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Will We Have Inflation, Deflation, or Hyperinflation? Part 4 (Final)

Econophile's picture




 

From The Daily Capitalist

This is is the final part of my four part article that deals with what I feel is the primary question investors must now answer: is our future to be inflation or deflation? The answer has vast implications to our investment planning and decisions for the near term, and possibly for our long term. It is a very complex question with a lot of moving parts involving economics and politics.

 

Like it or not, it is economic theory that is driving macroeconomic policies and political decisions that determine whether we will have inflation or deflation. Since not all of my readers are sophisticated traders I have tried to present the issues in a direct and hopefully understandable way. To those sophisticated readers, please bear with me.

Part 4 of 4

What is Money Supply Doing Now?

Money supply will tell you if we are headed for inflation or deflation. If we look at the rates of change of M1 or Austrian True Money Supply (TMS), they are declining. In fact, M1 and TMS appears to have peaked in 2009 and have been declining on a year-over-year basis ever since. On an absolute basis, as shown previously, M1 growth is flattening. These two charts below show the year-over-year percentage change in money supply.

What Will the Fed’s Options be in a Double-Dip Economic Decline?

This is the main point. If, as I have been saying, the economy declines in the second half of 2010, what will the Fed do?

Let me paint a scenario. In any scenario with declining economic growth, unemployment will rise. If unemployment at the narrowest measure is now 9.7% and at the broadest measures (U-6) is 16.9%, rising unemployment will become politically unacceptable to the Obama Administration.

I believe the politicians will first take Paul Krugman’s advice and extend existing stimulus programs and create new ones to spur spending. All the talk about fiscal sanity and deficit warnings will be forgotten as politicians on both sides of the aisle panic. Look for further extensions of the home buyer tax credit program, and other programs that politicians believe will help businesses in their districts. Cash for [Your Industry Here] will be the byword. It will add to an already huge federal debt and will result in more wasteful spending and non-viable short-term results.

On top of all this, the politicians will hammer Bernanke to create jobs, which is one of the Fed's mandates.  But how can he do that? He will try to inflate.

The Fed has limited options in such a case. They can’t reduce the Fed Funds rate any further and they can’t force banks to lend. It is likely that banks will further restrict credit as the economy declines.

I think their only viable option is to use Open Market Operations (OMO) to inject new money into the economy. The next question is: what will they buy?

From January, 2009 to April, 2010, the Fed acquired $1.25 trillion dollars of mortgage backed securities (MBS) through OMO purchases. The only problem is that it didn’t do much for the economy. Most of the OMO money pumping has been going into the hands of the big financial institutions which has been driving the financial markets. It is no coincidence that Goldman Sachs had 63 perfect trading days in Q1. New York restaurants are recovering nicely.

There is a theory called the Cantillon Effect which says an increase in money supply doesn’t affect all prices equally: money flows initially into some assets, tends to stick there, and the inflationary effect is borne by later by consumers who get no benefit from the new money, only the burden of higher prices. Such an effect may have occurred when the Fed bought MBS from dealers which resulted in cleaner balance sheets and high profits for the big banks and left consumers with slightly higher prices. But I recognize that this idea is conjecture on my part. But, as I pointed out above, (i) OMO money pumping doesn’t have the same multiplier effect as lending by banks, and (ii) credit is still declining.

There are two other asset purchase choices the Fed may consider in its Open Market Operations. Neither alternative is good:

Alternative No. 1. Buy bad CRE loans (non-MBS) directly from regional and local banks.

If it buys CRE debt from smaller banks, it would compound the problem it already has with MBS purchases. That is, it is unlikely they could sell these assets for what they paid.

The positive effect, in the Fed's eyes, is that banks would more quickly repair their balance sheets and regain financial health. This would then allow them to raise needed Tier 1 capital and commence lending to viable businesses (this is a big “if”). The Fed recognizes, as Monetarists, that they need to get the smaller banks lending again to spur the economy and create inflation.

This of course ignores the “moral hazard” caused by bailing out troubled banks. But I don’t think there is a lot of political sentiment to allow massive bank failures. And the political pressure on the Fed to “do something” will be intense.

Setting all this Monetarist-Keynesian folly aside, the question still remains: if these banks are artificially restored to health, would that lead to economic expansion? In my opinion it will lead to a “bomb-bust” cycle (economic stagnation and inflation).

Alternative No. 2. Buy Treasury paper which would have the effect of monetizing Federal debt (the government prints currency to pay for its own debts).

