Jesse joins Charles Hugh Smith and Gonzalo Lira in assessing which flation will win. He is currently in the stagflation camp with a leaning toward the hyperinflation possibility. He certainly isn’t in the deflation camp.
16 April 2011
Well, the good news for everyone is that nothing seems inevitable here, that there is almost always a choice, but it is often wrapped up in a nice looking rationale, with all the compulsion of a necessity, for the good of the people. Us versus them in a battle for survival and all that. And clever leaders on the extremes provide the ‘them’ to be dehumanized and objectified. The leftist wishes to murder the bankers, and the fascist the lower classes and outsiders. The extremes of both end up making life miserable for almost everybody except for a privileged few.
And so I reiterate that in a purely fiat currency, the money supply is indeed fiat, by command.
People like to make arguments about this or that, about how so and so has proved that the Fed does not or cannot do this or that, that banks really create money only by borrowing, that borrowing must precede this or that.
It’s mostly based on a fundamental misunderstanding of what money is all about, with a laser beam focus on hair-splitting technical definitions and loquacious arguments more confusing than illuminating, lost in details. In a simple word, rubbish.
Absent some external standard or compulsion, the only limiting factor on the creation of a fiat currency is the value at exchange of the issuers bonds and notes, and currency which is nothing more than a note of zero duration without coupon.
If I had control of the Fed, unless someone stopped me I could deliver to you hyperinflation or deflation without all that much difficulty from a technical standpoint. The policy reaction of those who might be in a position to fire or lynch me is another matter. The Fed not only has the power to influence money creation in the private banking system. It has the ability to expand its balance sheet and take on existing debt of almost any type at will and at any price it chooses.
But that is the case as long as the Fed has at least one willing partner in the primary dealers, and the Treasury is in agreement. And even that requirement for a primary dealer is not all that much of an issue given the amounts of existing sovereign and private debts of which the Fed might avail itself for the forseeable future.
So at the end of the day, a thinking deflationist is almost reduced to the argument that ‘the authorities will not allow it’ or ‘will choose deflation rather than inflation’ And this is technically correct. However, let us consider my earlier statement about those who might fire or lynch one for making a highly unpopular choice.
It is economic suicide for a net debtor to willingly engage in deflation when they have other options at their disposal, and especially when those decisions involve people outside the system.
That is not to say that the deciders could not opt for economic suicide, but the people designated to suffer and die for that choice and cause might not take kindly to it. Deflation favors the creditors significantly, and those creditors tend to be a minority of domestic elites and foreign entities. Both the extremes, hyperinflation and deflation, are choices best implemented in autocratic governments.
There are those who observe that Franklin Roosevelt ‘saved capitalism’ by his actions in the 1930′s and I believe they are correct. If one considers the various other outcomes in large developed nations to the Great Depression, whether it be Italy, Germany, Russia, or Spain, the US came out of it fairly intact politically. People conveniently overlook the undercurrent of insurrection and violence that was festering amongst the suffering multitudes, and the growth of domestic fascist and communist organizations. There were several plots to overthrow the elected government by military means, although the history books tend to overlook them.
So it is really about making the best choice amongst bad choices. This is why governments choose to devalue their currency, either with quantitative easing, or explicitly against some external standard as the US did in 1933. Because when the debt is unpayable, it must be liquidated, and the pain will be distributed in a way that best preserves the status quo.
Hyperinflation and a protracted deflation are both very destructive choices. So therefore no rational government will choose either option.
They *could* have those choices imposed upon them, either by military force, political force, or by economic force. Economic force is almost always the cause of hyperinflation.
So you can see why a ‘managed inflation’ is the most likely outcome at least in the US. The mechanism has been in place and performing this function for the last 100 years.
The problem or twist this time around comes when the monetary stimulus does not increase jobs and the median wages, because of some inherent and unreformed tendency in the economy to focus money creation and its benefits to a narrow portion of the populace. The result of this is stagflation which although not indefinitely sustainable can be maintained for decades. Most third world republics are like this. A vibrant and resilient middle class is sine qua non for a successful democratic republic, and this has strong implications for the median wage. The benefits and the risks of growth and productivity must be spread widely amongst the participants. Oligarchies tend to spread only the risks, keeping most of the benefits to themselves.
This is essentially the reasoning that occurred to me when I looked at the US economy and monetary system in the year 2000.
