Deflation, Hyperinflation, Stagflation, and Where We Are Going

 

This is a repost of a column from four years ago almost to the day.

This is where I make the case most explicitly for the stagflation forecast I made in 2005.

Although I add one parenthetical note and some underlining for emphasis, otherwise I did not have to change a word.  I could have rewritten a few things a little more smoothly but at this point why bother.

I believe that things are playing out pretty much as I had thought with a few notable exceptions on the particulars.    The 'top down' approach to monetary stimulus favored by the Fed and their Banks and their politicians is fostering more inequality and slack aggregate demand while inflating select asset prices, a type of stagflation.  The 'inflation' component of that has not yet set in yet generally, but is certainly visible to anyone who uses incidental things like healthcare, higher education, and food. 

I think that the same dynamic is playing out in Europe and the UK.

It will end involuntarily in a social dislocation, or by a voluntary reform.  Since the oligarchs have apparently not yet been satisfied in their acquisition and looting, they believe that they can keep pushing the envelope for now.

One new area of thought for me now is how China and Russia and a few of their friends will attempt to implement a new regional currency and a global reserve currency with some inclusion or reference to gold, and perhaps silver.  That they are leaning into this area is to be found in their own words and actions.  

What I am struggling with is how they might do this without exposing themselves to currency manipulation and rigging, which is probably a lot easier to accept as a given now than it was in 2011, although it was certainly occurring before all these market rigging scandals broke.   I don't think a market was left untouched.

I suspect it will center around the terms for the exchange and the valuation or peg.  A misstep will open them to the predations of the global hedge funds and the Banks, and the status quo centered on the Dollar. 

One of the more interesting facets of this will be how this new monetary group deals with the bucket shops on the Hudson, that great price setting mechanism without a firm tie to reality.  I believe that recent developments are suggesting that they will make those markets as they are less relevant to the real world, which is precisely both their strength and their weakness. 

Their strength is that they may set price without the necessary reference to real world market supply and demand for surprisingly protracted periods of time.  And this is also their weakness, because with the right push in the right direction it will not take much to displace them since they do not have their feet firmly planted on anything substantial. 

The trick to be to throw them over without undue collateral damage to the real economy, a task that is not without some significant efforts.  If only the Banks would show the same forethought and courtesy when triggering their own financial crises.

16 April 2011

A Review on Where We Stand with Regard to Deflation, Hyperinflation and Stagflation

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, (but the DX Index will be highly misleading - Jesse) and gold and silver and harder currencies appreciate (Well that one has gone sideways for now in this metals bear market - Jesse), 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.

“One day you will go the ATM and the dollars will be Blue---not Green ---and you will get a few less than you expected.”

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.  (As the MMT crowd has suggested - Jesse)   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.

Money Supply Figures: Monetary Inflation But Real Economy Is Dysfunctional

"He that gives good advice, builds with one hand; he that gives good counsel and example, builds with both; but he that gives good admonition and bad example, builds with one hand and pulls down with the other."

Francis Bacon

The growth in the MZM and M2 money supplies are very strong, almost remarkably so given the very slack growth in employment and GDP.

So why do we not see any serious inflation in prices?  Or real gains in employment for that matter.

As an aside, I think some of the more 'modern'  and aggressively modified measures of price inflation, like chained CPI, do not measure price inflation at all, but the consumer behaviour of product substitution under increasingly trying circumstances as people cope by reducing their standard of living. That is a measure of gradual deprivation, not inflation.

I would like to see a system where no social policy is passed that the leadership of a country does not accept first.  If there is to be austerity, pension cuts, reductions in medical services and food, let them accept it first for the good of the country and an example to their citizens.  I do not say this out of meanness, but charity.  For the double standard with selective justice is the slow and silent killer of oligarchies.

The velocity of money tells part of the story. Please note that those charts below are based on much longer timeframes to show that they are a trend, and not a short term affect of the collapse.

The 'velocity of money' is a calculation that shows the relationship between money supply and real economic activity as a ratio. It is falling to new lows. Some might even use the word 'plummet.' There is lots of new money, but not so much real activity.

The standard economic answer would be that the US is in a liquidity trap, and the recovery will have lags in employment gains.   The money is added, and then recovery follows, with employment showing the longest delay.  The standard remedy would be to create more jobs, artificially if necessary.  But that is not much different than unemployment insurance and programs like food stamps.  It is kind, and sensible, but not sustainable. 

A liquidity trap is described by Keynesian economics as a condition in which injections of money can support zero interest rates, but fail to generate real economic activity.

I think the current situation in the US and UK in particular involves a serious policy error in the failure to address the problems and imbalances that caused the financialization of the real economy, and its subsequent collapse under the weight of malinvestment and corruption.

Aggregate demand is not stimulated because sufficient money does not reach consumers, as it passes through a corrupt and broken financial and political system, being diverted largely to insiders at 'the top.'  Nothing could be more clear than looking at the statistics regarding income inequality.

Any gains by the large middle and lower classes will tend to be short term and illusory, involving more household balance sheet problems and debt until the system is reformed.  Some of this has to do with a policy bias that considers the vast mass of the people as consumers, but not as workers.

Merely adding more financialized money into an unreformed system will further compound the problems, and ultimately force a more significant crisis and change.  This is true whether done does it via more debt issuance or flashier gimmicks like modern monetary totems.

The underlying social tensions can only be ignored by the comfortable for so long.  As a corollary, applying austerity without reform is insanely self-destructive.  The proof of this is forthcoming.

Japan has been able to hold their system together for a protracted period of slack recovery due to their demographics, their industrial policy position in the world economy, and a largely homogeneous and communal society that cares for its own.  The US and the UK will have a shorter half life I am afraid.

The situation is Europe is a bit different, and likely to result in serious dislocations in their organizational fabric fairly soon if some of the problems there are not addressed.  The monetary union without fiscal cohesion is inherently unstable.  Only fraud allowed it to last as long as it did.

There is a possibility that the current policies in the US may succeed if austerity if not applied, and something happens in the currency war to affect the balance of trade.  I am not optimistic  So let's see what happens.

