In Jim Grant's latest Interest Rate Observor, he makes a point that I have long assumed I understood...until I thought about it at a basic level. The result: It turns out I don't understand. I assume his logic is correct, but I'm not sure how.
The point: Grant says that a current account deficit creates leverage through reciprocal investment by the surplus nation in securities issued by the deficit nation. For example: we buy a million striped socks from China for a million dollars. They take that million dollars and invest it in treasuries. (so far, quite familiar territory for me there)
...then he claims that the $mm is now serving "double duty": The money is back in the US, so we still have it. But it's also "gained" by China. Hence, it is both of the following: 1. not lost by the US, and 2. Gained by China.
I don't see how that's double duty. If I work for XYZ Inc., and they pay me a million dollars, and I take that million dollars and invest it in XYZ stock shares...I have chosen to invest that $mm, rather than spend it. Technically, it is not serving "double duty".
Similarly, China has chosen to invest that $mm, rather than spend it. Where is the leverage? If the answer is exemplified by the US turning around and using that same $mm to buy another million pairs of socks, then that leveraging effect isn't really the result of the trade deficit. It's just debt creation. We could achieve the same thing by borrowing $2mm from China and using it to make the socks ourselves.
But then they wouldn't also have the money. So I think I just answered my question. I'll post this anyways in case I'm still missing something.
Thanks,
Brett
what is leverage?
Where there is no property there is no justice; a proposition as certain as any demonstration in Euclid
Fools! not to see that what they madly desire would be a calamity to them as no hands but their own could bring
Just in case you're not being sarcastic...The point is about credit expansion. For example, the fractional reserve banking system expands the money supply by leveraging a unit of savings. (ie, the same dollar of savings is used many times over, and accounted for in credit relationships - it is leveraged). Deleveraging is the collapse of those offsetting relationships as the debts are repaid. If the leverage is used for risk investment, some portion vanishes in default (see Lehman, BSC, etc). At least, that's the gist of it in practice.
brettman9:I don't see how that's double duty. If I work for XYZ Inc., and they pay me a million dollars, and I take that million dollars and invest it in XYZ stock shares...I have chosen to invest that $mm, rather than spend it. Technically, it is not serving "double duty"
whoever you bought XYZ shares from has your cash, which gets money multiplied through fractional reserve banking?
nirgrahamUK: brettman9:I don't see how that's double duty. If I work for XYZ Inc., and they pay me a million dollars, and I take that million dollars and invest it in XYZ stock shares...I have chosen to invest that $mm, rather than spend it. Technically, it is not serving "double duty" whoever you bought XYZ shares from has your cash, which gets money multiplied through fractional reserve banking?
More to the point: let's say I bought XYZ debt (instead of shares) from XYZ inc in a debt issuance to finance their payroll, and then let's say XYZ used that capital to pay me another million dollars in salary...They would have paid me twice with the same million dollars.
Now I have 1 million in cash and 1 million in XYZ debt assets.
I deposit the cash in a bank.
The bank then loans out 900k of my savings to XYZ, who uses that to give me my bonus.
Now I have 1 million in XYZ debt, and 1.9 million in cash at the bank...
The bank then lends XYZ 1.71 million of my savings. XYZ uses this as a cash holding for extra liquidity.
Now I have 1.9 million in the bank, and XYZ has 1.71 million in cash. And the bank has 290k in cash reserves.
All leveraged off of the original million dollars.... That million dollars is now acting like 3.61 million in liquid spendable money, and 290k in reserves with the fed.
Now if XYZ goes belly up and defaults on their debt, to me (1 million) and to the bank (2.61 million), causing the bank to collapse...now I have 250k (from the FDIC) and no job.
Probably some errors in there...but that's basic idea. My original point was about whether or not this same dynamic is actually rooted in sovereign relationships when all is said and done. That's Grant's point, I think.
brettman9: More to the point: let's say I bought XYZ debt (instead of shares) from XYZ inc in a debt issuance to finance their payroll, and then let's say XYZ used that capital to pay me another million dollars in salary...They would have paid me twice with the same million dollars. Now I have 1 million in cash and 1 million in XYZ debt assets. I deposit the cash in a bank.
brettman9:The bank then loans out 900k of my savings to XYZ
The bank then loans out 900k of my savings to XYZ
brettman9: [XYZ] uses that to give me my bonus. Now I have 1 million in XYZ debt, and 1.9 million in cash at the bank...
[XYZ] uses that to give me my bonus.
brettman9:The bank then lends XYZ 1.71 million of my savings. XYZ uses this as a cash holding for extra liquidity.
brettman9:Now I have 1.9 million in the bank, and XYZ has 1.71 million in cash. And the bank has 290k in cash reserves. All leveraged off of the original million dollars.... That million dollars is now acting like 3.61 million in liquid spendable money, and 290k in reserves with the fed.
brettman9:Now if XYZ goes belly up and defaults on their debt, to me (1 million) and to the bank (2.61 million), causing the bank to collapse...now I have 250k (from the FDIC) and no job.
brettman9:Probably some errors in there...but that's basic idea. My original point was about whether or not this same dynamic is actually rooted in sovereign relationships when all is said and done. That's Grant's point, I think.
Government Explained 2: The Special Piece of Paper
Law without Government
Yeah...Point was not about inflation. As I said (and you, I'm sure, correctly pointed out), there were errors in my example. But they don't dispense with the point, which was to describe how leverage builds in the system as a function of many normal taken-for-granted processes at the heart of our current financial paradigm. And also to imply indirectly what all the talk about the carnage of deleveraging is really about. In addition, my point with the original post hopefully comes through a bit more clearly: that there is a meta-nightmare possibly now just beginning, if the same deleveraging process takes hold at the wider sovereign debt level.