Where's the Beef?

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JAG
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Where's the Beef?

In my time here at CM.com I have been exposed to a lot of interesting ideas and I have learned a great deal from the discussions here. But at the same time, in the midst of all this information, it can be hard to distinguish legitimate concerns from fear-based exaggerations. This predicament often reminds me of that old TV commercial that asked “Where’s the beef?”

If one can use a hamburger as a metaphor for the cognitive process, the oversized bun represents the overall reaction to a given topic, and the undersized beef represents the facts or “meat” of the argument or topic. Using this metaphor, I would like to tackle one of the more widely accepted expectations here in this community and ask “Where’s the beef?”

The Hyperinflated Hamburger

The Bun: Massive Inflation or Hyperinflation is just around the corner.

A site search for the term inflation produces 811 hits, and a site search for the term hyperinflation produces 321 hits. Anyone that has been part of this community for a reasonable period of time can attest to the fact that massive inflation and/or hyperinflation is a major concern here, and rightly so. The Fed’s (proverbial) printing press has been going full-bore for nearly two years, and the Federal deficit is unspeakably large, massive inflation is a certainty, right?

The Meat: Where’s the inflation? Despite unprecedented increases in the base money supply and massive government spending, consumer price inflation is nowhere to be seen. Take a look at these consumer price charts:

Prices for your food, restaurants, home improvement, telecommunications, electronics, and personal care products are lower now than they were 2 years ago when the monetary deluge began.

Why doesn’t the meat of this argument measure up to its bun? I have a few theories:

1) There is no “printing press”, per se. The real issue in this situation is not monetary inflation, but rather credit-inflation. This article from MIsh in 2007 clarifies the distinction between money and credit: Counterfeiting Money - Crime or Good Economics?

Money itself (however one defines it) is a claim on real savings (a placeholder for saved goods). For example, a baker makes bread, so what he actually saves is bread. The baker only transforms his savings into money (typically a monetary commodity that has a prior demand for other uses, such as gold) because that's far more convenient. The baker can not actually save bread, as it would get old.

Therefore money, as such, is a claim on real goods. Credit by contrast, is a claim on money itself, which in turn is a claim on real goods. In our present system, credit claims on money to be paid back in the future masquerade as actual money and can thus be termed "synthetic money". In addition there is a "multiplier" effect. Someone gets a loan and spends it on goods. That money is deposited and is treated as money regardless of whether or not it is backed by real goods. Via sweeps and still more lending (see Money Supply and Recessions), the same money is lent out time and time again (the multiplier effect). This is the failure of the central bank administered fiat system: monetary claims proliferate beyond actual production of goods to back them up. In a honest system, only actual savings would be transferred from savers to borrowers (with banks acting as middlemen).

This "credit inflation" is thus fundamentally different from the "Weimarian printing press inflation". The Weimar situation brings about hyperinflation as the monetary unit itself is inflated in its physical form, as banknotes. By contrast, a credit inflation that creates claims that masquerade as money is prone to deflation because the money needed to pay back the credit is in a shortage (relatively speaking) compared to the outstanding credit claims.


The Fed can increase the supply of money, but it cannot directly increase the supply of credit. Credit inflation is what fuels price inflation and credit inflation is created by the banking system.

2) Bank reserves do not seed credit money creation. In his paper The Roving Cavaliers of Credit, Australian economist Steve Keen proposes that there is no empirical evidence to support the conventional model of the “money multiplier effect”:

Two hypotheses about the nature of money can be derived from the money multiplier model:

1. The creation of credit money should happen after the creation of government money. In the model, the banking system can’t create credit until it receives new deposits from the public (that in turn originate from the government) and therefore finds itself with excess reserves that it can lend out. Since the lending, depositing and relending process takes time, there should be a substantial time lag between an injection of new government-created money and the growth of credit money.

2. The amount of money in the economy should exceed the amount of debt, with the difference representing the government’s initial creation of money. In the example above, the total of all bank deposits tapers towards $10,000, the total of loans converges to $9,000, and the difference is $1,000, which is the amount of initial government money injected into the system. Therefore the ratio of Debt to Money should be less than one, and close to (1-Reserve Ratio): in the example above, D/M=0.9, which is 1 minus the reserve ratio of 10% or 0.1.

Both these hypotheses are strongly contradicted by the data.

Testing the first hypothesis takes some sophisticated data analysis, which was done by two leading neoclassical economists in 1990.[3] If the hypothesis were true, changes in M0 should precede changes in M2. The time pattern of the data should look like the graph below: an initial injection of government “fiat” money, followed by a gradual creation of a much larger amount of credit money:

Their empirical conclusion was just the opposite: rather than fiat money being created first and credit money following with a lag, the sequence was reversed: credit money was created first, and fiat money was then created about a year later:

“There is no evidence that either the monetary base or M1 leads the cycle, although some economists still believe this monetary myth. Both the monetary base and M1 series are generally procyclical and, if anything, the monetary base lags the cycle slightly. (p. 11)

The difference in the behavior of M1 and M2 suggests that the difference of these aggregates (M2 minus M1) should be considered… The difference of M2 – M1 leads the cycle by even more than M2, with the lead being about three quarters.” (p. 12)

Thus rather than credit money being created with a lag after government money, the data shows that credit money is created first, up to a year before there are changes in base money. This contradicts the money multiplier model of how credit and debt are created: rather than fiat money being needed to “seed” the credit creation process, credit is created first and then after that, base money changes.

It doesn’t take sophisticated statistics to show that the second prediction is wrong—all you have to do is look at the ratio of private debt to money. The theoretical prediction has never been right—rather than the money stock exceeding debt, debt has always exceeded the money supply—and the degree of divergence has grown over time.(there are attenuating factors that might affect the prediction—the public hoarding cash should make the ratio less than shown here, while non-banks would make it larger—but the gap between prediction and reality is just too large for the theory to be taken seriously).