The UK may provide a good counter example to the US  Some new school of economic thought may find some useful data from that, if they can free themselves from the 'say for pay' mentality that currently impairs the public policy discussion in a disgraced profession.

Shock B: I'll Bust a Cap in Your Curve, And Then Some...

Ben Bernanke and his gangsta bankas have been following the approach outlined in this paper from 2004, Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment, which is excerpted below, and also in his famous 'printing press' speech on avoiding deflation from 2002.

I have written about this before several times over the years, but perhaps it is a good time to review the Fed's game plan.

The first item, communications to model and influence the perception of the markets, is obvious. Jawboning is a major element of any financial intervention. Acknowledging or denying the intervention is all about the message as well.

The most recent statement from the Fed, for example, about keeping rates at the zero bound for the next two years, depending on how the economy fares, is a good example of this. Other actions they may take through their own speeches, and the statements of informal intermediaries in the industry and the press, are good examples as well.

The expansion of the Fed's Balance Sheet is also known as quantitative easing, and that has been done at least twice now, and in epic proportions.

The third option, the targeted purchasing of certain assets, has been done to a large extent to support the banking and mortgage system, but not necessarily the real economy.  This is the program by which the Fed has been taking non-traditional assets into its portfolio in the various vehicles it has constructed in order to shore up the shaky creditworthiness of the TBTF asset profiles.

What the Fed is not doing in a major program yet, although it certainly has done it in the past, is to conspiculously shift the duration of its Treasury bonds portfolio in order to achieve certain interest rate objectives, effectively setting caps on target rates up the curve.

In 1961 in a program called Operation Twist, the Fed moved the duration of its portfolio to help lower longer term rates.  It should be noted that OT1, if you will,  was conducted during the fixed exchange rate period known as Bretton Woods I, which included the redeemability of dollars for gold.  Also, although the short end of the Treasury curve was not at the zero bound,  it was not viewed as adjustable for policy constraints than the zero bound.

So there are some subtle differences perhaps in any OT2 which the Fed might announce this week, or soon thereafter.

John F. Kennedy was elected president in November 1960 and inaugurated on January 20, 1961. The U.S. economy had been in recession for several months, so the incoming Administration and the Federal Reserve wanted to lower interest rates to stimulate the weak economy. Under the Bretton Woods fixed exchange rate system then in effect, this interest rate differential led cross-currency arbitrageurs to convert U.S. dollars to gold and invest the proceeds in higher-yielding European assets. The result was an outflow of gold from the United States to Europe amounting to several billion dollars per year, a very large quantity that was a source of extreme concern to the Administration and the Federal Reserve.

The buying of the longer end of the curve, moving out from the bills to the shorter notes, has been telegraphed repeatedly to the markets this year. So it does appear likely.

The effects would be to lower real rates more broadly across the curve, perhaps taking them all negative, or at least closer to zero on the longer end depending on how one wishes to calculate inflation. I think the Fed uses their chain deflator.  I doubt its accuracy for practical purposes, but let's not quibble.

This is 'bad' for the dollar and good for gold and longer dated Treasuries which will enjoy a brief rally. However it will drive yield hungry investors to seek other alternatives, perhaps in the stock market and overseas.   It may shake up the Treasury markets on the longer end moreso than we might expect if there is an erosion in confidence in the US' ability to put its house in order without devaluation of the dollar debt.  That erosion may be well-founded.

Such a policy move is intended to stimulate consumption and investment in situations where the middle of the curve and out is used as a benchmark for setting non-governmental interest rates.  There is thinking that by moving out from the short maturies, the pull lower on the even longer rates will be more pronounced.

I do not think this alone will work. Banks are reluctant to lend at any price, and lowering the rates would not improve the credit risk profile of potential borrowers.

The Fed could also reduce the interest it pays on reserves to zero, or even place a negative rate on it. This would stimulate banks to put the money to work in the markets for projects with positive yields. This is not so different from the Fed's actions in driving consumers out of short term bonds and zero interest savings accounts, which they have done from time to time.

There is some further indications that the Fed will be using a reverse repo mechanism in order to grow bank credit in a more targeted fashion.  I will not get into that further here, because if it does develop I am sure there will be much more lucid explanations given in some detail based on Fed announcements.

But it does follow the theme of actively stimulating lending in ways other than lowering rates, even on the longer ends of the curve.

The Fed might couple this with government guarantees on loans for example, for certain situations where the government wishes to stimulate activity, such as housing for example. It is hard to imagine anything like this passes through the dysfunctional Congress.

There is another option that the Fed has, which is not cited in the summary of this paper shown below.

For this we have to turn to Chairman Bernanke's famous speech on Deflation in 2002 in which he stated that 'the Fed's owns a printing press' and highlighted various steps which they might take to insure that deflation does not happen in the US, the ability and the resolve of the Fed to prevent it, and some of the options the Fed might have if they reach the infamous zero bound:

However, a principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition. As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero. In the remainder of my talk, I will first discuss measures for preventing deflation--the preferable option if feasible. I will then turn to policy measures that the Fed and other government authorities can take if prevention efforts fail and deflation appears to be gaining a foothold in the economy...

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure--that is, rates on government bonds of longer maturities.

There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time--if it were credible--would induce a decline in longer-term rates.

A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.

Lower rates over the maturity spectrum of public and private securities should strengthen aggregate demand in the usual ways and thus help to end deflation. Of course, if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years. Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association). Historical experience tends to support the proposition that a sufficiently determined Fed can peg or cap Treasury bond prices and yields at other than the shortest maturities...

If lowering yields on longer-dated Treasury securities proved insufficient to restart spending, however, the Fed might next consider attempting to influence directly the yields on privately issued securities. Unlike some central banks, and barring changes to current law, the Fed is relatively restricted in its ability to buy private securities directly. However, the Fed does have broad powers to lend to the private sector indirectly via banks, through the discount window. Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral. (Obviously the Fed has already been doing this as well).

Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.17 The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.

Each of the policy options I have discussed so far involves the Fed's acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money. (I think the Obama Administration used this as the rationale for extending the Bush tax cuts).

