Elliott's Paul Singer On How Money Is Created... And How It Dies
When we launched our series into the US Shadow Banking system in the summer of 2010 we had one simple objective: to demonstrate just how little the process of modern (and by modern we mean circa 2004 not 1981) money creation was understood. Here was just one example where some $17 trillion (back then, now less) in credit money was rapidly liquidating, an amount greater than the entire M2 and even M3 (had that series still be in circulation) and yet not one academic, pundit or self-professed money expert had or has still accounted for the massive impact of this monetary abstraction on the markets and the economy, which as most know "grows" (to use one of the most misunderstood words in all of economics) primarily by expansion (or contraction as the case may be) of credit, both traditional, which is Bernanke's domain, and "shadow", courtesy of America's #1 export: "financial innovation."
It is now three years later and we are happy to report that almost not one person, not those that hide their complete lack of understanding of the money creation process behind big words, circular arguments, and three letter "monetary theory" acronyms, and certainly not those who set monetary policy, have understood a single thing of what we have been trying to explain all this time, which is merely the modern monetary reality but not from some textbook theoretical perspective, but from a purely practical, where money is nothing more than 1s and 0s in some server, standpoint.
However, one person has. That one person is Paul Singer. Paul is not some fringe blogger, some academic with a chip on his shoulder and an inferiority complex, nor some lunatic gold bug. Paul runs Elliott Management, one of the five biggest hedge funds in the US, which at last check had some $21.1 billion under management. And having managed money successfully since 1977, and witnessed numerous cycles of growth and contraction, not to mention money creation and liquidation, we would argue that his opinion on virtually all matters finance and money-related is second to none. It is certainly orders of magnitude more relevant and correct than that of the shamanistic central planning hacks who sit down every month in Marriner Eccler building to form a circle of depraved (and arguably deferred genocidal) cluelessness, and after a theatrical vote a la Stalingrad circa 1954, determine the cost of money (at least they did in the Old Normal) without even understanding what money actually is.
So for anyone who wishes to know what really happens in the modern world when money is created - and that would be most people who pretend to be informed on this, and other modern financial topics as nowadays it is all about money creation (and soon, destruction) here is, from Paul Singer's latest monthly letter, an extended discussion on the nature of money, how it is created, and most importantly, how it dies.
Money Tsunami
The concept of “money” used to be simple: items of recognized value, initially in the form of shells, livestock, and then precious metals. At some point, someone decided to print currency on paper, but it was widely understood that it had to be backed by something real, like gold or silver. That history is oversimplified, but it illustrates this central truth: Money that is created at will, rather than grown in the field, mined from the earth, or otherwise subject to supply limitations, can be easily degraded. Nobody would want to own something that may or may not have value and purchasing power in the future. What, then, determines the value of money? The worldview and ethics of those in charge of the printing presses are obvious answers that are often overlooked. Another is the confidence (or inertia!) of the people who hold and trade the money, or claims denominated in money.
Fast forward to the modern era, which features central banks, so-called “fractional reserve banking,” leverage, and derivatives. Central banks allowed commercial banks to create money by making loans while keeping small amounts of reserves on hand or at the central banks. As money market funds, bank CDs, and other like instruments were created and then became a sizeable portion of the global financial system, things got even more complicated. An obvious clue that the very definition of money, to say nothing of the appropriate ways to analyze and adjust monetary policy, have departed from the understanding and control of monetary authorities can be found in the proliferation over time of acronyms to describe what used to be called simply “the money supply”: M1, M2, M2A, M3, MZM, and several others.