Academic economics responded to these empirical challenges to its accepted theory in the time-honoured way: it ignored them.

Well, the so-called “mainstream” did—the school of thought known as “Neoclassical economics”. A rival school of thought, known as Post Keynesian economics, took these problems seriously, and developed a different theory of how money is created that is more consistent with the data.

This first major paper on this approach, “The Endogenous Money Stock” by the non-orthodox economist Basil Moore, was published almost thirty years ago.[4] Basil’s essential point was quite simple. The standard money multiplier model’s assumption that banks wait passively for deposits before starting to lend is false. Rather than bankers sitting back passively, waiting for depositors to give them excess reserves that they can then on-lend,

“In the real world, banks extend credit, creating deposits in the process, and look for reserves later”.[5]

Thus loans come first—simultaneously creating deposits—and at a later stage the reserves are found. The main mechanism behind this are the “lines of credit” that major corporations have arranged with banks that enable them to expand their loans from whatever they are now up to a specified limit.

So the unprecedented amount of base money currently being injected into the banking system is a response to the mountain of credit money created in years past, and doesn’t portend a subsequent explosion of credit money “just around the corner”.

 

3) The Overlooked Component of Monetary Inflation; Velocity. John Mauldin does a great job explaining the velocity of money in this excerpt from his March 10th, 2010 letter, The Implications of Velocity :

Basically, when we talk about the velocity of money, we are speaking of the average frequency with which a unit of money is spent. To give you a very rough understanding, let's assume a very small economy of just you and me, which has a money supply of $100. I have the $100 and spend it to buy $100 of flowers from you. You in turn spend $100 to buy books from me. We have created $200 of our "gross domestic product" from a money supply of just $100. If we do that transaction every month, we will have $2400 of annual "GDP" from our $100 monetary base.

So, what that means is that gross domestic product is a function of not just the money supply but how fast that money moves through the economy. Stated as an equation, it is P=MV, where P is the nominal gross domestic product (not inflation-adjusted here), M is the money supply, and V is the velocity of money. You can solve for V by dividing P by M. By the way, this is known as an identity equation. It is true at all times and all places, whether in Greece or the US.

Our Little Island World

Now, let's complicate our illustration a bit, but not too much at first. This is very basic, and for those of you who will complain that I am being too simple, wait a few pages, please. Let's assume an island economy with 10 businesses and a money supply of $1,000,000. If each business does approximately $100,000 of business a quarter, then the gross domestic product for the island is $4,000,000 (4 times the $1,000,000 quarterly production). The velocity of money in that economy is 4.

But what if our businesses get more productive? We introduce all sorts of interesting financial instruments, banking, new production capacity, computers, etc., and now everyone is doing $100,000 per month. Now our GDP is $12,000,000 and the velocity of money is 12. But we have not increased the money supply. Again, we assume that all businesses are static. They buy and sell the same amount every month. There are no winners and losers yet.

Now let's complicate matters. Two of the kids of the owners of the businesses decide to go into business for themselves. Having learned from their parents, they immediately become successful and start doing $100,000 a month themselves. GDP rises to $14,000,000. In order for everyone to stay at the same level of gross income, though, the velocity of money must increase to 14.

Now, this is important. If the velocity of money does not increase, that means that (in our simple island world) on average each business is now going to buy and sell less each month. Remember, nominal GDP is money supply times velocity. If velocity does not increase, GDP will stay the same. The average business (there are now 12) goes from doing $1,200,000 a year down to $1,000,000. The prices of products fall.

Each business now is doing around $80,000 per month. Overall production is the same, but divided up among more businesses. For each of the businesses, it feels like a recession. They have fewer dollars, so they buy less and prices fall. So, in that world, the local central bank recognizes that the money supply needs to grow at some rate in order to make the demand for money "neutral."

It's basic supply and demand. If the demand for corn increases, the price will go up. If Congress decides to remove the ethanol subsidy, the demand for corn will go down, as will the price.

If Island Central Bank increases the money supply too much, you will have too much money chasing too few goods and inflation will rear its ugly head. (Remember, this is a very simplistic example. We assume static production from each business, running at full capacity.)

Let's say the central bank doubles the money supply to $2,000,000. If the velocity of money is still 12, then the GDP will grow to $24,000,000. That will be a good thing, won't it?

No, because with the two new businesses only 20% more goods are produced. There is a relationship between production and price. Each business will now sell $200,000 per month, or double their previous sales, which they will spend on goods and services, which only grew by 20%. They will start to bid up the price of the goods they want, and inflation sets in. Think of the 1970s.

So, our mythical bank decides to boost the money supply by only 20%, which allows the economy to grow and prices to stay the same. Smart. And if only it were that simple.

Let's assume 10 million businesses, from the size of Exxon down to the local dry cleaners, and a population that grows by 1% a year. Hundreds of thousands of new businesses are being started every month and another hundred thousand fail. Productivity over time increases, so that we are producing more "stuff" with fewer costly resources.

Now, there is no exact way to determine the right size of the money supply. It definitely needs to grow each year by at least the growth in the size of the economy, the population, and productivity, or deflation will appear. But if money supply grows too much then you have inflation.

And what about the velocity of money? Friedman assumed the velocity of money was constant, and therefore he stated that inflation is always and everywhere a function of the supply of money. And it was, from about 1950 until 1978 when he was doing his seminal work. But then things changed.

Note that nothing Friedman says contradicts the equation MV=PT, if you assume constant velocity. Almost by definition you get inflation if the money supply grows too fast.

Let's look at two charts sent to me by Dr. Lacy Hunt of Hoisington Investment Management in Austin (and one of my favorite economists). First, let's look at the velocity of money for the last 108 years.