The monetization of federal debt on a large scale basis would certainly increase the money supply. The downside is that it would cause greater economic distortions than if they bought bank CRE debt because the effect would be to fund wasteful government projects.

Further they still have the problem of getting banks to lend and if they just buy Treasury paper from these small banks, they will sock the cash away at the Fed as excess reserves.

Will Inflation Be the Effect of the Fed’s Action?

In either alternative or a combination of the two, we would have inflation because money supply would increase. How much inflation depends on how much cash is injected into the system. Such inflation would eventually cause another artificial business cycle that would further damage the economy by destroying more capital as the new money is misdirected into businesses that would not be otherwise viable but for the effects of inflation. This is called “malinvestment.” We are presently suffering the results of malinvestment in real estate assets.

This new cycle will be less of a boom and more of a bomb. This is what happened in the 1970s when the CPI went sky high yet economic activity stagnated. Stagflation was the term devised to describe it.

The problem is this: how many times can you destroy capital before you have jeopardized the ability of investors and entrepreneurs to create new profitable businesses?

Real wealth as I discussed before, is not a piece of paper. It is goods produced that are not consumed. (See my article, “Money: A semi Fictional Fable.”) Money is just a way of holding wealth until you wish to consume something. If I am a factory owner producing silicon chips for Apple, and I save some of my profits rather than spend all of it, those savings are real capital.

It is difficult in our complex economy to measure “real capital.”

Some Austrians believe a decline economic activity indicates a decline of real capital. I would agree that is probably the case, and, I would agree the last two cycles have been destructive of real capital. I do know that more pieces of green paper will only result in malinvestment (the destruction of more real capital) and rising prices.

When will we see inflation?

This is where I believe the deflationist argument fails. The deflationists believe we will have years of deflation because of the credit freeze. Banks are still loaded with bad debt and viable borrowers are difficult to find. While I understand the similarities with the Japanese experience (massive fiscal stimulus, zero interest rate policy, low inflation, and stagnation) I believe the situation will be different here.

That difference is that we are cleaning up our mess whereas the Japanese, perhaps because of cultural reasons, let bankrupt (zombie) companies and banks stay alive. This tied up capital in unprofitable businesses (malinvestment), and new capital was not able to be directed to entrepreneurs and profitable companies.

While we may be going at it slowly, America has a rich tradition of failure, foreclosure, and bankruptcies which acts as a cleansing mechanism to rid the economy of malinvestment. This is what Joseph Schumpeter referred to as “creative destruction,” or the process by which capitalism corrects its mistakes. This process is occurring here, but the problem is that the process is being slowed down by government policies that prevent bankruptcies (mark-to-make believe, extend and pretend, delay and pray, and TARP, TALF, Cash for Clunkers, and housing subsidies).

I don’t agree with the deflationists that deflation is a decline in real estate asset values. I believe the deflationists conflate deflation and deleveraging. I agree with the deflationists that deleveraging and the decline in real estate values has and will limit economic activity because it has suppressed bank credit, but it isn’t deflation.

Further, as pointed out by Austrian economist Bob Murphy, we haven’t seen deflation yet, or at least it has not been reflected in the CPI. In fact, he says, we haven’t had deflation since the Great Depression.

At some point the Fed's efforts to increase money supply will be effective. It is difficult to predict when that will be.

I think we are seeing current declines in money supply growth as a response to the Fed’s cessation of MBS purchases. It is possible that we may go into negative territory which would be deflation, but, with evidence of a double-dip economic decline, the Fed will do everything it can to re-inflate and I think they will succeed.

This time the result will be stagnation and inflation.

Will We Have Hyperinflation?

Is hyperinflation possible in America? The proper question to ask is if it is probable. To that question I would say no. Hyperinflation would result in the destruction of our monetary system and Ben Bernanke and just about everyone at the Fed and the Administration’s economic advisors understand this quite well. I believe they understand the mechanism of printing money as the cause of hyperinflation.

I am also aware of the implications of runaway Federal debt and the political choices the government has to pay it: higher taxes and/or inflation. The third method to pay it would be a thriving economy caused by a reduction of government’s heavy hand, but free market capitalism is out of favor right now.

To prevent runaway inflation the Fed would raise interest rates, increase reserve requirement, and sell assets to stabilize money supply. The hit to the economy would be worth the risk. This is essentially what Volcker did back in 1979-1980. If it really got rough, price and wage controls would be instituted on a temporary basis to cool things down. I am aware of the implications of such controls and the massive price distortions they cause, as is Mr. Bernanke. But it would politically acceptable on a temporary basis. That famous Republican, Richard Nixon, did this in 1971. We all understand that such controls only further distort the economy because only market prices enable us to make economic decisions, which is why such controls would be short lived.

