Yet another inflation question (but this one's real good!)

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Lemonyellowschwin's picture
Lemonyellowschwin
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Yet another inflation question (but this one's real good!)

Let us recap:

1.  The money supply must continually expand.  If it does not, it becomes a big crunch of defaults cascading inward.

2.  The money-supply-must-always-expand-model is inconsistent with economic reality because the economy can no longer grow at a rate that can keep up with the need for money to expand.

3.  The economy is in the can.  Deflation either is occuring or is a major threat.

4.  The Fed-government axis desperately wants to avoid deflation because the bing crunch of cascading defaults would be really, really bad.

5.  Therefore, the Fed-government axis is trying to keep the system alive by borrowing and printing and thrusting money into the banking system and the economy.  (I call this artificial money for lack of a better term -- humor me).

6.  The risk is that this will cause a great deal of inflation down the road and possibly be really, really bad.  I accept this theory.

However (and here is my question):

Why is the inflation risk any higher under this scenario than if the economy were to have continued expanding on its own.  In other words, if the Fed-government is merely injecting artificial money to substitute for the money that is being lost as part of the natural contraction, why would this be more inflationary than if the economy were to have continued to grow on naturally.  Is there something different about this artificial money?  Is it a function of goods and services declining while the money supply increases?  Is the artificial money replacing, not money at all, but formerly-perceived asset values?  Is it a function of the deficit increasing and being blindsided by inflation in the form of a collapsing dollar triggered by an overseas sell-off?  Is it that more money is being created than would ever have been created even in a naturally-expanding economy?

 If this question doesn't make sense, I apologize in advance and will try to do a better job.

andrewj's picture
andrewj
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Re: Yet another inflation question (but this one's real ...

 I think this is an excellent articl,e Id love to hear Chris's view.

Andrew Wilson NZ

 

http://www.informationclearinghouse.info/article21451.htm

kwwilson's picture
kwwilson
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Re: Yet another inflation question (but this one's real ...

The biggest issue, AS I SEE IT, is that the money being created to try to stave off deflation is not replacing money that already existed.  Follow me for a second, and please holler if I make a wrong turn!

We had a nice bull market, and then ran into the inevitable correction.  Bubbles, err I mean Alan Greenspan tried to stave off the correction, so he encouraged inflation through monetary means.  This led to asset price inflation.  I think most everyone now agrees to this much.

Now we have entered a bear market in seemingly all assets.  Lets suppose that I held one one ounce silver American eagle coin.  Lets suppose that I saw the inflationary rise, oh about January of this year, several months before the peak, just so that I am not accused of using the extremes.  If memory serves, in January that eagle had a spot value of about $17, plus about a $1 premium.  So my buy in was $18.  Now today, my local store is willing to give me a $3 premuim, but the spot is only $10, so If I was forced to liquidate my coin I would be losing about $5.  However, that five bucks didn't disappear, It was just transferred from my pocket to the coin dealers pocket. 

So, If I could convince my bank that I had suffered a 40% loss, and was now practically insolvent, and they decided to bail me out, sorry I mean rescue me, the $5 that they would print and deposit back into my pocket is not a replacement for the $5 I lost, it is a duplicate.  I have my full $18 and the coin dealer still has the $5 he made by being smarter than me.

Hey, this sounds like a good plan, how do I transfer my bank account to the fed? 

caroline_culbert's picture
caroline_culbert
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Re: Yet another inflation question (but this one's real ...
Lemonyellowschwin wrote:

Let us recap:

1.  The money supply must continually expand.  If it does not, it becomes a big crunch of defaults cascading inward.

2.  The money-supply-must-always-expand-model is inconsistent with economic reality because the economy can no longer grow at a rate that can keep up with the need for money to expand.

3.  The economy is in the can.  Deflation either is occuring or is a major threat.

4.  The Fed-government axis desperately wants to avoid deflation because the bing crunch of cascading defaults would be really, really bad.

5.  Therefore, the Fed-government axis is trying to keep the system alive by borrowing and printing and thrusting money into the banking system and the economy.  (I call this artificial money for lack of a better term -- humor me).

