Showing posts with label monetary crisis. Show all posts
Showing posts with label monetary crisis. Show all posts

02 January 2015

The Great Fallacy at the Heart of Modern Monetary Theory


As with all theories that miss the mark, Modern Monetary Theory presents some insights into the matter of course, but seems to hinge on one or two key assumptions that are more matters of assertion than historical or even practical experience. It is founded not so much an economic theory, but on a belief without a firm foundation.

This paragraph taken from Yves Smith's recent article about MMT

"The sovereign government cannot become insolvent in its own currency; it can always make all payments as they come due in its own currency because it is the ISSUER of the currency, not simply the USER (as a household or private business is).

This issuing capacity means that the government does not face the same kinds of constraints as a private sector user of money, which in turn exposes the fallacy of the household analogy, so beloved in popular economics discourse."

The finances of a sovereign are most assuredly NOT like those of a household. And those of a Bank are not like a household either.

In several ways they can be the inverse of a household in their motivations. For example, when household spending is slack because of an economic shock, the government may wish to engage in more spending to counteract this.  Some think it is the role of government to keep the economy out of what is called a liquidity trap or as I understand it a feedback loop of cutbacks that greatly exacerbate the problem of slack demand.

This is one of the points of having a government, that is, to do things that the individual cannot do well alone, no matter how powerful they may think that they are, and to protect the rights of the many from those who are more powerful, both foreign and domestic.

But here is the matter of disputation, emphasis in caps theirs, in italics mine. "The sovereign government cannot become insolvent in its own currency; it can always make all payments as they come due in its own currency because it is the ISSUER of the currency, not simply the USER."

Do you see what is missing here, and more importantly, what is implied?

What is missing is the acknowledgement that the users of a currency, call them 'the market,' can and will and have quite often throughout history questioned the valuation of a currency, and often to the point of practical worthlessness, if certain actions are taken by the sovereign in creating their currency.
 
This speaks to a principle that I spelled out some time ago, that the practical limit on a sovereign government in printing money is the willingness of the market to accept it at a certain value. And this applies to any sovereign, more readily perhaps if they are smaller and weaker, but always given time nonetheless.

If Russia, for example, were to merely start printing more rubles and set a target valuation for them, they could enforce this internally. And in fact, many sovereigns have done so throughout history. I remember visiting Moscow shortly after the fall of the Soviet Union, and marveling at the disconnect between the official stated valuations and the actions of the ordinary people in seeking alternatives like the US Dollar, gold, diamonds, and even Western style toilet paper, a more useful sort of paper than the ruble.

Technically Russia could not become insolvent in rubles, because they could always print more of them to pay all their debts, make purchases, and salary payments. The great caveat in this is that Russia had to maintain a measure of control and enforcement to make that principle 'stick.'

And this is what probably makes MMT inadvertently statist, and dangerous. That is because this belief only works within a domain in which the state exercises complete control over valuation.

In the case of the US dollar as a global reserve currency, if this theory is applied, and one of my great fears is that it will be, then there is an inherent need for the Dollar Cartel to continuing expanding their span of control over all of the producing and purchasing world, in order to enforce this belief.

I am sorry to have to disagree with people whom I like and enjoy reading, but as you can see I think there is an important point of disagreement here. And given the number of sovereigns who have defaulted, causing significant pain in their people and in the lives of others, it is not a trivial thing.

I suppose that there are many other things in MMT that are correct, as it seems to be quite the usual thing in many ways, but there is an important exception in the assertion that the state has no limit to its power to set value, because that is exactly what is implied in the canard that a sovereign cannot default in its own currency. Technically it cannot because it can always print more than enough pay off debts and make more purchases. But it can create money in such a way as to break the confidence of the market, and call its valuation into question. And this is a de facto default.

What happens when the people refuse to accept it at their stated value?  What happens to people who do not agree that the State can do no wrong?  Because if the State can never be at fault in creating and spending money, that makes it a problem and a source of great mischief.
 
In the historical examples the government always resorts to force of some sort in varying degrees, and official exchange rates, and other actions not only on their own people but on their neighboring sovereigns who refuse to submit to the valuation of a currency by official diktat.

It is a dangerous statement that might be remedied by an acknowledgement that there are practical limitations on the power of the State in creating money, and that it is related to the willing acceptance and confidence of the people in its fairness and justice, and especially people who are not part of that same economic sphere of influence.   And if the adherents of a belief cannot agree with this, then it calls into question all the other aspects of a belief that is based on such an absurdity a priori principle. 
 
So it was with the 'efficient market hypothesis,' which believed that people acting in a group are naturally good and rational, and therefore needed little or no regulation.  It was widely accepted in economic circles, and those who did not accept it were dismissed as unsophisticated.  And it did not matter that this assumption was shown to be blatantly incorrect to anyone who is familiar with the reality of the marketplace, or has ever driven on a modern high speed motorway.

People on the whole are not naturally rational, good, and self-regulating to a degree sufficient to permit with the dispensation of the rule of law.  If only this were true!  And a persistent minority among them are so much not inclined to the good as to be sociopaths and inclined to be criminals.

And unfortunately politicians who act for the State are not angelically good and beneficent either. But this is what is implied in creating a system that allows for their acquiring and exercising almost unlimited power that is beyond question, in money or in anything else, but in particular something as important as the general means of exchange and valuation.


31 May 2011

Jim Grant Discussion with James Turk on Money, Bonds, the Fed, International Trade, and Gold



"...I have a dreadful confidence that existing [monetary] arrangements will not last."

James Grant

This is an excellent discussion of some of the key topics affecting global currency and the roots of the financial crisis.

It provides some background for the unfolding currency war and the evolution of the global reserve currency which is in progress today.

I think it is fair to say that very few people understand this, and yet it is having a tremendous impact on their lives, and that effect will be increasing, perhaps exponentially, over the next few years.

It is said that a shark must keep growing and moving to remain alive, and can never be at rest. It must continually devour all that it can to survive.

This is the nature of a Ponzi scheme as well, since it is founded on nothing more than a growing believe, and misplaced trust. It can ultimately tolerate no dissent, and needs continue to add converts to it, whether it be by persuasion or force.

And therefore we have the not incidental connection between a global fiat currency such as the American Dollar or the British Pound and a far reaching military-political empire. When the empire stops expanding, the currency begins its slow but inexorable decline.