Of course, in lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets. (I believe the Fed has already been doing this with the help of a few Primary Dealers.)

In summation, I think Bernanke's next move will be to start capping the two and three year rates, with the five year to follow. The purpose will be to keep rates low for the purpose of enabling spending and devaluing the dollar. I do not think he will have to expand the Fed's Balance Sheet to accomplish this.

But it is important to note that while the Congress can enforce a debt ceiling on the US Treasury, there is no such hard ceiling on the Fed's Balance Sheet. And this is probably the genesis of Presidential candidate Perry's scarcely veiled threat to Mr. Bernanke and the use of the word 'treason.'

I am not saying that the Fed is right in what they are doing. I am using Bernanke's thinking, and his own words, to determine what the Fed is likely to do next. I have been using this model for the past five years, and it has served me well. 

I have some sympathy for Bernanke, because he has few allies, especially among the libertine left and the luddites of the right, and the serpentine Obama.  The major obstacle to the US recovery is a failure in governance.

I have very little sympathy for the manipulation of certain markets traditionally viewed as safe havens, based on the rationale outlined in Larry Summer's paper about Gibson's Paradox, and the linkage between interest rates and gold.  That appears to be roughly analagous to machine-gunning the lifeboats.
Deflation or inflation are truly policy decisions in an unconstrained fiat currency regime such as that enjoyed by the US. On this Mr. Bernanke is correct, and anyone who thinks otherwise does not understand a fiat money system.  It really is that simple.  To their credit, the Modern Monetary Theorists understand it very well, except for the downside of excessive money creation in a co-dependent world, even if one does enjoy the exorbitant privilege of the world's reserve currency.

Various interests have been seeking to restrain the Fed, ranging from large creditors such as China, and the domestic monied interests who have already received their bonuses and bailouts, and who do not wish to see their dollar wealth erode. One is richer if all around them are made relatively poorer, or so some lines of thinking go.  And of course there are the prudent savers, who have been fleeing the dollar to the relative safety of some foreign currencies and hard assets like gold and silver.

I would hope that by now that any reader here would know that, at least in my judgement, deflation through hard money and austerity, or inflation through stimulus and money printing, are both unable to achieve a sustainable economic recovery because the system is caught in a credibility trap in which the governance of the country is unable to act justly and reform the system without implicating themselves in the compliant corruption that caused the unbridled credit expansion, massive frauds, and financial collapse in the first place. 

This was a major contributor to Japan's lost years.  The lack of will was in the failure of their largely single party system to correct the inefficiencies and crony capitalism of the banks and their keiretsus that provided a drag on all stimulus and the real economy, siphoning off the additional money into unproductive projects and support for zombie corporations.

The Banks must be restrained, and the financial system reformed, with balance restored to the economy, before there can be any sustained recovery.

Federal Reserve
Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment

Ben S. Bernanke, Vincent R. Reinhart, Brian P. Sack

8 April 2004


Abstract

 The success over the years in reducing inflation and, consequently, the average level of nominal interest rates has increased the likelihood that the nominal policy interest rate may become constrained by the zero lower bound.

When that happens, a central bank can no longer stimulate aggregate demand by further interest-rate reductions and must rely on “non-standard” policy alternatives. To assess the potential effectiveness of such policies, we analyze the behavior of selected asset prices over short periods surrounding central bank statements or other types of financial or economic news and estimate “no-arbitrage” models of the term structure for the United States and Japan.

There is some evidence that central bank communications can help to shape public expectations of future policy actions and that asset purchases in large volume by a central bank would be able to affect the price or yield of the targeted asset.


Non-Technical Summary

 Central banks usually implement monetary policy by setting the short-term nominal interest rate, such as the federal funds rate in the United States. However, the success over the years in reducing inflation and, consequently, the average level of nominal interest rates has increased the likelihood that the nominal policy interest rate may become constrained by the zero lower bound on interest rates. When that happens, a central bank can no longer stimulate aggregate demand by further interest-rate reductions and must rely instead on “non-standard” policy alternatives.

An extensive literature has discussed monetary policy alternatives at the zero bound, but for the most part from a theoretical or historical perspective. Few studies have presented empirical evidence on the potential effectiveness of non-standard monetary policies in modern economies. Such evidence obviously would help central banks plan for the contingency of the policy rate at zero and also bear directly on the choice of the appropriate inflation objective in normal times: The greater the confidence of central bankers that tools exist to help the economy escape the zero bound, the less need there is to maintain an inflation “buffer,” bolstering the argument for a lower inflation objective.

In this paper, we apply the tools of modern empirical finance to the recent experiences of the United States and Japan to provide evidence on the potential effectiveness of various nonstandard policies. Following Bernanke and Reinhart (2004), we group these policy alternatives into three classes:

1. using communications policies to shape public expectations about the future course of interest rates;
2. increasing the size of the central bank’s balance sheet, or “quantitative easing”; and
3. changing the composition of the central bank’s balance sheet through, for example, the targeted purchases of long-term bonds as a means of reducing the long-term interest rate.

We describe how these policies might work and discuss relevant existing evidence...

Additional Reading:
The Upcoming Expansion of US Bank Credit - Alasdair MacLeod

Gold and Interest Rates: More than Joined at the Hip - Rob Kirby

“The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it.”

John Kenneth Galbraith

Inflation, Deflation, and Stagflation, Japan and the US

Here is a question from a reader which I found to be well stated and probably of a more general interest.

"I was thinking about your general forecast which you posted a while ago, and I wanted to see if my understanding of it was correct.

You had said that your forecast for the US was stagflation because the US is a net importer, unlike Japan which is a net exporter, despite both countries pursuing a policy of ZIRP + QE.

Is the reason for Japan's deflation that all the excess liquidity leaves Japan in search of a yield (due to ZIRP + QE), and not into tangible goods (due to Japan being a net exporter/net producer)? This would be in contrast with the US, where much of the excess liquidity from ZIRP + QE flies into tangible goods due to the imbalance caused by the US being a net importer/net consumer (though undoubtedly much of this excess liquidity leaves the US in search of a yield as well). Is this correct?"

