John Taylor's Controversial Outlook On Inflation: "Not Here, Not Now"

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Gully Foyle's picture

http://theautomaticearth.blogspot.com/2011/01/january-14-2011-zombie-mon...

2: Inflation

The fact that there’s all that zombie money around (or zombie credit, to be precise) leads many to believe the US witnesses inflation. Not true. First off, inflation is not the same as rising prices. Prices can rise because of different causes: scarcity, speculation and (real) inflation. And it’s important to be able to identify which of these causes is in play. If you call all price rises inflation, you lose the ability to distinguish between the causes, which means you lose a crucial analytical tool. There may be those who would like nothing better than for us to lose that tool, but it’s not smart to give in.

I know the media has force-fed the incorrect definition of inflation to the masses, and I know there are plenty of people who say rising prices is all they care about, not monetary theory. However, a clear view of causation is essential when it comes to defining your reaction to rising or falling prices, and prices that rise because of scarcity demand a totally different set of actions than those that do because of a rise in total supply of money and credit, combined with velocity of money, which is what inflation truly is.

The present, incorrect and force-fed "meaning" of inflation as all price rises no matter what their cause is, is relatively new. Rising prices used to be referred to as "(currency) devaluation". Not perfect, but way better than what we have now, where terms like “monetary inflation", "price inflation", "consumer inflation", "energy inflation" all the way down to "cookie inflation" fill the media.

Why is the distinction between the definitions important? Because today in the US both the money/credit supply and the velocity of money are falling (deflation), while some prices are rising, in particular those of food and energy. And no, you can't have deflation in one sector and inflation in the other. That really turns the whole debate into obscure nonsense. It's important that we can determine that if prices rise in times of deflation, the cause for those price rises must be something other than inflation.

In today's world, that something else is speculation. But not of the ordinary kind. What we have right now is zombie money speculation. The same unrecognized losses in the financial system that our governments cover up with criminally negligent accounting non-standards cause prices of oil and food to rise, since that's where the zombie money -inevitably- ends up. And it's not just the banks that invest zombie money, it's all of us.

If banks would have been forced to reveal their losses, the hammering of home prices would have been huge. Since this did not happen, a lot of people are still sitting pretty in their homes, which are way more overvalued -in free market terms- than just about anyone is ready to recognize. Also, if banks had revealed their losses, unemployment rates would have been far higher than they are today.

I know what many are thinking: maybe it's not such a bad idea to cover up those losses. But you're not seeing the whole picture. First, the cover-up has enabled the banks to access your money in order to pay down their debts. And second, zombie money is not the same as real money, as something that has been earned by adding real value. Zombie money is not real.

I read a piece at Zero Hedge the other day by a group that calls themselves the NIA, for National Inflation Association. But they don’t even know what inflation means. Hence their slogan: "Preparing Americans for Hyperinflation". Hey, if you can't define inflation, chances are you’ll miss the truth on hyperinflation too. Look, the US depends for its money and credit supply on international bond markets. Whenever Bernanke turns on his so-called "printing press", which in actual fact is an "additional credit" press, it's not as if free money is created. There‘s interest to be paid on all of it. And while interest rates may be low right now, it's not Bernanke who sets those rates, try as he might to make you think so.

If and when the bond markets decide that the risk on US debt rises enough -or too much-, they will decide what the interest rate is, not Bernanke, and not Geithner. Obviously, with every dollar printed, risk assessments will rise, and the outcome is inevitable: less appetite for US debt (don’t forget that there's plenty zombie money in the bond markets too), and higher rates. And only if and when the US no longer has access to international markets does the option of hyperinflation come into play. Now, I may be quite negative on the prospects for the US economy, but a full separation from global debt markets is a while away yet, and that means the prospect of hyperinflation is as well.

Preparing for hyperinflation is not just useless at this point in time, it's also damaging in that it makes people blind to the real problem: deflation. And before we get to hyperinflation, if we ever do, deflation will cause so much pain and grief and unrest and death, that the very thought of hyperinflation will come to be seen as a highly delusional non-issue.

So how long will the zombie money last? Can it last as long as Bernanke and Geithner and Obama and Dimon want it to? No, in fact, they're fighting a lost battle against time itself.

