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To: Canuck Dave who wrote (12965)	6/24/2003 11:52:59 AM
From: austrieconomist	Read Replies (2) \| Respond to of 39344

The problem with equating these market debt instruments with money creation is that they are merely "asset/debt" arrangements that are in balance. No money is created. On the other hand the Fed can create money by making a deposit where previously no asset existed. This is what is inflationary -- creating money where previously none existed. That is what debases the currency.

To: Canuck Dave who wrote (12965)	6/24/2003 12:28:57 PM
From: austrieconomist	Respond to of 39344

credit vs. money (continued). Interestingly, the always excellent and brilliant John Hussman (Hussman Econometrics) posted his weekly report today which expanded and explained my point on the difference between credit and money creation. Asset backed securities don't create money but do expand the probability of money creation in the future. "Of course, if somebody owes short-term interest, somebody else must be earning it. Who owns all of this low interest rate paper if the companies issuing it are so vulnerable to default risk? That's the secret. The companies don't actually issue it. Instead, much of the worst credit risk in the U.S. financial system is actually swapped into instruments that end up being partially backed by the U.S. government. "See, a risk-averse investor might be somewhat reluctant to lend short-term money directly to, say, General Motors. To see how the U.S. government becomes a counterparty to this debt, grab a pen. "First, suppose that Citibank gets money from its depositors at a floating rate, and lends to mortgage holders at a fixed 6%. Now GM issues bonds yielding 7%, and enters a swap with Citibank, in which Citibank pays GM 6% fixed in return for floating + 1% (the U.S. swaps market for this kind of transaction is huge). Well, now GM is paying an actual interest rate of floating + 2% (pay 7% to bondholders, get 6% from Citibank, pay Citibank floating + 1%). Meanwhile, Citibank is earning a fixed 1% margin regardless of interest rate movements (pay depositors floating, get 6% from mortgages, pay 6% to GM, get floating + 1% from GM). Neat. And since Citibank is federally insured, Uncle Sam is now a counterparty that effectively shares the risk in the case that GM defaults. Similar transactions serve to swap risky corporate and mortgage borrowing into safe government agency paper issued by Fannie Mae and Freddie Mac. "Now make no mistake, I do strongly believe that bank deposits and government and agency debt are safely backed by the U.S. government and that this is a good commitment. The holders of stock in banks or mortgage companies like Fannie Mae and Freddie Mac may not be so secure. For several years now, our stock selection approach has led us to avoid large commitments to financial company stocks. "The key point is that a lot of debtors have linked their borrowing to short-term interest rates. This is tolerated by the financial system because the debt has been swapped out through financial intermediaries like banks, so investors get to hold relatively safe instruments like bank deposits and Fannie Mae securities. Still, the mountain of debt in the U.S. financial system - tied to short-term interest rates - is ultimately and perhaps somewhat inadvertently backed by the U.S. government. THIS IS LIKELY TO RESULT in FUTURE MONEY CREATION (emphasis supplied). Meanwhile, we aren't very willing to own much in the way of financial or mortgage company stocks, because these institutions may be vulnerable to credit problems even if their depositors and bondholders are not.