Inflation or Deflation?

Houses are always liquid (in the future) at some price, but since we are trying to anticipate the future outcomes, it is the assumption of the current market price in the future (a snapshot in time), which is an erroneous mathematical model. An analogy is if we erroneously assume a mass on a spring will be moving down in the future, because it is at current time snapshot. The correct model of the velocity is a differential equation of all the forces involved:

https://www.youtube.com/watch?v=JbwGlTz0wqk

The key point is that the market prices of houses is HIGHLY LEVERAGED to the interest rate, thus any snapshot of net worth including a snapshot of the current market price of a house, is an incomplete and erroneous mathematical model. The market price of houses is based on the intersection of the supply and demand curves, and the demand price curve (the maximum prices the buyers can pay) is based on the monthly payment, which mathematically can not exceed (a reasonable % of) the buyer's income.

Since we can see from the net worth statistics, that at least 49% of the people are (or nearly) bankrupt if the market price of their house drops significantly, we can see that there is contagion risk. If interest rates rise significantly enough, the market prices of houses will plummet.

Next let me explain how I know mathematically that eventually interest rates must rise significantly.

The above contagion risk is why the Fed is forced to hold the short-term bond interest rates down near 0% and long-term bonds down around 3% currently (which translates to roughly 4% mortgage rate as you said).

What does free (nearer to 0%) money do to an economy? It encourages investment in less productive sectors. Low interest rates redistribute capital from the most productive sectors to the lowest ones. This is true because capital (unlike money or finance) is finite. Capital is actual productive resources. We use money and finance to allocate it. Labor (your brain and mine) is one main example of capital. Raw materials is another lesser significant one (in this new knowledge based economy).

Thus while we keep interest rates low, we are destroying (wasting or misallocating) capital.

We can see this is capital destruction is ongoing if we calculate the aggregate statistics using methods before the Clinton hedonics, as ShadowStats.com does for Fortune 500 clietns. There we see that real GDP has dropped by 25% since 2001, and real GDP growth has remained negative. We see that unemployment is continually worsening.

We can't tighten fiscally without gutting the income and thus also plunging the prices of houses. We can't raise interest rates also.

So what we are doing is borrowing to delay the inevitable crash, and misallocating more capital and making the end crash worse.

Remember also that the value of a bond is highly leveraged to the market interest rate. Thus an owner of a bond profits when the interest rate continues to drop. Bonds plummet in value if the interest rates rise significantly.

The interest rates have been perpetually declining since the early 1980s, when Paul Volcker used double-digit interest rates to contain inflation and tame the gold and silver prices. This declining interest rate regime has been sustaining the misallocations of capital that occurred along the way. It is a mathematical bubble.

All bubbles have to be popped eventually. We are sustaining the historic misallocations, by piling on more debt and misallocations. Interest rates will eventually rise, and the massive accumulated misallocations will default.

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So far, the USA real GDP shrunk -25% (1/4) since 2001

http://www.shadowstats.com/imgs/sgs-gdp.gif?hl=ad&t=

Factoring in the 1% US population growth rate. that is a -38% contraction since 2001, meaning it will take +61% real growth (over 0 years) to get back to prior level. Say it takes 20 years to get back, so that means +83% real growth needed (factoring in population growth over the 20 years).

Code:

        Prophet      Nomad        Hero        Artist
High       Childhood    Elderhood    Midlife      Young Adult
Awakening  Young Adult  Childhood    Elderhood    Midlife
Unraveling  Midlife      Young Adult  Childhood    Elderhood
Crisis      Elderhood    Midlife      Young Adult  Childhood

I presented the generational research in the Transparency blog, which explains why we are not going to agree on the use of the government to enforce values:

http://relativisticobserver.blogspot.com/2012/04/transparency-way-of-future.html?showComment=1335900204476#c1703906618219560883

At least we can be rational about understanding why we have different political philosophies.