The zombie money has to disappear, and it will. It all starts and ends with US and European real estate, the one biggest investment of those of us living on Main Street, by far. US home prices have now fallen for 53 consecutive months, despite the fact that Fannie Mae and Freddie Mac buy up and guarantee near 100% of all mortgages, and despite the fact that the Fed has purchased huge swaths of the securities allegedly backed by these mortgages.

All those trillions "worth" of your money haven't been able to prevent that. And no amount of additional trillions will. Foreclosures are setting brand new records across the country, even as banks are ever more nervous about their paperwork, and their balance sheets. It doesn't matter how much money Washington throws at the issue, other than it’ll make you a whole lot poorer, for you’ll never see it back.

A further deterioration in home prices can't be prevented. Fannie and Freddie can’t buy 101% of mortgages; they're buying close to a 100% right now and prices still fall. Wal-Mart greeters, burger flippers and the rest of the great unwashed will not be allowed back into the housing market. There are over 10 million homes on the market, and perhaps twice that if you count all foreclosed properties that banks sit on (and the millions they won’t foreclose on), plus all those that people would like to sell but can't lest they go underwater. And the pool of potential buyers has shrunk with a vengeance since the 2005-6 "heydays". Huge increase in supply, huge decrease in demand; e all know where this will go.

Now, take Fannie and Freddie out of this picture. What do you see? They’ll be taken out in some way, and at some time, and it won’t take years. I know what I see: the housing and mortgage situation in the US has turned into what I've always called the “Bulgaria model”, where you guarantee the mortgage on your neighbor's home, and he guarantees yours; anything goes as long as it's not the free market your politicians and media tell you about. And we know what happened to Bulgaria in the end, don't we?

I’m all for a society, a government, that takes care of the weakest in its midst. I’m all against a government that props up the strongest in its midst, in this case the bankers with bonuses larger in one year than the weaker among us can make in a lifetime, the same bankers who lost more money in bad wagers than the entire country can cough up, and still be economically viable. We’re fast becoming zombie societies.

But first we'll have to live through this:

3: Food prices

Let’s start with the news that the Tunisian president has fled his country, and the military's taken over, according to Al Jazeera. Mass protests are ongoing in Morocco and Algeria. The riots in Tunisia are not all about food prices, but they were certainly a substantial factor. And more, much more, of the same is on the horizon, in many different places. But food prices this time around are not rising because of widespread dramatic shortages, at least not so far. And Lester Brown, much as I like the man, has it completely wrong:

The Great Food Crisis of 2011

[..] whereas in years past, it's been weather that has caused a spike in commodities prices, now it's trends on both sides of the food supply/demand equation that are driving up prices. On the demand side, the culprits are population growth, rising affluence, and the use of grain to fuel cars. On the supply side: soil erosion, aquifer depletion, the loss of cropland to nonfarm uses, the diversion of irrigation water to cities, the plateauing of crop yields in agriculturally advanced countries, and -- due to climate change -- crop-withering heat waves and melting mountain glaciers and ice sheets.

In the same vein, the peak oil crowd fails to see what drives up oil prices today. Yes, long term trends affect prices to some extent. But no, Lester, you can't provide an accurate assessment of what’s happening if you don’t include the very obvious contribution of speculation, especially that which originates with zombie money. Ditto for oil prices.

Food prices are rising partly because, let’s not forget, China, unlike the US, does have inflation, with its money supply going through the roof. But much more than that they're rising because we have elected to kill off the principles of our own western economic systems, which were once supposed to be based on free market ideas, that dictate that success is rewarded and failure punished.

They have since come to resemble some kind of sophomore notion of Darwinianism, where the upper alpha rhino gets all the girls and the rest get none at all. And that in turn is supposed to pose as justice in human societies, whereas in reality it’s nothing but what happened in Bulgaria for decades.

The consequence is that the zombie money is now allowed to drive up food prices to levels which make sure that millions of people around the world will go hungry, and will revolt as a result of that. Blankfein, Dimon et al have long since realized that they can't maintain their velvet “God's work" thrones just by robbing Americans of all they're worth. Their losses are far too great. They need to have access to everyone's wealth all over the world.

