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Couple of points... - There has been no economy that has been able to grow debt as fast as China has without accumulating a large amount of bad debt. This is j

by slv77 11y ago

Couple of points... - There has been no economy that has been able to grow debt as fast as China has without accumulating a large amount of bad debt. This is just as true for the US in the 1920's, Japan in the 1980's, Greece, Spain, Iceland, Portugal, Brazil, Mexico, etc. - China has grown debt to GDP at a breathtaking pace. - Savings and debt are opposite sides of the same coin. Once a loan goes bad the debtor's promise to provide economic value is broken. At this point somebody has to bear the loss through a reduction in future consumption, there is no free lunch. - There are choices in how those costs are allocated. For example they can be through the bankruptcy courts, inflation, reduced interest in savings, taxes and reduced social services (by taking it on the government balance sheet) and external default. - How those losses are allocated are politically sensitive. They can and often lead to revolution and war. - Savy investors are aware of these trade offs and will attempt to position themselves to avoid losses. - The central bank has its own balance sheet which aren't just numbers on that can be written off. A central bank which bought bad debt and then wrote it off would be insolvent and would require recapitalization itself. - Giving money is the prerogative of government. A central bank who gives money in the guise of a loan would quickly find themselves in conflict with the government. That is why the US had both TARP and QE. - Even if the government gave permission for the central bank to montetize the bad debt Savvy investors would know that monetization of bad debt would lead to inflation. Investors would respond by hoarding commodities, capital flight and leveraging assets (which is happening now). This is happening now (capital flight, accelerating debt growth, hoarding of gold)

ww520 11y ago
Fair points. There will certainly be turmoil and pain in a downturn. The main thrust of my comment was to dispel the notion that recapitalizing banks or QE to write off non-performing loans would cause uncontrolled inflation. This misconception is a misunderstanding of how fiat money creation and destruction work in the modern economies. The oppose is true. Not doing those would cause credit crunch. The Great Depression at 1929 was the result of credit freeze when banks saddled with bad debts could not function at normal money creation. I'll address one of your points. Central banks writing off the debt it bought would not go insolvent and don't need recapitalization by others. Central banks can create all the money they need at will. Insolvent is when you can't pay back the debt. The central banks don't owe debt. They own the debt; they can do however they like with them, including forgiving the debtors. The mandate for central banks, at least in the U.S., is to keep inflation at a modest low rate window and keep unemployment low. Everything else is secondary.
- slv77 11y ago
  The thrust of my comment is that resolving bad debt isn't merely a painless exercise in monetary policy. Resolving the bad debt requires somebody to absorb those losses through reduced future consumption. Who absorbs those losses is essentially a matter of public policy, not monetary policy. The only thing that is special about a central bank is that their special relationship with the government exempts them from the regulations that apply to other banks. However, they still have a balance sheet with debts, which are deposits with the central banks and federal reserve notes (cash) and assets which are assets and loans that have been purchased on the open market. The central bank also has a small amount of capital which is the ownership stakes of the member banks. Half of which is on deposit with the Federal Reserve and half of which isn't invested but can be called if required. That ownership stake has a guaranteed 8% return (and an effective 16% return) which is a nice deal if you can get it. Due to its special status a central bank can't be subject to bank runs or be forced into receivership by regulators but it can still be balance-sheet insolvent. And a balance sheet insolvent central bank is a wounded central bank because it loses some of it's ability to control monetary policy through reducing its balance sheets. In severe deflationary conditions a central bank may take more risks that may put it in a position of being balance sheet insolvent. For example, through the purchase of long term zero coupon government bonds at face value. The effect is to tell the markets that the central bank is putting a ceiling on interest rates long term regardless of inflation which encourages speculation. Ultimately if a central bank has a consequence free way of creating all the money they needed at will their would be no need for taxes because the central bank could just give the government all the money it wanted.
  - narrator 11y ago
    The bad debt was used for capital creation. The capital created may be wasted. The restriction of consumption has already happened during the boom when the investment of the money in creation of capital goods caused individuals to restrict consumption for other reasons. As an example, consider that perfectly good farmland in the central valley was being used to construct houses that would later be marked down to half their value during the bust. The land, labor and capital were being drawn away from other uses during that period of investment. So your argument that the payment must be made later in the real economy ignores the disruption that the initial boom created. The boom is not the free lunch that must later be paid for, the boom is the destruction of the existing structure of the economy that will hopefully increase efficiency enough to provide for increased consumption of consumer goods at a later time to make up for the restrictions during the boom. In China, instead of creating a period of reseting to the previous price relationships that existed before the boom and returning all the property back to the lenders or those who lend new money from them, they simply warp the economy in yet another direction that the central planners and their partially privatized counterparts in the bank think will improve production capacity. The government in China regularly lets very bad investments fail, and many important hedge funds and such have failed completely where in the west they would be saved. The U.S central bank has a balance sheet but they can create unlimited liabilities. Federal Reserve Notes are debt of the federal reserve that is redeemable for 1 for 1 with other federal reserve notes and has the handy and unique property that it is the only valid legal tender for paying federal taxes and must be accepted for settlement of any debt, which is what gives its intrinsic value.