We Gen X did not grow up entitled. We have to struggle on our own to get where we are. We don't feel entitled, and thus we are not stakeholders in the society that the Boomers built. We trust the free market, because that is what we were dealing with on our own. Social security won't be there for us. The boomers took more than all (debt every where). We've had to scrap and negotiate hard to get some. And instead of giving back to us now the peace of individual freedom that we want, they want to put their value system on us (which will continue to escalate the wars).

So there is conflict ahead.

The Heros are going to rebuild new institutions and fighting the wars to tear down the current corrupt ones. We Nomads are caught in the cross-fire and just trying to find a way to not get squeezed out. Thus we have no choice but to discard the social contract, as it won't be rebuilt in time for us.

So now we can understand why boomer's (you) politics are loyalty, enforcing idealistic values, and maintaining entitlements.

And Gen X's (me) politics are liberty, pragmatic survival, individualism (honor), and distrust of values and institutions. I am libertarian anarchist. So trying to convince me that the entitled state should enforce values, is like me telling you that we should privatize the government.

Fascinating.

It explains why we are going to disagree about any political/social topics, such as Hackers, Transparency, media's role in society, etc..

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Some useful tables (although I think this deviates in some cases from the generational theory in the prior comment):

http://www.financialsense.com/contributors/james-quinn/2011/11/03/bad-moon-rising

The Boomers (elders) and Heros (youth) are archtypes and will be at odds. Boomers will judge them to have threatened values (remember the Heros are protected), yet ironically the above link claims the Boomers did more drugs, volunteered less, have lower college education, and higher teen pregnancy than the Heros do.

Globalization is the devaluation of passive capital in response to technological shift.

Professor, your thesis is almost correct, but as far I can see, you may have missed a very important cause and effect relationship.

I have got it all figured it out now.

globalization process is driven primarily by monetary expansion and the consequent increase in risk appetite

Agreed.

every period of globalization coincided with a stage of the industrial revolution in which accompanying the expansion in international trade and capital flows is a major technological boom, driven also by monetary expansion<

midst of a technological boom that seemed to be changing the globe beyond recognition, and certainly beyond the ability of his elders to understand. As part of that boom, capital flowed into remote corners of the earth, dragging isolated societies into modernity. Progress seemed unstoppable

But in spite of the enthusiasm for science that accompanied each wave of globalization, as a historical rule it was primarily commerce and finance that drove globalization, not science or technology, and certainly not politics or culture. It is no accident that each of the major periods of technological progress coincided with an era of financial market expansion and vast growth in international commerce. Specifically, a sudden expansion of financial liquidity in the world’s leading banking centers — whether an increase in British gold reserves in the 1820s or the massive transformation in the 1980s of illiquid mortgage loans into very liquid mortgage securities, or some other structural change in the financial markets — has been the catalyst behind every period of globalization

Financing becomes available for risky new projects such as railways, telegraph cables, textile looms, fiber optics, or personal computers

My thesis is that the monetary expansion is caused by technological shifts (not the other way around as you have it), via the mechanism where the majority of the population has been reduced in relative knowledge value w.r.t. to the knowledge producers of those technological shifts. Thus all forms of passive capital have to be devalued, and the most expedient political mechanism for such adjustment is monetary expansion.

The proof is that new (as opposed to existing) knowledge production can not be acquired with money nor finance:

http://www.zerohedge.com/news/2012-11-04/bitcoin-seen-through-eyes-central-banker#comment-2951089

http://www.coolpage.com/commentary/economic/shelby/Demise%20of%20Finance,%20Rise%20of%20Knowledge.html#FinanceabilityofKnowledge

Globalization takes place, in other words, largely because investors are suddenly eager to embrace risk

Remember on a long enough timeline all persistent borrowers and speculators end up bankrupt. Risk is statistically speaking, another way of saying "devaluation". I provided quantitative evidence, even for Coca-Cola dividends over 46 years:

http://www.coolpage.com/commentary/economic/shelby/Demise%20of%20Finance,%20Rise%20of%20Knowledge.html#KnowledgeInvesting

