Here Is Something To Think About With Regard to Money

Here is something to think about as the Fed continues to expand its Balance Sheet by buying Treasury (and mortgage debt), with an emphasis on systemic limitations that become a little more apparent at the ZIRP boundary where organic money growth is stultified.

As you may recall, the Fed refunds all profit it makes, that is revenue in excess of expenses, back to the US Treasury. And that includes all the interest collected on the bonds its holds.

So as the Fed buys Treasury debt, and holds it to expiration, it refunds all of the interest payments back to the Treasury, less their expenses.

As long as there is at least one Primary Dealer available to make a market in Treasury debt, the Fed, which is technically prohibited from buying the bonds directly from the Treasury, there is a fairly strong measure of control over both the interest paid and the amount of debt which can be issued.

As a thought experiment, what would it be like if the Fed expressed a willingness to buy ALL outstanding Treasury debt at a set schedule of prices?  What are the limiting factors?  What happens to the debt payments of the Treasury?

Now what would happen if the Bank of England or the European Central Bank stated the same policy for all the relevant sovereign debt?  Would it be the same?  Or why would it be different? 

At the end of the day, the value of a fiat currency is intimately involved in confidence in the mature judgement and trustworthiness of the parties involved in its issuance. 

This is why, although it was superficially 'clever,'  the platinum coin was such a dodgy idea to resolve what was essentially a financing disagreement.

As I have said, at the end of the day, the only limiting factor on the Fed and the Treasury is the value at market of the currency, especially with regard to international transactions.

Isn't fiat currency grand?

Here are two very simple models of currency supply 'management.' The 'considerations' could be thought of as degrees of freedom.

I could have added a significant amount of detail to both pictures, but I wanted to capture the 'essence' of the system in each.  

In the Tripartite Market System the level of debt issuance and its price takes the agreement of at least three parties:  the Treasury, the Fed, and the Debt Market as represented by the Primary Dealer.  In this system it is the level of debt issuance that is managed, and the prices paid for it.

In the Unilateral System the Treasury determines the level of dollar issuance according to its needs.

I *think* one can contrive a non-debt based system that involves more than one party, and does not necessarily require a non-governmental party to be directly involved.

Technically the existing arrangement between the Congress and the President is a two party system.  The Congress authorizes expenditures and the President ratifies, enacts, and adminsters them. 

The 'debt ceiling' arrangement in which Congress refuses to 'pay' by deferring to finance its own previously authorized expenditures is a bit of an anomaly and a symptom of dysfunction.

Gold Chart: The 'Cup' Has Formed As Confidence Continues to Erode

"A moment guessed-- then back behind the Fold
Immersed in Darkness, round the Drama rolled
Which, for the pleasure of Eternity,
He doth Himself contrive, enact, behold.

But if in vain, down on the stubborn floor
Of Earth, and up to Heaven's unopening Door,
You gaze Today, while You are You-- what of
Tomorrow, when You will be You, no more?

Omar Khayyám, Rubaiyat

Today's Fed statement confirmed that QE3 is here.

After some initial hesitation the markets shot higher, believing that the Fed would do 'whatever it takes' to bring down real unemployment and to protect the financial markets.

Given that most if not all of the stimulus provided by the Fed has gone to the top percent of the economy's participants, I am struggling with what has changed that will suddenly spread the wealth to the 99 percent. The trickle down theory? Oh please.

He is monetizing the wrong debt for the wrong people in the wrong ways.

Without reform, Bernanke can print until the dollars come home to roost, before he will meet any broad employment targets in this economic structure. Unless the wealthy start hiring people to push their wheelbarrows of money to the stores.

The country needs to find a backbone and act on reform. But like Achilles, it dithers on the beach. For what reasons we may never know for certain, until history has its say.

Gold and silver took off higher like scalded cats. The charts had predicted it but I did not believe it, at least not so quickly. But there it is.

Gold has completed a 'cup' on the daily chart.

Now we would need to see a nice 'handle' to go with it.

There certainly remains the possibility that the 'cup' could fail, and gold could fall back into its broad trading range. That would be manipulation, and it could continue to work for the time being. Modern money is a funny little magician that way. I don't think we have seen anything quite like it, even in some of the more famous manias.

Bonds are the mother of bubbles. But momma swings a big stick.

Here is a look at my 'shadow' chart on gold, that I keep in background to watch developing scenarios without having to engage in unnecessarily tedious redrawing of the published chart.

The 'rim' looks to be around 1770 to 1790.

If this works, the target for this formation would be 2000+ in the next two months or so.

