not happy would be an understatement.

The talking heads on US news channels were quick to point out that that “would never be attempted in the US”.  Too late, it has already happened.  

Language is important.  We (the US) recently experienced our 3rd round of “Quantative Easing”.  QE is truly a case of “ex nihilo” (out of nothing).  QE is the process whereby the Fed simply creates a balance on a Central Bank’s books.  Create is the key word.  They simply change the numbers in the computer.  The Banks can then use this “money” to buy back bonds.

So if the QE money was created from nothing why does it have value?  As has been pointed out on this blog money is fungible.  When added to the US money supply the QE money draws value from every other dollar in existence.  That includes the ones in your pocket, your investment portfolio and to relate this back to Cyprus it draws value from every dollar you have in the bank.

In a real way the US government has already done what has been proposed for Cyprus, we (the US government) just called it QE instead of calling it a confiscation of money from your bank account.  Genius.

4 comments:

  1. Here I will ask a question that will expose me as an economics novice:

    If I understand all of this correctly, a big fear about QE3 (or 2 or 1 for that matter) was that it would create rampant inflation. Thus far inflation has held rather steady at something like 2% with (is this right? I may be wrong, but don't have time at this moment to search for real numbers).

    Furthermore, some serious economists have called for an inflation target of more than 2% - again, if I'm not mistaken this is the position of the Fed (correct me if I'm wrong).

    Is there a simple explanation for this? In spite of the various rounds of QE, the inflation fears seem not to have come to fruition, at least not yet.

    Maybe this has all been discussed in detail in previous posts that I missed. Or perhaps I should return to school and study economics!

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    Replies
    1. As you point out QE has not lead to “rampant” inflation even though, I think, QE is inflationary by definition. I think one of the quotes of the day on this blog was from Harry Truman asking for a one handed economist that could not keep saying “on the other hand” so obviously even so called experts on the economy often contradict each other.

      Here is my layman’s opinion on why inflation is at relatively low levels in spite of QE (and other issues as well). When the inflationary pressure of QE is dumped into the entire US economy it has been offset or negligible due to the deflationary pressure of other items.

      My pick for the economic element stabilizing inflation at the moment is housing costs which are still near that of 2008.

      I do believe that we have seen “rampant” inflation in the last 5 years in areas such as food and fuel, but I think it would be unfair to tie that directly to QE. “On the other hand” it would not be proper to take QE out of the equation.

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  2. A similar viewpoint http://www.realclearpolitics.com/articles/2013/03/26/can_it_happen_here_117629.html

    ReplyDelete