Inflation or Deflation?

...Now sure, The Fed can start printing money like mad and buy all these Ts, making their balance sheet expand like a balloon - or a bubble. And Bernanke, yesterday in his testimony, claimed that this didn't constitute "printing money" or "inflating the money supply."...

...The problem is that this is only monetarily neutral if the asset is actually worth a dollar (shelby notes, i.e. "is liquid"). If it is in fact worth 50 cents then he printed the other 50 cents, and devalued every other dollar in the world by the same amount...

...An asset is worth only what an uncoerced buyer and seller will transact at. This is first-semester economics...

...I think it key to say that money supply aggregates (e.g. M3) are not liquid capital. So as long as most people do not jump off the Titantic (dollar), then the system can hyperinflate the M3 as has been the case since 2006, without it manifesting into hyperinflation of prices (that matter to those public...food is only a small portion of American's expenses...housing/stocks/bonds is a huge component of their net worth). But once the public starts to cash out of dollars, then hyperinflation results...

...unlike the West whose illiquid net worth is intimately tied to the financial markets...

...I was saying this a long time ago, remembering how many NPLs in Asia during the 1997 crisis, and noting that China had grown way too fast on redundant export industries, for it to be consistent with a sustainable development. But the wildcard is higher savings rates and low penetration of personal credit, at least in come of the asian countries. But I am not convinced that there really are higher savings rates-- that may be stored in illiquid things like houses and condos?...

...inversion disappeared from LIBOR but moved over into the intermediate area of the US Treasury Curve, where it is far more dangerous.

China, Japan and Saudi Arabia should bring the curtain down on this farce right damn now, because Treasuries are rapidly becoming no more secure than ordinary corporate debt and the buyers sure as hell aren't being compensated for that risk.

Treasury buyers are being robbed blind along with US investors who think they're "fleeing to safety."....

...There is a very real risk that this Treasury Issue could force GDP return on new debt below zero. If that happens then the stability of the monetary system disappears immediately and you will see instantaneous and very large fails in the Treasury marketplace...

...Everyone is screaming about "increasing credit growth" - including Nouriel Roubini this morning on CNBC. What Nouriel and the rest who are calling for this sort of "tonic" are missing is that you can't increase credit growth into the market until the existing bad debt has been defaulted as the GDP contribution from additional debt load is dangerously close to going negative, and as it approaches zero you get no economic benefit from doing so...

...If that ratio goes negative then you are forced to issue new credit (debt) just to cover interest payments, at which point you no longer can get out of the mess without what amounts to a monetary and economic system collapse...

...our researchers anticipate that, before next summer 2009, the US government will default and be prevented to pay back its creditors (holders of US Treasury Bonds, of Fanny May and Freddy Mac shares, etc.). Of course such a bankruptcy will provoke some very negative outcome for all USD-denominated asset holders. According to our team, the period that will then begin should be conducive to the setting up of a « new Dollar » to remedy the problem of default and of induced massive capital drain from the US...

...which means for our researchers that, at the end of this semester, the world enters the « decanting phase » of the crisis, i.e. a phase when the outcome of the shock settles down. This phase is the longest (from 3 to 10 years, according to the country) and the one affecting the largest number of people and countries. It is also the phase when the components of new global equilibriums will start to appear...

...I contend that at the end, there will be only dollar debt remaining on net balance sheet (net worth will have moved out of fiat). The debtors (holding no gold or silver) will be happy to have their debt revalued lower relative to gold, the gold holders will be happy to receive some gold instead defaulted dollar debt, and the indebted gold holders may lose their gold via means-tested bankruptcy laws. The Amero will likely be fractionally backed by gold, with the fractional nature insidiously hidden to appease the majority who want to continue to use debt...

1. Allow the defaults, do not bail out, strengthen the value of the dollar. This would be a deflationary recession that would last maybe 3 years at most before bottoming.
   
2. Bailout defaults, trash the dollar with hyperinflation due to negative REAL GDP growth per stimulus bailout credit created. This will be a hyper-inflationary catastrophic DEPRESSION (dep-flation, depflation), which will last 10 - 15 or more years and generate massive world upheaval.

explore wrote:I just listened to two presentations. One, Nouriel Roubini, argues that we will be experiencing deflation http://www.bloomberg.com/avp/avp.htm?N=av&T=Roubini%20Sees%20%60Significant%20Downside%20Risk%27%20for%20Equities&clipSRC=mms://media2.bloomberg.com/cache/vycr2Mqgo39U.asf

explore wrote:The other, Albert Friedberg, expects to see inflation http://www.niagaracapital.ca/pganalysis2.htm (download the 10/28/08 conference call).