This is a very nice summation of a portion the effects, but misattributes the causes.  And like most summations it crushes many of the key points of a slightly more complex theory and overstates the importance of current trade balance.

In a fiat currency not constrained by external standards or other exogenous constraints, monetary inflation and deflation are always and everywhere a policy decision. As latitude on the monetary supply is constrained, so obviously the freedom to decide (choose if you will) is obviously constrained to a similar degree. 

If you are Greece and under some contraints imposed by the ECB that controls your currency, you have fewer choices and greater prices to pay in making them. If one controls their own currency and is large and 'important' enough to make their decisions stick it is another matter altogether.  The Wall Street banks understand this all too well.

The US is a democratic republic and a huge net debtor, in both current and future obligations. The choice of genuine deflation as such would therefore be a national economic and political suicide favoring foreign holders of its debt. I cannot think of a reasonable scenario for such a choice except for coercion such as war reparations and under heavy constraint. But it is a possible choice.

Further complicating the decision is the inescapable fact that the US holds what is still the world's reserve currency despite a movement to alternatives. A stronger dollar and monetary deflation would crush the world economy by destroying the interconnected global banking system as it is now constituted, in addition to devastating its own domestic economy.  Deflation does favor the ends of a powerful few, however, so it cannot be said to be off the table.

Further complicating matters is that the people of the US are more independently minded, educated, and well armed than is normal around the world, despite a more recent program of cororatist propaganda that seems to have co-opted  their news media.  They are more like the Swiss in some regards.  I know this comes as a surprise to most of them, but it is how it is.  The US is a beacon of liberty to the world for good reasons, although that beacon occasionally flickers and suffers abuses, sometimes seemingly irrecoverable.

Their increasingly predatory financial system, together with the ownership of the world's reserve currency, probably dictated the accumulation of that large debt, significantly held by foreigners, if one subscribes to the theory of Triffin's Dilemma, which I do.   The US had to print more than it consumed to supply currency for growth in the developing world,  which was unfortunately engaged in currency manipulation and state mercantilism, and the financial system turned this into debt which it owned.

So the obvious choice is for a monetary inflation to soften the blow of what is going to be at least a de facto default on what is now a mathematically unpayable debt. Let's be clear about this. The US is facing a default and the bulk of the discussion now is about how to distribute the pain, and not fix the problems which caused the crisis in the first place.

The mercantilists who hold dollars, as a result of their gaming the global trade and fiat regimges, wish the US to suck it up and take it all.  This is preferable to growing their own domestic economy and allowing their people to become more independently powerful, thereby threatening them.  And the domestic monied interests wish the pain to fall largely on the weak and the many, the elderly and the poor. All of these actors are in a power position because they were the greatest beneficiaries of those structural distortions that have led the world to this crisis in the first place.

And yet the monetary inflation will not be able to have its usual effect, the magic that fiat has worked in the post WWII environment. This is because the economy is distorted, and organic growth of jobs and the median wage has been rendered untenable without significant reform in the domestic economy and global trade.

And the powers that be and the thought leaders are stuck in a credibility trap, through which they cannot effect the required reforms without indicting themselves, or at the least, dismantling the socioeconomic structure to which they own their ascendancy, whether it was through sheer luck and positioning in one of the bubbles, or in service to the monied interests by dismantling the regulations and promoting the frauds.

So the most likely course is an ineffective attempt to maintain the status quo, which cannot possibly become self-sustaining. And this is stagflation, which will continue until some crisis is large enough to change it.

It is tempting to use Japan as an experimental counterpoint to the US, but highly misleading and the cause of much misunderstanding.

Japan is most unlike the US, although the Yanks like to think of the rest of the world as little Americas, yearning to evolve into their image. The political structure is that of a one party government that was imposed on a military oligarchy which in turn had evolved from a relatively recent system of feudalism. There was no popular revolution in Japan that created their system of government.  It was imposed.  And the people have adopted it to suit their own preferences.  There is nothing wrong with that.  Nations should be able to have the type of society that suits their national character within some reasonable degrees of freedom of choice.  One size does not necessarily fit all.

The Japanese economy is highly controlled and centrally planned, following an industrial policy formed by an entrench bureaucracy in MITI and the handful of kereitsus that essentially run the country like feudal lords of old.

It is a closed society, an island, with a largely homogeneous population and limited immigration. The oligarchy has a sense of national honor and responsibility. The social mores would not permit the type of personalities of the 'greed is good' world view, at least not explicitly.

Deflation suited them, and that is what they obtained. But it is important to realize that the people did not suffer deprivation because of the social contract between rulers and people, the lords and serfs. This social contract is essential to understanding the situation. And of course the fact that the people continue to have a decent, if somewhat constrained by western standards, style of living that has been consistently acceptable to them for many years.

Lower prices yes, but the losses and deprivations were not visited on the people, at least not yet. There is not the same cult of selfishness and greed, and denigration of obligation as there is in the states. Contrast CEO pay in Japan and the US.  The losses were exported around the world and finessed by an increasing government debt, much of it wasted on the keiretsu's pet projects, despite the ongoing trade surpluses. But Japan appears to be heading for a change as the corruption and mismanagement of the oligarchy continues to peak through the studied facade.

So this is more the basis of my forecast, and I do not see a change in this until the US changes its financial system, and reforms its political system in a meaningful way, to diminish the influence of wealth and power and restore a balance with the voting public.  There are no such things as free trade or free markets, just as there is no free lunch.  All is subject to imperfection and abuse, and requires diligent effort, frank discussion, transparency, and conscious intentions.  Opening your markets to slave labor makes everyone a slave.

The world economy is a very complex system, and those who think they understand it with slight effort are probably wrong and sometimes tragically so.  Unfortunately they are also easily led, and in the pursuit of simple solutions may choose power over wisdom, to their own destruction.

Inflation and Deflation: US Money Supply Figures - We're Not In Kansas Anymore Toto

Here are the latest Money Supply Figures from the St. Louis Fed.

I start with the narrowest measure, the Monetary Base and widen out to M2 which is the broadest measure of US money supply currently available, with MZM serving a similar function for the short term.

