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The boom and bust cycle
This post was first published at Bawerk.net. You may also follow us on @EBawerk
As is clear to all with half a brain the production of un-backed fiat money distorts the economic system. Simply told, when an entity in society is given monopoly to manufacture medium of exchange at its own discretion they will harness this power. Slowly at first, unsure about its effects, but always testing the limits of the privilege bestowed upon them.
As always, they will overexploit the power. They will manufacture money and give it to the masters that coercively secure the continuation of the power. The masters will obviously spend the money, creating a transaction in which nothing is payment for something. These transactions are by definition unsustainable because they violates Say`s law. We call them “bubbles”
In a free market supply is used to create its own demand. When people spend fiat money they exercise demand without providing supply. Said in other words, spending fiat money is tantamount to capital consumption and makes society poorer.
While the boom that follows money spending feels good, it must inevitably come to an end because the economic system cannot maintain the constellation that was induced by the money printing in the first place. Within the boom lays the seed for the necessary bust.
We have made a metric that sums up fiat money in its purest sense and compared that to the underlying trend growth of nominal GDC.
Our hypothesis is simple: if money growth exceeds the GDC metric a deflationary busts will inevitably come. If authorities refuse to accept reality and print more fiat money at the first sign of bust, they may “save the day” but they will “ruin tomorrow”!
For every action taken there will be an equal and opposite reaction! When the fiat masters go too far they create the set-up for an imminent deflation.
We looked at this relationship and as the chart below show, a boom-bust cycle based on monetary expansion is clearly visible.
Source: Federal Reserve of St. Louis (FRED), own calculations
Our main concern is obviously what happens when the equal, but opposite reaction comes as a consequence to the monetary experiment dubbed the “Bernanke-put”.
A secondary concern is indirectly derived from this. Money printing tears the social fabric apart and people react by taking up massive amounts of debt; debt that will never be repaid in currency units of equal purchasing power.
Now, if the equal reaction comes, that will raise the real burden of outstanding debt, which consequently will bankrupt all debtors.
The next chart looks at various sovereigns’ roll-over risk for 2014. The exceptionally large amount of debt taken on since the financial bust in 2008 will forever constitute a massive risk for the issuing country as debt is never repaid, only rolled-over, that is old debt is paid with new debt.
Source: Bloomberg, International Monetary Fund (IMF - WEO), own calculations
By this it is obvious to us that deflation simply cannot be allowed to happen! Our monetary masters will lose everything if they even flirt with the mere idea! Witness the taper scare this summer!
And since we are getting close to the next cycle low, why even bother try.
Source: National Bureau of Economic Research (NBER), Bureau of Labor Statistics (BLS), own calculations
Concluding Remarks
We leave the last word to the real Maestro
"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises
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Great to see the work of Bawerk and Mises here. It encourages we believers, and will be documented, so those who don't understand will have the ability in the future to come back and research what happened to them.
Also remember Volker era. 30 year bond and CD's at 18- 20 percent interest rate sounds good to me----bring it on! Screw all those that live beyond their means
What goes up will come down. I remember what happened during the Volker tightening; real estate deals became hard to finance and assumptions recieved premiums. Might do well to put an assumable note on realty. It would be a hedge to the coming inversion. Partition the property and have partial interest sales; take advantage of the assumption premium while retaining the controlling interest.
I thought Alistair Macleod invented the FMQ
http://www.financeandeconomics.org/interview-with-max-keiser/
Well, when Japan goes, it'll be fascinatin'
Ok...so assuming that the current printing goes on for another year, we can expect a continuation of the current bogus but rising market conditions? And can we assume that smart people will be piling into gold as they look towards the train wreck that is coming? So we stay fully invested but with one hand on the sell button and accumulate gold/silver along the way? Is this the game plan that we should take from this?
Everything goes down in deflation except the USD. I tend to agree with the article that deflation will be the ultimate outcome not inflation (Though a hyperinflationary move could happen afterward) but I know a lot of folk here are 180 the other way. IMO best way to play this since no one knows when the monster called the FED will die is this.
1.) Have an allocation of good stock you can live with, with an option floor beneath it. Go a year out and something that will protect you if it blows up. 25% to 33% allocation. This will keep you above inflation until the train ends.
2.) Have some allocation to Physical metals, 10% to 20%. Let's face it if deflation happens you wont get wrecked on this but if somehow a Zimbabwe deal comes, does it really matter if you have then a net value of 1M in physicals or 10M? All you should worry about is relative wealth which is that case would make you in the top 5% of wealthiest in the world. Thats good enough for me and I wont get gutted if deflation happens first.
3.) Have some land. I know this may be too much for most people but if you can have 10% in land that would be ideal, if not you will have to make due
4.) Have Cash, lots of it and try to have it in a couple different of different currencies. When deflation happens you will have at least 50% of your money available to buy everything at rock bottom prices. And believe me there will be a lot. Those that believe the USD is going away thats fine. I respect your opinion, I just have a different view though as my physicals hedge suggests, I am not saying it cant happen.
5.) Always always have a hedge somewhere or at leat be prepared to lay one in at a moments notice.
To me it is always relative wealth that matters. I could care less about money but how much money I have compared to others. You just want to be in the top 10% or higher which I have been lucky enough to have been for some time.
Note, any one could be wrong and I certainly could be but I think a plan like this makes everything feasible no matter what the outcome. Unless of course Obama decides to put us into Nazi slave camps... Thats another chapter.
I wish I could sell debt that I made in my basement out of paper and ink.