6.  The risk is that this will cause a great deal of inflation down the road and possibly be really, really bad.  I accept this theory.

However (and here is my question):

Why is the inflation risk any higher under this scenario than if the economy were to have continued expanding on its own? 

My guess is that if the Fed staves off an immediate depression now, the dollar value decrease, from the affects of inflation, will rebound "in the long run".

Lemonyellowschwin wrote:

 

In other words, if the Fed-government is merely injecting artificial money to substitute for the money that is being lost as part of the natural contraction, why would this be more inflationary than if the economy were to have continued to grow on naturally.  Is there something different about this artificial money? 

They feel that letting the market "run its course" has created a lot of money to be lost for "Wall Street" (the life-blood to our country and our so-called capitalism ideology).  Secretly, I think they're finding any way for "the men behind the curtains" not to lose their shirts.  As long as Main Street consumes, the richer Wall Street gets and the fatter the men-behind-the-curtain get.  Problem is... is that Main Street has maxed out on their line of credit.  They can no longer consume like they have in the past.  The market and thus the fiat currency system (Fed Reserve) depend upon a certain rate of consumption.  This rate of consumption is part of their formula.  When a constant, such as the rate of consumerism, changes drastically so does it's product or dividend.

Lemonyellowschwin wrote:

 

Is it a function of goods and services declining while the money supply increases? 

The correlation between the [declining goods and services] and the money supply is irrelevant at this point.  Everything that happens on this earth has a percentage correlation with everything else.  It happens that goods, such as "consumables" and certain "services" will decrease as a result of this phenomenon.  "Sustainables" and other "services" might increase.  The types of services always change according to the demand for them (or they starve).  The reason I said the question was irrelevant was because, the services increasing or declining is minor compared with what kinds of services are increasing or declining. 

Lemonyellowschwin wrote:

 

Is the artificial money replacing, not money at all, but formerly-perceived asset values? 

Yes... that is why they are called bubbles (because they contained assets that were not inflationary, but was grossly inflationary-- and everyone knew it!)  Remember the Crash Course and the horizontal line of the increase in inflation?  It's not the inflation that was/is the problem... it was the vertical graph (the gross inflation--too good-to-be-true-money-making-schemes with housing equity)

Lemonyellowschwin wrote:

 

Is it a function of the deficit increasing and being blindsided by inflation in the form of a collapsing dollar triggered by an overseas sell-off? 

...Don't quite understand this question, but our dollar value has fallen and risen (as well as gold) recently compared with the Euro, Pound, Yen, Ruble, and etc.  People thought we were going to lose value in the dollar after our "inflationary" period but if we did have an inflationary period it was so tiny that we didn't even notice and went right into a recession (which keeps the dollar value relatively high-- and the guys behind the curtain don't lose thier shirts since our dollar is moderate even though we're in the worst economic crisis since the Great Depression).  Geez... how did they manage to pull that one off?  Our economy is in the toilet, yet the men-behind-the-curtain are still holding their assets unaffectedly.

Lemonyellowschwin wrote:

 

Is it that more money is being created than would ever have been created even in a naturally-expanding economy?

Most people believe that in a system, such as ours, that we will go through periodic "crashes" every so many years.  The friggin market is based on sentiment and stupid psychic ability.  They know our patterns, behaviors, and activities better than we do.  They can predict our moves with a certain calculation of probability based on patterns and so forth.  They also predict crap like "crashes" mathematically.  Everything by math.  Without computers, human predictors, would be priceless considering the amount of variables involved in making such accurate predictions. 

This is the same question I had/have to.  "Naturally-expanding economy" is a hypothical since it never happened and never will.  What did happen is that we created a lot of paper money.  Would there have been just as much created had we not printed any?  Maybe... maybe not.  No one will know since that line has already been crossed. 

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andrewj
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Re: Yet another inflation question (but this one's real ...

 this from the london banker,

 

 

Deflation has become inevitable

For a while now I have been on the fence on the inflation/deflation
issue – whether the massive monetisation of bad debts by central banks
and governments will lead to rapidly escalating inflation as currencies
are debased or, alternatively, lead to deflation as bad debts and
illiquidity undermine all commercial and financial activity in the
economy. I’m now coming down on the side of deflation for a very simple
reason: there is no longer any incentive to save or invest, and so debt
and investment cannot increase much beyond current bloated levels.

