Sunday, July 22, 2012

Libor Manipulation, Velocity, and Sterilization

The Libor manipulation may have had a positive purpose/effect. Not that I approve of manipulation. QE (quantitative easing bailout) money was given to banks to cover the Bank of International Settlement Basil 2 Accords. The Basil 2 Accords increased fractional reserve requirements of banks. However, had the QE money gone into the real economy, it would have caused much greater inflation than we have seen.

By artifically increasing Libor, interbank loaning was still expensive compared to buying bonds. Thus, banks who got QE, bought bonds with it instead of lending it out to smaller banks. Thus most the QE money stayed out of the real economy. When central banks buy bonds or conduct foreign currency swaps, this decreases velocity in the money supply as money is tied up in bonds or tied up in a foreign currency and consequently is not circulating in the real economy. This practice is called "sterilization".

Both overall Money Supply and Velocity contribute to inflation if they exceed economic growth.

dM/dt (money supply) + dV/dt (velocity) = dP/dt (price/inflation) + dR/dt (Real Output)

The recent LIBOR Manipulation scandal is an interesting manifestation and evidence for Velocity of Circulation.

1 comment:

Ivan PFMP™ said...

More ridiculous methods of artificial sustention of a system that is well beyond it's terminal phase.

The question is, "What are we going to do about it".

Are we going to fight each other in endless arguments about who is right or are we going to decide upon a singular solution.

Each monetary reform proposition is diluting the soup even further.

The PFMPE™ are ready and are more the happy to discuss any proposition of monetary reform in order to get down to the bottom of this issue, and to decide on a singular solution to this corruption.