Wednesday, June 5, 2013

Does Credit Drive The Economy Part II

As a follow-up to my previous post on the subject, I decided to try an alternative methodology that compares gross public spending and net private debt on an annual basis in analyzing the composition of new money creation. The graph is below. I tried to make it prettier than the previous one but I still haven't figured out how to reduce the number of decimal places on the Percentage axis (last time I did it manually…too time-consuming). It's a free program so I can't complain:

My observations…others may see more…

The peaks and valleys are more extreme, but they tend to oscillate around the 40% (average) level, just as the moving average in the original graph did.

For the years 2009 thru 2011 private debt went negative so the ratio can't be calculated. For the year 2012 private debt contributed about 5% to the new money total before taxes.

For the years that net private debt went negative (debt service exceeded new loans) private debt subtracted from total spending. What a drag!

The point that net private debt plunged drastically and went negative corresponds generally to the time the GFC hit.

Clinton's balanced budgets (or very nearly balanced) occurred in the years 1998 thru 2001. Spending declined drastically between 1992 and 1997, from $340B/year to $103B/year. These years correspond to a marked increase in debt issuance. We had headroom…we used all of that and then some.

That's about when banking policy enabled lending to borrowers that were marginal at best and uncreditworthy at worst…prudent underwriting was abandoned.

Conclusions…

We appear to be approaching a stable balance between debt service and incomes…I don't think we're quite there yet but at least debt service isn't dragging the economy down any longer. This doesn't mean borrowing will necessarily accelerate.

Private debt (mainly households) can drive the economy…into recession.

It's all on public spending from here on out.


30 comments:

  1. Good work Paul

    I think when someone says credit drives the economy the next question should be, what drives credit? The answer to that I think is incomes drive credit (monetarists might say asset values). So then the next question is what drives incomes? The answer to that is spending I think. The final question can then only be who is the ultimate spender or the original spender and that is the govt.

    When MR calls govt a currency user they might be technically correct form current arrangement. Something is never constrained in the amount of spending it does. Someone must have the capacity to originate spending with no need of income. If we deem that the CB that is still a govt decision. CBs arose form govts not vice versa.

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    1. Greg, thanks. That's pretty much the path my thinking takes when I try to answer the questions in my head.

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    2. To a large degree its circular. Credit drives income and income drives credit under the current credit based system. Expectations and confidence can send the loop upwards or downwards I suppose.

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  2. Shouldn't you be comparing net private debt to net public debt for apples to apples? In one case for private debt your number factors in money which is taken out of the private economy due to repayment of debt. The public debt number should do similar by factoring in money taken out of the economy via taxes.

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    1. F,

      All income is taxed...income that results from public spending and income that results from private debt expansion. The income from each source looks the same to the tax system.

      It makes no sense to assume taxes only apply to public spending. How would only those dollars be targeted for taxation? Income is income.

      Further, TCMDO is a running total...it is an accumulation of the annual increase in debt. FGEXPND is an annual record of spending not an accumulation. Apples to apples compares the annual increments or the running totals.

      Hope that answers your question.

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    2. "All income is taxed... It makes no sense to assume taxes only apply to public spending."
      That's not the point at all, and it's not an assumption I'm making. Let me try again. If I understand what you're trying to do, you're trying to measure the ratio between the rate of creation of credit money (private money) to the rate of creation of government created money (public money) in the economy. To do that, you're using the change in private money. :et's start there. This number includes cash injected into the economy via new loans, but it also includes cash removed from the economy via loan repayment. Subtract the 2 and you get the net private money added over a given time period. However, for public money, you're only counting money injected into the economy via federal spending. Just as private loan repayment removes money from the economy, federal taxation removes money from the economy. It doesn't have anything to do with income being taxed, or where the money came from that was being taxed. You're just identifying sources and sinks of money in the economy... and you're missing a sink. :) So again for public money, you just subtract the tax from the spend and you get the net money being added over a given time... in other words, the government's yearly fiscal deficit = new public money per year.