The one point I remain a little unclear on is how ‘hard’ the law is regarding the direct monetization of debt issued by the Treasury. I am not an attorney, but I am informed by those familiary with federal statutes that this is a gray area in the existing law but currently prohibited. But it is easily overcome as I said with the inclusion of one or two amiable primary dealers who will allow the debt issued by Treasury to ‘pass through’ their hands in the market, on its way to the Fed at a subsidized rate. For this reason, and for purposes of policy matters, and occasional economic warfare, countries may tolerate TBTF financial institutions with whom they have ‘an understanding.’
I have also come to the conclusion that no one knows the future with any certainty, so we must rely probability and risk management to guide our actions.
So really absent new data the argument is pointless, a matter of uninformed opinions. The dollar will continue to depreciate, and gold and silver and harder currencies appreciate, until the fundamental situation changes and the US economic system is reformed.
I think there are other probable outcomes that involve world government and a currency war, and this also is playing out pretty much as I expected. Fiat currency can take on the characteristics of a Ponzi scheme, whose survival is only possible by continuing growth until all resistance is overcome.
This is the conclusion I came to in 2000. I admit I was surprised by the Fed’s willingness to create a massive housing bubble, and the willingness of the US government to whore out the middle class in their deals with mercantilist nations; their hypocrisy knows no bounds.
So that is the basis of much of my thinking and I wanted to take a moment to share it with you in a compact, highly condensed format.
I remain a little unsettled on the issue of hyperinflation, because there is the possibility that a large bloc of countries could join together to repudiate the dollar. Since so much dollar debt is held in these foreign hands, that is the kind of exogenous force that could trigger a bout of what might be termed hyperinflation. I don’t see the dollar going to zero in this, but rather the dollar having a couple of zeros knocked off it, with a new dollar being issued. I have read John Williams case for hyperinflation several times now, and see nothing more compelling in it.
Indeed I think the reissue of the dollar with a few zeros gone is inevitable. It is the timing of that event that is problematic. It could be one year, or it could be fifty years. There is a big difference there for your investment strategy.
And yes, the government could just get medieval on your asses, and seize all the gold and silver, force you to take the value of the dollar at whatever they say it should be. They could also seize all the farm land, all the means of production, and tell certain groups of people to get on freight trains for resettlement in Nevada. I think we can stipulate that governments can do this, and the people can accept it to varying degrees. If you wish to make this the dominant assumption in your planning then by all means.
For those who simply say “I disagree” or “Go read so and so he has proved this or that” I say that people believe lots of things, and can find data selectively to support almost any outcome they prefer, But the market is the arbiter here, and the verdict so far is beyond all question. The Fed is doing exactly what they said they would do, so there should be no surprises. And they have more in their bag of tricks.
If there is new data I would certainly adjust my thinking but absent that I now consider this settled to my satisfaction, and wish to turn instead to more thinking on what changes need to occur to prevent the system breaking down, and restoring it to some semblance of reasonable functionality.
The Watchdog says:
Break out your bell bottoms and put on some KC and the Sunshine Band. It’s the ’70′s all over again. I loves me some Mila Kunis from That ’70′s Show…
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16th April 2011 at 12:06 am
Reverse Engineer says:
I’ll pick Door 2 Monte.
RE
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16th April 2011 at 12:25 am
cahuitabeachbound says:
Then Came Bronson
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16th April 2011 at 12:42 am
ecliptix543 says:
Then came Reagan…
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16th April 2011 at 9:22 am
Surly1 says:
Really interesting article. Jesse may well be right:
“So you can see why a ‘managed inflation’ is the most likely outcome at least in the US. The mechanism has been in place and performing this function for the last 100 years.”
Am thinking that there is still plenty of residual wealth in the hands of the middle class that can still be squeezed out for the benefit of the 1 per centers, given a long enough time frame. “Managed inflation” will do this very nicely.
“The problem or twist this time around comes when the monetary stimulus does not increase jobs and the median wages, because of some inherent and unreformed tendency in the economy to focus money creation and its benefits to a narrow portion of the populace. The result of this is stagflation which although not indefinitely sustainable can be maintained for decades. Most third world republics are like this.”
Sounds familiar, and seems to be unfolding before our eyes. A 7-12 per cent inflation rate will cook off people’s cash at a slow enough rate so that people will bitch about prices much in the same way they do about the weather, but not be moved to riot in the streets. Frog slow-cooking in the pot…
“A vibrant and resilient middle class is sine qua non for a successful democratic republic, and this has strong implications for the median wage. The benefits and the risks of growth and productivity must be spread widely amongst the participants. Oligarchies tend to spread only the risks, keeping most of the benefits to themselves.”