Summary

  1. Inflation or deflation is a monetary phenomenon. An increase in money supply causes inflation. A decrease in money supply produces deflation. (Ceteris paribus.)
  2. Price increases are a result of inflation, not inflation itself. The main impact of inflation is malinvestment.
  3. The Fed has been trying to inflate the money supply to end the credit crunch.
  4. The Fed’s inflation efforts have been mixed. Most banks are still not lending and credit and money supply have been declining.
  5. Banks are not lending because their balance sheets are loaded with bad CRE debt which has caused them to be concerned about their financial viability. In addition they have difficulty attracting viable borrowers.
  6. The government has enabled banks to postpone the inevitable write-downs of bad debt which has drawn out the credit crunch and has impeded economic recovery.
  7. Monetary stimulus has been achieved by the Fed’s Open Market Operations which has injected almost $1.25 trillion of new money into the economy.
  8. The impact of such stimulus has served to benefit the large money center financial institutions, and does not appear to have aided liquidity or to have stimulated economic growth other than the financial markets.
  9. Government fiscal stimulus has had little positive economic impacts on the economy, and, as the effect of government spending winds down, we are left with wasteful spending of no lasting economic benefit and high public debt.
  10. Recent increases in consumer spending and consumer lending are temporary blips caused by government stimulus programs and are having no lasting effect.
  11. Money supply has increased since the October, 2008 crash, but there are signs that it is beginning to decline again.
  12. While the CPI has been increasing, increases are modest and are a result of the Fed’s less inflationary OMO purchases of MBS.
  13. The current trend of the CPI seems to be declining.
  14. It appears that economic activity is slowing down as stimulus runs out and money supply declines, and that we are headed for a double-dip decline.
  15. Until banks’ balance sheets are cleaned up by resolving the overhang of bad CRE debt, they will continue to restrict credit and thus constrain the growth of money supply.
  16. The deflationists’ analogy to Japan’s experience from 1989 to 2003 is only partially applicable. The American tradition is to allow banks and businesses to fail.
  17. This cleansing process is ongoing but is slow because the government has given banks incentives to delay the process.
  18. The deflationists have yet to show that deflation has occurred as they say. While asset values are declining, mainly real estate assets, money supply has not crossed the deflation Rubicon yet.
  19. The deflationists seem to conflate the concepts of deflation and deleveraging, which aren’t the same things.
  20. A double-dip decline will put political pressure on the government to take any steps they can to thwart the decline.
  21. An inevitable increase in unemployment will be politically unacceptable to the Administration and Congress.
  22. The government will renew attempts at fiscal stimulus on a grander scale.
  23. The Administration and Congress will put pressure on the Fed to counteract the decline. All politicians and most Keynesians and Monetarists believe that price inflation is preferable to price deflation.
  24. Inflation destroys real capital which will limit future economic growth.
  25. The Fed has limited options to create inflation but they will attempt to do so by injecting money into the system through OMO.
  26. One option is to buy Treasury paper, thus monetizing federal debt, which will ultimately create price and monetary inflation.
  27. Another option is to buy CRE debt from smaller banks to clean up their balance sheets and allow them to resume lending activities and expand money supply which will result in inflation.
  28. The problem will these alternatives is that they will serve to reduce economic growth by causing malinvestment and the further destruction of real capital while at the same time create price increases, which is called stagflation.
  29. If inflation gets out of hand, it is probable that the government will impose temporary price and wage controls while they counteract inflation through increased interest rates and other restrictive monetary policies.


For those of you who wish to read the entire article as one downloadable PDF, please go here.

 

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Wed, 06/30/2010 - 09:48 | 444044 ozziindaus
ozziindaus's picture

On top of all this, the politicians will hammer Bernanke to create jobs, which is one of the Fed's mandates.  But how can he do that? He will try to inflate.

How can he do that indeed. I have repeated this in so many other posts. Jobs should not be viewed as needs or wants. Charities are needs and wants. Jobs must meet some demand and be productive (obviously) otherwise it's simply a transfer of wealth.

The Fed's mandate (one of) is not to technically create jobs (Mr Obvious again) but to provide an economic environment conducive to entrepreneurship and expansion of private businesses to meet consumer demands. The caveat is that the Fed is not in complete control of interest rates (another supposed mandate) but reactionary to market forces through the bond market.