Previously I have commented on the 'shadow M3' figures done by a few enterprising fellows. As you may recall the Fed stopped publishing M3 a few years back. M3 itself was not the issue but rather the Fed chose to stop reporting a key component of M3 called 'eurodollars' or US dollars held offshore in Europe or anywhere else.  The rationale was that it was too expensive to obtain this data. There are those who found this to be a bit disingenuous for a non profit seeking organization that operates on a cost plus budget.

Those who are attempting to estimate M3 gather what actual remaining data  they can, and estimate eurodollars by  'modeling' them based on trends and correlations as they were in place when the Fed stopped reporting.

As I cautioned before from my own work in the BIS currency reports, there were huge flows of dollars into Europe during what I called the eurodollar short squeezes. The problem with BIS however is that their reporting lags by almost nine months, so the figures are never really current.

I suspect that as these figures unfold we will see that the Fed has created and made available large amounts of dollars that were presented to European institutions, and that this money is not being captured in any of the existing money supply figures, except perhaps the Monetary Base, and that estimates of M3 are likely to the low side because of this change in trend of eurodollars.

So what does all this mean, what is the important 'takeaway?'  It means that deflation is not occurring at the moment because the Fed has taken those actions which it said it would do, plain and simple.  On the other hand there is some inflation appearing but nothing notable with the exception of health care, service fees particularly financial, and a few hard assets. This could start changing even in the face of slack aggregate demand, but not in the face of another significant economic collapse such as in Europe or China. 

And unfortunately recent evidence suggests strongly that the Fed has been misrepresenting what it has done in the financial crisis.  This is unfortunate because it suggests that not only other things were misrepresented, but that there is an ongoing coverup of what has been done, and likely what is being done today.    Coverups tend to feed on themselves, and provoke other new abuses of the public trust.  Also it calls into question all that a private and guarded institution has said in the past based on their reputation.  I do not think people fully realize the implications of this yet. 

In this stage of the Currency War we seem to be in something like the phase of WW II called the 'Phoney War' that occurred between September 1939 and May 1940.   But it does seem to be heating up.

Those who wish deflation to occur badly enough will find it where they will, whether it be in M3 estimates or credit figures. I find it highly ironic that when estimated M3 recently seemed to be showing deflation it was embraced by a particular chatboard site who previously had forbidden its mention when it had showed inflation some years ago. Further, credit is not money. Credit is a source of money creation as is the Fed's balance sheet. The Fed's Balance Sheet is not 'money' per se. It is a source of money creation.

It should also be remembered at this point that a fiat currency is backed by the economy of a country and its official cashflows (primarily taxes) as well as its reserves. As a country's GDP and cashflow deteriorates the soundness of its currency can deteriorate even if the nominal levels of money remain unchanged. I think we are seeing quite a bit of this today.  This deterioration in the backing of a currency is no different from a devaluation in its effect.

Can deflation occur? Absolutely. Give me control of the Fed and I will give you a rip snorting deflation by raising the overnight rate to 20 percent and calling in the reserves so to speak.

But one cannot deal in possibilities when investing, merely safeguard or hedge against them based on the estimates of probability. Well, you can deal in possibilities, but this is largely a means of self-deception, a means of continuing to embrace a theory or investment strategy that has been proven incorrect when it is too difficult to give it up and admit your error.  That difficultly may arise from practical matters, but it is my experience that it is normally attributable to stubbornness, or pride, and sometimes even corruption.

"Faced with the choice between changing one's mind and proving that there is no need to do so, almost everyone gets busy on the proof." John Kenneth Galbraith

Obviously gold and silver and some other things have been rallying smartly for the past ten years in response to the decisions made by the Fed and the US government of both political parties, whether they will admit it or not. When this changes, when the dilution of the currency stops and begins to recover to strength, then I would think it appropriate to change my own particular investment strategy, which is hedged against the unexpected even now. But not until then.  I do not expect inflation to obtain serious traction until foreign governments start rejecting the dollar in size, or the velocity of money begins to obtain some traction in the real economy.   The Fed assures us that they will act to control the spread of inflation when the time comes. But for now the banks appear overstuffed with cheap liquidity, something I like to call hot money.

This type of abundantly cheap, hot money tends to seek higher beta or risk, often in the form of equities and dodgy financial schemes and investments, rather than productive lending.  As the CEO of a Fortune 500 was heard to observe in private, having paid an absolutely eyebrow raising sum for another company in the heady time of the tech bubble, "Yes I paid a high price, but my currency (company stock) is cheap."  He was willing to take an outsized risk because he believed that his overvalued currency was going to become worth a lot less.  He just did not realize at the time that it would eventually become nearly worthless. It did and he was sacked.  I think the analogy to Ben and his Fed, and the way in which they are throwing dollars around, to private and especially to foreign banks,  is quite analogous.  The looting will continue until the value of the overpriced stock is depleted.  That Wall Street will be taking about 8 percent of the total short money supply as its bonuses this year speaks volumes about the value of the dollar and its future.

I saw this coming in 2001 but have to admit I was terribly wrong on timing in 2004, having underestimated the Fed's willingness to obtain international banking cooperation, primarily from Japan the UK and Europe, to generate a massive housing bubble. I will not make that mistake again I hope.

And if you have been wrong in your assumptions or assessment, it is never a shameful thing to admit it, gather yourself together, and go forward from there, because all this indicates is that you have received new information and that you accept it, which is the high mark of intellect and objective science.

Even the mighty Nobel laureate Paul Krugman has recently expressed his disillusionment with Mr. Obama's Hooverism, Freezing Out Hope.

"What’s even more puzzling is the apparent indifference of the Obama team to the effect of such gestures on their supporters. ... Mr. Obama almost seems as if he’s trying, systematically,... to convince the people who put him where he is that they made an embarrassing mistake."

Contrast this with his earlier chastisement of those who were already recognizing that Barry the reformer was either an ineffective nincompoop or an establishment shill.