There are larger patterns forming on the chart that call out higher targets.  As to where this ends, it ends when the economy is reformed and the median wage is healthy.

The chart situation in silver is similar, but the percentages are greater. The targets there would be roughly 43, and then 60+. This is by no means a top target.

One step at a time.  In the event of a liquidity panic or exogenous event the charts may defer.

Missouri's Sound Money Bill

"I don't think this has any practical implications,” says David Rapach, associate professor of economics at St. Louis University. “This could be a combination of nostalgia toward both states' rights and the gold standard, but we moved away from those types of models for good reasons.”

Perhaps the good professor has never heard of Gresham's Law, or seen The Hunger Games.   But it does fit my model that most economists' understanding of current economic events has a lag of about ten years.   That is why so many of them missed the build up to the financial collapse.

I would not underestimate the ingenuity of the public and their preference for stable value, and their building resentment at being bullied and abused by pampered elites in a distant city. The Sound Money Bill may be a local protest, but so was The Boston Tea Party.  

Missouri's Sound Money Bill Is Really a Protest
By David Nicklaus
April 24, 2012

When the dreaded hyperinflation arrives, the Missouri House wants Missourians to be ready.

Last week, the legislative body passed the Missouri Sound Money Act of 2012, which declares U.S. gold and silver coins to be legal tender in the state.

That sounds a bit odd, especially since the federal government already recognizes its bullion coins as legal tender.  It's just that nobody's going to pull out a $50 gold piece to pay for snacks at QuikTrip, because the ounce of gold in the coin is really worth $1,600.

Backers of the Sound Money Act envision a system in which you could deposit gold and silver coins in a vault and get a debit card tied to their metal value. If the Federal Reserve debases the value of the dollar – a favorite prediction among the gold-bug set – gold and silver would rise in value, and prescient Missourians could brag about their enhanced purchasing power.

Utah passed a legal-tender law last year, and South Carolina's legislature is considering one this year.

Rich Danker, economics director of conservative lobbying group American Principles in Action, said a couple of institutions in Utah are working to create the gold debit-card system. Until that's in place, sound-money advocates have to spend out of bank accounts denominated in dollars, just like the rest of us.

Missouri's legal-tender bill would benefit precious metals investors by eliminating state capital gains taxes on U.S.-minted coins. A fiscal note says the state treasury could lose more than $370,000 a year.

That's a small price to pay, backers argue, for monetary freedom....


Read the rest here: Missouri's Sound Money Bill Is Really a Protest - St. Louis Today

Securitization - The Undead Heart of the Shadow Banking System

Here is a study of the shadow banking system, and what changed that helped to fuel the credit bubble and the financial collapse.

The root of this was in the overturning of the Glass-Steagall, the well funded lobbying effort for deregulation in the financial sector under the banner of the efficient markets hypothesis and the trickle down theory, and of course, a systematic undermining of regulation, the media, and the law by the monied interests.

Debt is not money. But it can be animated and treated as faux money through fraud, and the end is always bitter for the many, but sweet for the perpetrators of this scheme, if they can get away with it and keep their loot.  They are actively on the look out for fall guys and patsies, and their number one target are their past victims.

There is a difference, the subtlety of which is lost on many, between the deleveraging of a debt inflation and a genuine monetary deflation itself.  In this case the traditional money supply is expanded to save the banking system, which is the primary victim of a debt asset deflation.  That highly unproductive expansion of the fiat money supply, without a commensurate increase in production of real wealth, is what is causing the recession in the real economy today, and the soaring price of hard currency alternatives. 

The real economy is starved for real money, but instead is flooded with counterfeits which flows to frauds of every type.  It cannot bear to submit to economic discipline because it is not born of savings and investment.

Since this is someone else's thoughts it would be extraordinary for me to agree with everything, but I found it a fresh take and well said, and substantially congruent with my own thoughts.

Enjoy.

Securitization – the Undead heart of the Shadow banking machine
By Liar's Lexicon

At the centre of all debates about the Banking crisis, the shadow Banking system and the bank bail-outs is Debt. For a long time I have been arguing that what this debt is, is in fact a new, bank created, bank issued and ultimately bank debased debt-backed currency. And the collapse in value of this unregulated currency IS the crisis. Its cause and its logic.

In order to explain why I think this and why I do not think ‘fixing’ the banking system back to any semblance of how it was, just prior to the crash, will be anything other than a disaster, I have to explain how debt is turned into money. And how, clever as this process is, it also contains within it the seeds of its own undoing.