Deja vu, anyone?
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16th April 2011 at 10:14 am
anonymous says:
It’s a test.
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16th April 2011 at 11:16 am
Welshman says:
We have two saying what is going to happen, and Jesse says stagflation maybe. So the things that one needs for survival are going to inflate, and shit you don’t need will be cheap. Sound like the most likely sernario, and a death sentence for old poor folks.
Maybe Casey should start a time-share convalescent hospital in Argentina.
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16th April 2011 at 11:18 am
acjitsu says:
There will be a brief period of deflation as QE2 “ends”. Enter QE3. When the market recognizes this insanity, interest rates will rise, metals will explode, housing, stocks will “deflate”. The elite will have plenty of gold and silver related assets and buy everything else up on the cheap. So we will have simultaneous inflation, the subsequent devaluation of the dollar, and deflation in everything else. The elites know this and will profit handsomely from it while Joe Q public pays the elite back for their fraudulent behavior through high inflation and increased tax burden. Bend over and be prepared to take a chain saw in the rear… That’s my take…. When has there been any real deflation post the Gold Standard? As some say, History doesn’t repeat itself but it often rhymes….
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16th April 2011 at 11:27 am
Welshman says:
Acijtsu,
So your theory is the “Chainsaw Economy”. I hope I can take that sitting down please.
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16th April 2011 at 12:00 pm
efarmer says:
I want deflation so I can get that lake house on the cheap.
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16th April 2011 at 3:34 pm
Zara says:
” I think the reissue of the dollar with a few zeros gone is inevitable. It is the timing of that event that is problematic. It could be one year, or it could be fifty years.”
He’s really going out on a limb here…
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16th April 2011 at 4:24 pm
Reverse Engineer says:
Latest from TAE
RE
Sunday, April 17, 2011
April 17 2011: Bailing Out The Thimble With The Titanic
Ilargi: The European Union is home to over 500 million people. Only 4.7 million of them live in Ireland. But they have still needed massive bail-outs from the EU, and will likely need more. Greece has 11.3 million inhabitants, Portugal 10.6 million. The former has been bailed out already, the latter has now officially applied to be next in line for a bail-out.
Another small nation, Finland, with 5.3 million people (barely more than 1% of the EU population), threatens to throw a big fat monkey wrench into all the works of Brussels finance. The True Finns party is slated for a major victory in today’s elections, they may even emerge the biggest party, and their campaign was based on no more bail-outs, period.
On Friday, Britain announced it wants no part of a new European emergency facility, the European Stability Mechanism, which is supposed to be ready by 2013. These developments will make it much harder to keep Europe together. And as long as Europe has no better answers to the financial crisis than the US has, i.e. mass transfers of public funds to failed banks, all of it facilitated by fraud accounting, why should any nation volunteer to participate in any of these schemes? Not one single common citizen will emerge any the wiser or better off from them. Quite the contrary.
In America, there is a very interesting video from Eric deCarbonnel, which very clearly shows the Federal Reserve executing fraudulent actions, in this particular case by selling put options on its own debt. The Automatic Earth staff writer Ashvin Pandurangi discusses deCarbonnel’s findings. Ashvin also explains why he draws different conclusions from the material presented by deCarbonnel than does Tyler Durden at Zero Hedge.
——————————————————————————–
Ashvin Pandurangi:
Bailing Out The Thimble With The Titanic
Dr. Steve Keen, the ever-insightful Australian economist who runs the Debt Deflation website, wrote an excellent piece in March of 2009 entitled Bailing out the Titanic with a Thimble. It essentially argued that the U.S. government’s fiscal stimulus and the Fed’s liquidity injections would be wholly insufficient to restart growth in the private credit markets, and so far this analysis has been spot on.
Ilargi and Stoneleigh, who run The Automatic Earth, have also been preaching this same message for several years now, and have repeatedly stated that the U.S. dollar and Treasury market would be the beneficiaries of the debt deflationary trend. It was most recently repeated in Ilargi’s latest post, Our Prosperity is Owed Back Plus Interest.
Yet, since late 2010, it would appear on the surface that long-term Treasury rates have been inching upwards and that commodity prices have been going through the roof. This superficial trend has led many commentators to “double down” on their predictions of a Treasury market collapse and imminent hyperinflation of the dollar.