And since oil and food are traded on international commodity markets, and they have gotten hold of all the money America is worth, and then some, they can play these markets as much as they want, whether it’s wheat or natural gas or gold. People like to claim that gold will rise as the US dollar becomes worth less, but they forget that it’s zombie money that has been buying gold, and that has thus lifted gold prices. Once daylight comes and the zombies are gone, there's only one way left to go for gold prices too.

So, once again, when will the zombie money see daylight?

This could be caused by any of a myriad of choices. We could force all banks to put foreclosed homes on the market, all at once. Or tell the same banks they have no right to foreclose on homes they have no perfect(ly legal) paper trail on. We could force all derivatives contracts out into the open. Or just the mortgage backed securities; that would do it. Provided we fold Fannie and Freddie, and not let the FHA or any of those guys take over.

As I wrote eons ago, even just closing down Fannie and Freddie for business one or two months would probably do the trick. China could wreck the US economy in 5 minutes simply by demanding to know what their purchases of Fannie and Freddie debt are worth (they have a lot of it). Or it could be a small country, maybe not Iceland, but surely Vietnam, or Belgium, or Denmark, insisting on knowing what that paper their banks and pension funds have so heavily invested in is really worth. MBS, or any other species of derivatives, the whole shebang only has a value attached to it by the grace of nobody trying to figure what that value is.

Is US housing debt, and the securities and derivatives based on that debt, a zombie, or a person? It may certainly seem confusing late at night. But then again, you can't have meaningful relationships with zombies, they're sort of one-dimensional. Funny how that resembles the person-rights US companies enjoy,

And frankly, does it really matter? What we know for sure is that the zombie money we elected to have flow through our financial systems is going to kill a lot of people this year. Want to plead innocence? How long do you think that excuse will be accepted?

Cue Tunisia.

Where our zombie money kills real people. Today.

Tyler Durden's picture

Good analysis. And one which also woefully ignores the Fed's resolve.

JW n FL's picture

There is no Print Club.. 1st rule of Print Club!

JW n FL's picture

anyone that can put together 5,000 words and discuss the economy and not once fucking take into account the FED and the Print Jam that is happening...

lets just say it wasnt Tyler... you figure out who...

Beatscape's picture

Correct me if I'm wrong, but I'm pretty sure his euphemism for the Fed is the "zombie" money.  Therefore, the Fed does play a big part in this analysis.

 

snowball777's picture

While the discount window is its likely origin, the "zombies" in this scenario are BofA, Wells, Citi, etc

Beatscape's picture

Right, made flush with zombie $$ courtesy of Bennie and the Inkjets, not only from the discount window, but from buying all their toxic MBSs and various derivative instruments as well.

JW n FL's picture

The 0%+++++ FED Window uesed by the "Investment Banks" that are now called "Banks"... is the largest issue...

So the FED who orders the Treasury to PRINT...

 

It doesnt matter... either you know or you dont... and talking to me isnt going to teach you anything you dont want to know or already know.

Terminus C's picture

That was my assumption as well.

It was a good analysis.  Tyler's point was that Gully is not taking into account the determination of the Fed to create "zombie money".  This indeed could extend the charade significantly further than Gully was alluding to.

We have two choices

Hyper-inflate, which will lead to deflation post annihilation

or

deflation as soon as "the light shines on the zombie money", as Gully puts it.

Either way it's not going to be pretty.

 

JW n FL's picture

The would be intellectuals... educated, as dictated here (broadly)... would like to realize change... all of them following a different dream... none with the horse power to feed and army... result, 1/2 the nations police fired... community cohesion disrupted... if, big if... services, needs.. like food and / or other... become disrupted... they will all have change... but none of their dreams will be fulfilled, the resulting chaos will of course kill.. Fairly... the good and bad equally... and in the end, there will be an effort to consolidate.

Un-like anywhere else in the world there are 5 maybe 10 guns per person... our standing military forces will return to their home towns to fire on their own families?

no...

this can get really bad for everyone... and as evil as the FED is.. it is truly the lesser of two evils...

and for those that doubt, imagine shinning my toe nails for me before I get out of bed every morning... and dont have a cute wife or daughter... because I have needs...

and if that doesnt help you see... imagine that I am the nicer verity of evil lurking.