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    3. "you're trying to measure the ratio between the rate of creation of credit money (private money) to the rate of creation of government created money (public money) in the economy."

      Not exactly…I'm calculating the total amount of money creation in the economy from all sources.

      "This number includes cash injected into the economy via new loans, but it also includes cash removed from the economy via loan repayment."

      Yep. So far so good.

      "However, for public money, you're only counting money injected into the economy via federal spending."

      Yep…that's all the public money there is.

      "Just as private loan repayment removes money from the economy, federal taxation removes money from the economy."

      Exactly.

      "You're just identifying sources and sinks of money in the economy... and you're missing a sink. :)"

      I'm not missing a sink…I have two sources and two sinks…the sinks are debt repayment and taxes.

      The mistake you're making is assuming taxes occur immediately as the public spending hits private sector bank accounts. It has to become income first before it can be taxed.

      When taxes are paid, it comes from the pool of money recorded as income. Some of that income came from spending of what was originally public money, some of it came from money originally created through loans. At this point all money is the same.

      Thus, taxes are paid with income earned using both sources of money, and debt service is paid from income using both sources of money.

      Taxes don't just subtract from the public money source, and debt service doesn't just subtract from the private debt source. You are trying to make it that way in your mind but in fact the subtractions come from the pool of funds.

      The simple way of looking at it is…

      Pour water from two containers…container A and container B…into a third container. Then remove water from the third container using two dippers, dipper A and dipper B.

      From which container did the water in each dipper come from, container A or container B. It's impossible to know, but it doesn't matter anyway.

      The amounts removed will be in proportion to the ratio of the amounts added.

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    4. You're getting confused on what you're measuring. For money creation, you don't need to care about timing of income etc. your logic for skipping taxes could easily be applied to private debt repayment. Why are you including debt repayment in the private credit figure? people don't just repay debt with private money only. That is the same argument you've made against taxes, but it's irrelevant for what you're measuring. Private and public money are fungible. In your water analogy you're mistake is the equivalent of not wanting to measure the water flowing out which originated from bucket A.

      I give up... You're so close to something meaningful, but it's not currently right. You need to forget income process for this, it's irrelevant.

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  3. Paul, if you have any respect at all for balance sheets, you have to subtract all the revenue government removes from the economy. Otherwise your "putting money in" number is overstated.

    If the government spends $10 and taxes $6, the net addition to "money in the economy" is $4. It doesn't matter which six dollars it took.

    What are you using to make the graphs? Maybe it works like Excel, where the graph picks up the number formatting from the cells that the plotted values are in.

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    1. Art, read my reply to F.

      "If the government spends $10 and taxes $6, the net addition to "money in the economy" is $4. It doesn't matter which six dollars it took."

      Exactly…so where is the disagreement?

      The removals don't occur until later, after income is earned. At that point all of the new money created is mixed together and indistinguishable. Both taxes and debt service are paid from income.

      Subtracting taxes from public spending in isolation ignores that fact…it assumes taxation occurs the instant the money hits the balance sheet.

      It doesn't and by the time taxation occurs all money (dollars) are the same…mixed together…fungible. We add the sources together, then subtract the sinks.

      It would be impossible to pick out and target dollars that were originally public spending for taxation.


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    2. You keep saying you agree taxes should be taken out, then you never take then out due to some incorrect logic. It's like saying private debt repayment shouldn't be taken out because it doesn't get repaid immediately and has to be spent into someones income first, but you do subtract this repayment anyway. You're contradicting your own logic there. Income has absolutely no role in calculating money supply our change in money supply.

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  4. F, Seems like you have completely misunderstood what I've presented, and the argument I'm making.

    The problem at hand is to determine the level of the sources of newly-created money ADDED to the domestic non-government each year…expressed as a percentage of the total…for EACH YEAR between 1970 and 2012.

    That was the stated goal. It's simple arithmetic.