by slv77 11y ago

ww520 11y ago

Fair points. There will certainly be turmoil and pain in a downturn. The main thrust of my comment was to dispel the notion that recapitalizing banks or QE to write off non-performing loans would cause uncontrolled inflation. This misconception is a misunderstanding of how fiat money creation and destruction work in the modern economies. The oppose is true. Not doing those would cause credit crunch. The Great Depression at 1929 was the result of credit freeze when banks saddled with bad debts could not function at normal money creation. I'll address one of your points. Central banks writing off the debt it bought would not go insolvent and don't need recapitalization by others. Central banks can create all the money they need at will. Insolvent is when you can't pay back the debt. The central banks don't owe debt. They own the debt; they can do however they like with them, including forgiving the debtors. The mandate for central banks, at least in the U.S., is to keep inflation at a modest low rate window and keep unemployment low. Everything else is secondary.

slv77 11y ago
The thrust of my comment is that resolving bad debt isn't merely a painless exercise in monetary policy. Resolving the bad debt requires somebody to absorb those losses through reduced future consumption. Who absorbs those losses is essentially a matter of public policy, not monetary policy. The only thing that is special about a central bank is that their special relationship with the government exempts them from the regulations that apply to other banks. However, they still have a balance sheet with debts, which are deposits with the central banks and federal reserve notes (cash) and assets which are assets and loans that have been purchased on the open market. The central bank also has a small amount of capital which is the ownership stakes of the member banks. Half of which is on deposit with the Federal Reserve and half of which isn't invested but can be called if required. That ownership stake has a guaranteed 8% return (and an effective 16% return) which is a nice deal if you can get it. Due to its special status a central bank can't be subject to bank runs or be forced into receivership by regulators but it can still be balance-sheet insolvent. And a balance sheet insolvent central bank is a wounded central bank because it loses some of it's ability to control monetary policy through reducing its balance sheets. In severe deflationary conditions a central bank may take more risks that may put it in a position of being balance sheet insolvent. For example, through the purchase of long term zero coupon government bonds at face value. The effect is to tell the markets that the central bank is putting a ceiling on interest rates long term regardless of inflation which encourages speculation. Ultimately if a central bank has a consequence free way of creating all the money they needed at will their would be no need for taxes because the central bank could just give the government all the money it wanted.
- narrator 11y ago
  The bad debt was used for capital creation. The capital created may be wasted. The restriction of consumption has already happened during the boom when the investment of the money in creation of capital goods caused individuals to restrict consumption for other reasons. As an example, consider that perfectly good farmland in the central valley was being used to construct houses that would later be marked down to half their value during the bust. The land, labor and capital were being drawn away from other uses during that period of investment. So your argument that the payment must be made later in the real economy ignores the disruption that the initial boom created. The boom is not the free lunch that must later be paid for, the boom is the destruction of the existing structure of the economy that will hopefully increase efficiency enough to provide for increased consumption of consumer goods at a later time to make up for the restrictions during the boom. In China, instead of creating a period of reseting to the previous price relationships that existed before the boom and returning all the property back to the lenders or those who lend new money from them, they simply warp the economy in yet another direction that the central planners and their partially privatized counterparts in the bank think will improve production capacity. The government in China regularly lets very bad investments fail, and many important hedge funds and such have failed completely where in the west they would be saved. The U.S central bank has a balance sheet but they can create unlimited liabilities. Federal Reserve Notes are debt of the federal reserve that is redeemable for 1 for 1 with other federal reserve notes and has the handy and unique property that it is the only valid legal tender for paying federal taxes and must be accepted for settlement of any debt, which is what gives its intrinsic value.