Friedberg runs a hedge fund that was up over 35% for the year ending at the end of this past September, so he has been doing something right. Similarly, Roubini’s predictions have been quite successful of late.

explore wrote:I just listened to two presentations. One, Nouriel Roubini, argues that we will be experiencing deflation http://www.bloomberg.com/avp/avp.htm?N=av&T=Roubini%20Sees%20%60Significant%20Downside%20Risk%27%20for%20Equities&clipSRC=mms://media2.bloomberg.com/cache/vycr2Mqgo39U.asf

The other, Albert Friedberg, expects to see inflation http://www.niagaracapital.ca/pganalysis2.htm (download the 10/28/08 conference call).

Friedberg runs a hedge fund that was up over 35% for the year ending at the end of this past September, so he has been doing something right. Similarly, Roubini’s predictions have been quite successful of late.

Shelby wrote:...Both (Roubini and Friedberg) have same mistake, they think credit = capital...

...the 800 lb gorilla is:

hyperinflation of value of real non-credit-based assets (TANGIBLES) combined with broad deflation of value of overvalued credit-based assets (INTANGIBLE PROMISES)...

Hommel wrote:...a mere 2.5% rate of interest, from 1 ounce of gold invested 6000 years ago, could compound its way to becoming all the atoms of the universe, all of it would have to be gold, and all of it would belong to one person. Clearly, that is absolutely impossible...

Hommel wrote:...If you invested 1 oz. of gold 6000 years ago, and compounded it at ¼ of 1% per year, then you’d own more gold than has been mined in the history of the world, over 6 billion ounces, which is obviously impossible...

Hommel wrote:...Over 2000 years, one dollar at 6% interest will grow to $385,855,472,630,337,000,000,000,000,000,000,000,000,000,000,000,000! (or one ounce of gold will grow to that many ounces at 6% in 2000 years!) See why usury is forbidden?...

Shelby wrote:...There has never been a 100% gold standard, and there will never be as long as some people want to use debt, because debt is impossible on a 100% gold standard. Proof: 1 oz of gold compounded at 3% since 0 A.D. is orders-of-magnitude more gold than exists on earth...

Hommel wrote:...basic math that shows that paper usury systems must fail due to the inescapable conclusion that you cannot compound your way to owning every atom in the universe...

Shelby wrote:Credit != Capital, Tangibles Usury Can Not Exceed Production Growth Rate

(!= means "does not equal")

This may be one of the most important things I will ever write......

......Specifically the cartoon explains that Tangibles Interest Rates Can Not Exceed Production Growth Rate:

http://www.takelifeback.com/hegawid/25.gif
http://www.takelifeback.com/hegawid/24.gif
http://www.takelifeback.com/hegawid/17.gif
http://www.takelifeback.com/hegawid/14.gif

And that loaning intangible promises has no limit, other than the limit of gullible foolishness/idolatry of those who participate:

http://www.takelifeback.com/hegawid/25.gif
http://www.takelifeback.com/hegawid/24.gif

And such foolishness empowers the social meddling machine (aka government):

http://www.takelifeback.com/hegawid/22.gif


======================
And this brings me full circle to refute and clarify something that has been bothering me for about 2 years, specifically the allegation of immorality/non-prosperity of usury and the definition of "excessive interest"......

......The only natural law is that one can not loan TANGIBLES at a higher rate of interest than their net supply growth rate, i.e. "excessive interest" is a function of production or productivity. The higher the productivity, then the higher the interest rate than can be tolerated indefinitely. For example, I think the annual mine production of gold is about 1 - 2% of the above ground supply, thus a non-excessive interest rate for loaning gold is < 1%.

What is correct that "excessive interest" (meaning unsustainable, resulting in failure) is the charging of interest rates on PROMISES to deliver TANGIBLES (e.g. future's markets), which exceed the net supply growth rate of those TANGIBLES.

And that folks is the delimma the world is in now, after having increased derivatives (PROMISES) to estimates of a $quadrillion ($1000 trillion), up from a few $billion in 1990s......