Add modern derivatives, which entered the scene in a significant way only some 30 years ago, and the picture becomes even murkier. To demonstrate this, in slow motion, consider the creation of a credit default swap (CDS), and then a mortgage collateralized debt obligation (CDO). Assume an investor wants to be long the credit of IBM. The investor offers to sell to a dealer a CDS on IBM. The dealer purchases the CDS and either keeps it or lays off the risk by booking an offsetting transaction with someone else. Actual securities issued by IBM are not part of these transactions – the CDS is just a contract between the investor and the dealer. As IBM’s credit quality is perceived to change, the price of the CDS will fluctuate and money will change hands between the investor and the dealer (based on the “mark to market”). This position is basically a borrowing by the investor who now “owns” a security referencing the credit of IBM, and who has put up only a small deposit – a tiny fraction of the notional credit exposure that the investor is long. It also represents a highly-leveraged loan by the dealer. Although the investor/borrower does not receive the full proceeds of this “loan,” he or she bears the full risk of loss on the underlying asset. It is as if the investor borrowed money from the dealer, added a small amount of his or her own money, and purchased an IBM security with the total amount of money. Interestingly, such borrowings also have the effect of impacting the price of the actual underlying assets (in this case, IBM credit) due to arbitrage pressures. In effect, these transactions by investors and non-bank dealers represent many of the characteristics of the creation and dissipation of money, but they are outside the traditional and commonly-understood mechanics of fractional reserve banking. Most economists would not consider these transactions in the context of money supply, but we think that they are being mechanistic and not seeing the actual effects of the basically unlimited ability of private derivatives transactions to have many of the same effects as are caused by the creation and destruction of “money.”
The ecosystem of mortgage securitizations has similar characteristics. It starts with the tranching of pools of mortgages into mortgage-backed securities (MBS) and then the referencing (via derivatives) of low-rated tranches to form new securities called synthetic CDOs. Based upon fanciful assumptions about diversity that prevailed pre-2008, the bulk of synthetic CDOs that referenced low-rated mortgage-pool tranches magically turned into AAA-rated securities. These instruments, even in subprime mortgage securitizations, were consequently treated by regulators as zero-risk-rated. Until the music stopped, these high-rated securities had many of the powerful multiplier effects of money. Furthermore, the institutions that packaged and sold the MBS, and those that put together the synthetic CDOs, performed many of the functions of banks (conjuring credit out of small reserves) even if they weren’t banks. Finally, the entire process caused demand for houses to increase and prices to rise.
The purpose of this part of the discussion about money is to show that things have gotten really complex and subtle in the modern banking and derivatives era, and that the old model of money as being solely or mainly the product of bank reserves and bank loans is woefully inadequate.
Now one more element should be added to this mix: quantitative easing, or QE. The government spends money on roads, bureaucrats’ salaries, entitlements, etc. To pay for such spending, Treasury sells a security to the public, and it has an obligation to repay the purchaser when the security matures. The security might be a Treasury Bill, a 30-year bond, or anything in between. The Federal Reserve (or the Fed, as it is commonly known) has the ability to set short-term interest rates, which has incentive/disincentive effects on bank lending and consumer spending. In a nutshell, that model has prevailed as the status quo since the Fed was created in 1913, up until 2008.
Since the crash of 2008, there has been an additional dynamic at work. Namely, the Fed is purchasing massive amounts of Treasury securities, either directly or on the open market. To be clear, the cash outlays by Treasury for government spending are the same as in the preceding paragraph. The difference is that post-crash, there are far fewer securities outstanding that the Treasury must pay off at maturity, because trillions of dollars of such securities are owned by another department of the federal government. We think this process is the effective equivalent of money-printing.
For those who think otherwise, we pose the following question: If QE did not have the effect of printing money, why would the Fed do it? We do not think that QE is merely a duration swap. If the government simply wanted shorter duration and cheaper borrowing costs, the easy course would be for the Fed to set interest rates at zero and for the Treasury to issue only 30-day Treasury Bills to pay for government spending. One possible outcome of such an approach would be that the price of long-term bonds would be uncontrolled, and could possibly fall precipitously, thereby driving up long-term interest rates. Instead, the government adopted a zero interest rate policy, or ZIRP, and Treasury’s borrowing rates dropped as the Fed purchased its bonds, elevating the prices of virtually all other securities. All of this contrivance is intended to be an indirect way of supporting economic activity, and perhaps it has done that to some degree. But it is causing massive distortions of risk-reward in stocks and bonds, as well as significant expansion of future risks of both inflation and severe losses in asset prices. These losses would be experienced by both the Fed and by investors.