In Lombard Street,
Bagehot’s seminal tome on fractional reserve central banking, Bagehot
advises any central bank facing a simultaneous credit crisis and
currency crisis to raise interest rates. By raising rates they will
ensure that foreign creditors remain incentivised to maintain the
general level of credit available while the central bank resolves the
local liquidity crisis through liquidation of failed banks and
temporary liquidity support of stressed banks.

The very opposite
policies have been pursued by central banks in the US, Europe and UK
since the beginning of the sub-prime crisis in August 2007. They have
cut policy rates drastically, and as the crisis escalated and spread,
the yield on government debt has dropped to negative territory.
Meanwhile they have shielded those responsible for the creation of
record levels of bad debt from any regulatory accountability, relaxed
transparency of accounts, and provided massive taxpayer-funded
financial infusions to prevent failure and liquidation.

While in
the short term these policies have expediency and the maintenance of
market “confidence” on their side, in the longer term these policies
must undermine any confidence a rational and objective saver or
investor might have that savings or investment in the US, EU or UK will
be fairly remunerated at an above-inflation rate, or that savings and
investments will be protected by effective oversight and regulation
from the sorts of executive debasement and outright misappropriation
and fraud that are beginning to colour our perceptions of the past
decade.

Anyone sitting on a pile of cash now is unlikely to want
to either (a) place it in a bank, or (b) invest it in the stock market.
As a result, the implosion of the financial and real economy must
continue no matter how big the central bank’s aspirations for its
balance sheet or the treasury’s aspirations for its deficit.

If
US, EU and UK had substantial domestic savings to fund their banks (as
in Japan in 1990), then perhaps the consequences would not be so
imminently disastrous. Lacking sufficient domestic savings, however,
their actions will likely make foreign creditors in Japan, China, the
Gulf and elsewhere question whether it is worthwhile to keep pumping
scarce savings into such flawed and reckless economies.

During
the reckless boom years, savings collapsed in bubble economies as
retail and commercial and financial actors alike chased speculative
yields with greater and greater leverage. During the reckless bust
years, savings will collapse further as retail and commercial and
financial actors chase safety by hoarding their meagre remaining assets
from further erosion by refusing to lend at negative returns and
refusing to finance failed corporate and investment models that only
enrich poltically-connected management and intermediaries.

The
determination to avoid any accountability for failed banks, failed
business models, failed regulatory systems and failed academic
rationales for all the above invites anyone with spare cash – an
increasingly select crowd – to withhold it from further depredations.
It is this instinct, more than confidence in the government, which is
driving so many to seek the temporary safety of short-dated government
securities.

The result of discouraging domestic and foreign
creditors and investors must be inevitable deflation as debt levels
become increasingly hard to finance and ultimately contract.
Irresponsible central banks and governments can try to bail out the
failed banks, businesses and municipalities at the centre of every
popped bubble, but the bubble economies are ever more certain to
deflate with each bailout. Each bailout further undermines the market
discipline which is bedrock to a saver or investor’s decision to part
with hard-earned cash by trusting it to the intermediation of the
management of a bank or business.

It’s this simple: I won’t
invest in a country that bails out failure and punishes savers. I won’t
invest in the US or UK until they change course and protect savers and
investors, ensuring a reasonably predictable positive return. In the
EU, I will be very selective, preferring those conservative states like
Germany that never embraced the worst excesses, although sadly still
have fall out from individual banks' stupidity in buying into foreign
excess. I will know when it is safe to reinvest when policy interest
rates, bank/intermediary oversight and accounting standards give me
confidence I am better protected than the corporate or financial elite.

While
it may take the Asian and the Gulf State investors longer to embrace my
analysis, I have no doubt that they too will eventually conclude that
parting with their savings under the terms now on offer will only
deepen their losses. They would be better off keeping the money at
home, investing locally under local laws and vigilance, and letting the
US and UK implode.