Therefore the private sector creates productive jobs and that's the way it should remain. Those waiting for the government and Fed to rescue the economy will die waiting.

Wed, 06/30/2010 - 09:22 | 443996 ozziindaus
ozziindaus's picture

I don’t agree with the deflationists that deflation is a decline in real estate asset values. I believe the deflationists conflate deflation and deleveraging. I agree with the deflationists that deleveraging and the decline in real estate values has and will limit economic activity because it has suppressed bank credit, but it isn’t deflation.

Wanna bet??

A decline in real assets to the extent we are experiencing with RE and CRE, increases the probability (transpiring) of complete default. This is classic deflation since it targets credit (inflation) with leverage.

Wed, 06/30/2010 - 09:06 | 443967 dryam
dryam's picture

In a debt based money system it's all about what the money multiplier is & if the banks are lending.  There are so many reasons why the banks won't lend right now.  In addition to the explicit reasons, the bank cartel is not incentivized to create high inflation.  Overall deflation rules (strong negative money multiplier) until there is some type of bottoming process.

Wed, 06/30/2010 - 08:20 | 443907 moneymutt
moneymutt's picture

Is this a given, proven dynamic by real world historic examples?

"The downside is that it would cause greater economic distortions than if they bought bank CRE debt because the effect would be to fund wasteful government projects."

The issue raised is a very legit concern and a intuitive sense of what might happen if we monetize, but do we really know this, thoroughly, solidly.

From the very few (too few in my mind) examples of countries monetizing and spending it on infrastructure and such projects, inflation has not resulted, certainly not automatically and inevitably. American colonies did it and did well, Guernsey did, pre-WWII Germany did it (via govt scrip), built the Autobahn and did very well. If govt spending was used for useful things to community and it put money in pockets of workers, would not the lower unemployment and better economy help heal regional banks. These examples show it is possible to do this without debt or inflation...i.e. sustainable.

Wed, 06/30/2010 - 19:28 | 445407 Econophile
Econophile's picture

Moneymutt,

Japan proved my assertion.

Wed, 06/30/2010 - 20:08 | 445469 moneymutt
moneymutt's picture

perhaps, to me they still did it thru debt, not monetization...is my impression wrong?

Mon, 07/05/2010 - 15:41 | 453332 Econophile
Econophile's picture

Well they spent hugely and they financed debt through the Postal Savings system. They are the biggest holders of government debt. That is why they don't need to go to the international markets. But they reduced the "Fed Funds" rate to zero and tried QE. Remember the carry trade? Because of the zombie situation, they couldn't get credit into the system and experienced deflation. No bond vigilantes to keep them honest. Had they B/Kd these banks, then credit would have flowed.

Mon, 07/05/2010 - 15:41 | 453331 Econophile
Econophile's picture

Well they spent hugely and they financed debt through the Postal Savings system. They are the biggest holders of government debt. That is why they don't need to go to the international markets. But they reduced the "Fed Funds" rate to zero and tried QE. Remember the carry trade? Because of the zombie situation, they couldn't get credit into the system and experienced deflation. No bond vigilantes to keep them honest. Had they B/Kd these banks, then credit would have flowed.

Mon, 07/05/2010 - 15:41 | 453330 Econophile
Econophile's picture

Well they spent hugely and they financed debt through the Postal Savings system. They are the biggest holders of government debt. That is why they don't need to go to the international markets. But they reduced the "Fed Funds" rate to zero and tried QE. Remember the carry trade? Because of the zombie situation, they couldn't get credit into the system and experienced deflation. No bond vigilantes to keep them honest. Had they B/Kd these banks, then credit would have flowed.

Mon, 07/05/2010 - 15:40 | 453329 Econophile
Econophile's picture

Well they spent hugely and they financed debt through the Postal Savings system. They are the biggest holders of government debt. That is why they don't need to go to the international markets. But they reduced the "Fed Funds" rate to zero and tried QE. Remember the carry trade? Because of the zombie situation, they couldn't get credit into the system and experienced deflation. No bond vigilantes to keep them honest. Had they B/Kd these banks, then credit would have flowed.

Mon, 07/05/2010 - 15:40 | 453327 Econophile
Econophile's picture

Well they spent hugely and they financed debt through the Postal Savings system. They are the biggest holders of government debt. That is why they don't need to go to the international markets. But they reduced the "Fed Funds" rate to zero and tried QE. Remember the carry trade? Because of the zombie situation, they couldn't get credit into the system and experienced deflation. No bond vigilantes to keep them honest. Had they B/Kd these banks, then credit would have flowed.