Notice that the velocity of money fell during the Great Depression. And from 1953 to 1980 the velocity of money was almost exactly the average of the last 100 years. Also, Lacy pointed out in a conversation that helped me immensely in writing this letter, that the velocity of money is mean reverting over long periods of time. That means one would expect the velocity of money to fall over time back to the mean or average. Some would make the argument that we should use the mean from more modern times, since World War II; but even then, mean reversion would result in a slowing of the velocity of money (V), and mean reversion implies that V would go below (overcorrect) the mean. However you look at it, the clear implication is that V is going to drop. In a few paragraphs, we will see why that is the case from a practical standpoint. But let's look at the first chart.

Now, let's look at the same chart since 1959 but with shaded gray areas that show us the times the economy was in recession. Note that (with one exception in the 1970s) velocity drops during a recession. What is the Fed response? An offsetting increase in the money supply to try and overcome the effects of the business cycle and the recession. P=MV. If velocity falls then money supply must rise for nominal GDP to grow. The Fed attempts to jump-start the economy back into growth by increasing the money supply.


Monetary inflation is not just a function of money supply, but also a function of how fast that money moves through the economy. From the chart above, you can see that the velocity of money is currently slowing. The banking system is  playing catch-up to the enormous amount of credit money that it created in years past, and thus is in a holding its pattern. Additionally, Mr Mauldin gives this explanation as to why the velocity of money is currently slowing:

Now, why is the velocity of money slowing down? Notice the real rise in V from 1990 through about 1997. Growth in M2 (see the above chart) was falling during most of that period, yet the economy was growing. That means that velocity had to rise faster than normal. Why? Primarily because of the financial innovations introduced in the early '90s, like securitizations, CDOs, etc. It is financial innovation that spurs above-trend growth in velocity.

And now we are watching the Great Unwind of financial innovations, as they were pursued to excess and caused a credit crisis. In principle, a CDO or subprime asset-backed security should be a good thing. And in the beginning they were. But then standards got loose, greed kicked in, and Wall Street began to game the system. End of game.

The financial innovation that drove velocity to new highs is no longer part of the equation. Its absence is slowing things down.

So, in my opinion, I must conclude that this expectation for massive inflation secondary to the Fed’s recent actions has no “meat” per se, and I like some meat on my burger if I'm going to swallow it.

If you made it to the end of this gargantuan post I must commend you for your endurance and thank you for your super-human attention span. (another post of this length and you can start calling me Vanity Fox!Laughing)

Best....Jeff

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ao
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Re: Where's the Beef?
JAG wrote:

If you made it to the end of this gargantuan post I must commend you for your endurance and thank you for your super-human attention span. (another post of this length and you can start calling me Vanity Fox!Laughing)

 

ROTFLMAO!

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Re: Where's the Beef?

Jeff,

Thanks for the great post.  As a recovering inflationist who is now leaning towards the deflationary camp, I find this very informative.  Cheers!

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Re: Where's the Beef?

 

 As of 2008 we're not in Kansas any more..... it's gone bye bye..

 

 I think linear thinkers will be totally screwed if they're still playing draughts on a 3d chessboard...

  a purple swan ?

 Who'd a thunk it !!

 I'm betting on hyper-bi-stag-dis-inflation.. or something.. :o)

 ah sod it.. I'll plant some more peas.... while I sup a cheeky little all-grain number with bobek hops.

 

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Re: Where's the Beef?

We should all be switch-hitters.  Ready for inflation;  ready for deflation.  Cuz IMO they're both coming simultaneously -- deflation in Plasma Screens, and inflation in Broccoli.  More or less.  

Holding cash and PMs -- and Viva, dagnabbit! -- Sager

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Re: Where's the Beef?

I have also recenly moved over to the deflationista barracks myself. In defence of most deflationists, I've come to learn that most deflationists recognize an inevitable case of hyperinflation or currency devaluation, but more rapidly in the event of a bond market collapse (and opinions differ there and is another discussion altogether).

My favorite deflationists are over at The Automatic Earth (TAE). I'm particularily fond of Stoneleigh who was a former contributor at The Oil Drum (TOD). Take a look at the following article by Stoneleigh over at The Oil Drum (http://europe.theoildrum.com/node/5917).

 

Admittedly, I might be slightly biased as she is local to me and I was lucky enough to organize a presentation by her to our local Peak Oil Discussion Group and some of the TAE blog dogs and readers (45-50 people showed up). If you're interested in hearing an MP3 recording of the presentation she made (most of the graphs she reffers to are in the TOD document) you can listen to the presentation at http://www.firstgatemedia.com/reports/stoneleigh/. The session was held in a local community center and unfortunately a dodgeball match was being played in the adjacent room and was a minor distraction. It's also unfortunate that the Q&A that followed wasn't captured as it lasted for another 2 hours and ranged from conspiracy theories to personal financial advice.

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Re: Where's the Beef?
JAG wrote:

In my time here at CM.com I have been exposed to a lot of interesting ideas and I have learned a great deal from the discussions here. But at the same time, in the midst of all this information, it can be hard to distinguish legitimate concerns from fear-based exaggerations. This predicament often reminds me of that old TV commercial that asked “Where’s the beef?”

Jeff,

Outstanding post!

I'll take a different stab at the same Where's the Beef? analogy: The best discussions on this site tend to occur in the Martenson Insider posts and the comments on the Martenson Reports. I think the reason is that Chris always gives us plenty of meat - facts, charts, figures, statistics, and well thought-out arguments. In those discussion threads, a lot of really good stuff tends to be discussed. But in many of the forum threads, there is no such context. IMHO, that's the main reason that discussions tend to stray into hyperbole and baseless personal beliefs as opposed to well-reasoned opinions.

What we need more of is posts like this one! If more site regulars (other than Chris himself) started threads that actually contained some meat to start with, I predict that the ensuing discussions would be meatier as well.

Moving on to the topic at hand, I think you are arbitrarily interchancing price inflation and monetary inflation, which are not the same thing. I also think your rhetorical question "So where's the inflation?" with all the price charts is missing the point. I think we all agree that deflation is winning the day. For now. The question is whether government reaction to the deflation risk will mushroom into a hyperinflation, a la Eric Janszen's KaPoom Theory.