This discussion is presented as a contrast to Modern Monetary Theory.




27 January 2011

The World Is Waiting For The Sunrise: A Practical Guide to the Re-Monetization of Silver


Here is an excerpt from a longer discussion presented by my friend Hugo Salinas-Price in London today.

Although the proper title of the presentation is 'A Discussion of Precious Metals As Money,' I tend to call it 'A Practical Guide and Rationale For The Re-Monetization of Silver.' You can read the presentation here. I present an important excerpt, part III, below.

For my own part, I do not favor a return to a formal gold or silver standard at this time. I do not prefer it because I do not wish the developed and dominant nations to monopolize and formally set the price of these metals as they have been doing informally, given the unstable, opaque, and dare I say conflicted, nature of their financial systems. Any monetary system requires some measure of transparency and honesty and these are sadly lacking in the modern financial system.

Rather, I think it would serve the purpose to have a trusted coin available with the sanction of the State, at a floating price, to serve in parallel with whatever fiat currency regimes that may be locally in place. 

Thus one could call it the re-monetization of silver, but not the imposition of a formal gold or silver standard. This has two striking benefits: the flexibility to informally devalue or strengthen the national fiat currency, with a sound and safe way to store individual wealth and promote savings and the accumulation of capital for productive investments.  A progressive country might even treat the gain (or loss) of the bullion coin's value as a non-taxable item, providing some remedy to the people if the central bank indulges in printing money and quantitative easing.

This is similar to that which we have today, except that the coin would provide a reliable and practical means of obtaining and storing wealth for the individual, far superior to the ad hoc system of precious metals ownership in place today that is greatly abused by naked short selling and paper leverage, the same taint of the banks which has devastated the global financial system. 

I would look for keen opposition to this by the Anglo-American banking cartel and their friends in central government, since this proposal is inimical to the domination of others through the absolute control of a paper money system and the process of confiscating wealth in the form of inflation, fees, and frauds.  However, I think the zenith of their power is already passing, and because of their foolish and reckless excesses the tide history is about to roll over them.  Most of those close to the system will never even see it coming. Such is the way of long cycle changes.

I believe this proposal offers a unique opportunity to whatever country first steps forward to take it, and provide a universally acceptable metal coin with a floating value that can be used for public and private transactions in their country, as well as private transactions in other regions of the world. After all, one of the primary currencies in young America was the Spanish Dollar, the silver eight reales coin, the source of the phrase, 'pieces of eight.'

With the inclusion of modern technology to promote confidence and inhibit counterfeiting with some elementary testing equipment, some fortunate country could establish itself as the first nation to introduce a hard alternative currency for itself and for the world, in the face of a failing post-Bretton Woods monetary system, to the benefit of their people.

I do not expect the US or the UK to be this innovator, and in fact to stubbornly resist it for the reason cited above. Rather it is more likely to be some emerging economic power such as Mexico, India, Venezuela, Russia or China.  Or perhaps even a confederation of countries or US states acting for the benefit of their people in the face of the powerful banking lobby centered in Washington and New York.

I see this as important now because of an abiding belief that the US dollar reserve currency and international trading regime is highly unstable and too likely to collapse because of a loss of confidence under the weight of pernicious financial corruption. Obama's failure to reform has sealed its fate, and I think we are beyond the point of no return.

I also see great peril in the west with regard to the principle of the private ownership of property, a deficiency created by the very banking system that rose to power on the canard of deregulation and free markets, which has been used as a guise by which to plunder the wealth of the nation. The large scale seizure of property through a highly questionable and fraudulently based foreclosure process may be a portent of things to come. Savings held as electronic digits are much easier to control, debase, defraud, and devalue. 

And I think confidence in the financial markets and assets are at all time lows among the people, despite the aggressive public relations campaign to the contrary being conducted by the bankers and their demimonde in the corporations, central banks, and central governments.

Thus there is an obvious need for a store of wealth that is universal, liquid, portable, and not as subject to the whims of the shadow banking system and the financial plutocracy.  This could happen in the existing system if naked shorting were banned and the regulators would perform their sworn duties to the people, but that appears to be unlikely, and all too easily corruptible. A

Alan Greenspan has said that to the extent that a fiat currency and credit system acts with measured restraint, 'acts like gold,' it can be sustained with an orderly growth and stable prices. And if all good boys and girls act with perfect rational honesty and lack of overly selfish interest and misbehaviour, markets will be naturally efficient and require no regulation.

That is the very point of this. They have not, they do not, and they can not do so in the future, because of the tendency towards corruptibility that a pure fiat system offers to the politicians, insiders, and financial engineers. Abuse of power, as in a dictatorship, is maintained only to the extent that they can extinguish and suppress the alternatives, and even the knowledge that other choices exist. The strength of a broad democracy lies in transparency and relatively independent alternatives, a refuge if you will from the vagaries of human error and venality.

So a convenient and widespread bullion coin appears to be a good alternative. Admittedly it would not be a panacea. There are none. Every system requires work. But some systems are easier to maintain, more robust, less susceptible to failure, and just better than others.

The question in my mind is not so much 'will it happen?' as it is 'who will be the first?' To me it would be the ultimate irony if such a move to promote economic freedom came from a non-Western country.

The World is indeed in the winter of its financial discontent, and 'waiting for the sunrise.'

The World Is Waiting For The Sunrise:
Part III of a four part presentation
By Hugo Salinas-Price
The Cheviot Sound Money Conference
Guildhall, London, England
27 January 2011

Since ancient times one of the most important activities which any State exclusively reserved to itself was the minting of the nation’s money.  In our age we have seen that modern banking systems have completely usurped this fundamental function of the State. Had the banking systems of the world fulfilled this function correctly, we should not be pondering monetary matters.

The fact is that the banking systems of the world have one and all followed the same banking rule book, which they altered when the rules proved an impediment to increased profits, and they have managed to expand themselves into total bankruptcy. Not only that, but having taken over the power of issuing money – of zero quality – they have arrogated unto themselves as if by a natural, God-given right the function of being the central promoters of growth and prosperity.

Thus have the money-lenders promoted themselves into a ruling plutocracy. We are now witnessing the inevitable downfall of these plutocracies which have not been interested in the welfare of their nations, but first, second and last in their own enrichment and power. Thus the plutocrats have bankrupted themselves out of greed and irresponsibility.