Other monetary expansions were sparked by large increases in U.S. gold reserves in the early 1920s, or by major capital recyclings, such as the massive French indemnity payment after the Franco-Prussian War of 1870,

In all these cases, you will find that there was some technological shift that caused passive capital to devalue and adjust. These adjustments are painful, because passive capital due its definition is an inherently bankrupt economic model that delays adjustment, as I have explained at the many links in this post.

support for globalization quickly wanes. Populist movements, never completely dormant, become reinvigorated. Countries turn inward. Arguments in favor of protectionism suddenly start to sound appealing. Investment flows quickly become capital flight

The technological change doesn't reverse! Rather the passive capitalism is devalued and there is an adjustment process called
"globalization", which is really just the technological destruction of top-down power (and passive capital, nation-states, etc). The top-down power (and its masses of dependents) tries to consolidate by retreating to greater economies-of-scale, i.e. greater centralization, e.g. supranational institutions.

The result is increased fragmentation by decreasing the size of the fragment closer to the individual (e.g. the combustion engine or the personal computerization), while the passive capital gains a greater fragment size, e.g. from tribes to feudals to nations and now heading to world governance. But the top-down control is losing power as its fragment becomes larger.

This is an incredibly important and profound realization!

Please (Ctrl+F in most browsers) search for the word fragment "automat" at each of the following linked posts of mine, to understand how I see that computerization is driving the current global monetary expansion. For example, China is using a Yuan peg monetary expansion to price its manual labor (up to -800%) below the profit margin of automation, thus stalling the onslaught of computerization.

http://www.mpettis.com/2012/10/27/when-the-growth-model-changes-abandon-the-correlations/#comment-18795

http://www.mpettis.com/2012/10/27/when-the-growth-model-changes-abandon-the-correlations/#comment-18823

http://www.mpettis.com/2012/10/27/when-the-growth-model-changes-abandon-the-correlations/#comment-18682

http://www.mpettis.com/2012/10/27/when-the-growth-model-changes-abandon-the-correlations/#comment-18648

But in the meantime, the computerization epoch is accelerating with billions carrying a PC in their hand (Android and Apple's iOS). See also the discussion of acceleration of computerization development models with the "inverse commons", "cathedral vs. bazaar", and "top-down vs. decentralize" at the following links.

http://www.coolpage.com/commentary/economic/shelby/Demise%20of%20Finance,%20Rise%20of%20Knowledge.html#FinanceabilityofKnowledge

http://www.zerohedge.com/news/2012-11-04/bitcoin-seen-through-eyes-central-banker#comment-2951115

http://www.zerohedge.com/contributed/2012-10-18/shipping-news-and-bit-more#comment-2904368

As your quote of Alphonse Rothschild indicated, most people simply can't see the technology that we see accelerating, and thus they have all the wrong theories about cause and effect. The following links are very entertaining, once you understand the correct cause and effect I explained above.

https://goldwetrust.forumotion.com/t182-technology-that-changes-everything#4754

http://www.mpettis.com/2012/10/27/when-the-growth-model-changes-abandon-the-correlations/#comment-18959

http://www.zerohedge.com/news/2012-10-28/charting-undoing-credit-fueled-globalization#comment-2926945

http://www.zerohedge.com/news/2012-10-21/chinese-gold-imports-through-august-surpass-total-ecb-holdings-imports-australia-sur#comment-2908306

http://www.zerohedge.com/news/2012-10-21/chinese-gold-imports-through-august-surpass-total-ecb-holdings-imports-australia-sur#comment-2908534

This is so profound, I am hopeful that you and others will help promote this understanding, as I don't have the capability to spread such
information, as my field (of computer programming and computer science) is rather abstruse and obfuscated from the mainstreams.

Professor, sharing your thesis and allowing blog comments, helped and motivated me to arrive at this understanding. Thank you. You are one of the knowledge producers and you are participating in this new computerized, inverse commons, bazaar is better than cathedral, knowledge age.

The above is probably the apex of my magnum opus polymath-like contribution to the field of economics. So I better get back to programming now.

We are both so pressed for time. I was hoping someone who writes for a living would be interested.