The Fed’s explanations of these policies are delivered with equanimity and aplomb. However, in our view, the inventions of modern finance have “gotten away from them” and are not adequately understood by the money-printing overseers. A “smoking gun” is the complete failure of policymakers (and financial-institution executives) to predict or understand the circumstances surrounding the 2008 financial crisis – neither the inner workings/interconnectedness of the institutions involved nor the risks inherent in the system. Recently released minutes of Fed meetings in 2007 make it clear that they did not understand the modern financial system: its structure, the instruments that comprised it, the implications of the leverage and risk-taking afforded by untested derivative products, and the vulnerability and opacity of the major financial institutions. It does not mean that the Fed has no credibility when it acts or makes pronouncements today. But it certainly means that they should not have a great deal of presumptive credibility, especially about elements that are experimental and untested or that they got so wrong recently (like QE, and the risks of a system comprised of modern highly-leveraged financial institutions laden with derivatives positions, respectively).
It is critically important for investors to try to understand what global QE is actually doing, where it may lead, and what will happen when it slows, stops or shifts into reverse. What we urge most strongly is that the current atmosphere of calm and stability, and the lack of virulent inflation, must not be relied upon to continue forever. There are certain words and phrases in official communications that give some hint of the uncertainty that exists about key elements of central-bank policies: confidence, anchored inflationary expectations, and velocity are prime examples. Our takeaway is that when investors lose confidence in ZIRP-soaked, QE-ridden, faith-based paper money, the consequences could be abrupt and catastrophic to societal stability. We do not know exactly what to do about it, except to urge policymakers to STOP substituting QE for sound tax, regulatory, labor, environmental, and fiscal policies.
Due to the combination of the lagged nature of inflation in wages and consumer prices, the vital (if possibly more ephemeral than policymakers think) role of “confidence,” and the fact that each particular brand of paper money is competing with other currencies that are similarly mismanaged, the world is in a position today in which the major central banks see only the beneficial effects of QE and not the risks. Bonds that otherwise might be collapsing and repudiated are at sky-high prices with stingy yields. Reported consumer inflation is near historic lows. Consequently, central bankers think that what they got away with yesterday will also work today and next week. Investors either have not figured out that they are long seriously overpriced promises or think that they will all have the luck and perspicacity to reject such instruments before they plunge in price.
The reason we combined derivatives and QE in this discussion is that both are proud inventions of modern financial science, both have many of the characteristics of money-creation, and both are undertaken without any real understanding by public or private sector leaders of their nature, power, interconnectivity, and ultimate consequences. QE is exceptionally dangerous and way past its tipping point. We do not believe it can be unwound without serious consequences. Central bankers think (hope?) that it can be easily unwound at some future date, but they may not be right.
When the rejection of long-term bonds and paper money starts at some unpredictable future time, it may be fast and difficult to contain or reverse. History is replete with examples of societies whose downfalls were related to or caused by the destruction of money. The end of this phase of global financial history will likely erupt suddenly. It will take almost everyone by surprise, and then it may grind a great deal of capital and societal cohesion into dust and pain. We wish more global leaders understood the value of sound economic policy, the necessity of sound money, and the difference between governmental actions that enable growth and economic stability and those that risk abject ruin. Unfortunately, it appears that few leaders do.
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It came as a shock to customers in the industry because money market funds had long been viewed as a safe investment, precisely because, on the surface, they are often very similar to banks. They even issue credit cards and checkbooks in the United States. The shadow banking industry often acts in unpredictable ways. For instance, money market funds in the US increased global uncertainty when they withdrew billions of euros from French banks. International central banks had to be deployed in a bailout. Banks were given a fresh hit of $$$$$. This greatly came to compromise France.
http://silvervigilante.com
The reality that the plan isn't working is beginning to set in on the establishment. But Singer is a "progressive" conservative; when liberals start asking for "sound money", you'll know its about to go. But unfortunately they may not have enough time for that "revelation".