We have shown how the Treasury of the UK can have a silver coin minted, and how it can endow that coin with a monetary value. Please notice that we are not assigning this task to the Bank of England. The Bank of England is a Central Bank, a financial institution which regulates banking in the UK. Among other responsibilities, it is in charge of monetary policy, which means that the creation, maintenance and increase or decrease in the amount of fiat money circulating in the UK is within its authorized sphere of action.

The historic development of banking all over the world has led to the present situation, where all money is the exclusive preserve of banking systems and their Central Banks and where, in fact, there is only one kind of money in the world, fiat money.

We live in a world where the dominant paradigm is fiat money issued exclusively by a Central Bank and its related banking system. Humanity today knows of no other money but this!

If and when the Treasury of the UK, in obedience to the instructions of Parliament, proceeds to the minting of a one-ounce pure silver coin with no engraved value and issues a monetary quote for that coin, this will be a revolutionary event from the point of view of the bankers.

The prevailing paradigm of fiat money, and only fiat money, issued exclusively by the Central Bank and its related banking system will have been broken! The State, through the Treasury, will be creating true money.

This will be permanent money which will remain in circulation until it is so worn out that it has to be replaced, at Treasury expense, with new coinage; money that will never be at risk of disappearing due to a collapse of the banking system. Banking, the business of lending money, is a legitimate business subject to risks which all businesses must run. However, the creation of money is not and cannot be a legitimate function of banking: there is a conflict of interest involved in the union of the two functions. The present worldwide monetary and financial disarray is evident proof of this statement.

The rupture of a paradigm is a rare event; entrenched ideas are hard to dislodge. A fresh approach leads to new avenues of action and opens up new horizons which can resolve the total dead-end confronting the world. The system of fiat money issued by banking systems has exhausted itself and cannot offer real alternatives to progress, but only such aberrations as QE 2.

The first thing that will happen when the prevailing monetary paradigm is broken is that people will immediately begin to regard money in a different light: they will have an option, where there was previously no option at all. Britain would no doubt receive the monetization of a silver coin most enthusiastically. The demand for the coin would be enormous.

If the bankers are allowed to have their way, there will be no monetized silver coin. They will adamantly oppose it. They will be frightened to death of the preference which the British would surely give to the silver coin. They will allege that if the silver coin becomes a reality, Britain is doomed. The bankers are prisoners of their paradigm and can think in no other terms.

No one can foresee all the consequences of introducing a silver coin into circulation in parallel with paper and digital money. Churchill once said, “In politics, experimentation is revolution.” However, real silver money has been the rule in history, not the exception; thus a partial return to silver money as an option alongside paper and digital money is hardly an innovation or experimentation. In historic terms, what has been experimentation – and QE 2 is avowedly experimentation – has been global fiat money created by bankers who quite evidently have had no notion of what they were doing and did not know or did not care what the consequences of their actions would be. The British would experience the joy of holding real money in their hands and saving money that will surely be worth something in the years to come: money that cannot be devalued. Revolution, for the bankers who have not lived up to the trust placed in them; for the people, it heralds peace of mind and hope for a better future, not revolution.

Should not a proposition which offers something sure to be welcomed unquestioningly by hundreds of millions of individuals all over the world be worth considering, notwithstanding the objections of the bankrupt bankers? The deep-seated dread on the part of the bankers regarding the latent preference for silver (and gold) on the part of the population reveals a fundamental social instability which will have to be addressed at some point.

Politics implies tensions between sets of ideas. At some times, ideas that further social progress, prosperity and good husbandry are paramount; at other times, the prevailing ideas impede prosperity, breed apathy and promote profligacy.

There is now a potential tension between two conflicting ideas: the idea of the Welfare State, which is tottering on to its eventual collapse, and the idea of taking one’s welfare back into one’s own hands, which at present revolves around an unexpressed mute desire for savings of real, tangible money such as monetized silver. The monetization of a silver coin would provide a channel for that potential tension and create an enormous tide of savings in silver coins.

We believe that the undoubted desire of all peoples of the West - and of the East, as well - is to enjoy real money as the foundation of their economic efforts, and that this desire has been unexpressed and mute because no one has proposed a means of satisfying it. Silver money, which has ever been the money of the people, can become a reality that comes to life in parallel with the prevailing fiat money. Its further development and growth in importance can be only dimly sketched, but it comes to life pregnant with possibilities.

The creation of a silver coin with a stable monetary value, which can remain in permanent circulation in parallel with paper and digital money, would finally close the circuit that turns a worldwide desire into an actuality. The surge into silver money would be enormous. Should we fear what the people desire, or should we understand that desire and its justification, and open the way for it to express itself?

We also believe that the monetization of a silver coin by the method we have outlined – its various details are suggested but can be altered to suit – can become the irresistible objective of a political party that wishes to come to power; there is a silent desire for real money on the part of all people of the world and - the world is waiting for the sunrise!

24 December 2009

Who Is Buying All These US Treasuries (And Can They Keep It Up in 2010)?


Earlier this evening I was reading the latest issue of TheContraryInvestor "Quite The Personal Bond," and was puzzled by his account of the Treasury market.

As shown in this chart, the foreign sector has begun to reduce their exposure to US sovereign debt, just as they were sellers of Agency debt in 2008.



So who is buying Treasuries according to the latest government data?

"US households purchased $529 billion of US Treasuries in the first nine months of 2009, accounting for 45% of total new Treasury issuance. And you have been wondering just how Treasury yields have stayed so low for so long? Wonder no more. US households have done the heavy lifting unlike any other buyer this year. And as we have stated in the past, this decision by households has been driven by two very strong human emotions- fear and greed. Fear of losing money in what is a once in a generation credit bust environment. And greed from the standpoint that the Fed has made money funds completely unpalatable in terms of nominal yield prospects. Of course Treasury yields are not much higher by any means."
So far this year the Fed has purchased $293.3 Billion of Treasury Debt, and is by far the largest purchaser of Agency Debt at $803.8 Billion.

Foreign entities bought $373.3 billion of Treasury debt, and were net sellers again of $110.3 billion of Agency debt and $73.1 of US corporate debt.