 

Return2Sanity's picture

Zombie money can bid up commodity futures to the moon, and that will get US farmers planting from fencepost to fencepost in 2011. But zombie money isn't going to consume a million tons of potatoes, so once the trucks start rolling off the farm and down to the supermarket, only the real spud eaters have the power to set market prices. So, unless Bernanke starts mailing cash out to every Joe 6-pack, zombie money is likely to be eating a big loss by mid-summer.

Monday1929's picture

some confusion here- Tyler, Taylor, Foyle.

Mike2756's picture

Assuming the Fed survives in current form.

Ilargi's picture

Well, Tyler,

I'll stand by what I wrote. I think you perhaps woefully overestimate the Fed's powers more than I ignore its resolve. Which I don't. I just don't see how it would rule the day. It doesn't operate in a vacuum.

 

Kindly,

Ilargi

The Automatic Earth

idea_hamster's picture

This...

Whenever Bernanke turns on his so-called "printing press", which in actual fact is an "additional credit" press, it's not as if free money is created. There‘s interest to be paid on all of it.

...confuses Fed and Treasury.  The Fed doesn't pay interest on "Federal Reserve Notes."  It's true that the money created is not "free" -- it's a tax on those who hold cash balances, generally the poorest and least politically connected strata of the population.

The post is good to the extent that it focuses on the difference between inflation and changes in relative prices.

But any interest is owed by the Treasury.

pton09's picture

You are pretty naive.  Yes, interest rates will rise but will real rates rise?  How can we have positive real interest rates with a 15 trillion debt? 

Ignore inflation at your own risk, I do find it comical you fancy yourself so much more enlightened the inflationists. 

Good luck hoarding your US dollars,

centerline's picture

Great work over at AE Ilargi.  I stop by daily along with a few other good sites.  Regardless of any disagreements, what I am enjoying reading here today is shift of focus from the microeconomic filth (LOL) to things more meaningful to those of us who are not trading for a living.    

I need more cowbell's picture

Chris Martenson, who would basically agree with Ilargi, also came to the conclusion that AE writers continue to ignore the bad debt stays hidden, under mark to fanatsy, and therefore ( so far ) no debt destruction by default.

The question remains, can this be done indefinitely?

centerline's picture

One step further... what is the mechanism that will drag those debts into the light?  Considering the Fed does not answer to anyone - and it is clear our politicians will do nothing (for at least fear of financial implosion, with a lovely photo of them with thier finger on the big, red, shiny button for all of history to enjoy - right or wrong) - it seems the fantasy can continue until something really meaningful breaks.  The most likely outcome in my humble opinion is an outright currency crisis... the death of the dollar... and likely death of those debts denominated in the dollar.  

assumptionblindness's picture

...can this be done indefinitely?

As each day continues to get more bizarre then it would appear so to a lot of us. 

If there was one thing that used to give me hope it was the knowledge/belief that the United States derives a tremendous amount of economic power from its status as custodian of the world's reserve currency.  I used to take comfort in the delusion [emphasis ADDED] that the US would not continue to inflate the ponzi-finance economy and thereby piss away its reserve currency position.  I was wrong.  I now know that without ponzi-finance, there is NO ECONOMY.  (See F.I.R.E. economy)  In short, saving the ponzi is of greater importance to our national security than saving our status as custodian of the world's reserve currency.  That being said, I think that TPTB doesn't expect that we will loose our custodial status to any other individual NATION.  Time will tell... 

The one thing that we have all been debating is a 'break' towards the direction of hyperinflation or towards deflationary collapse.  When viewed through the eyes of Madoff or Mr. Ponzi it quickly becomes obvious that either direction is the ruin of a ponzi scheme.  You can't generate too high of returns or your dividend outflows will outstrip your ability to bring in new money.  In a deflationary scenario, redemptions are the ponzi-killer.  In order to maintain a ponzi a 'sweet-spot' must be maintained.  I now believe that there is a coordinated effort in the western world to do what ever it takes to stay in the sweet spot.  

