Thursday, October 2, 2008

The Dollar Remains Strong

The Euro is 1.38. Pound is 1.76. The Dollar is as strong as it has been in a long time. The rest of the world is still keeping shortest t-bill rates low (at <1%). All this reflects a confidence in our government as the truly risk free products that make us the reserve currency of the world.

You see, to understand how powerful the US government money creation can be, consider the following series of statements. Our government debt is currency that can be traded for dollars. When we issue debt and someone buys it, this has the same benefits as printing money. Actually its even better than printing money because there is a complex multiplier effect.

Lets take a look at the transaction taking place: US government sells bond; investor buys bond and marks as an asset on its balance sheet; government gets dollars from investor and marks liability on its balance sheet. Since federal government debt is regarded as "risk free", that means the government's balance sheet is effectively infinite. So now the government has cash to spend and the investor has assets to hold or use as collateral for loans (which would increase the money supply even further).

Our government debt is regarded as a cash equivalent because they can be sold so easily after purchase or used to get a cash loan with which to buy other dollar denominated products. So when our government sells debt, the money borrowed becomes multiplied several times over because our debt is so liquid. if the government takes the borrowed cash and then loans it as a bailout to dying banks, then the money becomes levered even further.

Some people have wondered how the hell inflation wouldn't go crazy with all this money creation, but that is where our highly liquid capital markets come in. Foreigners face a choice of what to do with all the dollars we give them: invest them in our markets or sell them, ruin your cheap currencies, reverse the trade balance that gave u the dollars, and fuck yourself royally. which would you choose? They all invest in our markets and as long as we sell enough shit into them to mop up liquidity we're all good. sometimes they lead to asset price bubbles, and everyone loves them on the way up. Such is the economy.

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