Hyperinflation

As the chart below shows, in some 200 years of history, when expressed as a ratio of total sovereign debt to tax revenues, the empirical data as compiled by Reinhart and Rogoff ranges from 2x to 16x. This is shown by the blue bars in the chart below.  So where are we in this cycle as the debt clock counts down? As the red bars show, we are in a very uncomfortable place, with Japan now at the highest such ratio in history, well above the highest recorded which always ended up in default, while the US, whose such ratio is over 600%, is above the long-term average of about 520% public debt/revenue. The problem is that every current and subsequent attempt to reflate merely pushes both of these higher, until one day the marginal growth creation of every dollar in new debt becomes negative. How much higher can consolidated global debt go before global GDP is not only no longer growing, but every incremental dollar in debt has a negative impact on GDP, as was the case for the US in the fourth quarter? Keep an eye on global economic growth: if and when the world enters outright recession: the most feared outcome by all central bankers who realize they are out of weapons and their only recourse is much more of the same, that may be cue to quietly leave town.

JPY could fall a lot further because weak JPY has been the most effective tool to create equity market wealth and spur Japanese demand. Moreover, Citi's Steven Englander notes, Japanese policymakers do not have many other options. If JPY is ticket for the Nikkei to regains ground lost versus other equity markets, USDJPY would have to go into three digits. By implication JPY would have to weaken a lot more. The loss of market share in part reflects long-term structural issues but Japanese governments (like others) are more mindful of incurring the anger of domestic political constituencies by making tough structural reforms than of G20 counterparts by weakening the exchange rate. From a political perspective, the Nikkei-JPY relationship is too much a good thing for Japanese policymakers to give up - but divergences are abundant at the short- and long-end of the JGB curve - and too much of a good thing in this case is a disaster.

Asset inflation often produces something called "wealth illusion," the belief that pricier asset holdings necessarily make one permanently richer. Illusions are dangerous. Eventually, painful reality intervenes. The "wealth illusion" of asset inflation is seductive, which is why central banks in charge of a fiat currency and subject to no external disciplines so often drift in that direction. Politicians smile in satisfaction and powerful Washington lobbies cry for more.  But an economy built on an illusion is hardly a sound structure. We may be doomed to learn that lesson once again before long.

The insanity that has gripped policymakers all over the world really is a sight to see. There was a time when central bankers were extremely careful not to do anything that might endanger the currency's value too much – in other words, they were intent on boiling the frog slowly. And why wouldn't they? After all, the amount by which the citizenry is plucked via depreciation of the currency every year is compounding, so that the men behind the curtain extract more than enough over time. The latest example for the growing chutzpa of these snake-oil sellers is provided by Lord Adair Turner in the UK (as it faces its triple-dip recession) - who sees the current policy is evidently failing, so he naturally concludes that there should not only be more of it, but it should become more brazen by veering off into the 'Weimaresque'.

While Japan's recent attempt to massively reflate and break out of its "liquidity trap" - an artificial construct to explain what happens when an artificial model, created by a flawed and artificial economic theory explodes in a singularity of Econ PhD idiocy leaving billions of impoverished people in its wake, is nothing new, there are those who are rather skeptical this latest attempt to achieve what Japan has not been able to do in over 30 years will work. And while one can come up with complicated, expansive, verbose theories based on Keynesian DSGE models and other such gibberish, why this time will be different for Japan, there is a very quick and simple argument why it won't.

The most vocal justification provided for the disappointing Q4 GDP print by the mainstream was an increase in US government "austerity" resulting in a decline in the government contribution to the economic bottom line in the last quarter (or first fiscal quarter of 2013). Ironically, both total spending and total debt issuance in the past quarter increased, which means that far from being austere, the US actually spent more, not less, i.e., the opposite of austerity. And while it is true that Defense spending declined by a tiny amount in the past quarter compared to the year ago, it was more than offset by a surge in Medicare and Medicaid, as well as Social Security, or, as they are better known, welfare. And, as the CBO yesterday showed, these two components of US spending, which together account for half of all US spending and which couldn't be funded by all US revenues even if the government spent $0.00 for all other programs, which will soar in the coming years as US society ages, as more workers retire, and as more are reliant on Uncle Sam for the payment of every bill. So the next time someone say that the US has a defense spending problem and nothing else, show them this chart.

How does the saying go: it is better to keep your mouth shut and be thought a clueless Keynesian muppet than to open it and remove all doubt? Sure enough, if there was any confusion as to the level of economic comprehension (or lack thereof) of Japan's chosen savior du jour, one who is hell bent on destroying its currency and sending energy costs into the stratosphere (but don't worry - as Rajoy would say, inflation is plunging, except for the things that are soaring) the following two snippets should clear up the situation once and for all.

Gold climbed $5.70 or 0.34% in New York yesterday and closed at $1,673.50/oz. Silver inched up to $31.86 in Asia, then it fell back to $31.38, and then rose to a high of $31.91, but eased off in afternoon trade and finished with a loss of 0.35%.