So IMHO, the fact that there is no apparent price inflation yet is irrelevant. None should have been expected yet. Price inflation is a symptom, not the cause, as explained in the Crash Course. I realize that you also made the legitimate point that so far, there hasn't been a whole lot of net monetary inflation because money is being extinguished at least as fast as it's being created. My point is simply that these are two separate issues, and I think you're mixing them.

I also want to point out that the reason many of us feel hyperinflation risk is high is that we see a chain of events - dominos lining up, if you will - on the horizon. But those things haven't happened yet. Very roughly, here's the line of dominoes that I think could lead to a hyperinflationary outcome:

  1. The Fed Floods the market with liquidity to combat deflation, with the intent of mopping up that excess liquidity as the economy recovers. This is a present-day fact and not up for debate or speculation.
  2. Federal gov't borrows and spends like crazy, in pursuit of Keynsian stimulus prescription. This too is a present day fact. The remaining dominos are speculation about what could happen.
  3. Foreign creditors get nervous and start demanding higher yields on treasury debt. We are seeing strong signs that this has begun.
  4. The Fed is forced to monetize in order to prevent long-dated treasury yields (to which mortgage rates are indexed) from exploding. This has a short term antidote effect but further increases nervousness of foreigners as the money supply is expanded considerably more than extinguished debt is causing it to contract.
  5. As long-term yields creep higher, borrowing costs increase, government is even less able to fund its operations and stimulus, and more monetization is required. A vicious cycle ensues. This is the point where the Fed looses control and is unable to make good on its promise to mop up excess liquidity.
  6. Foreigners loose their U.S. Treasury risk appetite completely and a hyperinflation spiral ensues.

Admittedly, this thesis assumes some dominos that haven't fallen yet falling in a certain way.

If foreign creditors never loose interest and keep on lending indefintely at something close to present terms, I think it's a no-brainer that MIsh and the deflationists win the prize. But as soon as Domino #4 becomes something they have to do in order to avoid a failed auction, I think it's a pretty safe bet that at least very high inflation, if not hyperinflation, has to be the outcome. I admit that Domino #4 hasn't fallen yet, but it sure looks me like that's where we're headed.

Thanks again for a great thread, Jeff!

Erik

 

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Re: Where's the Beef?

JAG

Great post.

You've been very thorough with your counter to the hyperinflation scenario but I still don't see where you stand. What do you think will happen? Will we have deflation without any hyperinflation?

 

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Re: Where's the Beef?

I think the greatest deflationary force stems from the fact that all of our money is temporary, some of it is destroyed every day.  Money is created through debt and it is destroyed when the principal is repaid to a bank.

If new loans are less than existing loan principal repayments over a given time period, the money supply will decrease which is deflationary.  We are seeing this now as there are not enough new willing and worthy borrowers to offset the huge amount of debt repayment taking place in our economy. 

To prevent a depression (heavy deflation) the government has stepped in to act as the borrower of last resort from the Fed which is the lender of last resort.  Our huge deficits are necessary to bring an adequate amount of new money into the system.  Of course, eventually the government will not be able to borrow enough - it is a perpetual spiral.  We are artificially sustaining the required flow of new money, separate from market forces.

The private Federal Reserve system creates "reserves" by buying government securities through the FOMC (New York Branch).  And they destroy these reserves when the securities are sold.  Whenever the Fed wants to, they can crash our economy and create massive defaults by simply selling government securities.

The velocity of money cannot offset these forces.  While money may be spent many times over a given time frame, whenever it is used to repay bank principal - it is destroyed.  It can only repay principal debt once.

The solution has always been right in front of our noses.  We need to take back the creation and control of our money supply by ending the fed.  There is no reason for us, as a nation, to borrow from private banks when we can create it ourselves for free.

It is not an exaggeration to say that our future freedom and well being hinges on our collective ability to figure out this obvious truth.

Larry

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Re: Where's the Beef?
Ruhh wrote:

My favorite deflationists are over at The Automatic Earth (TAE). I'm particularily fond of Stoneleigh who was a former contributor at The Oil Drum (TOD). Take a look at the following article by Stoneleigh over at The Oil Drum (http://europe.theoildrum.com/node/5917).

Ruhh,

Thanks for the link to the Stoneleigh article.  I found it very informative.

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Re: Where's the Beef?

Nice post!

I have a few wrinkles to toss into the classical economic arguments laid forth, however.

One of the grander mistakes made by the Fed under Greenspan (and continued by Bernanke) was in thinking of inflation as only applying to consumer goods and commodities.  Without relaunching into the flaws of the CPI measure, it does not capture asset inflation which is every bit as real (or fake depending on how you look at it).  As far as Greenspan/Bernanke were/are concerned, ridiculous house and stock prices were/are measures of rising wealth, while the owner's equivalent rent component of the CPI is a useful way to cover up the true rate of underlying inflation.

The destruction that results from asset inflation can now be seen in communities near you.  States and municipalities rigged up their budgets to follow the inflating assets and this turned out to be a very bad idea.

So I am not a big fan of using the CPI as a useful means of assessing the true rate of inflation or the risk that current monetary and fiscal policy represent to the future purchasing power of a dollar.  The CPI tells us something about a subset of prices but leaves out far too many and distorts those that it does measure.  Anytime I view any BLS statistics on prices I am always squinting at them with a hefty measure of skepticism.

Next, when considering the velocity of money please remember that it is not a measured but an inferred value.  If either GDP or the money supply figures are distorted, the the implied velocity will be distorted as well.  I have my concerns over both GDP and money supply.

Here's my own personal favorite article on inflation: http://www.hussmanfunds.com/wmc/wmc100119.htm

After reading it, let's discuss ways in which excessive growth in government spending will not result in higher inflation.  This time.