    Gross Public Spending ADDS some amount each year…the series is presented by FRED as an annual amount…through SPENDING.

    Private debt is presented by FRED as an accumulating TOTAL, so it has to be converted to an annual-change series for us to compare apples to apples.

    I converted it to an annual-change series to compare to another annual change series measuring SPENDING from that source. Apples-to-apples.

    It's no different than the relationship between the amounts column and the balance column in your checkbook. One can use either to derive the other.

    Both are measures of SPENDING…a special kind of spending…that creates new money.

    At this point one can calculate the percentages…taxes aren't even in the picture yet.

    Which I did. That's the blue line on the graph.

    The other graphs are straight plots of FRED data.

    You are welcome to subtract taxes from whatever you want but I defy you (or anyone) to tell us where the income originated from that was taxed.

    You are welcome to show us calculations.

    Anyway, subtracting taxes and net exports from the total will have no bearing on the ratio of the original sources…taxes and net exports are ex-post (after the spending and after the income is recorded).

    True transactions occur monthly and even daily…this is intended to be a reasonably accurate estimate. I used annual data.

    At this point there is no way of knowing which dollars are paying the taxes and to claim that taxes accrue only against public spending is arbitrary and frankly, silly. Further, debt service also accrues against income from both sources.

    Those items can only be logically subtracted from the total. The percentage distributions thus persist.

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    1. You're misinterpreting data, and misunderstanding how to measure what you're interested in. You should listen more to the guys who have been trying to explain this to you for weeks.

      "Gross Public Spending ADDS some amount each year…the series is presented by FRED as an annual amount…through SPENDING. Private debt is presented by FRED as an accumulating TOTAL, so it has to be converted to an annual-change series for us to compare apples to apples... Both are measures of SPENDING…a special kind of spending…that creates new money."

      Wrong. Private debt presented by FRED, then converted to an anuual change by you contains additional money via new loans, and subtracted money via repayment of old loans. If you want to compare apples to apples, you would only want NEWLY created loans. But those apples are meaningless. You need to be comparing the oranges... net change in public debt vs net change in private debt. You've got the private side correct for reasons you don't understand, and the public side wrong due to a misunderstanding of what you're trying to measure.

      "You are welcome to subtract taxes from whatever you want but I defy you (or anyone) to tell us where the income originated from that was taxed."

      You keep thinking this matters, but it doesn't. Think bank to your water analogy. Why on earth would you care where the water came from as it exits the bucket? It's completely irrelevant.

      "You are welcome to show us calculations."

      I just did in my other post. See link to FRED.

      "At this point there is no way of knowing which dollars are paying the taxes and to claim that taxes accrue only against public spending is arbitrary and frankly, silly. Further, debt service also accrues against income from both sources."

      Again... doesn't matter in the slightest. You're not measuring ANYTHING that has anything to do with income or what money is taxed where. You don't care what happens in the bucket of water while its in there, you only care about the absolute quantity in the bucket. And you're accidently counting a sink which you say doesn't matter (debt repayment, but it actually does matter), and you're not counting a sink which also matters (taxes).

      If you're trying to ignore all sinks, your private number is wrong due to debt repayment being included in your private money FRED series.

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  5. This is what you should be looking at if you want to calc a ratio:

    http://research.stlouisfed.org/fredgraph.png?g=jh4

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    1. “This is what you should be looking at if you want to calc a ratio:

      http://research.stlouisfed.org/fredgraph.png?g=jh4” - F


      If this is meant to be an example of doing it right you've missed the target by a bit...

      You're comparing the annual increment of the SUM of public debt and private debt (TCMDO) to net private saving (the deficit). ????

      The deficit has no real-world meaning other than contribution to net saving, but it doesn't tell the whole story re that either because debt is in the picture and Sectoral Balances don't see debt.

      First, you have to subtract out public debt...then you are still comparing gross spending to net saving. You still have not accounted for the contribution from debt.