Wed, 06/30/2010 - 08:27 | 443914 Seer
Seer's picture

"These examples show it is possible to do this without debt or inflation...i.e. sustainable."

Sustainable?  For how long?  If it's an issue of growth it WILL end eventually.

Would future generations be happy about out building more highspeed motorways, when in their future they won't be of use to them?

We're still thinking way to short-term.  And as a result it'll not end up well, govt projects or otherwise.

Wed, 06/30/2010 - 07:32 | 443874 MarketFox
MarketFox's picture

Excellent work....and follow through....

.............................

The total asset valuation and total credit available represented a 100/100 fraction which peaked in 2006/2007....

 

Now the cumulative fraction is approximately 60/100 after one adds current asset valuation and credit contraction....

................................

There are many forms of asset valuation via accounting norms....which are also altered in a legal political manner....

True asset valuation is private side induced...such that it is the private side valuation that pulls the tax wagon....

................................

Thus it will not be until there are tax structure reforms that prove to add to the private side.....whereby private side valuations will improve and multiply...

Until then...the 100/100 which has shifted down to 60/100....will shift even lower with more monetary dilution or increased taxation....

Thus the answer truly relates to government tax reforms....

ie a 15% consumption tax that replaces all other taxes ...especially the individual/corp. income taxes....would add to the private side such that 100/100 could go to 140/100...or even 200/100.... 

And the 60/100 could go to 30/100 from 60/100 if there are increases in taxation or further monetary dilution....

 

Wed, 06/30/2010 - 07:18 | 443866 yabs
yabs's picture

comparing the situation of the 70's  to today is like comparing a fart to hiroshima

Wed, 06/30/2010 - 07:17 | 443865 yabs
yabs's picture

comparing the situation to today is like comparing a fart to hiroshima

Wed, 06/30/2010 - 07:12 | 443862 Nobody
Nobody's picture

One of the effects of Nixon's policy was:

Farm commodities prices doubled and tripled.  Farmland doubled in value

One of the effects of Reagan/Volcker's policy was:

Farm commodities prices dropped 40%.  Farmland lost 65% of its value.  

Wed, 06/30/2010 - 07:42 | 443880 Seer
Seer's picture

Nixon's administration helped push big Ag.  Reagan's helped push big Banks.

BIG  = FAIL!

Wed, 06/30/2010 - 05:59 | 443825 chrisina
chrisina's picture

<blockquote>The deflationists’ analogy to Japan’s experience from 1989 to 2003 is only partially applicable. The American tradition is to allow banks and businesses to fail.</blockquote>

Haven't seen much of this "American tradition" lately, have we?

<blockquote>To prevent runaway inflation the Fed would raise interest rates, increase reserve requirement, and sell assets to stabilize money supply. The hit to the economy would be worth the risk. This is essentially what Volcker did back in 1979-1980.</blockquote>

FYI, the level of Govt debt in 1979 was 30% of GDP (the lowest it's been since WWII). Today it is 90%. Same thing with private debts, about 3 times as much as in 1979.  So you think Bernanke raising rates like Volcker did then is realistic?

And what about the Fed selling assets? You mean the junk they bought recently? Who is going to buy it? At a tenth of the price the Fed paid for it? That's not going to help much reducing the Fed's balance sheet is it?

The situation today has ABSOLUTELY NOTHING to do with 1979. Back then leverage was low and nobody had even thought of peak oil. Today leverage is astronomical and won't get any bigger no matter what the Fed does and the supply of oil isn't going to grow any further limitting future growth prospects.

Our problem today is far too much debts and not enough cheap oil. Central banks do not have any magic wand that can solve this. If a sufficient percentage of creditors loose confidence in the ability of debtors to honour their obligations (either via default or via being paid with freshly printed paper) central banks won't be able to prevent a run on the dollar. Rest assured that in that case, the tools that will need to be used won't be those of a central bank (raising rates and selling assets) but those of a totalitarian military and police state that will need to control every aspect of the economy.

Wed, 06/30/2010 - 08:58 | 443954 Variance Doc
Variance Doc's picture

My thoughts exactly.  Nice summation!

Wed, 06/30/2010 - 05:57 | 443824 yabs
yabs's picture

You say that Japan kept zombie companies alive but the Us doesn't?

so what are Fannie Mae, bank of America, AIG, Citigoup etc

I think they would fit the definition of a zombie wouldn;t they?