All of these rich people want a solution that preserves the value of their paper. Good luck to Ben in trying to start that "virtuous cycle". This grumbling from the establishment is going to get worse, and then all them will rush into commodities, like bread, oil, metals, driving up the price. And we are going to get screwed, because we got no paper, just debt.
So, anyone here who think these are just sour grapes is mistaken, this is how I see it going down. What will be the trigger for them to lose trust with each other, not sure, but knowing these arrogant fools, it doesn't take much.
I wish this whole financial enterprise would be separated from real economy and just implode in outer space of reality.
What will be the trigger for them to lose trust with each other,...
I'm betting about 60/40 that it will be an exogenous (external to finance -a war probably) event that gets the ball rolling.
'when liberals start asking for "sound money", you'll know its about to go.'
Don't know about that, but I do know everyone will eventually beg for sound money...which was planned from the beginning. We'll beg & THEN they will give it to us. When commodity prices go through the roof, and people are starving and crammed into rentals they can't afford it will come.
Do you think the ones that have had years controlling fiat currency don't know what they're doing?They do, and all is going along as planned.
Don't confuse intelligence for wisdom. What's really frightening is that they don't know what they are doing, and I do believe that they will panic.
I see this economy in philosophical terms as extension of liberal postmodern ideas. Where there is no standard for anything.
Is it a central plan of some sort; yes, but its not a matter of flesh and blood.
I can tell you exactly when the Dollar will collapse. When Bennie or his successor stops the flow. That's when the music stops and the chairs are all taken.
"You've got to dance as long as the music is playing."
Fucking right! SUPER BOWL WEEKEND BITCHES!
this is so much nonsense, let me explain it in a way most of you will understand. when the Cohen brothers make a film, Fargo, Brother Where Are Thou?, No Country for Old Men.. when they produce a new film there are no standards, according to existing standards. They freestyle it, not according the to the market, which is driven by high tech gadget films and super heroes, but according to their own view of things. the only way to measure a Cohen brothers film is to ask the question, does it follow its own premise?
now the Fed has to follow its own premise, and to that end it has technically a number of policy objectives (some of which contadict one another) so you think the Fed is protecting the dollar but if you saw Bush2 the movie you know that isn't the premise at all, all the while they said they were for a strong dollar, they were destroying the dollars value.
so the question is not what Fed policy movie is this now (yes we are pinning interest rates to unemployment) but what is the real story (it ain't unemployment) but jobs figure in this thing like the poor foil who gets done in early, usually because he doesn't know the real story (8 month pregnant Fargo sheriff walks out into the snow to look at dead state trooper "he looks like a nice enough fellow..") not a whiff of fear in her voice... you see she has a copy of the script, and now wall street has a copy, and the box office receipts will start rolling in, because its really only a matter of meeting their own (often perverse0 standards..
There is a dumb article about 'money' that appears on ZH at least once per week. Almost everything about this particular screed is wrong ... but it provides some entertainment ... since Spring Training is two weeks off.
BTW, there is non-stop discussions about money and its creation/implications all over the Internet outside of academic economics: Doug Noland @ Prudent Bear, John Hussman, Randall Wray and Ed Dolan @ Economic Monitor, Steve Waldman, David Beckworth, Peter Dorman, Tim Duy, Scott Fullwiler, Izabella Kaminska, Josh Hendrickson, Merijn Knibbe, Ashwin Parameswaran, Cullen Roche, Nick Rowe, Scott Sumner, Stephen Williamson ...
Frances Coppola ... Steve Keen (who has made a career out of discussing money), not to mention Axel Leijonhufvud ... economists have been discussing modern monetary issues since Kurt Wicksell during the 'wildcat banking' era ... Singer does not know what he's talking about.
How about getting rid of the Austrians who pimp for the American Nazi Party/Aryan Nation. Good grief!