I need to get back to what I do for a living. I am crossing the chasm momentarily to try to convey the ideas to those in the fields of economics and writing.

>
> you say; "My thesis is that the monetary expansion is caused by
> technological shifts (not the other way around as you have it)."
>
> i would propose something a little more complex (and probably a little
> more intuitively appealing to someone like you): money is part of a
> feedback loop between changes in underlying "liquidity" and changes in
> the technology that responds to changes in money. this means, of
> course, the changes in liquidity are reinforced both on the way up and
> on the way down.

I see an even more complex relationship, but I think it is opposite to the relationship you are thinking. The *ADOPTION* of knowledge production accelerates as the liquidity peaks and declines, which is reinforcing its crash on the way down. This acceleration is because the technological shift becomes popularized, as the liquidity peaks and its bankruptcy is revealed.

Right now the shift that is changing the world is open source software, but this seems ludicrously narrow to assert. Wait until the liquidity peaks, then you will observe open source goes mainstream adoption (by the new Art generation, as I explained with the link to the Long Wave Cycles):

https://goldwetrust.forumotion.com/t9p570-inflation-or-deflation#4735

The increase in liquidity is the way the damn breaks as the epochal fragmentation of power by the technological shift (e.g. combustion engine or the personal computer) causes a huge swath of labor to fall out of the marginal profitability of *UNleveraged* supply and demand, and this unemployment drives the demand for debasement and leverage. This runs until it reaches peak bankruptcy at minimum liquidity.

I believe you are thinking that *new* knowledge production (i.e. innovation) responds to liquidity. I think that premise is entirely false. I can't find any evidence whatsoever that the micro-economic phenomenon of the efforts of a few random individuals is driven by liquidity. Bill Gates wrote Microsoft BASIC with very minimal capital from his partner's income, and a lot of personal sacrifice, given by his desire to innovate, not liquidity. Ditto Steve Jobs. Ditto myself on one of the world's first WYSIWYG word processors in the 1980s (pre-dated MS Word). Ditto Eric Raymond who wrote The Cathedral and Bazaar (that is driving globalization via open source). There only needs to be sufficient wealth, that we had time to do this, but this was static wealth, not responding to any near-term changes in liquidity.

> this may explain the violence of the credit cycle,
> and it may also explain the classic minsky recommendation that rather
> than try to prevent crises (which is impossible) we try to manage them
> by embedding countercyclical mechanisms into the financial system.

Try to tell billions of people to get with open source now, and they will look at you cross-eyed. You simply can't do the adjustment any other way, than bankrupt the masses with liquidity first.

Open source will be in everything, not just for programmers. All processes that involve policies and procedures.

Correction on the logic.

Note that as *new* knowledge production decreases, then the passive capitalists' accumulate more *proportion* of global wealth via compounded interest rate, e.g. in the extreme degenerate case automation replaces all labor and no one has an income to buy the production but this also drives production and wealth to zero (100% proportion of 0, is still 0).

Monetary expansion can not drive *new* knowledge production, because ingenuity and innovation is not driven by liquidity, but rather by individual creativity and dedication, which has nothing to do with some hard resources capital limitation. If anything, more liquidity distracts more people towards consumption, and away from innovative discipline. This is even more obviously true in the software programming age we are in now, e.g. the Mythical Man Month proves that adding more money, can not increase the rate of productivity in software creation.

We can think of productivity as being the ratio of *new* qualitative knowledge production per tangible measurable of production, since all value-added comes from knowledge production. Since we can't measure the former, we typically measure the proxy of production per employee, but this isn't correct as I explain below.

Monetary expansion can drive the adoption of *existing* technology (i.e. existing knowledge), because technology adoption is analogous to the professor's point about China's infrastructure being too expensive to be justified by the level of value-added (*new* knowledge production) in the economy. Liquidity can allow many people to have access to technology that they can't yet justify in terms of their *new* knowledge production capability, i.e. misallocation of capital. For example, multitudes use their smartphone to do mindless and addictive activity of tweeting their every daily action. Note the wireless tower and network build out in the USA is a negative ROI business.