"US households purchased $529 billion of US Treasuries in the first nine months of 2009, accounting for 45% of total new Treasury issuance. And you have been wondering just how Treasury yields have stayed so low for so long? Wonder no more. US households have done the heavy lifting unlike any other buyer this year. And as we have stated in the past, this decision by households has been driven by two very strong human emotions- fear and greed. Fear of losing money in what is a once in a generation credit bust environment. And greed from the standpoint that the Fed has made money funds completely unpalatable in terms of nominal yield prospects. Of course Treasury yields are not much higher by any means."
So, according to the government, US households are absolutely piling into US sovereign and corporate debt at record levels, and at record low interest rates.

And almost no one but the Fed is buying Agency Debt.

Bill Gross of Pimco has the largest mutual fund ever, compliments of the bond stampede. The prior record was in 2007 with a growth fund that was decimated by the market crash of that year. And this is why I think we might see quite a bloodbath in the bonds in 2010, as mom and pop get skinned by the Street for weighing in so heavily on this one sided trade in US sovereign debt. The US household sector is a slow moving convoy, presenting a traditional and tempting target for the Wall Street wolf packs.

Here is another viewpoint on essentially the same data that I was just reading this evening at Trader's Narrative titled, Is It All Just a Ponzi Scheme? His take on this is a little less sanguine than the ContraryInvestor.
"At first it seems that the common US household is stepping up and lending Uncle Sam the almost $2 billion. We’ve discussed at length the stampede of retail investors into bond funds this year. But as Sprott [Asset Management] details below, according to the Fed’s own disclosures, this is not what is happening. No wonder then that the US dollar has cratered and gold is the best performing asset this decade..."
Sprott Asset Management says:
"Our concern now is that this is all starting to resemble one giant Ponzi scheme. We all know that the Fed has been active in the market for T-bills. As you can see from Table A, under the auspices of Quantitative Easing, they bought almost 50% of the new Treasury issues in Q2 and almost 30% in Q3. It serves to remember that the whole point of selling new US Treasury bonds is to attract outside capital to finance deficits or to pay off existing debts that are maturing. We are now in a situation, however, where the Fed is printing dollars to buy Treasuries as a means of faking the Treasury’s ability to attract outside capital. If our research proves anything, it’s that the regular buyers of US debt are no longer buying, and it amazes us that the US can successfully issue a record number Treasuries in this environment without the slightest hiccup in the market."


So what does all this mean?

The bottom line is that the data seems to indicate that the foreign sector traditional buyers (at least for the past 20 years or so) of US sovereign debt are walking away from the market as they had said they would do, and are moving their reserves into other instruments.

This may not be such a great problem if the US trade balance continues to narrow, but it certainly is not healthy to see the Fed and the US household sector as the major markets for US sovereign debt.

If 2010 is not a year of recovery for the average American, the ability of the Treasury and Fannie/Freddie to keep expanding their debt offerings is going to become quickly constrained. How can Joe Sixpack keep saving and buying Treasuries, and at the same time consume at a rate sufficient to grow GDP? All on a stagnant median wage and a contracting housing market? Think the rest of the world is suddenly going to grow a taste for US exports? Will the US retreat into isolationism and trade barriers? That might not be Price Index friendly.

The US is marshaling its ratings agencies and multinationals to cast doubt on the European union, their currency, and their solvency, and threaten to take them down first to maintain an equilibrium of failures.

But in fact, the US is much closer to the point of a serious debt crisis than one might imagine from what is being put out by most US based financial analysts. There is a nasty convergence of constraints bearing down on the Fed and the Treasury that look to push the ability to market dollar debt to the breaking point. If a couple big States go under next year, the dominoes may start falling very quickly.

I see the problem, but I have to confess that I do not yet see how the Bernanke Fed intends to dodge this collision. And I know that they must see this as well, and have a game plan. Could counting on an exogenous event that would provoke an artificial demand and neo-isolationism (something like a regional war, or at least a trade war) be called a plan? Can they possibly be in denial, and just looting the capital before the Empire falls? It is hard to see how the resolution of this will unfold just yet, but I am pretty sure that many of the simple scenarios that people are laying out so nicely with such fine rhetoric are more fantasy than probable outcomes. This is going to knock our socks off default-wise.

If you think that this crisis will be deflationary, then you might be a bit surprised to see what happens if and when a US sovereign debt offering fails in the market. It will not be pretty. And it will not be dollar friendly in the longer term. But who can say what will happen, when there are so many possibilities.

The market may likely reveal to us what is coming, if we are observant, and lucky, and have the willingness to listen to what we may not wish to hear.

There are some definite gaps and assumptions in the case that Sprott makes, raising more questions than providing answers. It is possible that Americans have shifted an enormous amount of capital out of consumption and stocks into Treasuries. It is also possible that this is just masking something else, as Sprott suggests. But this does not affect the argument we make, that something has got to give, as the US consumer is tapped, and cannot sustain this type of sovereign debt purchasing given the offerings that the Treasury must make in 2010. And if it is something else, then that will be revealed 'when the tide goes out' next year. The Fed and its enablers are the buyers of last resort, increasingly so. And that means increasing monetization, and a stretching of the value basis of the bonds and the dollars.

Read the full analysis from Sprott Asset Management here.


25 November 2009

Gold Is Rallying Because....


Gold is a superior store of value.

It resists the attempts by the monetary authorities to debase it, because except for concerted attempts to suppress its price through non-profitseeking selling at key market points by central banks, and naked short selling by the global commercial banks in the paper markets, gold cannot be created and controlled by financial engineers like Ben Bernanke.

It provides a refuge, a store of wealth for private citizens during a period of general currency risk.

A simple chart should suffice.



As part of the quantitative easing regime, the Fed has so debased the financial system that dollar debt is paying negative interest rates once again as it did in the 1970's.

In other words, it is costing money to hold dollar financial assets because of the mispricing of risk being engineering by the G7 central banks.

So, people and some central banks are seeking refuge in a stable store of wealth that is beyond the control of the financial engineers.

"With the exception only of the period of the gold standard, practically all governments of history have used their exclusive power to issue money to defraud and plunder the people." Fredrich August von Hayek
"The gold standard has one tremendous virtue: the quantity of the money supply, under the gold standard, is independent of the policies of governments and political parties. This is its advantage. It is a form of protection against spendthrift governments." Ludwig von Mises
Alan Greenspan himself states the case most eloquently in his famous essay from 1966 Gold and Economic Freedom.
"This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard."

When the currencies of the US and Europe are debased by the financial engineers for the sake of the banks, when spendthrift governments run enormous deficits to fill the pockets of their special interests, informed wealth seeks a refuge in places where it cannot be so easily consumed for the exclusive benefit of the political elite.