"Look, Obama didn’t pose as a Nation-type progressive, then turn on his allies after the race was won. Throughout the campaign he was slightly less progressive than Hillary Clinton on domestic issues — and more than slightly on health care. If people like Ms. [Naomi] Klein are shocked, shocked that he isn’t the candidate of their fantasies, they have nobody but themselves to blame." Paul Krugman, NYT June 16, 2008

I am not going to get into the relative merits of one course of public policy decision or another here. My point rather is to demonstrate once again that with a fiat currency the matter of inflation or deflation, within a range of exogenous constraints, is a public policy decision tied intimately into the form of government that one holds as its objective and the nature of the society that you wish to encourage.

I do not wish to single out Krugman with the tautological indictment of being human. He almost appears as a Diogenes, a beacon of objectivity, compared to his ideological counterparts. Too often economists cloak themselves in the robes of a quantitative and objective science, with such canards as the efficient markets hypothesis, supply side economics, the inefficiency of regulation versus unregulated markets, and bailoutism as hard facts, when they are nothing more than arguments in favor of one set of government policies or another.

And far too often they are doing it for pay it appears, which is intellectual dishonesty, malpractice if you will, that is inexcusable and contemptible, one of the reasons why economics is considered by some a disgraced, although not irredeemable, profession these days.  But since these fellows are generally associated with the 'greed is good' school, which elevates the ends above all else, once ought to expect to hide the silverware, whiskey and women when they come to town.

Many things are possible, but not all things are equally probable. As Walter Bagehot famously observed, 'Life is a school of probability.'

For a nation that is a net debtor, deflation is tantamount to suicide. But other nations, most recently Germany in the past century, committed a form of national suicide in service to hubris, and an elite few, and a mistaken understanding of what constitutes a civil society and what it means to be human. They are certainly not the only society to have done this, and I would not presume that they are the only people who will have fallen prey to this self-destruction in the future.

So there is some precedent for disaster. Germany was certainly not the only society to have done this, given the examples of China, Russia, Japan, and Italy, and I would not presume that they are the only people who will fall prey to this self-destruction as well. Having high ideals or having previously suffered oppression is no guarantee of future goodness. Rather it is the attitude of yourself in relation to the 'other.' That is the whole of the law.

Indeed, such a temptation to dehumanisation is tailor made for a generation raised on the notion of their natural goodness, accepting themselves as they are, rejecting and tearing down any external standards of goodness and worth in other people. They see no need to change and work together, but rather to give in, to wallow, in their basest and most selfish impulses, self-centeredness, the greed-is-good meme of the me generation, in a time of general apostasy to all but the lowest form of our self. Class War and the Decline of the West

The madness of crowds seems to have been all the rage in the twentieth century, and what I see now are people who are more technically proficient, more cunning, more skilled in the ways of mass deception and intrigue, but alas, perhaps not more compassionate and wise, and understanding of what it means to be human, truly content with themselves, and simply happy.

So bear these things in mind and protect yourselves as best you can despite the temptations and deceptions of our all too human frailties. It will not be easy, but it was not easy for our parents or grandparents, and theirs and those before them, because it never is. That is the nature of this world.  And even the once triumphant West at some point must learn to pull together again, or founder in a new season of infamy.

"For we wrestle not against flesh and blood, but against principalities and powers, against the rulers of the darkness of this world, against spiritual wickedness in high places." Eph 6:12

FOMC: Sound the Bell. School's In, Suckas

I do not expect this to change anyone's mind who has sworn themselves to a belief in a stronger dollar through debt deflation and credit contraction, with riches obtained by buying and holding Uncle Sam's proliferating promissory notes. Or those who believe in the instantaneous appearance of hyperflation for no discernible or inexplicable reasons for that matter.

Those who disagree with events as they are unfolding like to dismiss just about anyone who disagrees with them as naive and ignorant, and the Federal Reserve specifically as clueless and incompetent in their ability to generate monetary inflation and expand their balance sheet by buying existing debt of whatever type and flavor.

This is not giving the devil his due. That is the one thing that the Fed knows how to do and quite well: destroy the purchasing power of the dollar in the course of their financial engineering. They obviously have the tools as they have explained in detail, and from this statement and their recent actions it is clear that they stand willing and ready to use those tools again. You cannot say that Benny P to the M has failed to warn you.

What the Fed cannot do is breathe vitality into a zombie economy, and provoke a sustained recovery not tied to some sort of credit bubble. That is why stagflation remains the most likely outcome until the nation obtains the will and the determination to reform the financial system and restore a balance to trade and the real economy through a commitment to sound and practical public policy not driven by self-serving economic quackery. The dollar and bonds are made stronger through a vibrant underlying economy with the ability to generate taxable income and real returns to their holders.

But in the meanwhile the special interests will be served. A profound deflation and hyperinflation remain as possibilities for the future, but they will most likely be seen on the horizon in advance of their arrival as the result of some exogenous event or catastrophic failure. So far, not a glimpse.

Federal Reserve
Release Date: September 21, 2010
For immediate release

Information received since the Federal Open Market Committee met in August indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. Housing starts are at a depressed level. Bank lending has continued to contract, but at a reduced rate in recent months. The Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be modest in the near term.

Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period. The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings.

The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh.

Voting against the policy was Thomas M. Hoenig, who judged that the economy continues to recover at a moderate pace. Accordingly, he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and will lead to future imbalances that undermine stable long-run growth. In addition, given economic and financial conditions, Mr. Hoenig did not believe that continuing to reinvest principal payments from its securities holdings was required to support the Committee’s policy objectives. (Mr. Hoenig was NOT heard to say, "Suck it up, bitchez." That was the other fellow afflicted with dementia. - Jesse.)

Sound the bell. School's in, suckas. And Ben and the Banks have the hall passes, the keys to the restrooms, and chalk.

ZeroHedge: Richard Russell Slams Robert Prechter, Praises Gold, Tells Readers Get Out Of Stocks.

First, Richard Russell does not 'slam' Prechter because he is a gentleman and doesn't really 'slam' anyone. Fights between pundits can be fun in a voyeuristic way, but they are largely unproductive and generally used as a means of gaining attention, and providing distraction from what really matters, in the manner of panem et circenses. And sometimes people use provocative headlines to garner interest as well, in the manner of the New York Post and Daily News.