I agree that inflation pressures are low right now, and may be for some time, but the risks are growing enormously that we'll experience a severe monetary crisis somewhere and that this will result in what people will experience as higher prices.  For some things, but not all things.

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Re: Where's the Beef?


JAG wrote:

If you made it to the end of this gargantuan post I must commend you for your endurance and thank you for your super-human attention span. (another post of this length and you can start calling me Vanity Fox!Laughing)

Finally I get some notoriety around hereSmile!!!

An excellent post Jeff,

Best,

~ VF ~

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Re: Where's the Beef?

Hi Jeff.

Does this taste beefy to you?

What David has documented is the real cost of living or inflation. According to John Williams of shadowstats.com, the inflation rate in February is running at 9.4% annually. That is the “real cost of things!” (Williams calculates the inflation rate the way BLS did it in 1980.)  In a recent report, Williams said, “. . . evidence continues to mount of higher prices across a much broader spectrum of products and services. . . . eventually — within six-to-nine months — the broader inflation issues also should surface in official reporting.”     

http://www.kitco.com/ind/Hunter/mar292010.html

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Re: Where's the Beef?

First of all, thanks to everyone for the positive feedback. This post took some time to compile.

Dr. M,

Your reply was unexpected and greatly appreciated. I thoroughly enjoyed the Hussman article that you cited. In particular, I liked his insight into the Phillips Curve:

The Real Phillips Curve

Two weeks ago (Timothy Geithner Meets Vladimir Lenin), I made some remarks about the Phillips Curve that are far enough outside the mainstream that they deserve some evidence. I noted "It is commonly argued that we cannot observe inflation with unemployment so high. In my view, this is a misinterpretation of A.W. Phillips (1958) analysis. While the famed “Phillips Curve” was described as a relationship between (nominal) “money” wages and unemployment, the British data Phillips used was from a period when Britain was on the gold standard, and the general price level was extremely stable. Thus, any wage inflation observed by Phillips was actually real wage inflation.

"The Phillips Curve is simply a standard economic argument about relative scarcity. It says that when the labor markets are tight, nominal wages rise faster than the rate of general inflation (i.e. real wages rise), and when unemployment is high, nominal wages rise slower than the rate of general inflation (i.e. real wages fall). As we observed in the 1970's, high unemployment can exist in concert with high rates of inflation. All that happens, in that case, is that wages tend to rise slower than prices. Assuming labor productivity is growing as well, real wages don't keep pace with productivity growth. In any event, unemployment emphatically does not prevent the inflationary consequences of reckless creation of government liabilities."

Quite simply, the view of the Phillips Curve as a relationship between unemployment andgeneral price inflation wasn't even part of Phillips work, nor is it consistent with the data. This is almost frightening, because we continue to send bright-eyed undergraduate economics students out into the world believing something about Phillips' work that, as Adam Smith might say, "was no part of his intention."

The charts below are based on data since 1947. Monthly unemployment rates were sorted from highest to lowest, divided into equal groups, and the average unemployment rate and year-over-year CPI inflation rate were plotted for each group. What we observe in the data is strikingly opposite to the standard (mis)interpretation of the Phillips Curve. Indeed, higher unemployment is generally associated with higher, not lower general price inflation.

Contrast this with what I would assert is the real Phillips curve, which is simply a statement about labor scarcity. It says, in a very unadorned way, that when labor is scarce (low unemployment), the price of labor tends to rise relative to the price of other things (thus we observe real wage inflation). In contrast, when labor is plentiful (high unemployment), the price of labor tends to stagnate relative to the price of other things (real wages stagnate). Since productivity growth tends to be positive over time, it turns out that real wages actually fall on a productivity-adjusted basis when unemployment is high. From this perspective, it is no surprise that real wages fell by 1.6% in 2009, even as reported productivity grew.

 

This makes sense for the simple fact that unemployed people are willing to work for less if they can get work. So wages would rise relatively slower in periods of high unemployment as compared to periods of lower unemployment, and thus would not be able to keep up with rising consumer prices if or when they were to occur.

You also stated:

Without relaunching into the flaws of the CPI measure, it does not capture asset inflation which is every bit as real (or fake depending on how you look at it).

From reading your work in the past, I understand that CPI is a flawed measure. But what is important here is not the actual measure, but the current level in relationship to the level 2.5 years ago. It is possible that the BLS changes their methodology with every report, but I was ass-u-m-ing that this was not the case when I made the comparison.

If the stock market is a measure of asset inflation (you never know these days), then we have definitely experienced asset inflation over the last year. Will it last? I think we all are doubtful of that occurring, but perhaps you feel differently now.

After reading it, let's discuss ways in which excessive growth in government spending will not result in higher inflation.  This time.

The reason that I distrust this "foregone" conclusion is simply because it is so widely held. Granted, it is so widely held because recent history emphatically demonstrates a relationship between the two factors. But I'm not willing to assume that this relationship will hold in this new decade. I have some reading to do before I could participate in such a discussion, so as not to waste your time with "gut" speculation on my part.

Thanks again.

 

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joelandsonia
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Re: Where's the Beef?

I've recently subscribed here, been a long-term iTulip subscriber and also follow Fleckenstein.

One comment I've heard often on iTulip is "deflation in everything you want, inflation in everything you need".    Long-term, I can't imagine a non-inflationary outcome -- the government has no other way out.    Yes, Japan has been a special case for decades because of their internal financing, but that is coming to an end.   Many paths, but as Fleckenstein's site states, "In a social democracy with a fiat currency, all roads lead to inflation".

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Re: Where's the Beef?

Jeff. What an outstanding thread starter. Chock full of data, facts, and tidbits that allow me to see so much better into your thought processes. 

My position is that I am hedging both although my thinking has evolved to expecting potent deflation first followed by galloping inflation, then hyperinflation later. 1,000 trillion in derivatives globally. 50T global GDP. It won't take that much debt implosion to blow up M3. 