Some people point to sustained oil price increases as evidence of their predictions, but, as mentioned before, that trend has been wholly discredited as a byproduct of actual monetary inflation. It is merely a result of the Fed exporting speculative debt to investors worldwide, who fully take advantage of the “speculative” part by betting on increases in the prices of equities and commodities.
Other people have been focusing more on the Treasury market aspect, pointing to Pimco’s net short position on U.S. Treasuries and the brief trend of rate increases as evidence of imminent chaos in the market. Of course, they can also point to the fact that the federal government is running record deficits to allegedly support the private economy, with no real end in sight.
As The Automatic Earth has repeatedly cautioned, however, what matters most right now are the systemic dynamics of deterioration in private finances and social mood, rather than the fundamentally unsustainable nature of deficit spending. A major component of these dynamics is the monetary objectives and policies that will be undertaken by the financial elites through their proxy, the Federal Reserve.
Last week I wrote two pieces regarding this component, Jumping the Treasury Shark and Bill Gross: Master of Monetary Psy-Ops, and, specifically, about why the elites desperately want to maintain stability in the Treasury market, and how Pimco’s sharp reduction in Treasury exposure is most likely not a long-term bet against the market.
Today, we get a dose of healthy confirmation through a video report by Eric deCarbonnel at Market Skeptics, entitled:
FRAUD: Federal Reserve Is Selling Put Options On Treasury Bonds To Drive Down Yields:
It is featured in a Tyler Durden piece on Zero Hedge named Doubling Down To (DXY) Zero: Has The Fed, In Its Stealthy Synthetic Bet To Keep Long-Term Yields Low, Become The Next AIG? In essence, it reveals some strong evidence to suggest that the Federal Reserve is already, or is actively considering selling large amounts of protection against Treasury rate increases (Put Options) to various investors as a means of controlling the long end of the Treasury curve (which, as per deCarbonnel, is illegal). Indeed, the Fed actually used this shell tactic back in 2000, as explained by Vince Reinhart, who was Fed secretary and economist at the time [1]:
The System has also been willing to put its balance sheet at risk to encourage appropriate expectations about interest rates or to calm fears about funds availability. As plotted at the top right, the Desk sold options on RPs for the weeks around the century date change that totaled nearly $0.5 trillion of notional value. Given that the Desk already operates in all segments of the Treasury market, we wouldn’t have to move up a learning curve if instructed to increase purchases of longer-dated issues.
We find out that there is, in fact, no need for the Fed to “move up the learning curve”, step up its game and scale up the walls of the Treasury curve with multiple trillions worth of gross sales of interest rate swaptions. That essentially means that there is no desire on the part of financial elites to let long-term rates rise significantly or to let the Treasury market destabilize, and, on top of that, they are in the process of leveraging themselves to the point of absolutely no return.
The question then arises, however, of whether they will actually be successful in “pinning” long-term rates for a few years, or whether “Operation Swaption” is a time bomb set to detonate within the next year, when rates significantly increase in response to sovereign default and/or inflation concerns.
The analysis from Zero Hedge would suggest that the latter is a very likely possibility, as implied in the article’s title. Tyler Durden suggests that the Fed may be the next AIG, except without anyone big enough waiting in background to bail them out of their misery:
Alas, that [the Fed's printing press] will have no impact whatsoever, if indeed the Fed has been reduced to finding ever fewer counterparties to a synthetic bet to keep long-term rates low, as very soon, with inflation ticking up, all hell may break loose in an identical replay of what happened to AIG once the Fed’s put is called against it. [2].
Durden is making the assumption that there will be ever-fewer incremental buyers of Treasury bonds, and therefore fewer investors that would want to hedge their Treasury exposure by buying protection from whichever primary dealer bank (most likely JP Morgan) is acting as a front for the Fed. He is also assuming that inflation will “tick up” very soon, causing rates to increase and forcing the Fed to make good on their massive bets, which they simply cannot do, because it would expose them as being the underlying counter-party to the trade. Indeed, that would most likely trigger a self-reinforcing dumping of Treasury bonds and a set of events that would ultimately result in a full-blown currency crisis.
There are two major flaws that I perceive in these assumptions, however, with the first being that rising prices (what he calls “price inflation”), primarily for energy and food, will continue increasing as it has been over the last year or so. This argument has been addressed and largely discredited numerous times by The Automatic Earth, and even Zero Hedge itself has suggested, back in February, that the exact opposite may occur in the short-term.