Look at the markets.  We are observing low yields in bonds, steady gains in stocks, and general selling paralysis.  If TPTB succeeds in continuing to prevent that inflation or deflation break from occuring (through use of PPT, PM manipulation, stock market ramps, a myriad of bias-blinding 'official' statements/'leaks', toothless regulatory reform, economic statistic games, and effective 'green shoots' propaganda) then they may succeed in getting the sheeple of the world to accept a "new normal" and eventually drop this debate all together.  It is now rather obvious that the objective among TBTF is to get the speeple to quietly accept their place in the emerging global serfdom economy.

Our only hope now, unfortunatley, is growing geopolitical pushback which thereatens to monkey hammer our bus driver as we are guided towards a "new normal."  Cue the monkeys!!!  Go for the knees!!!

Double down's picture

IMO

Bad debts may be recognized when its relative size to excess reserves is minuscule.  Me thinks this is the reason for  issuing more treasury debt than required to fund the deficit.

I am having second thoughts about the treasury to fed reserve power relationship. 

If I were a congressman I would by now have come to the following, unfortunate conclusions:

Deficits no longer matter

AND/BECAUSE

There is no perceived inflation impact from QE.

Case closed.

 This is a carte blanch to issue unlimited amounts of debt and these incremental debts will have to be monetized or else the banking system will suffer from higher rates...  The feds third mandate will become "impaired". 

Others have said this but it bears repeating. Emergency measures will become everyday monetary mechanics.  QE will replace the overnight lending rate and therefore POMO will never stop.  The S&P will become/already is an inflation indicator.  

 

NOTW777's picture

"analysis?" how about someone who likes to hear themselves ramble.  no one else except the writer knows inflation but then the author goes on to include definitions of inflation that are common place

Misean's picture

I disagree that it "woefully ignores" at all. The Feral has been loooking for an asset to bubble and is so far having trouble finding one. As you note so well, no one is pouring back into the shlock market. Hot money (or his "zombie" money) is sloshing around, but it is NOT finding great traction to multiply (or lever if you prefer). I've been looking at the same thing and this is quite on point.

Blindweb's picture

Yes, like Denninger and Mish,  The Automatic Earth has very linear mental models of a very nonlinear world.

Sean7k's picture

Speculation is not the problem. Arbitrage is necessary for price discovery. This is a natural action in all markets. 

This article does a great job of clarifying inflation and fleshing out a better definition. It needs to be more forthright in identifying the real culprit: the creation of credit and the concentration of that credit in the hands of a very few people- the banks. Credit created at artificially low interest rates to be used to re-capialtize their malinvestment. 

This is made worse by moat built around the banks accounting systems, allowing them to forestall the inevitable as they attempt to push the cost of these losses on the taxpaying public, through the transfer of toxic debts to the FED balance sheet and the recording of interest on bad loans.

The monetary system is being made a mockery. The reserve status is being thoroughly abused and used as a weapon of mass economic destruction. The dislocations within the economies of the world are so disturbed, there are no tools to control the destruction.

To assume this is accidental or the work of imbeciles is dangerous. This is purposeful. It is a textbook case of system destruction to pave the way for a "new and improved" system of conducting global trade. 

It is impossible to have money behave in this manner, where no one can predict it's behavior and the options are spread over a spectrum of choices: inflation, deflation, hyperinflation, credit destruction from shadow banking, credit creation, or my favorite- the recent Irish method, dumping 25% of your GDP on to one side of the balance sheet.

Speculation? Bah! Criminal manipulation insured by government and the suspension of law and regulation? Better description.

snowball777's picture

But if the suspension of law, regulation, and the concept of moral hazard was a direct response to the effects of speculation...

centerline's picture

Speculation is "part" of the problem though.  Another facet is all the obligations that MUST have decent returns in order to avoid insolvency.  Those funds, amounting to significant capital, or forced into speculative and risky positions out of sheer necessity for yield.  A train wreck just waiting to happen.