Also I think the delevaraging will be greater than money printing and as this money does not go into the real economy at some point

a deflationary collapse is mathematically guaranteed.

All money is debt in this system remember and when debt saturation occurs as is happening now the system cannot grow anymore

Deflation First is my view with bouts of inflationary epissodes like last march to now but these are just short term bounces not the general trend

Wed, 06/30/2010 - 06:16 | 443833 Ned Zeppelin
Ned Zeppelin's picture

Agree - I disagree with the author, and believe we have moved mountains to preserve the TBTFs which are the poster child for "Zombie."  This is the massive failure of Bernanke, Summers, Geithner, Rubin, etc., and a hard rain's gonna fall because of it (or is it in spite of it).  What has been avoided is massive losses in one sector, the sector that has been running the pols for years, since the repeal of Glass-Steagall.

Wed, 06/30/2010 - 05:23 | 443808 reckoning
reckoning's picture

still no chart of M3... 

Wed, 06/30/2010 - 06:28 | 443843 Hedge Jobs
Hedge Jobs's picture

here is a link reckoning, you cant discuss deflation without looking at M3. looks like this was left out either through ignorance or to justify the Inflation bias of the article (no offence meant econophile i enjoyed the read but disagree)

http://www.shadowstats.com/alternate_data/money-supply-charts

If M3 at -6% doesnt point to deflation i dont know what does. At -6% deflation is already here.

the delusional shalom bernanke better fire up the printing press pretty soon.   

Wed, 06/30/2010 - 14:01 | 444554 Econophile
Econophile's picture

I don't use M3 because it includes savings and MM accounts which aren't demand deposits. Only M1 and True (Austrian) Money Supply accurately reflects money in circulation. Also, Fed doesn't use it any more, although Williams does. Thanks.

Thu, 07/01/2010 - 14:06 | 447015 Eternal Student
Eternal Student's picture

You should. It provides a much bigger picture of what's going on.

As for the artcile as a whole, I really don't think you understand what's going on. No offense intended. Like the Chicago School of Economists, you seriously leave out the impact of Credit, and that's where the game is. Unless you take that into account properly (as in including the Ponzi Finance of the Global Derivatives Market), you're not going to have a chance of understand why Deflation is happening. M1 just doesn't cut it. Neither does M3 fully, but it gives a better clue.

Also, while I found the articles enjoyable, what serious Deflationist is saying that deflation is about Real Estate prices? As you well note, inflation/deflation are a monetary phenomena. Going off on that Straw Man detracted from the general quality.

Still, I enjoyed the article, and thank you for writing it.

Mon, 07/05/2010 - 15:34 | 453322 Econophile
Econophile's picture

No I don't. I discussed this point at length. I just don't agree with Steve Keen and I explain why. I explain that RE prices are declining and that is deflationary in one sense of the word, but then, why is CPI rising? I think I explain all this in detail. I am fully aware of credit and I go into this in great detail. Again, it's a monetary phenomenon. Right now money supply is contracting, and this will lead to a decline in economic activity, perhaps deflation. But the Fed has the ability to inflate, if it wishes, and my guess during the next downturn, starting this half, they will pump. I explain how and why. I urge you to re-read the article carefully. I also explain why I don't use M3. I consider myself to be Austrian, not Monetarist. 

Thank you for reading.

Wed, 06/30/2010 - 05:00 | 443797 Kimo
Kimo's picture

Hyperinflation implies inflation runaway.  Fed can throw money at the system, but not jobs.  Prices may go up with each infusion, and wages may adjust, but it will not be self sustaining, so it will not be hyperinflation.

Wed, 06/30/2010 - 04:28 | 443782 Nout Wellink
Nout Wellink's picture

IMO the biggest flaw in this article is the assumption that the Fed and other central banks can 'control' everything. They can't. The Fed can use many tools to try to inflate the money supply and increase lending, but they have no idea how the reaction will be. As far as I am concerned, the greatest mania in mankind, excessive credit, borrowing and consuming, has come to an end. Social mood is low, so there is no chance the mania will return any time soon. So deflation is really a big threat and if they start panicking at the Fed, I believe Hugh Hendry is right: prepare for hyperinflation.

Wed, 06/30/2010 - 04:58 | 443796 Popo
Popo's picture

+1

History tells us that the Fed cannot control everything.   There is lots of revisionist (ie: bullshit) history, written by Keynesian economists which tries to pretend that past failures were simply the result of flaws in policy implementation.  It's simply not true.  The reality is that central banks are not the most powerful force in the market over the long term.