I'd be styling hard, dude.
Wait...You mean I don't even need paper and ink and I can do with a computer?
Awesome. Party at my house.
The Dude's National Bank. Free bong with every new account.
With the price of inkjet cartridges these days you'd still go broke!!
What is GDC?
Sir,
Whenever we talk about GDP we say gross domestic consumption or GDC. We wrote why here http://bawerk.net/?p=54
But even GDC is not an ideal description. GDP, or GDC is actually a measure of inflation. It is the amount of money spent on goods and services within a specified period of time.
GDP/GDC measures base money, banking leverage and velocity.
Regards
Bawerk.
I think the author is comparing GROSS DOMESTIC (Private) CONSUMPTION, which is one of the components of GDP.
This piece is very unclear and apparently contradictory internally. The writer tries to build on the Von Mises quote inappropriately. Von Mises developed a very mechanical analysis which has been favored by anti-government activists and others who use so-called "free market" propaganda. First of all, it is possible to halt a credit expansion by means of "government" intervention. Paul Volcker did it in the 70's. Secondly most "free market" propagandists are hypocrites who love nothing better than a sweet monopoly or oligopoly brought about by sheer size and control of the media.
Sir,
Read the Mises quote again. He says you may end the expansion voluntary, as Volcker did and as we show he did in our first chart, but that lead to severe hardship.
Interest rates were raised to 20 per cent and the only reason the US government could allow that was because the US was a net creditor while the government had low debt and modest deficits compared to today.
A voluntary abandonment today will be much harder. In fact we think it will be so painful that our masters will not dare try.
Regards
Bawerk
Thank you for the clarifications which I agree are valid. I would only point out that the "hardship" caused by Volcker's intervention, while real (and unavoidable), was far less than the massive unemployment caused by the absence of regulation in the period 2001-2007. I would also agree with those who point out the abuses that arise in government programs aimed to ameliorate the effects of unemployment. Adjustments where required and heavy auditing are the answer, not abolition.
What role does velocity play in FMQ?
Sir,
Simple and short answer; a lot!
Velocity today is very low and hence the destructivness of current monetary policy limited. This could easily change in the near future and will be completely outside Yellens control.
Six to 12 months after our masters say we reached full recovery price inflation will reach double digits.
Regards
Bawerk
Wow.
That top chart is pretty scary.
Does it mean that that giant green area will be followed by a red area of equal or greater size?
I like charts with pretty colors.
No, it does not! When debt is defaulted, you come back to zero. The amplitude does not mean anything. This is a point that most people do not get: DEBT is not generational, you don't borrow from the future--you borrow from yourself and the present.
Future generations will be debt-free, it's the NOW generation that will suffer the consequences of fiat printing until the cycle repeats itself.
We borrow from the future by making a promise to repay with future revenues and failing to honour that promise. This reduces the borrowing ability of our following generations.
Sir,
We partly agree. The current generation may enjoy a higher standard of living by consuming accumulated capital. This makes the next generation relatively poorer and we may say it was borrowed from the future.
Of course it is impossible to consume future production, but by consuming more than we produce today the underlying capital stock is affected.
Regards
Bawerk
Very good, you don't borrow from the future, as everybody keeps on insisting ad nauseum. Debts and assets always balance (cancel), so only the relative distribution persists (or simply does not).
But in the case of the USA, future generations may have significantly less purchasing power in global markets than is the case today. The fact that a house or hotel or a lettuce is worth only 1% as many dollars in Africa as the same good in the USA is an artefact of the terms of trade (and limitations in exchanging houses and lettuce), and not a property of the good itself. The terms of trade have in turn been determined by the relative productivity, which in turn is largely determined by availabe resources and the amount of productive capital (plant, infrastructure, skill).
But the terms of trade do not necessarily shift gradually; as with a see-saw, moving a weight along the board can cause a sudden reversal of equilibrium. The equilibrium is the financial (credits/debts) and political superstructure; the weight is actual consumption and production.
Sooo, what you're saying is that a society that consumes waaay more than it produces will fail? Who knew? I am in America, but I don't call myself an American anymore. Almost everyone I know works for gubmint or their contractors/subs. They proudly spend their days moving sheets of paper from stack "a" to stack "b", or ensuring that anyone who desires the independence of self-employment is properly "regulated". They cannot or will not comprehend that what they do is unnecessary and often detrimental, eventually, to their own well being. To top it off, they're generally compensated at a substantially higher rate than their counterparts in the ever shrinking private sector.
You're absolutely right that we're not borrowing from future generations. When I die, any debt I may have dies with me. Our gubmint, however is only too happy to borrow in my name, my progeny's name, their progeny's name, etc:. My gut tells me the national credit card is about to be declined, and this is when things get interesting.
So death of a currency it is...
Would killing the dollar be considered self-defense?
"Would killing the dollar be considered self-defense?"
You can't kill what's not real.
It is not the problem of "fiat" as initially stated. The problem lies with expanding credit extensively without any true assets to back the debt. Endless rehypothecation and loans based on wishful thinking. The unpayable debt is being papered over with new debt. No one has the ability to pay back the loans so the Ponzi collapses.
That is the very essence of a fiat currency backed by nothing at all and the surrender of any limitations on credit.
Theory of Money and Credit by Ludwig von Mises available at www.mises.org
the system is designed to fail and enslave because only the princaple is created not the interest.
so its a game of musical chairs until the whole game is over unlike the gold standard.
one system was crated by free men the other jews you figure out which.