This is sadly the case today, especially within the Anglo-American sphere of influence, from which the dollar had become the new opium trade, viciously addictive and debilitating. And so we have seen an historic flight to safety that began in the developing world, but is gaining momentum as the global dollar regime falters.

If you hold dollars, the Fed and the Treasury can confiscate your wealth, virtually at will. That is real power.

When the Fed lifts interest rates to again provide a positive return against inflation, then gold may stop rallying and reach a stable equilibrium price. This will be more difficult to do than it was to debase, as it is always easier to destroy than to create.

And it may be difficult to determine when that time comes, because the US bureaucrats have so thoroughly altered the Consumer Price Index over the past ten years that it is no longer a fair measure of inflation. Therefore it is a challenge to determine what is real and what is not, what is priced fairly and what is not. This is the hallmark of the modern western bankers and their accountants, and their demimonde in politics and the media.

Still, the message of the market is quite clear, to anyone who will listen.

A pleasant Thanksgiving holiday to my American friends, and a reminder to the rest of the world that you must muddle through without the direction of Wall Street for the next few days. How fitting that Thanksgiving was declared a national holiday by Lincoln in the depths of the Civil War, and made official by the Congress in 1941, at the end of the Great Depression, on the cusp of a terrible world war.

And Lloyd, I would not join the many and be happy at all if you took your own life as you have recently confessed that you feared they would. But there might be a cause for celebration if a master of the universe such as yourself would simply take this timeless message into you heart, and make it the light of the rest of your life. That is the right pricing of risk, the proper valuation of all that you are.

"Come, let us sing to the Lord; let us make a joyful noise to the rock of our salvation. Let us come before His presence with thanksgiving; let us make a joyful noise to Him with songs of praise. For the Lord is a great God, and a great King above all. In His hand are the deep places of the earth, the heights and strength of the hills. The sea is His, for He made it, and His hands formed the dry land. Come, let us worship respectfully, let us kneel before the Lord our Maker. For He is our God and we are the people of His pasture and the sheep of His hand. Now, if you will but hear His voice." Psalm 95
No time for despair, now is the time to be surprised by joy.
"I do not think of all the misery, but of the glory that remains. Go outside into the fields, nature and the sun, go out and seek happiness in yourself and in God. Think of the beauty that again and again discharges itself within and without you, and be happy." Anne Frank

22 June 2009

Some Common Fallacies About Inflation and Deflation: the Weimar Nightmare in Review


There are several fallacies making the rounds of the economic community, often put forward by pundits on the infomercials for corporate America, and also on the internet among well-meaning but badly informed bloggers.

The first of these monetary fallacies is that 'the output gap will prevent inflation.' The second is that a lack of net bank lending or other 'debt destruction' will require a deflationary outcome. Let's deal with the output gap theory first.

Output gap is the economic measure of the difference between the actual output of an economy and the output it could achieve when it is most efficient, or at full capacity.

The theory is that when GDP underperforms its potential, with unemployment remaining high, there can be no inflation because demand is weak and median wages will be presumably stagnant. This idea comes from neoliberal monetarist economics, and a misunderstanding of the inflationary experience of the 1970s.

The thought is that sustained inflation is due to a 'wage-price' spiral. Higher wages amongst workers cause prices to rise, prompting workers to demand higher wages, thereby fueling inflation. If workers do not have the ability to demand higher wages there can be no inflation.

While this is in part true, it tends to confuse cause and effect.

The cause of a monetary inflation, which is a broadly based inflation across most products and services relatively independent of demand, is often based in a monetary expansion of the currency resulting in a debasement and devaluation.

A monetary expansion is relatively difficult to achieve under an external standard since it must be overt and often deliberative. A gradual inflation is an almost natural outcome under a fiat currency regime because policy-makers can almost never resist the temptation of cheap growth and the personal enrichment that comes with it.

There can be short term non-monetary inflation-deflation cycles that tend to be more product specific in a market that is not under government price controls. But this is not the same as a broad monetary inflation or deflation.

The key difference is the value of the dollar which has little or nothing to do with a business cycle or product demand/supply induced inflation/deflation.

In the modern era the Federal Reserve can increase the money supply independent of demand by the monetization of debt, with the only restrictions on their ability to increase supply being the value of the dollar and the acceptability of US sovereign debt. This requires the acquiescence of the Treasury and the cooperation of at least one major money center bank.

People tend to invent 'rules' about how the money supply is able to increase, and confuse financial wagers and credit with money. This is in part because the average mind rebels at the reality behind modern currency and the ease at which it can be created. Further, people often invent facts to support theories that they embrace in an a priori manner.

In a pure fiat currency regime, the swings between inflation and deflation are almost always the result of policy decisions, with the occasional exogenous shock. A government decides to inflate or strengthen their money supply relative to productivity as a policy decision regarding spending, central bank credit expansions, banking requirements and regulations, among other things.

As a prime example of a rapid inflation despite a severe economic slump, what one might call uber-stagflation, is the Weimar experience.

Since pictures are worth 1000 words, let me be brief by showing you a few important charts.

The basic ingredients of the Weimar experience are...


A high level of official debt issuance relative to economic growth




High unemployment with a slumping real GDP



Wage Stagnation



I should stop here and note that although the statistics at hand involve union workers, in fact unemployment was widespread in the Weimar economy. The saving grace of being in the union was that one was more often able to retain their jobs and some level of nominal wage increases.

Anyone who has read the history of the times knows that unemployment, underemployment and slack demand was rampant, and that hoarding was commonplace as people refused to trade real goods for a rapidly devaluing currency.

Rapidly Rising Prices Despite Slack Demand and High Unemployment



So much for the wage price spiral and the output gap.

A Booming Stock Market, at Least in Nominal Terms



Booming Price of Precious Metals as a Safe Haven Even While Basic Material Prices Slumped


Notice the plunge in the price of copper as the economy collapsed and gold and silver soared.




If one can obtain a copy, as it is out of print, one of the best descriptions of the German inflation experience is When Money Dies: the Nightmare of the Weimar Collapse by Adam Fergusson. There is a copy of the book available online for free here.