 

 

Wed, 06/30/2010 - 04:37 | 443788 GoldBricker
GoldBricker's picture

+1

The essence of the article is that markets are now under government control, thus the variables are what decisions TPTB will make going forward. This may or may not be true.

The arguments of the deflationists I read (Rick Ackerman, Mish) are that the collapsing debt bubble will not be controllable, that it will be like pumping air into a leaking balloon, where the leak is faster than your pump.

Wed, 06/30/2010 - 04:01 | 443769 laosuwan
laosuwan's picture

great article. Zero Hedge leads the way.

 

Is anyone else here old enough to remember stagflation and the oil crisis?

 

What were the investments that did well during that period of stagflation?

Wed, 06/30/2010 - 08:58 | 443956 LePetomane
LePetomane's picture

Price inelastic industries did well: oil, nuclear, grocery, tobacco & alcohol etc.

Fri, 07/02/2010 - 10:53 | 449156 laosuwan
laosuwan's picture

the industries did well or their stocks did well?

Wed, 06/30/2010 - 06:23 | 443836 MichiganMilitiaMan
MichiganMilitiaMan's picture

My family invested in a very large garden.  We podded peas, snapped beans and canned corn/tomatoes for hours and hours.  We had a basement full of canned and frozen vegetables, and purchased bulk berries for freezing.  Many summer nights were Not spent playing wee and other non-sense.

Fri, 07/02/2010 - 10:55 | 449158 laosuwan
laosuwan's picture

Arent snap beans very high in estrogen?

 

 

Wed, 06/30/2010 - 04:33 | 443785 GoldBricker
GoldBricker's picture

Hey lao,

Yes, was in my 20s in that era.

What did well:

  • luxury housing
  • collectibles (my thing was coins)
  • gold (silver's rise was sharper and briefer)

Inflation was quite palpable then, plus we were not used to it, so everyone was trying to put their cash into real assets.

What got slaughtered:

  • blue-chip stocks
  • bonds, paid-up insurance policies, annuities, and anything else denominated in dollars.

The investments that got killed were precisely those that my parents (the WW2 generation) would've considered responsible, conservative investments, while the things that did well they would've considered frivolous, akin to gambling. I wonder if the future will be able to say the same thing of our own times.

Fri, 07/02/2010 - 10:49 | 449138 laosuwan
laosuwan's picture

GB:

 

I think I was 15 at the time and I just remember gas lines, union actions for higher wages, coupon clipping, etc.

 

Stocks are supposed to be an inflation hedge so I am guessing stocks got slaughtered because people had to sell to raise cash. = buying opportunity if you can call the market turn?

Avoiding dollars, we can all agree on that one.

So, commodities, real estate and gold it is then. Hey, sounds like Jim Rogers.

Wed, 06/30/2010 - 11:00 | 444166 ozziindaus
ozziindaus's picture

Generally, the public is always wrong.

Wed, 06/30/2010 - 04:23 | 443779 duncecap rack
duncecap rack's picture

Gold did very well.

Wed, 06/30/2010 - 03:31 | 443754 Apostate
Apostate's picture

This is fantastic work. I'm glad that you've stepped in to moderate this debate (so to speak) and put out a measured, reasoned paper independent of personal attacks, emotional reasoning, and other cruft.

This here is actually my greatest fear:

To prevent runaway inflation the Fed would raise interest rates, increase reserve requirement, and sell assets to stabilize money supply. The hit to the economy would be worth the risk. This is essentially what Volcker did back in 1979-1980. If it really got rough, price and wage controls would be instituted on a temporary basis to cool things down. I am aware of the implications of such controls and the massive price distortions they cause, as is Mr. Bernanke. But it would politically acceptable on a temporary basis. That famous Republican, Richard Nixon, did this in 1971. We all understand that such controls only further distort the economy because only market prices enable us to make economic decisions, which is why such controls would be short lived.

I've had panics about it repeatedly - that the government could actually keep its game going for a while longer. 

The trouble here is that raising rates and selling assets would push the states off the reservation even further.

The Fed could very well blow up the government, but save the dollar. I'm not sure if that playbook could work.

But I suspect that they might try. How do you jive that measure with the political situation? If a Democrat attempted to implement those policies, it would quickly annihilate the party. The Republicans could potentially pull off such a policy, but at the risk of incurring vast amounts of civil unrest from former government workers.

Any route the Fed takes will be messy.

How could the Fed raise rates without forcing a Federal debt crisis? 