Shelby wrote:...looks like the rate of increase of world above ground supply of gold peaked in 1999 at 1.87%, with worldwide 2570 tonnes produced with 137,290 tonnes of above ground supply at start of 1999 (or 1.91% in 1990 with 2180 produced on 114,110 tonnes):

http://minerals.usgs.gov/ds/2005/140/gold.pdf
http://www.lewrockwell.com/blumen/blumen14.html

...According to the WGC, this quantity was around 155,500 tonnes at the end of 2005...

Very interestingly, only 1.23% in 1980 with 1220 produced on 98,730 tonnes, down from 1.73% in 1970 with 1480 produced on 85,770 tonnes. In 1940, 2.48% with 1310 produced on 52,909 tonnes.

silberruecken wrote:http://mises.org/story/3040

...an increase in the money supply.[1] Accordingly, I will adopt that simple definition. Deflation will be defined conversely as a decrease in the money supply...

...What Is Money?...Complications arise in applying this definition, however, due to practices such as fractional-reserve banking...

Inflation or deflation?

* by Martin Hutchinson
* November 17, 2008

There is a considerable argument between commentators at present as to whether, apart from a pretty painful recession, we are in for a bout of inflation or deflation. Both sides have apparently cogent arguments, and maintain their positions with considerable vigor. Robert Samuelson, having recently published a book “The Great Inflation” that suggested another burst of inflation was inevitable, has now produced an op-ed in the Washington Post warning of the rapidly approaching dangers of deflation – such are the dangers of publishing schedules! Having in the past suggested that inflation was inevitable, I thought it worth looking at the deflationist case.

Money supply data, first, do not suggest that deflation is imminent, although to some extent they contradict each other. M2, the broadest money supply measure now published by the Federal Reserve, was up 7.4% in the 12 months to November 3 (suggesting a potential inflation rate of 6-7% since Gross Domestic Product growth was around 1% in real terms.) The St. Louis Fed’s Money of Zero Maturity, the closest we can now get to the old M3, discontinued by the Fed in 2006, is up 10.0% in the last 12 months, suggesting a somewhat faster rate of inflation, perhaps 8-9%. More recently however the two measures have diverged; in the eight weeks to November 4 M2 was up at a 19.9% annual rate while MZM rose at a 0.7% annual rate – a huge disparity that has yet to be explained.

Nevertheless, the “gold bugs” who would normally expect to profit substantially from an upsurge in inflation have had a terrible year, indicating that their thesis has in some respects gone horribly wrong. According to Mark Hulbert on CBS Marketwatch, Harry Schultz, Howard Ruff and Jim Dines, the three leading gold-bugs and prognosticators of economic doom, have each lost between 64% and 70% on their investment newsletters during 2008. Since this was the year in which their prognostications of doom finally appear to have come true, one can reasonably ask what went wrong!

Equally the majority view, that the principal danger facing the United States is a Japanese-style stagnation lasting a decade or more with prices declining slightly making real interest rates too high, also seems misguided. Japan was close to deflation even in the early 1990s, and then followed a poisonous mix of policies that failed to recognize the loan losses in its banks while attempting to spend its way out of trouble through the public sector.

The United States is doing the latter but not the former, which it is prevented from doing by “mark-to-market” accounting. While mark to market accounting has major defects in prolonging a bubble, since it allows bankers to enter into foolish deals in the hope of short-term profits and bonuses, it is highly salutary in a downturn, preventing any semblance of wishful thinking in assessing value-impaired assets such as mortgage bonds. That’s why the entire US banking system has been forced to turn to Uncle Sam for succor; it is also why that system is now entirely unable to carry on as if nothing had gone wrong as the Japanese banking system did in 1991-98. Thus with a banking system forced into realism and interest rates that are sharply negative in real terms, deflation seems an unlikely possibility, in spite of Treasury Secretary Hank Paulson’s determination to invest every spare nickel in the economy into its most unproductive and valueless assets.

The difference between the United States and 1990s Japan is further indicated by the credit crunch: Japan didn’t really have one, in the sense of a sudden constipation in normal lending that caused the economy to seize up. That suggests again that the US trajectory going forward is unlikely to resemble 1990s Japan (for good or evil – Japan avoided a really deep recession, though it suffered an appallingly long albeit shallow one.)