This occurred in an article that was the focal point of a piece I wrote shortly after it was published, Exporting Speculative Debt. The Zero Hedge piece contained the following argument regarding a peak in total margin debt used by hedge funds, and the lowest level of free cash since 2007, when the latest credit bubble also peaked:
At ($45.9 billion) this number is just below the ($52.8) billion last seen just before the August 2007 quant wipe out which blew up Goldman’s quant desk, and arguably was the catalyst for the beginning of the end. In other words, as we have shown, everyone is now purchasing on margin and the level of investor net worth is the lowest in over 3 years. Which means that should the market decline from this week persist and the Fed be unable to stop it, the margin calls will start coming in fast and furious, and unwinds in otherwise stable products like gold and silver are increasingly possible as hedge funds proceed to outright liquidations. [3].
That leads us to the second assumption, that the Fed will not be able to “pin” down long bond rates because there will not be enough incremental buyers of Treasuries seeking to also hedge their exposure. When global equity and commodity markets begin their downward cascade in response to the ongoing debt deflation and a temporary end to quantitative easing, margin calls will indeed be coming in fast enough to make your portfolio spin. The demand by institutional investors for a “safe haven” will emerge as quickly as the daylight descends into pitch black, and it will then become clear that the intent was never to bail out the Titanic with a thimble, but the other way around.
The bond markets of Japan and Europe simply can’t make the grade, and, as referenced in Jumping the Treasury Shark, there really isn’t enough gold to soak up all of that capital. Instead, the U.S. dollar and Treasury bond, because of their fundamental weakness, will be the refuge of choice and design, and this will also serve to aid the Fed’s Mafioso protection scheme for controlling rates. The world has been flooded with dollar-denominated debt for decades, right up until now, and soon all of those liabilities will come pounding on the front door. And who will answer? Why, the Fed and the financial elites, of course.
They will invite the debt deflation in with open arms, because now they are holding vast sums of cash, and Treasury bonds that simply cannot go bad. It will simultaneously be used as a justification for “gradual” austerity measures targeted at the middle and lower classes, as the public deficit will remain elevated to finance further bailouts of the financial elite class and brutal military operations for resources. The insidious shell game and unprecedented transfer of wealth will continue on, at least for some significant period of time, before the fires set by the elites burn out of control and finally engulf them.
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16th April 2011 at 9:37 pm
Market Shadows - Life vs. Stock Market says:
[...] “The problem or twist this time around comes when the monetary stimulus does not increase jobs and the median wages, because of some inherent and unreformed tendency in the economy to focus money creation and its benefits to a narrow portion of the populace. The result of this is stagflation which although not indefinitely sustainable can be maintained for decades. Most third world republics are like this. A vibrant and resilient middle class is sine qua non for a successful democratic republic, and this has strong implications for the median wage. The benefits and the risks of growth and productivity must be spread widely amongst the participants. Oligarchies tend to spread only the risks, keeping most of the benefits to themselves.” (DEFLATION, HYPERINFLATION OR STAGFLATION) [...]
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16th April 2011 at 1:14 am
Market Shadows Newsletter (7/1) | marketshadows says:
[...] “The problem or twist this time around comes when the monetary stimulus does not increase jobs and the median wages, because of some inherent and unreformed tendency in the economy to focus money creation and its benefits to a narrow portion of the populace. The result of this is stagflation which although not indefinitely sustainable can be maintained for decades. Most third world republics are like this. A vibrant and resilient middle class is sine qua non for a successful democratic republic, and this has strong implications for the median wage. The benefits and the risks of growth and productivity must be spread widely amongst the participants. Oligarchies tend to spread only the risks, keeping most of the benefits to themselves.” (DEFLATION, HYPERINFLATION OR STAGFLATION) [...]
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16th April 2011 at 1:55 am
Market Shadows Newsletter says:
[...] “The problem or twist this time around comes when the monetary stimulus does not increase jobs and the median wages, because of some inherent and unreformed tendency in the economy to focus money creation and its benefits to a narrow portion of the populace. The result of this is stagflation which although not indefinitely sustainable can be maintained for decades. Most third world republics are like this. A vibrant and resilient middle class is sine qua non for a successful democratic republic, and this has strong implications for the median wage. The benefits and the risks of growth and productivity must be spread widely amongst the participants. Oligarchies tend to spread only the risks, keeping most of the benefits to themselves.” (DEFLATION, HYPERINFLATION OR STAGFLATION) [...]
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16th April 2011 at 12:19 am