BUT...

from the carnage the government will try to print it's way out of the mess. Then you'll have too many dollars chasing nothing. 

Deflation first. (I'm preparing for it as this is the bone crusher coming... Present working theory of mine). 

Inflation is the end game. I have some long-term positions based on this. 

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Re: Where's the Beef?
Morpheus wrote:

Deflation first. (I'm preparing for it as this is the bone crusher coming... Present working theory of mine). 

Inflation is the end game. I have some long-term positions based on this. 

I will second that conclusion.  Massive inflation is definately in the cards but first we have a roller coaster ride to go on and the next drop is going to make many people loose their lunch.

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Re: Where's the Beef?
Ruhh wrote:

If you're interested in hearing an MP3 recording of the presentation she made (most of the graphs she reffers to are in the TOD document) you can listen to the presentation at http://www.firstgatemedia.com/reports/stoneleigh/

Ruhh, I can't tell you how much I enjoyed Stoneleigh's presentation. Even though I had previously read most of the material that she covered (on TAE), hearing her present it opened a new understanding of it for me. I retain and assimilate the spoken word much better than the written word, so this was a real treat for me. Thank you so much.

Everything that she said seemed to really resonate with me. For me, its almost too easy to agree with her perspective, which makes me worry a bit about why that is. Undecided

Anyway, thanks again....Jeff

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Re: Where's the Beef?
Erik T. wrote:

I also want to point out that the reason many of us feel hyperinflation risk is high is that we see a chain of events - dominos lining up, if you will - on the horizon. But those things haven't happened yet. Very roughly, here's the line of dominoes that I think could lead to a hyperinflationary outcome:

  1. The Fed Floods the market with liquidity to combat deflation, with the intent of mopping up that excess liquidity as the economy recovers. This is a present-day fact and not up for debate or speculation.
  2. Federal gov't borrows and spends like crazy, in pursuit of Keynsian stimulus prescription. This too is a present day fact. The remaining dominos are speculation about what could happen.
  3. Foreign creditors get nervous and start demanding higher yields on treasury debt. We are seeing strong signs that this has begun.
  4. The Fed is forced to monetize in order to prevent long-dated treasury yields (to which mortgage rates are indexed) from exploding. This has a short term antidote effect but further increases nervousness of foreigners as the money supply is expanded considerably more than extinguished debt is causing it to contract.
  5. As long-term yields creep higher, borrowing costs increase, government is even less able to fund its operations and stimulus, and more monetization is required. A vicious cycle ensues. This is the point where the Fed looses control and is unable to make good on its promise to mop up excess liquidity.
  6. Foreigners loose their U.S. Treasury risk appetite completely and a hyperinflation spiral ensues.

Thanks for the reply Erik.

To make a long story short, I generally agree with your progression of events, except that they don't all apply to me. For example, I will not need to worry about the end-stage currency crisis because I won't have any cash to devalue at that point. You see, I liquidated all my cash reserves trying to survive the deflationary crash that occurred just prior to the currency crisis. I had some gold and silver, but when the economy tanked and my business went under, I was forced to sell it all (for a song) to pay the rising property taxes on the roof over my head.

A currency crisis would occur secondary to an economic crisis, not the other way around. So my focus has to be on surviving an economic crisis (deflationary depression) first and foremost. If I survive that, the currency crisis/hyperinflation stage will be a piece of cake. Why? Because I will already become an expert at living with no money.

The Fed's Q.E. is not helping the economy recover: see Nathan Martin's THE Most Important Chart of the CENTURY

The latest U.S. Treasury Z1 Flow of Funds report was released on March 11, 2010, bringing the data current through the end of 2009. What follows is the most important chart of your lifetime. It relegates almost all modern economists and economic theory to the dustbin of history. Any economic theory, formula, or relationship that does not consider this non-linear relationship of DEBT and phase transition is destined to fail.

It explains the "jobless" recoveries of the past and how each recent economic cycle produces higher money figures, yet lower employment. It explains why we are seeing debt driven events that circle the globe. It explains the psychological uneasiness that underpins this point in history, the elephant in the room that nobody sees or can describe.

This is a very simple chart. It takes the change in GDP and divides it by the change in Debt. What it shows is how much productivity is gained by infusing $1 of debt into our debt backed money system.

Back in the early 1960s a dollar of new debt added almost a dollar to the nation’s output of goods and services. As more debt enters the system the productivity gained by new debt diminishes. This produced a path that was following a diminishing line targeting ZERO in the year 2015. This meant that we could expect that each new dollar of debt added in the year 2015 would add NOTHING to our productivity.

Then a funny thing happened along the way. Macroeconomic DEBT SATURATION occurred causing a phase transition with our debt relationship. This is because total income can no longer support total debt. In the third quarter of 2009 each dollar of debt added produced NEGATIVE 15 cents of productivity, and at the end of 2009, each dollar of new debt now SUBTRACTS 45 cents from GDP!

Not only is it not working, but Q.E. is now reinforcing the deflationary spiral in the economy.

I can't play for the endgame, when I won't survive the "mid-game". Its one step at a time for me.

Best....Jeff

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Re: Where's the Beef?
JAG wrote:

A currency crisis would occur secondary to an economic crisis, not the other way around. So my focus has to be on surviving an economic crisis (deflationary depression) first and foremost. If I survive that, the currency crisis/hyperinflation stage will be a piece of cake. Why? Because I will already become an expert at living with no money

I can't play for the endgame, when I won't survive the "mid-game". Its one step at a time for me.

Best....Jeff

Nail meet head. 

That's exactly what I have been thinking the past month or two. I have been in debates with folks at other sites, discussions really, where I asked them to plug the one hole in the hyperinflation theory that just stuck in my craw:

How is the government going to QE all that imploded debt coming our way Jeff? 

It can't. It simply cannot. So, the money supply will implode, and with it the global economy, What titled the argument is that China is now running a trade deficit. That means she needs dollars in a bad way to pay for resources. Demand for dollars is an accellerant. 