      I'm calculating the percentage of gross public spending and net private debt in relation to their sum...at the point of entry into the system...new money creation. The subtractions (taxes, etc. don't change that relationship no matter how you slice it.)

      Anyway, I'm fully aware of the fact that I'm comparing the ratio of gross public spending and net private debt (which is new money creation and spending)...and not GROSS private debt.

      There are several good reasons I'm not doing so...

      1. There is no series in existence enumerating Gross Private Debt that I can find.

      2. To calculate Gross Private Debt for ones self is a non-trivial exercise (difficult and time-consuming...try it...the best one could hope for is a reasonable estimate...which is fully dependent on your assumptions).

      Actually, I've spent quite a bit of time doing just that and I have come up with some useful rules-of-thumb, but in this case it just won't add much to the outcome other than tedium.

      3. Doing so does not significantly alter the accuracy of the result we are seeking, while making it orders of magnitude more difficult.

      4. At the end of the day, no matter when you poll the data the number of dollars and spending that were entered into the economy before taxes can always be found by using net private debt and gross public spending. Yes, taxes are taken out along the way, but they come out of ALL income proportionately...Debt service only comes out of incomes that have debt obligations attached.

      5. This is not true for gross public spending. To find out how many dollars from gross private spending remain in the economy after taxes we can't just subtract gross taxes...we must subtract pro-rated taxes based on contribution to income. Can't do that without a ratio.

      The reason I wrote the post before this one...was to debunk the claim that “90% of the money (or spending) in the economy resulted from credit”. That was pretty easy to do.

      If I were to do all of the hard work necessary to satisfy your demand that we use gross private debt the result would be pretty much the same (I've tried it, it wasn't worth the effort).

      Or do you object to using Gross private debt too? Are you arguing that taxes can only subtract from gross public debt? Are you saying that the sum of deficits is a perfect indicator of the level of funds contributed by public spending?

      If you do that you have left out a world of spending leading to taxable income. Expalin how you would handle that.

      How would you calculate the ratio between the two sources?

      Show us a better way in detail and I'll consider it. Right now you have all my cards up and you've shown me nothing.

      By the way, if folks are going to criticize, be organized, concise and show detail. Rambling criticisms will be ignored from here on out unless you meaning is clear.

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  6. @Greg,

    "I would say that incomes ARE the money supply" (where is your comment? I got the email but I don't see it here).

    I agree, if we mean income from thin air between the government sources and the domestic economy.

    Income doesn't tell the whole story either. Once funds enter the system via the sources, from then on spending only moves money around. there can be no expansion of balance sheets (in state money) without another external add (or contraction with an external subtract).

    And the debt contribution is a complicated one…

    if new lending is equal to debt service we have a standoff…there is no add…money creation is in equilibrium with money destruction…there shouldn't be any net spending in this case because even though the new loans are extra spending the debt service is equal, negative spending.

    At least that's how I perceive it. And I am measuring spending to coax out the ratios I need to allocate taxes to the right incomes.

    Further, a lot of new loans are just rolling over old loans. So I still think we only should be concerned with the nets with debt…it's a self-contained system.

    If there is no new net lending then debt service is a drag on income but it doesn't accrue against public spending.

    So I think all settlement with private debt has to be done first, otherwise you have a moving target trying to figure out what is driving spending.

    The fact that FRED or Z.1 doesn't try to keep up with Gross Private Debt is telling.

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    1. Nope, not there.

      Thanks for the tip Art, but it must be gremlins.

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  7. Im confused how does public spending create money? I thought money is created when the fed lends reserves and when the commercial banks make loans.

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    1. Unknown,

      First of all your second comment appeared in my email, not here. Where did you post your comment from?

      Public spending creates money by marking up bank accounts in the non-government. This is the only operation we should be concerned with, as it is the only one that matters. The rest involves a bunch of bureaucrats doing what they are told (by Congress) or get fired.