To do so I have to take you into the undead heart of the machine – securitization. Securitization is what animates the global financial and shadow banking system in whose shadow we now live. It is how modern finance turns debt into money. It is the impious alchemical dream of turning lead to gold, water into wine.

When Securitization was invented it soon wrested control of the money supply away from nations and gave it to the banks. Nations still printed and controlled their currency. But securitization gave banks the ability to print their own currency. And this new securitized currency, based on debt, was theirs to print, control, spend, and ultimately to debase. In short, it gave banks a power to rival nations. It is worth, therefore, understanding its outlines at least.

Please don’t panic. Like most financial stuff its not nearly as difficult as the priesthood would have you believe...

Read the rest of Part 1 here.

Read Part II here.

Read Part III here.

Adjusted Monetary Base Less Excess Bank Reserves

Thanks to my friend Gary at NowandFutures.com for this chart.

I like to think of the expansion of the monetary base as it has been implemented this time, versus 1933 , as a large animal passing through the body of a python.

Who knows what might come out after the banks are done digesting it.

In the second version of the chart below I have merely added a simple trendline.

Absent lending and a velocity of money the added liquidity at cheap rates, is perhaps little more than a subsidy and crutch to the zombie Wall Street banks.

More simply, the expansion is an artifact of the bank rescue and the assumption of bad debts and others financial obligations at above market prices, and not a program targeting the real economy. It is a variation on the efficient market and trickle down theory. Give the banks plenty of liquidity and they will lend it. No, they will take the Fed's riskless interest for the most of it, and gamble with the rest, demanding more guarantees, subsidies and benefits every step of the way.

Yes, the Fed has a 'blunt instrument,' but it is not as blunt and clumsy as Greenspan put forward, for example. The Fed has been primarily concerned with the banking system and its prosperity, both as monetary policy center and in its key role as regulator, and repeatedly allowed and even led the financially naive into trouble.

And they too often have responded to legitimate criticisms and questions from the Congress and the people with appeals to secrecy and snarky misdirection, abuse of their jargon, and the other things that serve to hide their actions.

So with the Fed inflating selectively on the banking side, without exercising vigorous oversight on the financial system, and the median wage languishing in the real economy, a forecast of stagflation, which is always and everywhere the outcome of policy error or exogenous shock, appears probable.

"Significant changes in the growth rate of money supply, even small ones, impact the financial markets first. Then, they impact changes in the real economy, usually in six to nine months, but in a range of three to 18 months. Usually in about two years in the US, they correlate with changes in the rate of inflation or deflation.

The leads are long and variable, though the more inflation a society has experienced, history shows, the shorter the time lead will be between a change in money supply growth and the subsequent change in inflation."

Milton Friedman

This is much more than a liquidity trap. The financial system is broken. It is corrupted and distorted, and it is acting like a weight on the real economy.  And the banking system has been broken since 1990's.  Perhaps broken is not quite the right word since it implies some accident and not a willful campaign of intent.

You can pour monetary stimulus into this corrupted system as the Fed did in the first decade of this century, and the results will be the same: financial asset bubbles, corruption, fraud, increased public debt, and a widening gap between the wealthy few running the system and the public who are paying for it.  The only thing good about stimulus is that it is better than austerity, if both are intended to sustain the unsustainable. 

Stimulus without reform is a waste, but austerity without reform is insane cruelty.

The message of OccupyWallStreet is fairly clear, but the status quo cannot hear the message: 'The Emperor has no clothes.' And today on Bloomberg the response was, 'They hate us for our prosperity.' What the protesters are saying is that the system is broken, we have lost confidence in it, and we want the change and reform that we voted for in 2008 and were never given.

To paraphrase Tacitus on the status quo of empire, "To ravage, to slaughter, to usurp under false titles, they call freedom; and where they create a desert, they call it prosperity."

Modern Economics: The Money Masters and Modern Economic Theory - Credibility Trap

Yesterday it was Yves Smith who took Paul Krugman to task. And I defended him in that instance in the comments. But now alas it's my turn, and I don't take this up lightly.  So I must think it is important.

And I do.  Because a false premise is being used to justify a false conclusion and by extension a matter of serious public policy in an ongoing debate. And people are in the streets about it.

In a recent op-ed Way Off Base Paul Krugman says:

"I see some commenters reacting to the failure of major inflation to break out by insisting that inflation is defined as an increase in the monetary base — that is, the bank reserves plus currency that are what increases when the Fed “prints money”. As it happens, that’s wrong: very old dictionaries defined inflation as a rise in money and/or credit, but the modern usage is, of course, a rise in prices.

