My unpublished (100,000 word) book “The Financial Jigsaw”, is being serialised here weekly in 100 Issues by Peter J Underwood, author
Quote of the Week: “It is the absence of facts that frightens people: the gap you open, into which they pour their fears, fantasies, desires.” – Hilary Mantel
Last week we looked at further examples of inflation models and more thought experiments to illustrate how difficult it is to build effective inflation and deflation models in a multi-product economy. Here is the link to last week: Issue 47
Stock Buy-backs and its effects on asset inflation
We have already looked at this subject but it again raises its ugly head as the markets continue to swoon and we go into the new quarter; this could mean inflation down the track:
“What this means is the following: with buybacks having become the most important marginal buyer of stocks, the one trading desk that dominates the daily flow of buybacks – which amount to just under $3 billion in gross purchases each and every day – has more influence on the overall market than even the NY Fed.
And the person who controls that trading desk will be the most powerful person on Wall Street. Meet Neil Kearns – a name few have ever heard of – certainly not a name on par with Stevie Cohen, Israel Englander, Larry Fink, Lloyd Blankfein, Jamie Dimon, Bill Dudley or any other hedge fund billionaire that is part of the Wall Street folklore – [he] is the head of Goldman Sachs’ corporate trading desk:”
https://www.zerohedge.com/news/2019-04-13/interview-most-powerful-man-wall-street
Now that Brexit might be coming to a conclusion after almost three years I will continue to provide weekly updates as events progress:
Brexit Update – 19th April 2019
Parliament is in recess so little to report on this front at present. They are all happily off on their holidays to exotic places as befits our endangered leaders. Let’s hope they enjoy the rest because when they get back all hell is going to be let loose. Why? If Theresa May and Jeremy Corbyn continue to engage in head-to-head discussions with no effective outcome then the European elections in UK on 23rd May will go ahead and the Tory government is going to be slaughtered.
The Brexit deadline to 31st October 2019 remains in place unless the PM can get Parliament to agree an exit plan beforehand – at present this looks unlikely. But with a review at the end of June with a decision to leave passed by Parliament by 22nd June, the UK will avoid confirmation of the EU elections having taken place on 23nd May 2019.
AND an extract from ZeroHedge:
“Over in the UK, as everyone starts thinking about chocolate eggs, there has still been no Brexit breakthrough. Rather, talks between Labour and the Tories over a Brexit compromise are apparently close to stalling, as should come as no surprise to anyone who knows UK politics; Tory plotters are working to undermine PM May’s authority even further; and there are warnings from Germany that there will be no further extensions to Brexit after October. Mr Market is having none of this, however, and GBP remains around 1.30”.
Details of Parliament’s deliberations can be found here:
The launch of the new ‘Brexit Party’, headed by Nigel Farage, passed successfully this week and with nearly 1,000 applications to be a candidate for the EU elections they have plenty of choice for some sterling personalities to challenge the wilting Tory Party and the non-starter Labour Party with their failure-in-chief, Jeremy Corbyn, dragging down their vote, as well as the Tories imminent demise:
While we are on the subject of Brexit, this article might be worth a visit as it describes what perhaps divides the Leavers and Remainers with such ferocity:
https://off-guardian.org/2019/04/10/what-divides-brexiters-and-remainers/
CHAPTER 9
Inflation & Deflation
“There are known knowns; there are things we know that we know. There are known unknowns; there are things that we now know we don’t know. But there are also unknown unknowns; there are things we do not know we don’t know” The original source of this koan may be ‘Landmark Education of Seattle’, Washington; although generally it is attributed to former US Defence Secretary. – Donald Rumsfeld
“There are three kinds of lies: lies, damned lies, and statistics” – Mark Twain
“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value” – Alan Greenspan
The Austrian school of economics has sound answers
I am a supporter of the Austrian school of economics which has always claimed: “fear the boom, not the bust.” It is in boom times when periods of rapid economic growth sow the seeds for a crushing collapse, as experienced in 2008 following the 2001-07 expansion ‘bubble’, which burst with serious consequences.
It may be claimed officially that today we continue to suffer these consequences by having been in a period of ‘disinflation’ (reduction in the rate of inflation) not to be confused with deflation (negative overall inflation) which I contend we have in fact suffered for at least ten years.
In the same way that our politicians claim to be ‘reducing the deficit’ but are not reducing the overall government debt; disinflation is a reduction in the rate of inflation rather than actual deflation which is the reverse of inflation. Austrian economic models will be discussed in Chapter 11 – Macroeconomics 101 in a few months’ time.
Inflation and the velocity of money
Inflation is accumulative, in the same way that debt accumulates over time, so that a measured annual rate of inflation compounds on a previous year’s inflation and results in a serious loss of purchasing power, sometimes over short periods of time. For example, if last year the rate of inflation was 10% per annum and this year it falls to 9% per annum we can say that we are in a period of disinflation; likewise if inflation suddenly falls to -1% then we can say deflation has occurred in that year but either way, over say five years, inflation has continued its ominous trend; a compounding effect.
However there is another aspect to inflation which is not always obvious and has to do with the ‘rate at which money moves through the economy’ and described by economists as the ‘velocity of money’. A simple equation links four variables associated with inflation caused by the changes in the supply of money which was proposed by the economist, Irving Fisher in 1911: M x V = P x Q; where:
- M is the total dollars in the nation’s money supply,
- V is the number of times per year each dollar is spent (velocity of money),
- P is the average price of all the goods and services sold during the year,
- Q is the quantity of assets, goods and services sold during the year.