Gold rose to a new record nominal high on the TOCOM at 0.156 million yen per ounce. The resignation of Bank of Japan Governor, Shirakawa on March 19 is pressuring the yen as is increased tensions in the Pacific between China and Japan -  Japan accused China of targeting a Japanese naval vessel and helicopter.

This week's Barron's cover looks like a pretty strong warning sign for stocks (not only the cover, but also what's inside). However, there may be an even more stunning capitulation datum out there, in this case a survey that we have frequently mentioned in the past, the NAAIM survey of fund managers. This survey has reached an all time high in net bullishness last week, with managers on average 104% long. The nonsense people will talk – people who really should know better -  is sometimes truly breathtaking. Recently a number of strategists from large institutions, i.e., people who get paid big bucks for coming up with this stuff, have assured us that “equities are underowned”, that “money will flow from bonds to equities”, and that “money sitting on the sidelines” will be drawn into the market. These fallacies are destroyed below. And finally, while, theoretically, the “inflation” backdrop is a kind of sweet spot for stock, even to those who insist that stocks will protect one against the ravages of sharply rising prices of goods and services, As Kyle Bass recently explained, the devaluation of money in the wider sense was even more pronounced than the increase in stock prices. Stocks did not protect anyone in the sense of fully preserving one's purchasing power. The only things that actually preserved purchasing power were gold, foreign exchange and assorted hard assets for which a liquid market exists.

The practice of gold leasing has been endorsed by none other than Alan Greenspan, former Chairman of the Fed. The gold is leased to a bullion bank, which typically pays one percent interest to the Fed, with a promise to return it on a specified date. The bullion bank then sells the gold on the open market and uses the proceeds to buy Treasury bonds, which will net a three to four percent return. The nicest thing about such an arrangement is that the lessor continues to claim it on his balance sheet as a line item: “gold and gold receivables.” After all, an asset that we have leased out is still an asset, even if it has now been sold by the lessee. In effect, this means that, if you bought a gold bar today, it is possible that it is a bar that was shipped from the Bundesbank to the Federal Reserve decades ago and is presently listed by the Fed on its balance sheet as “gold and gold receivables.” Both you and the Fed are claiming to possess the same gold bar. The fly in the ointment, of course, is that only one bar can be the actual bar. The other is a receivable and therefore is an asset on paper only. This, of course, means that there is less gold in the world than has been claimed. How much less? That’s anyone’s guess.

Despite the modest weakness in the long-bond, that so many herald as the next coming of the Great Rotation meme, it would appear that the longer-end of the Treasury bond term-structure actually flattened quite notably since the start of the year. Whether this bear-flattening reflects less extreme long-term concern of hyperinflation (small odds but high impact at long-end), mid-curve-based hedging (January was a massive IG issuance month and MBS convexity concerns are growing), or lower long-term growth/inflation expectations is unclear. But given the Fed's foot on the throat of the short-to-medium-term Treasury term-structure, the longer-end remains a marginally 'free' market and based on the chart below implies equities are well ahead of themselves as we draw a line under January 2013.

My colleague and erstwhile nemesis Gonzalo Lira posed the question above in a recent essay, and it is indeed a most puzzling one.  Given that the world’s central banks — joined most recently by a shockingly reckless Switzerland — are waging all-out economic war by inflating their currencies, shouldn’t gold be soaring?

Several years after revealing the first one hundred trillion modern-day banknote and seeing its economy implode in a cloud of hyperinflationary smoke, Zimbabwe's problems are back with a vengeance. And this time not even more currency destruction, as Zimbabwe does not actually have its own currency any more having largely shifted to foreign currencies primarily the USD and the ZAR - can help. The problem? The country is officially out of cash. From AFP: "After paying public workers’ salaries last week, the balance in cash-strapped Zimbabwe’s government public account stood at just $217, Finance Minister Tendai Biti said Tuesday. “Last week when we paid civil servants there was $217 (left) in government coffers,” Biti told journalists in the capital Harare, claiming some of them had healthier bank balances than the state. “The government finances are in paralysis state at the present moment. We are failing to meet our targets.”" Sadly not even the projected and quite hilarious 5% GDP growth of the now completely broke country, which can't even create money out of thin air as there is nobody who will lend it even one penny, will do much if anything. (Here we will briefly ignore the fact that Zimbabwe's net cash position is about $120,000,000,000,217.00 greater than that of the US)

The economy as we know it is facing a lethal confluence of four critical factors - the fall-out from the biggest debt bubble in history; a disastrous experiment with globalisation; the massaging of data to the point where economic trends are obscured; and, most important of all, the approach of an energy-returns cliff-edge. Through technology, through culture and through economic and political change, society is more short-term in nature now than at any time in recorded history. This acceleration towards ever-greater immediacy has blinded society to a series of fundamental economic trends which, if not anticipated and tackled well in advance, could have devastating effects. The relentless shortening of media, social and political horizons has resulted in the establishment of self-destructive economic patterns which now threaten to undermine economic viability.

“Those are my principles,” Marx said.  “And if you don't like them... well, I have others.”