The recent spate of truly terrible economic numbers, such as the 2.8% retail sales decline in October (4.5% down on the previous year) and the 32% decline in automobile sales, suggests that wherever the bottom of the recession is located, we will get there quickly. The US savings rate and the balance of payments both need to be improved by about 5% of Gross Domestic Product, so a top-to-bottom decline in GDP of at least 5% is likely,. However there is little reason for GDP to decline more than 5% top-to-bottom, or maybe 7% to allow for a little overshoot. Once GDP gets to its new equilibrium level powerful factors stabilize it and produce renewed growth – after all, at that new level of GDP the United States is once again internationally competitive, selling goods and services to customers worldwide in a way that has been impossible for a decade.

We are thus not looking at Great Depression II, in which GDP would decline 25%. To reach such an unpleasant re-run we would need a major outbreak of global protectionism, a final withdrawal of confidence by depositors in the US banking system and a swingeing increase in taxes, more than doubling the top marginal rate. President-elect Obama isn’t going to do that. Is he? If he doesn’t, and we avoid a Smoot-Hawley-style attack on world trade, then we will also avoid Great Depression – the Sequel. After all, the Depression was a primarily US phenomenon, caused and prolonged by egregious US policy errors –it was nothing like so bad in Britain, where economic policy under Chancellor of the Exchequer Neville Chamberlain was highly competent and basically the opposite of US failures.

However, if the recession is to be limited to a drop of 5-7% in GDP (itself somewhat worse than the 1974 and 1979-82 recessions, both around 3.5% of GDP) then at the present rate of decline we will reach bottom pretty quickly, in no more than 9-12 months. That tallies also with the housing price decline; house prices have already declined more than 20% nationwide, and from valuation considerations probably have no more than 10% or at most 15% to go. The banking system has already been bailed out by the Feds and probably won’t have to be bailed out again, but will see a gradual containment of losses in the next few quarters (with one or more huge incompetents finally slithering into bankruptcy.) The stock market has nearly reached its equilibrium of around 7,800 on the Dow (based on its early 1995 level of 4,000, inflated by nominal GDP growth since then). Although the market will doubtless overshoot on the downside, the dollar loss from a further decline to say Dow 5,000 is less than we have already experienced in the decline from 14,165 to below 9.000.

While US GDP is still declining sharply inflation will remain quiescent. Oil, minerals and agricultural prices will be on a generally downward trend, as the rest of the world, in particular the high-population growth centers of China and India, find their growth restricted by declining US demand. However, China has already indicated that it will not allow a US recession to stall its own growth; instead it has announced a 2-year stimulus program of $580 billion, about 15% of GDP. Thus commodity prices will remain supported by the continuous surge in Chinese and to a lesser extent Indian demand. US inflation will slow somewhat from its summer peak of close to 6%, but will not go into reverse, even while output continues its sharp decline. A renewed decline in the dollar, inevitable once US savings rates begin to recover and the tsunami of foreign capital into US bonds lessens, will cause the recent decline in import price inflation to reverse. Meanwhile cost increases already present in the system will work their way through to prices, causing continued modest upward momentum.

Even if inflation is declining gradually as output declines, it will not have time to become deflation in the 9-12 months before output reaches bottom – if we were about to experience Great Depression II the decline would be more prolonged, but we’re not. Once output has bottomed out, the inflationary picture changes radically. Budget deficits in the United States, the EU, China, India and Japan will be enormous, causing sharp rises in interest rates as government bonds “crowd out” the private sector. Money supply, which will have been increasing because of the very low nominal interest rates, will now be grossly excessive for the shrunken GDP.

Costs, which were held down by the wave of bankruptcies in the contraction, will once again increase as supply comes once again to balance demand. For one thing, higher interest rates and capital costs (through lower equity prices) will themselves produce a sharp upward ratchet effect on corporate break-evens, both in the US and more especially in emerging markets where capital will be scarce. Lower production volumes against which fixed costs can be amortized will also increase unit costs. The overall effect will be sharp upward pressure on prices -- those continuing to sell at a loss to keep the factory at its most efficient output level and workers employed will be rapidly driven out of business.

Inflation will thus resurge, both domestically and internationally, and will quickly reach the double-digit level at which central bank action to restrain it becomes unavoidable (amusingly, unexpectedly awful inflation figures are likely to appear before the January 2010 end of Fed Chairman Ben Bernanke’s term, forcing him to admit while still in office that his “deflation” warnings were hogwash.) Interest rates will gradually be forced upwards to inflation-plus-4% levels in the last months of 2009 and throughout 2010, producing a second “dip” of recession in 2011 and a non-inflationary recovery in 2012-13. The turn from economic decline (but not truly deflation) to inflation will be well indicated by the gold market, which can expect to surge as the economic bottom is approached.