From my own readings in this area, the people who tended to survive the Weimar stagflation the best were those who:
1. Owned independent supplies of essentials including food and shelter and were reasonably self-sufficient.
2. Had savings in foreign currencies that were backed by gold such as the US dollar and the Swiss Franc
3. Possessed precious metals
4. Belonged to a trade union and/or had essential skills or government position which guaranteed a wage
5. Were invested in foreign equity markets, and even in the domestic German stock market for a time

People will argue now that the Fed understands that inflation is caused by perceptions, and that by managing those perceptions inflation can be avoided because even those prices are rising and the currency is being devalued, if they ignore it the inflation cannot reach harmful levels.

This is what I call the "psychosis school" of behavioral economics.

Granted, perception is important, and managing perception may delay outcomes for a period of time. But unless the underlying cause of the problem is remedied during what is at best is an extended interlude, the resulting break in perception will ignite a firestorm of cognitive dissonance, loss of confidence, and social unrest.

In summary, in a purely fiat currency regime a sustained monetary inflation or deflation is an outcome of policy decisions regarding fiscal policy, monetary policy, and economic balance and output.

As long as the government is able to generate debt, deflation is a highly unlikely outcome. And when the government reaches the practical limits of debt creation, the underpinnings of the currency give way and the economy tends to collapse in a stagflationary slump.

There are no predetermined outcomes in a fiat monetary regime. Deflation, stagflation and hyperinflation are not 'normal' but are certainly possible if the central authority is permitted to abuse the real economy and the money supply for protracted periods of time.

What about Japan? Japan is the perfect example of a policy decision made by a fiat currency regime in what was decidedly NOT a free market, but under the de facto control of a highly entrenched bureaucracy, a single political party, and large corporate giants in pursuit of an industrial policy that favored exports and domestic deflation.

The difference between the Japan of the 1980s and the US of today could not be more stark. Choosing a deflationary policy and high interest rates as a debtor nation is economic and political suicide. It would be interesting to see what happens if the US elites try to take that path.

We will know if there is a true monetary deflation in the US because the value of the dollar will start increasing dramatically with regard to other hard assets, other currencies, goods and services, and precious metals and commodities. Prices will decline especially for imports as the dollar gains in purchasing power.

Remember that a true monetary inflation and deflation would only show up over time. Even in the Great Depression in the US, as demand slumped and prices fell, the stage was set for a significant devaluation of the US dollar and a rise in consumer prices well in advance of the eventual recovery of the economy that caused the Fed to tighten prematurely. As I recall the actual contraction in money supply lasted two years. This again highlights was an amazing piece of bad policy that Japan represents in its 'lost decade.'

People embrace beliefs for many motivations. So often I find they are not 'rational' and based on a scientific study of the facts, even on the most cursory level. Fear and greed and prejudice are often motivations that are surprisingly resilient, even in the face of overwhelming evidence against them. Leadership understands this well.

There are often appeals to private judgement. I do not care what you say, this is what I believe, what I think, what I feel. This is appropriate in the supra-natural realm, but in the natural realm there may be private judgement but the facts are public, and the outcomes are well beyond the complete control of the most fully-managed perceptual campaigns, at least so far in human experience.

"The lie can be maintained only for such time as the State can shield the people from the political, economic and or military consequences of the lie. It thus becomes vitally important for the State to use all of its powers to repress dissent, for the truth is the mortal enemy of the lie, and thus by extension, the truth is the greatest enemy of the State." Joseph Goebbels, of the perception modification school of economic thought


What is truth? It is difficult to estimate but not completely out of reach.

Our own view is that a serious stagflation with further devaluation of the US dollar as it is replaced as the world's reserve currency is very likely, after a period of slackening demand and high unemployment. A military conflict is also a probable outcome as countries often go to war when they fail at peace.

Weimar was not an anomaly although the level of inflation was indeed legendary. Argentina, post Soviet Russia, and most recently Zimbabwe are all similar examples. Serious Instances of Monetary Inflation Since World War II

There are many, many variables in play here, and policy decisions yet to be made. It is highly discouraging to see Obama's Administration fail so miserably to do the right things, but there is always room for hope, less so today than six months ago however.

Argue and shout grave oaths and wave our hands though we might, we are in God's hands now.

Let's see what happens.

A very special thanks to our friend Bart at Now and Futures who makes these charts, among other things, available on his highly informative web site for public review. If you are not familiar with his work you might do well to view it. We do not always agree, but he demands attention because of the rigor which he applies to his work for which we are grateful, always.

09 June 2009

Price, Demand, and Money Supply as They Relate to Inflation and Deflation


There are three basic inputs to the market price of something:

1. Level of Aggregate Supply
2. Level of Aggregate Demand
3. Relative Value (purchasing power) of the Medium of Exchange

Let's consider supply and demand first, since they are the most intuitively obvious.

The market presents an overall demand, and within that demand for individual products in particular.



Supply is the second key component to price. We are not going to go into more detail on it since what we are facing now is a decrease in Aggregate Demand.


It can seem a little confusing perhaps. Just keep in mind that if the aggregate demand decreases for goods and services for whatever reasons, such as severe unemployment, and supply remains available then prices will drop overall, with some variance across products because of their differing elasticity to price changes.

This is known as the Law of Supply and Demand.

How we do know when aggregate Demand is decreasing?

Gross Domestic Product = Consumption + Investment + Government spending + (exports − imports),
or the famous economic equation GDP = C + I + G + (X − M).

Consumption, or Aggregate Demand, is a measurable and key component of our GDP figures.

Given the huge slump in GDP, it should be obvious that we are in a demand driven price deflation on many goods and services. People are saving more and consuming less.

Now, that covers supply and demand as components of price, but what about money?

Money

Notice in the above examples we talk about Price as a value without a label.

Money is a medium of exchange. It is the label which we apply to give a meaning to our economic transactions.

If you are in England, or France, or Argentina, or China, the value label you apply to Price is going to be different according to local laws and customs.

Money is the predominant medium of exchange that a group of people have agreed to use when engaging in economic transactions that are not based on pure trading of goods, known as barter.

The source and store of wealth are the 'credits' within the system which one uses to exchange for products. The money is the medium of exchange.

If you work for a living, you are exchanging your time and your talent, which is your source of wealth, for products. The way in which this is labeled and facilitated in the United States is through the US dollar. I n Russia and China is it something else completely.

The Value of Money

How do we know what some unit of money is worth? Try not to think about your domestic currency. Since we use it so often every day, we tend to think of it with a set of assumptions and biases. Most Americans have little practical exposure to foreign exchange, and tend to think of themselves as living in a dollar-centric world.