The argument against this has always been
that with trillions already invested in the US during the deficit
years, the Chinese and Gulf States would suffer even more horrible
losses from a collapse of the western economies. This is accurate, but
not complete, as it ignores the relative value of cash investment at
the top and bottom of a bursting bubble. Once the collapse has bottomed
out, so long as a globalised economy survives, there will be even
better opportunities for those with savings to invest selectively in
businesses with clearer prospects and more certain profitability under
regulatory frameworks which have been restored to a proper balance of
investor protection and intermediary oversight.

Right now
survival of businesses in the West depends largely on political pull
and access to regulatory forbearance and central bank or treasury
finance. The market has failed, and officialdom is collaborating in
perpetuating that failure.

Should the western economies implode
in deflation, however, there will be new opportunities to return to
market-based policies that reward effective, efficient management and
punish corrupt, debased management. Until that happens, those that
invest will continue to lose money. Once deflation is exhausted, then
those that invest can expect to make and retain profits again.

I
think it took me so long to feel confident about predicting deflation
because the floating currency system under dollar hegemony and Bretton
Woods II distorts the workings of both inflation and deflation. Despite
the US being the epicentre of all the failed debts, failed
securitisations, failed credit derivatives, failed rating agencies,
failed banking businesses, failed corporate governance, failed
accounting standards, failed capital adequacy models, and failed
regulatory forbearance, the US dollar has recently strengthened as
deflation globalised. The US exported inflation in the boom years, and
now exports deflation in the bust years.

Since spring 2008, as
US investment banks sold off assets, imposed margin calls, and used
access to unsegregated wholesale assets in custody in the rest of the
world to upstream liquidity to their US-based parents and affiliates,
the dollar has strengthened relative to other currencies. The media
reports this as a “flight to quality”, but it is more like a last
looting of the surrounding countryside before dangerous brigands hole
up in their hilltop fortress. The brigands appear temporarily wealthy
compared to the peons left stripped and penniless and facing winter.
When the brigands have eaten all the stolen grain and livestock,
however, they will have no means to replenish except to use force to
raid the countryside again. The peons can always hunt, forage, farm and
carefully husband a surplus to gradually increase their wealth. If the
brigands raid too thoroughly or too regularly, the peons have no
incentive to grow crops or keep herds (negative savings returns) and
everyone starves (deflation).

In the meanwhile, the peons just
might wise up, hide any surplus more securely and organise mutual
defense against further attacks to ensure that their peon children
prosper and the brigands die off. That would be the end of Bretton
Woods II, and the rise of China, India, the Gulf and other productive
and/or resource rich states which invest surplus in domestic
productivity and regional growth.

I reread my piece on Fisher’s Theory of Debt Deflation in Great Depressions
the other day. One of the more confusing aspects is his assertion that
the dollar “swells” as debt deflation takes hold. What he meant, of
course, is that deflation increases the quantity of assets and the
likely investment return each dollar purchases as deflation wrings debt
and misallocation of capital out of the economy.

It is now clear
to me that policy makers in the West are determined to apply every
available resource to underpinning failure, misallocation and executive
excess. As this discourages the honest saver from parting with cash,
policy makers are ensuring that deflation will wreak its havoc on the
financial and real economies of the world. Only when that deflation has
played out and rational policies that reward market-based management
and returns are restored will it be worthwhile to invest again. In the
meanwhile, any wealth saved securely from state seizure will "swell" to
buy more assets in future - a key aspect of deflation and a key means
of restoring the control of the economy into the hands of more
farsighted savers and investors.

I have quoted Mr John Mill
before, but it bears repeating: ““Panics do not destroy capital; they
merely reveal the extent to which it has been destroyed by its betrayal
into hopelessly unproductive works.” The extent to which capital has
been betrayed in the past quarter century under Bretton Woods II, bank
deregulation and the Basle Capital Adequacy Accords is unrivalled in
the history of fiat banking. The bankers, lawmakers, regulators and
academics who collaborated in the betrayal still hold power, like the
well-armed brigands in the fortress, and their continued collaboration
to prevent accountability must inevitably discourage honest savers from
risking further loss. Even so, it is the savers/peons who hold the
ultimate power as they can starve the brigands.