      The Fed lending reserves to commercial banks is nothing more than maintenance of an accounting system. Mnney is created when borrowers take out loans. Again, bank accounts in the non-government are marked up.

      Banking is somewhat circular (all circuits are circular) but there is a feedback loop in credit that limits it…

      Loans are based on ability to repay…

      The ability to repay is based on income…

      Lending accounts for only a portion of income…

      If debt service (loan repayment) exceeds lendings' contribution to income, then the income has to come from another source…

      In the end there can be only one…

      Of course I'm referring to public spending.

      Public spending supports the payment system that is required for stability of the banking system.

      Some will argue that lending can also be based on the assets one holds…

      Those assets were acquired with income…

      Only financial assets can be used to repay debt…

      Most assets produce no income unless you sell them…

      Borrowing on the assets requires income for repayment…(see, it's all circular)

      Selling them requires someone else to have income or financial assets…

      If you follow this far enough one always ends up at public spending…

      The ultimate (root)) source of every currency unit in existence in the non-government.

      Anything of consequence that occurs in an economy (which is a machine) is dependent upon this source.

      Banking serves to eliminate some of the friction in the machine.

      Saving is a friction we haven't figured out how to eliminate.

      If we eliminate saving (and imperfect payment settlement) we eliminate friction and money creation expansion becomes unnecessary (but we need some to start with)…

      Then we have a perpetual-motion machine…

      Which is impossible (according to all known laws of the Universe).

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    2. I used my google account to post a comment maybe thats why it appeared ion your email.

      "Public spending creates money by marking up bank accounts in the non-government." Makes sense that when the gov spends the recipients accounts get marked up and the gov accounts gets marked down. But the gov needs to source net new funds from bond markets first so it isn't creating money is it? Unless you include the fed as gov somehow.

      "Saving is a friction we haven't figured out how to eliminate." Why is it bad? because money leaves circulation?

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    3. "But the gov needs to source net new funds from bond markets first…"

      The bond market can't create funds, so they can't be the "source"…

      The bond markets get their funds through govt spending.

      The only source of new "persistent" funding is govt spending from thin air…that's the definition of fiat…created from nothing.

      "Why is it [saving] bad?"

      I didn't say saving was "bad"…saving just "is" and it's unavoidable…a natural friction in an economic system.

      For you and me saving is "good" if we have some…

      For the economy it removes dollars from circulation as you pointed out…

      Those dollars must be replaced by new money creation.

      By the end of each budget cycle pretty much all money created has been saved in one form or another…

      The gov't must create more or the economy would stop dead in it's tracks…

      If the government doesn't create enough the economy contracts…

      Thus, public spending is the root source of all economic activity.

      Credit can be a proxy for a while, but credit is simply borrowing income the government hasn't created yet. Credit is limited by how much income public spending generates…because that is what supports debt service.

      This dynamic is partly due to the phenomenon we call "saving"…but mainly because flows can't happen until there is a stock from which the flow can emanate…

      A battery nust have "charge" before flow can occur (and the net flow of charge can only be in one direction).

      All stocks of state money originate from govt spending.

      The operations the Fed/Treasury engage in are a result of their need to satisfy certain conditions (law) set forth by Congress (issue bonds dollar-for-dollar with new spending). The conditions they must satisfy are all voluntary, contrived conditions…they create political constraints (we think we are out of money) but no mathematical constraints (we can't run out of something in unlimited supply…numbers to add to balance sheets).

      The notion that we are constrained by the interest rate we pay on bonds is another voluntary choice, the Fed controls the rate and can choose any policy rate it likes…remember when Volker chose to raise rates to 20+% back in the 1980's?

      As more and more money is printed bond rates will continue to approach zero. It will stay that way until the Fed has the policy space to raise rates again.

      Look at the trend of 10-yr Treasuries since all of this expansion in the money supply began around 1980…

      https://dl.dropboxusercontent.com/u/33741/10-yr%20bond%20yield.png

      …and look at a long-term chart of Japan's bond rates.