Let's use the Chinese yuan. What is the yuan worth? What if I offered you a roll of yuan in exchange for a day's work? How would you know if it was a 'fair trade?"

Since there is no fixed standard for money in our world, you would most likely inquire in the markets what you could obtain for those yuan I offered to you in an accessible market.

But what sets the rate at which yuan are exchanged for a given product?

In a free market system, it is a very dynamic system of barter. When you offer something for money, I know how much of my source or store of wealth I must exchange for the yuan to provide for the product offered.

Money is just a placeholder. We hold it because we expect to be able to trade it for something else which we really desire. You don't eat or wear money; you exchange it for things which you wish to eat or wear.

If the value of money changes, the price of all the things to which you have been applying that label changes. This is why it is important to distinguish between price changes because of changes in demand, and changes because of money supply. They are different, and require very different responses.

Money supply

In a very real sense, there is a relationship between how many goods and services are available, and how much money exists.

Let's say we are in China. I give you 100 yuan. Tomorrow the Chinese government triples the amount of yuan in the economy by giving each of its citizens ten thousand yuan for essentially doing nothing, for not producing anything more or less.

Do you think the 100 yuan will be worth as much as they were the day before? No, obviously not.

In real economies these changes tend to happen with a time lag, or gradually, between the action and the reaction. This is necessary because people can only adjust their daily habits, their economic transactions, gradually. Otherwise it becomes too stressful, since our daily routines and decisions are based so heavily on habits and assumptions of value and consequences.

But in general, if the supply of money is increasing faster than real per capita GDP over a longer term average the money supply is inflating, that is, losing real purchasing power.

Seems simple? Well its a bit more complicated than that unfortunately since these things relate to free markets, and if there is any other thing you need to remember, we do not have free markets, only free to varying degrees.

The logical question at this point is to ask, "What is the money supply?" That is, what is money and what is not?

We dealt with this at some length, and suggest you look at this Money Supply: A Primer in order to gain more knowledge of what is money and money supply.

We would like to note here though, that there is a difference between money supply and credit, between real money and potential money.

If I have 100 Yuan in my pocket, there is a real difference between that money, and my ability to work at some job tomorrow and be paid 100 yuan, or have you repay 100 yuan to me which I gave to you yesterday, or my hopes that I can borrow 100 yuan from some third party.

If you do not understand this, you will not understand money. It is one of the great charades of our time that risk has been so badly distorted out of our calculations. We cannot help but think that some future generation will look at us as though we had all gone barking mad.

The subject becomes even more complicated these days because we are in what is called a fiat regime. Fiat means 'let it be done' as we will it, and we are if anything in a very relativistic age in which we think we can will just about anything.

The major nations of the world get together and attempt to manage the value of their currencies relative to one another, primarily through their finance ministries and central banks.

Countries will interfere in the markets, much more than they will admit, to attempt to maintain certain relationships among currencies of importance to them. Sometimes they are overt about it, as when nations 'peg' one currency to another, and at other times they are more subtle and merely influence other currencies through mass purchases of debt and other forms of persuasion and the molding of perception.

I hope this helps. I don't intend to answer loads of questions on this, particularly from those who immediately start inventing complex examples to try and disprove this. Most of the time the examples betray a bias that person has that defies patience and a stubborn belief that everything is relative. In the longer term it is most assuredly not.

Each will learn at their own pace what is real and what is not. But they will not be able to say that they have not been warned that sometimes appearance is different than reality.

Here are some examples of money supply growth in the US. If you read our Primer you will know that MZM is by far the most important now that M3 is no longer reliably available.



Is money supply growing faster than real per capita GDP? Yes, decidedly so. And unless this trend changes significantly we will face a whopping monetary inflation.





Here is a chart that shows the buying of US debt that other countries have been doing through the NY Fed Custodial Accounts for a variety of motivations. Without this absorption of US money supply the value of the dollar would be greatly diminished relative to several other currencies. This is probably not a sustainable relationship but it has had a good long run because it is supported by the US as the world's superpower.

Other countries are essentially exchanging their productivity, their per capita GDP, for our excess money supply. This is why a US monetary inflation has remained manageable. Other countries are providing an artificial Demand for US debt at non-market prices.



One of the great errors of our generation has been the gradual and erroneous mispricing of risk through a variety of bad assumptions and convenient fallacies. Without the appropriate allowance for risk, there is no ability to discover valid pricing and allocation of capital.

The consequences of this abuse of reason are going to be enormous.

I do not see this improving quickly because the manipulation of risk for the benefit of the few, and the transfer of that risk to the public and the rest of the world, has tremendous value to the powerful status quo.

But the day of reckoning and settlement of accounts is coming, and as it approaches it will accelerate and come with a vengeance. For after all,

"Life is a school of probability." Walter Bagehot

School is almost out.

27 April 2009

A Crisis of the Fed's Making



After many years of credit binging and monetary mismanagement, the sorcerer's apprentices at the Fed are having to bail hard as the credit tsunami crashes.



Thanks to Sean Corrigan of Diapason Commodities Management for this chart.

19 March 2009

The Decline of the Dollar as the World's Reserve Currency


The arrogant belief that you are the 'only game in town,' and indispensable, provokes reckless behaviour that takes advantage of such a belief with abusive excess.

The time for the dollar to fall from its reserve currency status is coming precisely because of the years of reckless deficit spending beginning with the Reagan Administration.

This is also a model for the Wall Street moneycenter banks, who have abused their position in the financial system egregiously since the repeal of Glass-Steagall.

The likely result of this long cycle of reckless speculation and arrogance was forecast here in 2005.


Forecast 2005: The Humpty Dumpty Economy
Jesse's Café Américain

The current trend in the United States economy is not sustainable. This is a
realization that will penetrate the national consciousness slowly and unevenly.
Most economists agree on how this cycle will end (even if it is only privately), but
the great debate is in the details of how, and most importantly, when.

If one does not accept that the situation is unsustainable, and believes that things
can continue on endlessly just as they are, with the United States consuming the
bulk of the world’s savings and production because of who we are, then perhaps
this is symptomatic of the national epidemic we now suffer which the ancient
Greeks called hubris.