What Russell is saying is that Prechter is wrong in his interpretation of how deflation will play out, and what the endgame will look like. And he is saying almost the same thing that others, including Eric Janszen and myself, have been saying for quite some time, but in a slightly different ways.

Second, what Bob Prechter does not realize is that a contraction in credit does not imply a one for one decrease in 'money' just as an increase in credit these days does not result in a one for one increase in money. That is because credit is not money, it is the potential for money. Why more people don't get that is beyond me. They trumpet the diminishing returns of money production for each marginal dollar of credit, but they don't admit that this credit is vaporous, and as it dissipates it does not reduce money supply one for one either.

Third, and probably most importantly of all, even as the credit contracts, and the money supply contracts at some lesser rate as show in the money supply figures, the 'basis of value' of the money is also contracting. Since the US dollar is not based on gold, we have to look at what is providing the basis of its value. And what are those things, and what is happening to THEIR value.

And finally, there is a huge overhang of eurodollars out there, that are largely parked in Treasuries mostly of a moderate duration of three to ten years. By buying the Three and Ten year notes the Fed is 'monetizing them' and taking that supply off the market, softening the blow when foreign entities first stop buying them, and then eventually start selling them.

We can't detect the selling yet in the Fed Custodial accounts. And we do not have a reliable reporting of eurodollars because that is the ONLY component of M3 that was discontinued by the Fed a few years back. The rest were maintained. When the Fed said they would no longer report M3 what they were really saying is that they would no longer provide a reliable report on eurodollars. The conspiracy guys may have been right, but they were focusing on the wrong item.

Bernanke and the Fed are going to be playing these markets to manage bonds and the dollar, and it is going to be a balancing act, and most likely a race to the bottom. That is why it is hard to predict. So far Ben is being predictable, doing what he said he would do, even if it is not always clear to everyone. But he has some other things in his bag of tricks, and those might be a little more complex.

What the Fed is doing by lowering the Ten year note by buying it in the market, in addition to picking up the slack from the overseas banks, is trying to trigger another round of refinancing in corporates and mortgages. It is estimated that two trillion in refi's will be triggered if the Fed can get the Ten year down below 2.5 and even approach 2 percent.

And this prolonged quantitative easing has a secondary effect that supports this. These low rates tend to drive investors from low yielding instruments in search of return, which implies a mix of greater duration and risk. More on this at some future date.

I think Elliot Waves are popular because they are not particularly rigorous or scientific, are easily learned, and are flexible enough to justify almost any outcome you wish to see. Their value is that they remind people that things do not go straight up or straight down. Since most charting is just a forecast it might be no better or worse than the others.

But what does discredit Prechter is that he is using an economic monetary model from 'the last crisis' that was valid when the dollar was on an external standard. And it is a pure fiat currency now. That is a huge difference, and the failure to account for that in your thinking is an elementary mistake.

AND even worse, he has been repeatedly wrong about gold for the past eight years and has never admitted or understood why, and merely keeps moving his price levels. Although to his credit he has been very right about Treasuries, and people should not forget that either. Treasuries have been in an epic bull market for quite some time, and like bull markets in stocks have created quite a few market geniuses out there.

Bob has his points for and against like everyone else. He has made some very good calls, and some horrible misses. People tend to remember the hits and forget the misses.

Does Bob ever admit it when he is wrong? He has never done so on gold. And I find stubbornness in the face of failure to predict, the unwillingness to admit error and adjust, to be just the kind of amateurish investing error that causes people to take their trading accounts over Niagara Falls. And I think this is what concerns Richard Russell, that if and when the tide changes and the dollar resumes its long decline lower, that Bob will not recognize or admit it, and will take quite a few trusting souls over the cliff with him.

No matter what happens with easing or not, the primary issue is that a relatively small financial elite has taken control of the US economy, and is using it for their personal power and wealth, and corrupted the natural market processes.

And this corruption is being transmitted to the rest of the world's economy creating bubbles and collapses in distant places because of the importance of the US economy and the dollar. Since the Bankers have control of the issuance of the world's reserve currency, they can bend the world to their will, and their willfulness is not beneficial to anyone except themselves. The world is seeing the continuation of the 'cold war' under different means and with different objectives, and with a different set of adversaries and alliances.

But what about Japan? There are easily twenty examples of monetary crises and economic collapses since WW II, and Japan is the one seized upon as THE example of what MUST happen in the US, despite the tremendous differences in position of the two countries economically, culturally, and demographically. Talk about conformational bias. I have spoken about this at length in the past. Japan demonstrates that monetary outcomes in a pure fiat regime are a policy decision. And Japan was homogenous enough, and small enough, to play in its own policy sandbox long enough to realize the outcome that was achieved. Until recently, Japan was essentially a 'one party' democracy imposed on them after the War by the US, ruled by the LDP and the big corporations, the keiretsu.

All things considered, the Russian outcome seem more likely to me, except the US is short on natural resources, so it is hard to forecast what will finally trigger the recovery. The dominant industry is financial fraud, demand that seems to be on the decline in US' trading partners, unholy alliances amongst central banks notwithstanding.

The US financial sector is still greatly oversized, and exacting a debilitating tax on the real economy. The markets are manipulated and rife with fraud, so productive capital formation and allocation is short circuited by short term speculation at almost every turn. There will be no recovery unless the system can be brought back to a pre-bubble state. And the system will not cure itself by deprivation or a false austerity, dishing out more punishment to the victims. This will provoke a destructive reaction, not what anyone would call a cure.

That is the real issue. Everything else to me is a sideshow, gossip, distraction, and noise.

You can read the original article Richard Russell Slams Robert Prechter, Praises Gold, Tells Readers To Get Out Of Stocks.