 

(edit... forgot say "+1"  right on)

SDRII's picture

+10 - the idea of exporting inflation to the periphery to create max pain before the herd  storms the mother ship wherabouts the IMF/US/UK alliance launches a solution to quell the crisis. The key to watch for are the ongoping negotiation over what exactly the payoff will be to China/Russia for buyin? Note that the BOJ head was just named VC of BIS. The US/IMF push on the yuan to make it freely floating so it can be included in the SDR is woefully inadequate. When Brad Sester left the CFR to work on flows  for Treasury one can only imagine he joined the Hormats (GS) think tank on ways to stangle the resisters into submission. place your bets black or red?

Dental Floss Tycoon's picture

Fewer words but more substance. +100

Monday1929's picture

Jamie Dimon's children will find out that their father kills people. That will be a form of justice.

Gimp's picture

Great piece GF, totally agree that the tidal wave of very cheap money/credit causes speculation in all commodities globally which in turn kills the poor who now cannot afford to eat.

The banksters who are the speculators make themselves feel good by donating a pittance of their ill gotten gains to the local food bank....

 

wisefool's picture

Step 1: Store as much water as possible

Step 2: Poison the well (inflation)

Step 3: Become a savior by rationing out water to the people who used to use the well.

Step 4: Feel like you did God's work.

johnnymustardseed's picture

"Units of food and fuel purchased will drop as well, as each one is more expensive, cutting final demand and lessening the upward pressure on commodity prices. "

Starvation....the cure for inflation

Terminus C's picture

Starvation also handily deals with the other form of inflation that is causing humanity's problems... overpopulation.

really its a win/win...

Cognitive Dissonance's picture

Yes. And if I cover my eyes I can't see you either.

Temporalist's picture

Peek-a-boo!  Awww who's a cute wittle infwation?  You are!  You are a cute wittle infwation.  Yes you are.

Cognitive Dissonance's picture

McBaby will never know hunger as long as Americans can afford McFood, regardless of how far McFood drifts from being actual food or how expensive it becomes. Screw paying the mortgage, screw paying the utilities. I'm lovin' it.

And don't forget my fracking McToy.

 

 

BTW for those who would like the link to this real McDonald's ad used in India.

http://adweek.blogs.com/adfreak/2006/05/mcdonalds_gives.html

Monday1929's picture

The failed banker Dimon has soiled his diaper again. He needs another bailout. NOW.

USD-25's picture

Oh, ri-i-ight. Unlike the waste case on the wrong side of the tracks, I wake up in the morning and function fine. Therefore, last night's fun isn't going to impact my performance at all.

[I hope this guy knows that he's predicting a minor bloodbath due to margin squeezes.]

johnnymustardseed's picture

The FED and their right hand JPM will knock down commodities to prevent food riots here. They have shown their skill in that with silver.

alexwest's picture

typical idiotic, know nothing way of thinking..

#because the global economy is suffering from excess manufacturing capacity #and a deficit of consumption, history tells us there is little chance that #inflation will be a problem

so basically guy says how inflation happens ' PEOPLE MAKE MORE AND MORE MONEY, then bidding up prices for stuff,, manufacturing capacity is not capable to produce stuff ontime, thus sellers hike up prices and on on on '

LOL.. :)))))))))

what a stupid idiot... HEY asshole describe how HYPER INFLATION HAPPENED IN WEIMAR - i will do ' GOVERMENT PRINTED MONEY TO PAY DEBT (WAR DEBT)'

describe how HYPER INFLATION HAPPENED IN ZIMBABVE - GOVERMENT PRINTED MONEY TO PAY DEBT/ SALARIES /ETC..

describe how HYPER INFLATION IS GOING HAPPEN IN USA - GOVERMENT PRINTS +1.5 TRLN per year $ TO PAY SALARY / DEBT/ FOOD STAMPS /ETC

case closed

alx

chrisd's picture

Actually what happened in Weimar happened because it was a closed system and there was no place for that money to escape. Same as Zimbabwe. We aren't quite there yet so his analysis is correct. Taking steps to prepare for that are smart, but the odds are so small right now that the US becomes completely independent of other countries and their financing, it probably isn't worth your time.

Your analysis is less effective when you call everyone names (and use emoticons)

johnnymustardseed's picture

It could happen the day we lose reserve status and that is on the horizon