The misallocation can drive *new* "knowledge production" to be misallocated, e.g. too much software development to service mindless activities. Thus in a sense, this isn't *new* knowledge production, because it is mindlessly misdirected by liquidity. So liquidity can as I alluded earlier misdirect away from *new* knowledge production.

But what causes liquidity to increase? It is because the passive capital can not be returned and the multitudes can not be employed, because the true productivity (as I defined it) is not increasing fast enough. Remember my extreme example of if we automate everything and there is no *new* knowledge production, then there would be no employment and no income to buy the production.

Another possible conclusion is that monetary expansion runs at equivalent to the rate of compound interest, which was shown to be true:

http://www.goldmeasures.co.nz/2008/05/fiat-debt-money-how-it-drives-countries.html

Any (non-misdirected) *new* knowledge production (not the "knowledge" activity driven by liquidity) is not spread uniformly in the society and money expansion can not cause *new* knowledge production. Thus passive capital is not focused on *new* knowledge production (the returns only aggregate with the fewer *new* knowledge producers), thus is not obtaining sufficient ROI to be paid.

So we can't conclude for sure that *new* knowledge production causes monetary expansion, but we can conclude that monetary expansion devalues passive capital and the multitudes, relative to the fewer true knowledge producers. And we can conclude that if *new* knowledge production was not occurring, then standard-of-living would not be inexorably increasing.

So rather than concluding that *new* knowledge production is causing globalization, we can conclude that *new* knowledge production becomes amplified in relative value coincident with the monetary expansion of globalization.

Crackup Boom Accelerating

Refer to my prior comments below the "Recognizing the need for economic adjustment" article, for more elaboration on the stance I will summarize below.

In conclusion, the political and financial system is spiraling the toilet bowl and accelerating into maximum deception and free money misallocation as was the case up to 1929 due to the century-periodic technology paradigm shift and symbiotic globalism expansion and contraction. There is no way to stop it now due fundamentally to the impossibility of a meritocracy in the collective.

Head to gold and the computer age revolution and await the devastation and reversal of global trade circa 2015 - 2017, which will then persist for decade or more. The repetitive jobs are permanently lost to robotics. Even doctors will be unemployed due to IBM's more accurate (Watson) diagnosis computer, which socialized health care will accelerate due to cost rationing. The new jobs will come from different forms of hacking (and less technical derivatives of the new capabilities such as arts and entertainment), e.g. proliferation of open-source leverage and even selling zero-day exploits.

Spain's bond rates did not fall due to increased confidence (Michael correctly pointed out the mad rush to extract capital from Spain), rather Spain raided its social security fund to buy sovereign bonds.

The $1000 trillion (quadrillion) of bond derivatives hinge (refer to the Lehman example) on the key collateral of sovereign bonds. Only recently is there action towards allowing gold to be an alternative Tier 1 collateral asset.

As Kyle Bass recently pointed out, Japan has likely entered terminal velocity when it entered current account and trade deficits, thus the a currency crisis in Japan within two (2) years will likely set off massive bond derivative dominoes. The central banks will print free money like mad and send the globe into inflation hell, as they have no other choice.

The Fed is following the oscillation theme that Michael (and I) mentioned in the comments of the prior article "Recognizing the need for economic adjustment". The global free money capacity limit will be reached within 2 to 5 years.

France (and Italy) are also sliding into the abyss which will drag Germany into it as well. Global contagion can not be avoided.

This is also known as the Long Wave Cycle (or the Great Turning) in action.

I found zero evidence that knowledge production is created by monetary or credit liquidity.

Add two points, a) Fed is pumping billions into EU now, so it is a global "all for one, one for all" slow burn descent into the abyss, b) Socialized labor (i.e. minimum wage, laws against layoffs, mandatory health care, etc) will also accelerate the shift to robotics, because it becomes too expensive to hire humans, while robotic (computer) technology is halved into cost every 18 months due to Moore's Law.