      Restricting growth by restricting the money supply while allowing a small cohort to accumulate the lions share of saving has created the environment where rates have to remain low.

      At the end of the day all of this is hooey designed to make us think that we can't have good things unless we all "sacrifice".

      In the meantime those in control of the system don't sacrifice anything.

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    4. unknown,

      I think whats "bad" with savings, so to speak, arises from the expectations of the savers. And much of this has to do with flawed notions of our economy and flawed notions of what money is and what inflation means.

      If you start with the notion, and classical economics does, that money is a neutral veil and that what we are really examining is a simple barter economy with money just another good of value then you cant possibly coherently model a modern credit driven economy with banks, shadow banks, Central Banks and floating exchange rates. Its actually impossible. Money is just another scarce good in this model that must be "saved" before it can be "invested" and govts simply suck off the productive capacity of the citizens and act like they can spend better than the citizens them selves. In this model there can be no countercyclical stimulus, only falling prices will restore activity. Once things get cheap people will want them again (provided they have any money) and the whole process gets restarted with a percentage of the people dead, near death from starvation from lack of funds, hanging by a thread while eating and trying to save their house........ So in this model saving is virtuous and allows you to acquire a greater and greater percentage of the available real wealth. Money is also a thing of value itself that holds value as you save allowing you to have the same purchasing power in the future that you would have had today (if you were so foolish and spent it today!!) So in this model the money itself (which used to be gold.... we are told) is something to save, not just things purchased with the money. In this model inflation is anything that makes your share of the real wealth diminish over time. If you had the ability to buy 50% of everything (stick with me here) but instead saved half your purchasing power, inflation would be anyhting that meant you no longer could buy 25% of everything whenever it was you decide down the road to spend.

      Personally I think its very unreasonable of me to think that if I dont spend 1000$ today which could get me 100 steaks say, if I wait 10 years and then want to spend that money I can still get 10 steaks and if I cant ive been ripped off by inflation.

      The economy cannot produce stuff fast enough for all savers to get the return they expect in perpetuity. Inflation, as it is currently conceived, must happen. We are asking very unreasonable things of the people in our economy.

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  8. I dont know where the comment is, I thought I left it here. What email did you get and how did that part of my comment get in it?

    My comment was directed at part of Franks comment above (this is a really great discussion btw and I KNEW Art would show up to it.... this is in his wheelhouse) where he says

    "Income has absolutely no role in calculating money supply our change in money supply"

    Frank, are you sure of that? Seems to me you are making a monetarist error (I apologize if this is too much of an insult) and looking at money supply like a piggy bank or a fixed stock.. I think income IS the money supply. If something isnt flowing via income channels (and yes capital gains are income in this model) then its not part of the money supply and affecting prices. Income is the accounting record of a flow. But if it stops flowing then there is no price affect. Dont know what the stock of confederate dollars is but there is no flow of them so nothing is priced in them.

    As I see it banks and the govt are the flow sources of credit and govt money respectively and its the CB high powered money which sits atop the bank pyramid, guaranteeing it all. They can generate flows without a prior stock and the level of flow generation IS the money supply. Via loan repayment and taxation the flow is reversed at times but its the net flows that are the driver, it seems to me, not the accumulated stocks.

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    1. Greg, I get an email from the blog every time someone (including me) comments. Or so I thought.

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    2. "They can generate flows without a prior stock" - Greg

      And there you have the important distinction in this entire discussion

      From there we can logically proceed to all that follows.

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  9. > "They can generate flows without a prior stock" - Greg
    > And there you have the important distinction in this entire discussion

    They can, but they do not.
    If they did, they only did it once.
    After that one time, there was a prior stock.

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  10. "If they did, they only did it once." - Art

    It's been, many, many times…

    "After that one time, there was a prior stock." - Art

    OK, and…???

    This needs a lot more explanation…like what are you getting at?

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