Meanwhile, our crisis is about energy not money: the relative absence of energy and our waste-based economy. The problem is at the end of your driveways you fucking fools !
Money is created when you do some work, that is not immediately repaid. When someone does an equal amount of work for you, the money is destroyed. Until the work is balanced out, money is the place holder. Interest is not real money. It is not really created by work. It is negative work. It is work that will never actually be repaid. It will always be lost work. The principal is created by work. Repaid by work and destroyed. Interest destroys work.
the unemployment department is now called the "worksource center" and is located just behind the reception desk at the community college. make your own assumptions/come to your own conclusions.
this is not hyperbolic. it is anecdotal.
Kill the bank, their money dies. Gold is the only real money, everything else is credit.
I'll help gaurd the Getty Museum at the time of the collapse. Actually I bet you could tell the collapse is nigh if you notice truckloads of stuff moving out of the Getty and other museums.
I call this the Museum indicator.
OMG, is this author saying that something may be wrong?
har har har
"The concept of “money” used to be simple: items of recognized value, initially in the form of shells, livestock, and then precious metals."
What's intrinsically valuable about a sea shell? What can it be used for? What can gold be used for?
Money is a medium of exchange. Whatever serves the purpose, whatever does the job, is okay.
If you feel that fiat money is a giant conspiracy perpetrated by governments to steal value from the common people, then just put all your assets into gold. Who's stopping you? No one.
You may find it a little inconvenient paying for groceries or bus fares, but at least you won't have to worry about hyperinflation. Personally, I'm fine with things the way they are.
Paul Singer (68).
He runs Elliot Management Fund who owns NML Capital. He's a specialist in buying sovereign bonds of defaulted countries as Perú, Congo, Argentina, when the bonds worth nothing and then files lawsuits climing to be paid for the SB's nominal value.
Mitt Romney's advisor in the past elections, his NML Capital is based in the Caiman islands, a British colony and fiscal paradise. He's the main financier of the ATFA lobby (American Task Force Argentina), operating in the US against, of course, Argentina.
Among other things, this guys managed tu put a big rat in front of the doors of the argentinean embassy during past Argentina's independence day party in Washington.
These guys buy judges (as the one in Ghana who retained the argentinean navy's Fragata Libertad against all international laws), congressmen, journalists and whoever can be useful to their one and only goal: making money no matter what.
That's why we call them vultures. It's the way they feed themselves.
What in the hell can this guy teach to anyone of us except brutal and barbarian ways of stealing money from States previously squashed by the IMF, the World Bank and the banksters ZH readers seem to hate?
He lacks of legitimacy to pontificate about no fuk'ng shit.
One guy replied to me in a previous post saying "it's not the messenger, it's the message that matters". It does matter all right, the messenger.
So, if Paul Singer is looming evil, then what marks do you award the Federal Reserve or the Argentine Government?
I guess facts aren't facts when you think the other person is an asshole
Of course not, Catullus. It just pisses me off to be lectured by such a "professor". On the other hand, I've been saying for almost four years now (since TARP) that the US economy was going bankrupt, that the Euro was going to collapse, that the whole international financial system is run by a special mafia whose member are banksters as well as politicians, journalists, "specialists", "experts" (as this one, Paul Singer) and so on.
But see, reading this shit...
OF COURSE printing and selling derivatives it's the same as printing money out of thin air. No collateral whatsoever. Everybody understands it. There are several misleading statements here. See:
"A “smoking gun” is the complete failure of policymakers (and financial-institution executives) to predict or understand the circumstances surrounding the 2008 financial crisis – neither the inner workings/interconnectedness of the institutions involved nor the risks inherent in the system"
I intend this to be misleading. Policymakers didn't fail nor financial-institution executives. See their earnings (their personal earnings). They fully succeded! Most of them without consequences (it's been written on this forum how they always go free of charges in the remote case they come to be prosecuted. Remember recent article about those senators "trying t find out if..."?????).