This formula is purely theoretical and does not take into account one of the most important influences on economies: that of the combined effect of each individual’s behaviour otherwise known as the ‘aggregate of demand’, and now part of ‘behavioural economics’.
We see that each term is defined by the values of the other three. Unlike the other terms, the velocity of money has no independent measure and can only be estimated by dividing PxQ by M. Some supporters of this ‘quantity theory of money’ claim that the velocity of money is stable and predictable.
It is suggested that it is determined mostly by financial institutions. If that assumption is valid then changes in M can be used to predict changes in PxQ. If this is not true then a model of V is required in order for the ‘equation of exchange’ to be useful as a ‘macroeconomics’ model or as a predictor of prices and therefore inflation.
Financial repression is a method to engender artificial low interest rates
The uncertainty surrounding the theory of money and its unpredictability made policy-makers at the Federal Reserve rely less on the money supply in controlling the U.S. economy.
Instead, the policy focus has shifted to interest rates such as the setting of interest rate targets by the Federal Reserve, using money printing to maintain their targets, which at present are extremely low in historical terms.
These low rates are distorting economic signals, which are so necessary for the smooth functioning of markets, causing variable volatility globally within all markets. This process is referred to as ‘financial repression’ and many believe that the Federal Reserve has no option but to continue printing money (QE) forever because if they don’t the markets could collapse overnight.
Changes in money supply influence inflation
Ignoring the effects of monetary growth on real purchases and the velocity of money suggests that the growth of the money supply may cause different kinds of inflation at different times.
For example, rises in the U.S. money supply (money printing) between the 1970s and the present time encouraged, first a rise in the inflation rate for newly produced goods and services in the 1970s, and then asset-price inflation in later decades.
It may have encouraged a stock market boom in the 1980s and 1990s and then after 2001, a rise in home prices, being the famous housing bubble which collapsed in 2008. This theory assumes that the amounts of money in circulation are the causes of these different types of inflation rather than being the results of an economy’s normal reactions to supply and demand. The fact remains that inflation and ‘financial repression’ work together. They are inseparable partners and as inflation develops financial repression evolves into plain confiscation.
Following the 2008 crisis we have seen only increasing financial repression, mostly in the form of price manipulation. Some of this manipulation is overt, as with interest rates, and some is hidden, as indicated by gold-price manipulation, the consumer price index (CPI) or the published unemployment rates.
As the US national debt interminably grows this manipulation will be increasingly exposed and the general fear of confiscation will become tangible and in the public domain. Any rational investor can see that his bank account is at risk of confiscation and that the likelihood of being caught in a bank run is rising daily.
Little is being discussed in the mainstream media about withdrawal rates of money from bank deposits in the EU, UK and USA but it is happening. The Cyprus event is having its effect on the behaviour of bond investors, who are classed as ‘the smart money’, and who are ensuring the safety of their wealth by moving it to safer places.
The destruction of a currency through hyperinflation
Governments need bank deposits to fund the bonds they force their banks to buy. Regulations, the pressure on the bankers and the open threats are all part of the same means to coerce bankers to fund their debts with your savings.
Hyperinflation is the ultimate and most expensive bailout of a broken banking system, which every holder of the currency is forced to pay in a losing proposition, as it inevitably ends in a final destruction of the currency; there are plenty of examples, Venezuela being the most recent poster child with Zimbabwe and Argentina not far behind; Turkey is looking vulnerable too.
Hyperinflation is the ultimate failure of an economic system, which can be a good thing, because like a forest fire it is not until the old debris is swept away that a new system can grow and prosper; this is the hope upon which we must all rely.
The shrinkage of an economic system exacerbates a fall in tax revenue and increases the intervention of central banks leading to the self-fulfilling outcome of unmanageable government fiscal deficits.
Production output will fall and produce a shortage of goods together with an increase in the circulation of money which triggers higher inflation. The general reaction of government is to implement price controls which further distort the normal operation of markets and worsens the situation; politicians and bankers are left powerless.
We can now see how rising interest rates which attract deposits and hyperinflation can go together. The loss of confidence in the system will push interest rates higher, which causes even more difficulty in producing goods, unleashing shortages and higher prices.
Ludwig von Mises remembered in the case of the German hyperinflation: “…with a 900 per cent interest rate in September 1923 the Reichbank was practically giving money away…” (Chapter 7 of his book: “Money, Method, and the Market Process”). It is during a period of high inflation in goods, not matched by a balanced increase in wages, that people soon begin to ‘vote with their feet’ and leave the system altogether. This is happening already across the world under a process known as System ‘D’, when people opt out of the traditional market systems altogether: https://www.theburningplatform.com/2019/04/17/from-the-ashes/
The ‘wage-slaves’ finally wake up and decide that, at a certain point, one is better off working outside the system to avoid this hidden inflation tax and of course all government taxes. Just like the Romans, who left their cities during the slow decline of their empire, millions of workers in the developed world could decide to become ‘self-employed’ and leave the system.
This happens to be a typical characteristic of under-developed economies where it is nigh impossible for government to collect sufficient taxes to fund society. This feature of economies in decline is witnessed all too obviously in Venezuela, as well as Italy, Greece and Spain today as their economies implode on the anvil of austerity imposed by the EU, IMF and ECB.
To be continued next Saturday