Which leads to what I bolded in your statement. If you don't prep for deflation first you'll be worrying about inflation from underneath an overpass. 

Which is also another reason why I am rebalancing my PM's towards gold and away from silver. Ohh, I'll load up on Ag. But later, after future deleveraging occurs. 

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Re: Where's the Beef?

Erik. et al. 

To avoid being misunderstood, I still think that ZeroHedge is one of the best financial news outlets on the net, and on the planet actually. 

They really do expose a lot of horse hockey that others completely miss. 

They are current as hell. 

They actually press the MSM and congress to do their jobs. (They've broken many a scandal). 

The point I have is that Tyler is a bit of a sensationalist at times and I've been burned by that. His sensationalist headlines sometimes read into imminent doom and gloom that simply is not there. The other journalists at ZeroHedge are much less likely to fall into that trap. 

Nevertheless, if you read his stuff, and digest it, it is still extraordinarily germaine, and useful. Just read it and chew on it first before making declarations based on the lead title and/or his interpretations. 

I'd still recommend ZH as one of your must-reads. 

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Re: Where's the Beef?

Morph,

I agree with all your comments on ZH. Perhaps I got too excited saying the negatives without first emphasizing the positives.

A better way to express my feelings would be, I really think it a pity that Tyler's writing is getting more and more sensationalist every day. He was offering something unique and of extraordinary value, and I think he has recently begun to undermine his own value by overdoing the sarcasm and sensationalism.

But I still enjoy the Vampire Squid comments :-)

On Jeff's comments and Inflation/Deflation, I agree completely with both of you guys. Deflation is the name of the present game, and you gotta be ready to play it seriously. The day will come when inflation takes over, and it could happen suddenly. Gotta be ready for that, but placing your bets entirely in that camp now could be a good way to acquaint yourself with that overpass. I remain absolutely convinced that Gold will go to $2000/oz or possibly quite higher. The question is whether it goes to $500/oz first.

Erik

 

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Re: Where's the Beef?

I'm enjoying this conversation immensely, but there is a non-sequiter that I'm having difficulty with.  As earthwise posted, Shadowstats' CPI by 1980 measure is 9.4%.

earthwise wrote:

Hi Jeff.

Does this taste beefy to you?

What David has documented is the real cost of living or inflation. According to John Williams of shadowstats.com, the inflation rate in February is running at 9.4% annually. That is the “real cost of things!” (Williams calculates the inflation rate the way BLS did it in 1980.)  In a recent report, Williams said, “. . . evidence continues to mount of higher prices across a much broader spectrum of products and services. . . . eventually — within six-to-nine months — the broader inflation issues also should surface in official reporting.”     

http://www.kitco.com/ind/Hunter/mar292010.html

OTOH, as Erik T. posted:

Quote:

On Jeff's comments and Inflation/Deflation, I agree completely with both of you guys. Deflation is the name of the present game, and you gotta be ready to play it seriously. The day will come when inflation takes over, and it could happen suddenly. Gotta be ready for that, but placing your bets entirely in that camp now could be a good way to acquaint yourself with that overpass. I remain absolutely convinced that Gold will go to $2000/oz or possibly quite higher. The question is whether it goes to $500/oz first.

Erik

Perhaps I'm missing something, but how are these two pov's reconcilable? 

Doug

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Re: Where's the Beef?

Dollar illusions
Commentary and weekly watch by Doug Noland

http://www.atimes.com/atimes/Global_Economy/LC30Dj01.html

Quote:

With the above comments in mind, I'll briefly address this year's dollar strength. It is my view that dollar strength is specifically not based on sound fundamentals - it's a facet of the global bubble. The markets have gravitated to US financial assets because of the perception that the US enjoys a global competitive advantage in reflationary policymaking.

Let me attempt an explanation: US financial assets - hence the dollar - are perceived to benefit from a relative advantage versus other major currencies based upon, on the one hand, the virtual unlimited capacity for the Treasury to run massive deficits and, on the other, the Fed's seemingly endless capacity to purchase (monetize) US debt instruments and essentially peg interest-rates (short-term, and only to a lesser extent longer-term market yields). This extraordinary capacity and willingness by US fiscal and monetary policymakers to inflate credit and meddle (in the markets and economy) today bolsters marketplace confidence in the sustainability of economic recovery. As importantly, it cements the view that the soundness of credit instruments throughout the entire system - Treasuries, mortgages, financial sector debt, corporates, munis, etcetera - is underpinned by current and prospective reflationary policymaking. The markets' perception of "too big to fail" has inflated US securities pricing - reduced risk premiums - throughout the entire system.

The Greek and, to a much lesser extent, periphery Europe debt crisis has been a major development. Markets are in the process of disciplining politicians and bankers in Greece and elsewhere in Europe (most notably Portugal, Spain, and Italy). In stark contrast to the Treasury and the Fed, Greek politicians have lost their ability to attempt to inflate their way out of structural debt problems. The economy in Greece is forced to retrench, as fiscal discipline is imposed upon Athens. A painful period of economic restructuring has commenced. And as much as this is necessary for ensuring long-term stability, the short-term consequences are market unfriendly. Greece's inability to inflate credit and monetize its debt has created a situation of great marketplace uncertainty as to the value of its obligations and the soundness of its financial sector more generally.

The downfall of Greece - and, perhaps, European - debt profligacy has, in a way, restored the reign of King Dollar. There might be consternation as to the size of current and prospective US deficits (as well as governmental market and economic intervention), but for the most part the marketplace just loves US debt these days. In contrast to the hamstrung Greeks, the view holds that US policymakers certainly will not let anything stymie economic and financial recovery. If additional stimulus is needed, loads will be immediately forthcoming. Massive deficits are fine, as they ensure sustainable recovery. If zero interest rates are required for years, Fed chairman Ben Bernanke, his colleague Janet Yellen and others will faithfully deliver. The Federal Reserve may be winding down its various emergency programs and trillion dollar monetization, but the Fed surely wouldn't hesitate using these incredibly successful tools as needed. No Japan here. In short, dollar securities are underpinned by the markets' perception of a potent and comprehensive federal backstop.