Some day soon
savers will revolt at financing further depredations. They will refuse
to buy even government securities, gagging at the quantities of issue
forced upon them under terms of only negative return. When that final
massive bubble bursts, deflation will follow its harsh corrective
course and clean out deficit-financed “unproductive works”.

When
that happens, if reason is restored in markets with effective
oversight, I might consider investing again, very selectively, in
whatever productive works might then be on offer and only when secure
in realising - and retaining - a positive yield.

_________________

Ray Hewitt's picture
Ray Hewitt
Status: Gold Member (Offline)
Joined: Apr 5 2008
Posts: 458
Re: Yet another inflation question (but this one's real ...

Excellent article well worth a full read. I've culled out some paragraphs that I think are worth keeping in mind for our personal long term strategies. At the heart of it is to have wealth (gold & silver IMO) when wealth is in short supply.

Some areas of thought still need to be explored: According to the banker, the dollar will go from a highly valued currency in a era of deflation to a collapsed currency. I can't reconcile yet how that could happen. In all my reading experience, fiat currencies end in a hyperinflationary collapse. I'll be keeping my eyes open for an explanation of the former. Until then, I'll be looking for the inflection point when deflation morphs into inflation. Either way, the dollar's days are numbered.

The US exported inflation in the boom years, and
now exports deflation in the bust years.

When the brigands have eaten all the stolen grain and livestock,
however, they will have no means to replenish except to use force to
raid the countryside again. The peons can always hunt, forage, farm and
carefully husband a surplus to gradually increase their wealth. If the
brigands raid too thoroughly or too regularly, the peons have no
incentive to grow crops or keep herds (negative savings returns) and
everyone starves (deflation).

In the meanwhile, the peons just
might wise up, hide any surplus more securely and organise mutual
defense against further attacks to ensure that their peon children
prosper and the brigands die off. That would be the end of Bretton
Woods II, and the rise of China, India, the Gulf and other productive
and/or resource rich states which invest surplus in domestic
productivity and regional growth.

In the
meanwhile, any wealth saved securely from state seizure will "swell" to
buy more assets in future - a key aspect of deflation and a key means
of restoring the control of the economy into the hands of more
farsighted savers and investors.

The bankers, lawmakers, regulators and
academics who collaborated in the betrayal still hold power, like the
well-armed brigands in the fortress, and their continued collaboration
to prevent accountability must inevitably discourage honest savers from
risking further loss. Even so, it is the savers/peons who hold the
ultimate power as they can starve the brigands.

Some day soon
savers will revolt at financing further depredations. They will refuse
to buy even government securities, gagging at the quantities of issue
forced upon them under terms of only negative return. When that final
massive bubble bursts, deflation will follow its harsh corrective
course and clean out deficit-financed “unproductive works”.

Lemonyellowschwin's picture
Lemonyellowschwin
Status: Platinum Member (Offline)
Joined: Apr 22 2008
Posts: 547
Re: Yet another inflation question (but this one's real ...

So, Kww, you're saying that the money being replaced is not money that was lost by the economy as a whole, just certain sectors. 

I think this make sense.  Let's look at the state of affairs at the top of the bubble.  There was tons and tons of money being lent out on the basis of hysterically inflated asset values.  That money was spent in some form by the borrowers, much of it going overseas I suppose but it was still dollars and those dollars still exist out in the system, right?  Then when asset values started to collapse and the money was not being repaid, you had the lenders and holders of the mortgage backed securities holding the bag and sinking.  So, the Fed-govt. steps in to bail them out, in the process adding to the overall money supply.  I get it! 

P.S.  I had this all in my head before, then I started getting pumped up full of other information so this had to leave to make room, but now it's back.

andrewj's picture
andrewj
Status: Member (Offline)
Joined: Jul 28 2008
Posts: 16
Re: Yet another inflation question (but this one's real ...

 Watch these guys, a Swiss giant going down get out of its way.

 

 

http://www.creditwritedowns.com/2008/11/glencore-swiss-giant-on-edge.html

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