As often happens, the “gold bugs” will turn out to be right in the end, even if their performance during 2008 has been dreadful – for those that survive, 2009 is likely to be a banner year. Deflationists will proclaim each slowing inflation figure in the early months of 2009 to be evidence for their case, though in reality those months will see not true deflation but simply slowing inflation accompanied by sharp descent into recession. However in the long run, monetarists will prove to have been right – and the decade of excessive money supply expansion from 1995-2008 will impose its final penalties on the unfortunate US and global public. Monetarists will also have the satisfaction of knowing that higher real interest rates will have become inescapable, and that overexpansion of money supply will never happen again – until some future generation of idiots has forgotten the economic history of these decades.



(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)

...Deflation last occurred in the early 1930s, because (SHELBY REMOVED THE WRONG REASONING)...it was aggravated by the Federal Reserve's foolish contraction of the money supply. In the three years after the market crash of 1929, the Fed apparently shrank the money supply by nearly one-third -- precisely the wrong medicine for a fearful and credit-starved economy...

Isaac Newton wrote:...In China and Japan one pound weight of fine gold is worth but nine or ten pounds weight of fine silver, & in East India it may be worth twelve. And this low price of gold in proportion to silver carries away the silver from all Europe.

So then by the course of trade & exchange between nation & nation in all Europe, fine gold is to fine silver as 14 4/5 or 15 to on...

...It may be said that there are great quantities of silver in Plate, & if the Plate were coyned there would be no want of Silver money. But I reccon that silver is safer from exportation in the form of plate then in the form of money, because of the greater value of the Silver & fashion together. And therefore I am not for coyning the Plate till the temptation to export the silver money (wch has a profit of 2d. or 3d. an ounce) be diminished. For as often as men are necessitated to send away money for answering debts abroad, there will be a temptation to send away Silver rather then Gold...

...Flash Update Subscruption required November 23rd, 2008
• Monetary Base Annual Growth Now at 75.5% • Systemic Solvency Crisis Intensifies Anew...

...Raising taxes can delay this, but not prevent it. And might, actually, trigger it sooner; the historical evidence suggests that current tax rates may already be at above the minimum level where, by suppressing and unhealthily redirecting economic activity, they actually reduce total revenue. (One reason to believe this is that the much-derided “Bush tax cuts” actually increased revenues despite the effects of the dot.com bust.) But even if this isn’t true yet, diminishing returns will set in at some point as rates go up.

The only alternative to raising taxes (or deliberately inflating the currency, which in this context has similar effects) is to buy debt and pay entitlements out of that, pushing the unsustainability problem into the future.

The fundamental problem is that income-transfer programs (and the interest service on the debt purchased to keep them running) are spending wealth in higher volumes than the economy can actually generate, and demand for that spending is rising faster than the economy is growing. Thus, raising tax rates is no longer a way out, if it ever was.

At some point, the U.S. government is going to lose both the ability to increase revenues and the ability to sell bonds. At that point the entitlements system will crash. Transfer checks will either stop issuing or become meaningless because the government has, like some banana republic, hyperinflated the currency in order to get out from under its debt obligations.

Unlike the oncoming European demographic crash, the entitlements crash will be survivable in that there will still be people around to make things and trade things with. But it’s going to be ugly. probably rioting-in-the-streets ugly. People dependent on income transfers will starve or die of preventable diseases in large numbers, unless they can find work or private charity. Since many of those people will be old, work will be unlikely unless they are exceptionally capable at something. Families will have to re-assume the burden of caring for their elderly; retirees without children will be in especially severe jeopardy.

Violent revolutions have been fought over less wrenching economic changes than this one promises to be.

The next questions to ask are (a) when will it happen?, and (b) how can the pain be minimized?

There are good reasons to believe the crash could happen as early as 2012, with the trigger being the mass retirement of the Baby-Boom demographic bulge. That is, it will happen that soon if we are lucky.

If we are unlucky, the Federal government will concoct some sort of accounting flimflam (like Al Gore’s infamous lockbox full of IOUs from one part of the government to another) that will push back the day of reckoning out past 2020 — making the numbers and demographic profile of the stranded dependents worse every year it’s delayed. I think this is the most likely scenario, though I’d love to be wrong.

In the rest of this essay I am going to make, against my best judgment, the optimistic choice of a near-term crash; bear in mind that if I’m actually correct in my pessimism the devastation will be worse…