Source – hussmanfunds.com
– Many of the misconceptions that investors hold about the economy and the financial markets can be clarified by understanding the relationship between the “flow” and “stock” of various quantities in the economy.
Before going further, let’s take a minute for some background. The total quantity of currency and bank reserves in the economy – what’s known as the “monetary base” – is uniquely determined by the Federal Reserve, and is equal to the stock of Treasury and mortgage securities on the Fed’s balance sheet. Once the Fed creates a dollar of monetary base (which the Fed does by purchasing a government security and paying for it with Fed-created base money), that dollar remains in the form of base money until that dollar is retired by the Fed. Monetary base is retired when the Fed sells a government security, or receives payment at maturity. In both cases, the assets on the Fed’s balance sheet are reduced by the amount of government securities it no longer owns, and the liabilities on the Fed’s balance sheet are reduced by the amount of base money it takes back in. To see that a dollar bill is a liability of the Fed, read the top line of any bill in your pocket.
Again, base money, once created, cannot take another form. It must remain in the form of either currency or bank reserves, and must be held by someone in the economy at every point in time. From a “flow” perspective, it can only change hands until it is retired. One can use it to buy something else – stocks, bonds, apple pie, chinchillas – but the base money simply changes hands and becomes the property of the seller. It doesn’t “go into” stocks, bonds, apple pie, or chinchillas – unless the cash is actually baked in the pie or eaten by the chinchilla.
The same is true more generally. Every security that someone views as an asset is also a liability to someone else in the economy. Every share of stock that is issued must be held by someone in the economy, in the form of a stock certificate, until that stock is retired. Every bond that is issued must be held by someone in the economy until that bond is retired. In aggregate, stocks can’t “go into” bonds. Cash can’t “go into” stocks. Bonds can’t “go into” cash. They are all pieces of paper that remain in the form in which they have been created until they are retired by the issuer.
So how does the total volume of securities in the economy ever change? Simple. Securities are evidence of something very specific: the past saving of one person that is transferred (intermediated) to someone else. Securities are evidence that somebody earned money, had the option of spending it on consumption, and decided instead to save it and transfer it for use by another economic participant. New securities are created in the economy each time some amount of purchasing power is transferred to others, rather than consuming it.
Read Full Article…
RIELPOLITIK 