Let's leave the "financial sciences" statement aside... "Financial sciences"! Please! Such a reading hurts my brain. "Modern financial" is just a basic, tested and effective plundering method, just a bit less gory than the usual and historic violent slaughter well known and reported through History which is still in use, however, in some cases.
To Sun Rise: "what marks do you award the Federal Reserve or the Argentine Government?"
The Federal Reserve it's a private bank run by "the usual suspects". They don't even tell americans WHO are the owners of the FED. WHO OWNS THE FED?
– The Honorable Louis McFadden, Chairman of the House Banking and Currency Committee in the 1930s"
http://www.globalresearch.ca/who-owns-the-federal-reserve/10489
The argentine government is another issue. The argentinean central bank belongs to the State. I'd say the US belong to de FED, so to speak. I don't award any of them but that the way things are.
Thanks again for stating the obvious... again.
Now, off to the gun shop in the morning to cash out my layaway items...
“The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed, lest Rome become bankrupt. People must again learn to work instead of living on public assistance.” – Cicero , 55 BC
What have we learned in the past 2,067 years?
"The only thing we learn from history is that we learn nothing from history." - Hegel
New generations never learn the lessons of the past.
"This time is different" say the young - while the wise aged Men and Women of the society are ignored.
Each cohort of the young choose honest work and clean living, or dishonest work, or crime, or skullduggery, or nearly any combination of the above.
The good suffer on, the wicked enjoy their gains, and the wheel turns - interrupted only by collapse or war.
The good allow leaders rotten to the core because it is safer than dying in the streets, for a time.
Interesting . . . so our desire for safety fertilizes evil.
no..it is fear of change and increased suffering....shift happens and the mobocracy is scared.
a famous spoof quotation
The death of money is being hastened by another phenomenon, which is giving money for the acquisition of goods and services without anything in return.
For example, the governments hands out food stamps but what do the recipients give in return for this gift.
Government pays for keeping a 100 year old alive on life support but what is being produced for the benefit of the community?
Business builds massive excess capacity without any benefit being derived because it is idle but still requires interest payments.
And so the process continues until the system is well and truly dead.
People pay for degrees but thousands cannot find jobs in their field of study.
shadows from the past :
“…We cannot arbitrage fiat money, but we can repudiate the sovereign debt that backs it! And that repudiation will be the defining moment of this crisis…”...
The number that Elliott just did on Hess management was epic. Their DFAN14A was an all-time classic management beatdown. HARSH.
I would argue that options and OTC derivatives are the primary driver of market price moves in financial markets today, even though they are invisible to most market participants. There are a lot more derivatives being created and traded around between banks and financial entities than the underlying assets they are derived from. The tail is wagging the dog, because, it’s bigger than the dog.
options and otc derivatives have driven volumes since the mid-90's, since trading shifted from open outcry to electronic...whether central banks know this and have used these markets, clandestinely or otherwise, is a salient point.
is the fed going to hedge its book, as fraudie and funny (sorry, freddie and fanny) did with alacrity (in the name of convexity hedging) is an interesting point...(options, futures and swaps?).
(can't up arrow you by the way)
In my second year of engineering school we developed the math and equations for fixed rate loan tables. It was simple math by today’s quant standards, though, I’ve yet to meet a bank loan officer who knows how to do this. But, my point is all those formulas derived present value by discounting future cash flows. In perpetuity, the value of a riskless investment is simply the coupon payment divided by the real interest rate. This begs a question: what is the value in the long run of a money market or bond investment that pays no coupon while real interest rates are negative?
Answer: Only what the Fed will pay for it.
can someone please tell me why the Fed holding of Treasury debt cannot simply be cancelled? it is just an intra government book kepping entry.
same with social security trust funds, what is the big deal about cancelling the treasury holdings and just paying the money out of general expenditure, as the government would fo anyway?
that wipes around 7 trillion off the 16 trillion of debt issued.
OT...the UN thinks the US has a case to answer on the collateral damage of using drones
http://www.cfr.org/defense-technology/investigate/p29896
very well written