The Inflation and Deflation Debate Deconstructed

'What most people call reason is really rationalization. Given a new set of data, most people will search through it only for those examples that support their existing beliefs. Their beliefs are really opinions, a tenuous collection of myths, anecdotes, slogans, and prejudices based largely on justifying personal fear and greed. This is what makes modern propaganda so powerful; people do not bother to think critically and objectively and act for the greatest good. And in their ignorance they can find the will to do increasingly monstrous things, and rationalize them.' Jesse

In a purely fiat regime, the question of a general (monetary) deflation and inflation is a policy decision. Anyone who does not understand this does not understand the modern mechanism of money creation. As the pundit said, "The mind rebels..."

But rather than engage in the usual facile intramurals about the topic, let's consider something more important. How does one 'play this' which is really what all these discussions are about: self interest.

The champion of deflation is the Treasury Bond (and the Dollar), and of the inflationists, Gold.

There are extremes on both sides, and probably more sense in the middle, since life rarely sustains the extreme unless there are people messing about with it. The only naturally efficient markets are in ... nature, and that only as measured over the long term.

Anyone who doesn't think Treasuries have been in a long bull market are blind fools.

But the same is true of gold.

I will leave the dollar aside for now to simplify the discussion, but it hardly lends itself to the deflationary theory.

People who have taken positions and held them in both Treasuries and Gold over the past ten years have made money, a very nice return. When one has a theory that consistently and reasonably encompasses that, you might have something worthwhile.

The deflationists will say that gold is a bubble fueled by mistaken speculators, and the inflationists will say that the Treasuries are being supported and manipulated by the Fed. Neither is able to look out from their deep wells of subjectivity.

You may wish to consider that the great part of this discussion, inflation versus deflation, is a diversion. But that is a discussion for another time.

The question for all failing theories is, as always, what next. What is the alternate count.

Oh boy oh boy, [our desired outcome] is finally coming and when it gets here its going to be good. We are finally turning [Japanese / Weimar].

Things are in bull markets, or bear markets, until they are not. The undeniable trend break is the best indication of change in momentum.

But things in the world of complexity are rarely as simple or straightforward as the average mind will allow, or can accept.

Anyone who thinks the Fed is impotent has not been paying attention to the last one hundred years. The Fed is not impotent, merely constrained. Their constraint is the policy arm of the government, the dollar, and the bond, in the absence of some external standards including external force.

Until one understands that, nothing can or will make sense. That is why the current discussion is so nasty and propaganda-like. It is not about what will happen, but rather about a public policy decision, about what people want to happen.

Consider that these debates are merely diversions, to distract people away from the most significant factors in their troubles, which are exploitation and fraud, and a military-industrial complex that is largely unproductive in terms of organic growth, and is quite simply no longer sustainable.

Paid professionals who were arguing the virtue of credit expansion as the bubbles blossomed are now arguing just as strenuously for austerity now that the bubbles are collapsing, their masters having taken their spoils. They will say for pay, without regard for the solutions that are in the best interest of the country. Few are thinking of their country anymore, as the individual is conditioned to think of themselves as globalized abstractions.

As always, be careful what you wish for, because you may get it. In this current climate, this class warfare, the American nation is a house divided. And you know what happens to those.

And the winners may inherit the wreckage, a pyrrhic victory indeed, but they can console themselves with the satisfaction that they have won the irrelevant debate.

Not So Much Deflation as the Decay of Value: SP 500 Futures and Gold Daily Charts Updated at Market Close

Wash and rinse. Best way to get that stubborn money out of the public through fees, commissions, and of course front running for those perfect trading profits at the faux banks.


Chart Updated at Market Close

Now that option expiration is over gold is back to where it was a week ago, trying to break out of its large cup and handle formation. Silver is on the cusp of activating a massive and bullish multi-year chart formation of its own. It is an open question whether gold or silver will lead the way.

But I have to say that the CFTC is a disgrace. Eventually they will clean up their markets, but the foot dragging and dissembling is a mark against them. Chairman Gary Gensler knows better, but he is a Goldman alumnus, so what else would we expect? There are always many frustrated people in every organization trying to do a good job, so we should not paint them all with the same brush. The boss sets the tone, and Gensler's tone seems to be the status quo and crony capitalism. But that is the overall flavor of the Obama economic team.


Chart Updated at Market Close

Most people have a profound misunderstanding about the function that gold, and to a somewhat lesser extent silver, perform in the currency markets and wealth preservation trade.

The meme is that gold is a hedge against inflation. Over the past 100 years or so in particular, the greatest threat to the US dollar, and indeed to most currencies, has been inflation, which is the debasement of the value of a currency through printing or expanding supply faster than real growth in productive economic activity.

But was it really inflation that drove the gold hedge, or something more properly called 'currency risk.' Inflation through expansion of supply is just one facet of currency risk.

The risk today is not a gradual inflation through an overexpansion of the broad money supply, but something insidiously different, not seen since the last Great Depression. It is the risk of the default and devaluation, and the erosion of the assets backing the currency itself, which is not yet showing up in the conventional inflation figures.

What backs the US currency? Often referred to simply as 'the full faith and credit of the government,' it is the ability to collect taxes and service the debt with real returns, and of course and importantly the Fed's and the Treasury's balance sheets. I should have to say no more about this to anyone who has been following recent developments. The erosion of the ability of the government to produce revenue by taxing real income, and the rapidly declining quality of the assets held by the Fed, are obvious. Yes the US dollar may look good when compared some of the other wretched alternatives, but that appearance is like the portrait of Dorian Gray, not capturing the rapid decline in its own worth and well being.

So perhaps this will prove to be some help to those who are expecting debt deterioration and monetary deflation to deliver to them a stronger dollar and stable wealth. They fail to notice that this did NOT happen in the 1930's, and in fact quite the opposite occurred. I am now *hoping* for stagflation as an outcome because it seems better than the alternatives where the US and Europe now appear to be heading.

Yes, it can do so in the short term, particularly if you own the world's reserve currency, and that largely an illusion. But the decay is there for any who care to see it, and the rush to gold by the smarter money is also there to see, for those who will not willfully blind themselves to it.

There is nothing more disheartening than to watch otherwise good people fighting the last war, or perhaps most properly the wrong war, painfully unaware that their tactics and assumptions are misconstrued and self-defeating, and that they are committed to following 'leaders' who are articulate, persuasive, often very loud, and wrong.