As I noted above, markets have a dangerous proclivity for accommodating bubbles. I see ample evidence of such dynamics throughout currency, debt, and equities markets - at home and abroad. I would argue that the reinstatement of King Dollar is not, as some had expected, impinging global reflation. Indeed, rather than restraining reflationary forces, dollar strength may today be reinforcing them. I would argue that the dollar's newfound muscle has not yet impinged credit systems overseas, especially overheated credit in the "periphery". Meanwhile, it has helped underpin "core" US debt markets generally, which has played a prominent role in the ongoing reflation of the world's largest economy and stock market.

I recommend reading the whole piece.

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Re: Where's the Beef?

Regarding "the most important chart"...we had a fascinating discussion about that chart in the Insider area last week.

This seems like a good place to give people an idea of the kinds of discussions we're having over there.  Here's what I wrote:


Following the latest US Flow of Funds Accounts report, Nathan Martin of the FedUpUSA blog produced a fascinating chart. As shown below, it is constructed by dividing the change in GDP by the change in debt. It shows how much productivity is gained by infusing $1 of debt into the U.S. debt-backed money system.

I'm not quite sure how much to read into that chart.  It got some pretty good airplay, and it looks dramatic, but when either/both delta GDP and/or delta Debt go negative I am lost as to the meaning I should draw from the chart.

On the surface the chart seems to imply that we've fallen off of some cliff, a singularity sort of event from which there's no possible return.  I mean, my goodness (!), if we are churning out more and more debt but getting less and less GDP, then truly the wheels have fallen off the cart and there's no hope.  But in times of falling GDP and/or Debt, this chart becomes tricky to interpret. 

For example, if GDP grew by some amount, let's arbitrarily say "100," and Debt shrank by "100" you would still come up with a negative reading of -1.0 which would look super dramatic on the chart.  But what would that mean?  In my mind shrinking debt but growing GDP is a good thing, not a bad thing.

There are certain 'tricks' that ratios play when one or both numbers go negative so the visual cues offered by a chart may or may not be meaningful.  If both debt and GDP are positive, the ratio will be positive.  [Read this next part really fast for full effect -->]  If GDP is negative, the ratio will be negative if debt is positive and positive if debt is negative, but if GDP is positive and Debt is negative the ratio will be negative but positive if Debt is positive.  Confused yet? 

Most people would be, including (or perhaps especially) me without a bit of careful thought.

I happen to think that the downward trend while both GDP and Debt growth were positive is meaningful and provides an important clue, but I am far less convinced that this chart reveals anything critical now that GDP and Debt have slipped back and forth into negative territory over the past several quarters.   As illustrated in the table below, the chart can sport a negative or positive reading under a couple of conditions

As I look at that table, I can conclude that the "negative reading" offered up by the ratio is truly a bad event in one circumstance (GDP- but Debt+), but a good event under another (GDP+ but Debt-).

Perhaps there's another interpretation offered with the chart, but the chart itself (without significant data interpretation) does not provide me with a "smoking gun" pointed at our economic future.  Maybe, maybe not.

I'd need to see the base data and squint at it for a while to see what's really happening.

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Re: Where's the Beef?

Hi Doug,

Since the fall of 2008, I have kept my own "personal CPI" by tracking my purchases and expenses on my iPhone. Outside of gasoline, my expenses are the same across the board. In fact, a drop in my property taxes has more than made up for the small rise in gasoline over this period. I know that this could be completely different for another person or family.

As stated previously, my intention in citing CPI was only to show a relative drop in price levels over the period of Q.E., and not to debate which CPI measure was correct. Shadowstat's CPI shows this same relative drop in prices since 2008.

All I really care about is my personal CPI and its been flat for a year and a half.

I probably should have never introduced consumer prices in this discussion, because there are too many factors involved in the pricing of things for the information to be of any value in an inflation/deflation context.

Best...Jeff

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Re: Where's the Beef?
cmartenson wrote:

Regarding "the most important chart"...we had a fascinating discussion about that chart in the Insider area last week.

This seems like a good place to give people an idea of the kinds of discussions we're having over there.  Here's what I wrote:

I truly miss being an "insider". When I first saw this chart, I had the immediate thought "How would Dr.M approach this information?"

Perhaps if we get more drama in the marketplace, I will be able to justify the subscription expense to my wife once again.

Great analysis Dr. M, as usual.

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CB
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Re: Where's the Beef?

We have run off a cliff IMO - or rather the crash in 2008/9 revealed this fact to many for the first time. The 'recovery' since then has been due to the so far successful effort to push the day of reckoning off into the future by the public guarantees given to the private banking system - resulting in an easing of the fears of those investing in both public and private debt. For the US, with unemployment/underemployment at ~20% this fix has a limited shelf life. If real economic growth does not recover (growth not supported by government outlays, both direct and indirect) at some point the investor panic will return. The hope has been that the government guarantees will provide sufficient breathing space for the real economy to begin generating jobs. This seems a faint hope to me as the ability of the states to continue to support public employees and public spending is rapidly diminishing (todays article in the NYTimes and elsewhere as linked in the DD provides a public discussion of the situation). Layoffs in this sector will continue to diminish consumer demand - perhaps in a big way. There cannot be inflation when real wages are falling and the unemployment rate either remains at its current level or increases still further. The private sector cannot recover without consumer demand for products. The government credit bubble buys a little time - mainly by staving off the panic that would ensue if a large number of investors looked down at the same time and realized that we really have run off a cliff. There is a strong incentive not to look down - its not pretty down there - it is much easier to cling to the hope the system will stabilize itself without any radical changes or re-evaluation of its underlying assumptions ('sustained' growth).

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