"Where else will they put their surplus if not our debt? To whom will they sell their
goods if not to us? Who will teach them how to live, and govern them?" History
shows that even if such trends last far beyond most expectations, eventually a
day of reckoning arrives, in some frequently repeated patterns of systemic
failure....

Things rarely reach a turning point when we expect it. A true sea change is
slow to permeate the mentality of most people, because our experience is that
what happened yesterday will happen again tomorrow, and a long cyclical turn occurs
gradually and incrementally. We forget what happened even a few years ago.
Predictions of a continuance of recent trends are the common currency of most pundits...

However, and this is a common sense notion that has been nearly forgotten
by our generation, we have the ability to act in such a way so as to make the
improbable more likely to occur, to tempt fate by our actions. For example, there
is a certain probability of sustaining an automobile accident in the normal course of
our daily activities. High risk behaviors, such as speeding excessively or
drinking while driving, increase the chance of an accident. If one engages in high risk
activity, and nothing unusual happens, we become emboldened and think that
since we were able to drink moderately and drive last month, so we can drink
and drive this month and thereafter. Perhaps next month we drink a little more for
an indulgence, and again nothing happens. This cycle continues until something
changes our behavior, or simply ends when we literally hit the wall.

It would be our contention that the US is like such a driver, and we have been
economically tempting fate with increasingly risky behaviors. We are persuaded
that there is almost nothing we cannot do, almost nothing that can happen, that is
beyond our control. It is the propensity for people to increase and
repeat what they have been doing over time, to tempt fate through repeated and
increasingly risky behavior, and to forget the possibility of a sequence of
unfortunate events if you will, that gives rise to memorable events in history...

Predicting the failure of a complex system is not easy. One can examine it as a
whole, and determine that it will fail, and often calculate what must change in
order to allow the system to function more reliably. But it is often beyond our power to
calculate exactly how it will fail, and consequently when it will fail. This does not
invalidate the observation that the system will ultimately fail. It merely
underscores the unpredictability of timing a failure with the degrees of freedom
inherent in a calculation with a large number of exogenous variables. It is not
easy to predict exactly when a chronic DWI will demolish their automobile, but it
remains relatively predictable to say that they will do so as long as they maintain
their current mode of behavior....

There are four major types of tipping points:

o Demand: a break in the level of consumption in the US caused by the
unwillingness or ability of households to incur further debt to support
consumption beyond real wage growth

o Supply: a major disruption in the supply of an essential commodity like
energy, food, or raw materials, or even the realization that a major
commodity is in shorter supply than expected, such as silver or oil.

o Monetary: an inability of foreign central banks to continue to
monetize the US trade deficit and budget deficit through the recycling of
their trade surplus into US debt securities.

o Systemic failure: the failure of a major counter party that threatens the
US financial system, particularly in the hugely leveraged derivatives
market.

Two of the seals, Demand and Systemic Failure, have been broken, and the horsemen unleashed. Next comes Monetary, and then Supply, which is a Pale Horse.

There is still time to end this spiral of decline.


Reuters
U.N. panel says world should ditch dollar
By Jeremy Gaunt, European Investment Correspondent
Wed Mar 18, 2009 11:16am EDT

LUXEMBOURG (Reuters) - A U.N. panel will next week recommend that the world ditch the dollar as its reserve currency in favor of a shared basket of currencies, a member of the panel said on Wednesday, adding to pressure on the dollar.

Currency specialist Avinash Persaud, a member of the panel of experts, told a Reuters Funds Summit in Luxembourg that the proposal was to create something like the old Ecu, or European currency unit, that was a hard-traded, weighted basket.

Persaud, chairman of consultants Intelligence Capital and a former currency chief at JPMorgan, said the recommendation would be one of a number delivered to the United Nations on March 25 by the U.N. Commission of Experts on International Financial Reform.

"It is a good moment to move to a shared reserve currency," he said.

Central banks hold their reserves in a variety of currencies and gold, but the dollar has dominated as the most convincing store of value -- though its rate has wavered in recent years as the United States ran up huge twin budget and external deficits.

Some analysts said news of the U.N. panel's recommendation extended dollar losses because it fed into concerns about the future of the greenback as the main global reserve currency, raising the chances of central bank sales of dollar holdings.

"Speculation that major central banks would begin rebalancing their FX reserves has risen since the intensification of the dollar's slide between 2002 and mid-2008," CMC Markets said in a note.

Russia is also planning to propose the creation of a new reserve currency, to be issued by international financial institutions, at the April G20 meeting, according to the text of its proposals published on Monday.

It has significantly reduced the dollar's share in its own reserves in recent years....


Reuters
China backs talks on dollar as reserve -Russian source
By Gleb Bryanski
Thu Mar 19, 2009 11:24am

MOSCOW, March 19 (Reuters) - China and other emerging nations back Russia's call for a discussion on how to replace the dollar as the world's primary reserve currency, a senior Russian government source said on Thursday. Russia has proposed the creation of a new reserve currency, to be issued by international financial institutions, among other measures in the text of its proposals to the April G20 summit published last Monday.

Calls for a rethink of the dollar's status as world's sole benchmark currency come amid concerns about its long-term value as the U.S. Federal Reserve moved to pump more than a trillion dollars of new cash into the ailing economy late Wednesday.

Russia met representatives of China, India and Brazil ahead of the G20 finance ministers meeting last week, as the big emerging powers seek to up their influence on decisionmaking globally. Their first ever joint communique did not mention a new currency but the source said the issue was discussed.

"They (China) did not formally put forward their position for the G20 summit but unofficially they had distributed their paper regarding the same ideas (the need for the new currency)," the source told Reuters, speaking on condition of anonymity.

The source said the Chinese paper envisaged the International Monetary Fund's Special Drawing Rights (SDRs) being first assigned a role of a clearing currency on some transactions and then gradually becoming the main global reserve currency. "They said that the role of reserve currency should be given to SDR," the source said.

A U.N. panel of experts is also looking at using expanded SDRs, originally created by the International Monetary Fund in 1969, but now used mainly as an accounting unit within similar organisations as a new reserve currency instead of the dollar.

Currency specialist Avinash Persaud, a member of the U.N. panel, told a Reuters Funds Summit on Wednesday that the proposal was to create something like the old Ecu, or European currency unit, that was a hard-traded, weighted basket.

The SDR and the old Ecu are essentially combinations of currencies, weighted to a constituent's economic clout, which can be valued against other currencies and against those inside the basket....