Fri, 07/02/2010 - 10:57 | 449164 laosuwan
laosuwan's picture

obama is all about control. I look for something unexpected from him before the election. its going to get nasty in the states. 

Wed, 06/30/2010 - 19:26 | 444527 Econophile
Econophile's picture

Apostate, you bring up very good points. My answer is that I don't know. As I've pointed out, I'm just making an educated guess and try to figure out what is probable. But, as you say, shit happens and I'm not ruling that out.

Wed, 06/30/2010 - 02:06 | 443743 Johnny Bravo
Johnny Bravo's picture

I'd say that hyperinflation is not probable because we can still add a LOT of money to the system without breaking old price levels.  Simply put, there is not enough money in the system (and there won't be for a LONG time) to sustain the inflated levels created by the credit bubble.

I do think that attempts at reinflation are a real possibility, but there is nothing that can be done to this end without deflation occuring first.  Once deflation occurs, we should see a natural reversion to the mean.  Yet, people will not let the natural process of deflation cleanse the system to a level that is acceptable to spur new investment and growth.

Wed, 06/30/2010 - 03:54 | 443766 Seer
Seer's picture

"Yet, people will not let the natural process of deflation cleanse the system to a level that is acceptable to spur new investment and growth."

In your opinion, what level would That be?

Due to core resource depletion our existing infrastructure will either not support the new investment activity OR it will be irrelevant (to it).  While it 's possible that TPTB have some magic up their collective sleeves, the proabability is, at this point, clearly low.  So, assuming that no magic exists AND that fossil fuel depletion is as terminal as it appears (both possible, AND, given the available data, quite probable), could it be probable that no real investment opportunities, ones that would have a signficant economic lift, exist?

I would argue that not until our entire infrastructure collapses, and the controlling interests behind it,  will we see any significant "growth."  The big failing entities won't allow upstart competitors to further erode them (kind of like unions bargaining their companies into the ground); they will litterally kill our future as they attempt to hold on to their control.  But, for argument sake, let's say that a new paradigm shift was possible, how then would new upstarts manage to operate when the bulk of humanity is unemployed  (think Barbarians at the gate)?

It is, as suggested, about deleveraging.  Inflation, deflation, irrelevant.  The entire fucking infrastructure/paradigm is being deleveraged, and the velocity of this delveraging will suck everything into a black hole.

Have a nice day :-)

Wed, 06/30/2010 - 07:16 | 443864 anony
anony's picture

What is an 'investment opportunity'? 

From the results of the last 30 years it appears that those so-called opportunities were nothing but phantoms, engineered by sophisticated quant squads spread over the globe, to move a great many quadrillion dollars, euros, yen and renmimbi into the coffers of a select few of tightly connected criminals. 

The 'Manufacturing' of derivatives began a long time ago, so it could be surmised that genuine investment ceased to exist decades ago and everything done in that name till now has been and is pure bullshit.

I wonder how many 'investors' who bought gold at the low still own it, how many times they have bought and sold it, ditto with stocks, and other paper 'investments'. It's probably like mortgages. The originator is so far back in the line of subsequent 'investors' as to be invisible.

You're likely right, but i'd say deleveraging has been going on a lot longer than we think by those who 'created' the leverage in the first place.

 

Wed, 06/30/2010 - 08:56 | 443951 living on the edge
living on the edge's picture

I agree with your astute observation regarding derivatives. The banksters created these pieces of shit to either unload risky bad loans or to create a casino like investment atmosphere where they knew they could profitably control the final outcome. They essentially created credit out of thin air. The problem is they flooded the world with these malinvestments and now derivatives are blowing up worldwide. Additionally we are in the early stage of lawsuits being filed against the derivative originators, and I expect this trend to continue.

There is an epic battle to re-inflate the market by the Fed but in the end deflation will rule the day. Nearly 100-years of inflation will soon end. This is not going to be pretty. The only question remaining is will it end sooner rather than later?

Regarding your question of early buyers of gold holding their investment. I can speak for myself and a handful of others and we still own every ounce ever purchased. I have no desire to sell at these prices. The curious thing is with all the talk about gold today, I still know few people that own it.     

Wed, 06/30/2010 - 07:34 | 443875 Seer
Seer's picture

You make an excellent point, and that's what is investment.  In my context it's something that facilitates a long-term, positive contribution to society.  As you note, there has been lots of investing going on which has been anything but meaningful.

And yes, I'd have to agree with you that deleveraging has been going on for a long time.  I'd reckon that it's been happening since about 1970 (when the US dumped the gold standard, and when it also peaked in oil production).

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