Monday, December 15, 2008

Lost Money

There’s been a lot of talk about people losing money. Here, “lost money” will mean something different. If you lose $500 in Las Vegas, that’s not lost—the casino has it now. If you tried to flip a $500K house in Stockton and today you are lucky if you get $200K for it, that’s lost wealth, not lost money. Here lost money refers to cash outside the economic system that’s not available for spending; it’s “lost” to the economy, even if we know where it is.

Naturally, I’ve been following closely this latest expansion of base money by the Fed. A few days ago, what had been vertical growth since September has briefly flattened at exactly $1500B. Before, it had stabilized for over a two years around $850B; the rise to that level took years, so the latest 40% increase is very sudden and concerning. Put that in to a 10% fractional reserve system and that could inflate to another $6.5 trillion.

So far though, the U.S. dollar has been maintaining its trend of strength. Against stocks, commodities, real estate, and foreign currency it is much better off than it was a year ago. Though strengthening trends have leveled over the last month, it shows no sign no of remitting back to where it was. (UPDATE 5/20/10: it did over 2009, but today has rebounded and is showing strength again.)

Mish explained nicely with a series of charts from the Fed that the money printed isn’t going in to circulation. This money is on loan to banks, for them to lend out, but banks aren’t lending it out, so it’s just sitting in reserves. The reserve expansion of banks from $100B to $700B over nearly the same time course explains where most of where this money has gone.

So that’s what I mean by “lost money.” If one takes half the currency of an economy and puts it in coffee cans and buries it in the desert, prices will adjust to what money is left; they will fall to accommodate the reduced money supply. If the money is dug up and spent, as it redistributes throughout the economy, prices rise in response to the “new” money. Factoring in "lost money" simply says that prices adjust to what money is actually available for spending.

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