But that’s really a side issue. Nobody would care about the size of the monetary base except for the belief that increasing the base leads to a rise in prices. That’s not a question of definitions, it’s a question of your model of the economy."

For those unfamiliar with measures of money supply and the monetary base, see Money Supply: A Primer.

I don't know who these commenters are, but they *could be* those from the Austrian school, who tend to look to what they call True Money Supply. I would have to read up to find out what the anticipated lag times are between expansion and its aftereffects.  It could also be from those who are forecasting hyperinflation, but those are few and I am not among them.  My forecast has long called for a credit bubble followed by a financial collapse and stagflation as the most like outcome but it is no economic model, more of a judgement call.  The variables are too many and too exogenous for any model that I could possibly devise. . Or the model Paul references could be just a strawman.

Except for the Austrians, and of course perhaps Paul Krugman when it suits him, I don't know of many rational financial people who would look to a very narrow measure of money supply, especially the Monetary Base, and expect a simple causal effect in prices over a short period of time of even a few years, in an ongoing great recession with a very low velocity of money and little lending.  And of course the Fed is taking steps to ring fence their market operations.  And it seems to be working.

I thought the allusion to 'old dictionaries' versus 'new dictionaries' was an appeal to an authority that does not quite work anymore, as if Economics is somehow making steady progress, despite its most recent terrible flop and sometimes scandalous behaviour.   Yes Paul can point to a few timid warnings in old columns, but his models were remarkably silent in predicting the financial credit bubbles and collapse.

The answer of course is-- ta da, better models. And the definition is my shiny new model versus your old outdated model as I choose to define them.  But at the end of the day, the ideal economic model dictates policy with pristine mathematical objectivity.

Adjusted Monetary Base, who could care about it?

Well, the Fed spends quite a bit of time on it, and those who understand anything about economics know that in periods when the financial system breaks down, especially from some excesses promoted by central bank economists, the Fed becomes the 'lender of last resort.' And what they are lending is money they have created by expanding their balance sheet. If they were only providing temporary liquidity the balance sheet would not be expanding in such a parabolic manner and more importantly, remaining there.

In other words, the Fed becomes the 'money creator' and provider of last resort, expending a significant amount of effort to prevent monetary deflation which they find to be against their mandate of what-- a stable money supply and rate of inflation.

The monetary base is a source of money, not broad money in public hands, which the Fed provides under the duress of stressful financial conditions, rather than mere economic cyclical turns.   Which is fine, because that is their job as currently defined. And the Monetary Base is one way of measuring it.

The Monetary Base has a particularly long lead time, or lag as economists call it,  before even large changes appear in the real economy in the form of higher prices and a money supply that is growing in excess of some organic demand.   I am sure Paul is aware of the devaluation of the dollar and the dramatic expansion of the monetary base undertaken in the 1930's by FDR, and the rather dramatic change in trend for consumer prices that followed, albeit not only from that, but other price support programs.

There is definitely a kernel of truth in what Paul says. "By contrast, the model of an economy in a liquidity trap, in which big increases in the monetary base don’t matter, comes through just fine."  And Ben and the Fed are managing their activity with an eye to targeting it to the banking system, and taking steps to keep it from moving into the broader money supplies too quickly.

Adding liquidity from the monetary base in the face of sagging aggregate demand is not having a profound effect on broad prices in the relatively short term. I mean, duh. If the model suggested this it is right.

But that does not imply that some connection is not there, that it is meaningless.  What it means is that so far at least, the Fed is managing their quantitative easing reasonably well.  Unfortunately so well that it is not having the desired effect on the real economy or the banking system for that matter, except that the zombies are still standing.  Just because something is not yet a smoking ruin does not bring cause for celebration.

The Fed is 'bottling up' the expansion of the monetary base in the banks, and quite a bit more of it than we had suspected as eurodollars, money provided to banks overseas.  And they stopped measuring eurodollars a few years ago in one of the broadest money measures, M3. 

The Fed, and I assume Paul Krugman know all this, but believe that they will have the tools, and knowledge, and the latitude to reduce their balance sheet when the time is appropriate and the real economy and banking system recovers. 'Volcker did it.' And so can we, because the models say so.

What the Fed and Paul Krugman are really saying is "Trust us."  And our models.  And don't think that the BLS and the government are tinkering with the econometric measures.  Are you kidding me?   It takes a willful blindness to ignore some of the more egregious tinkering that the government is doing in the name of perception management.

As for the comment about 'printing money,' it was Ben himself that said, 'the Fed owns a printing press.' And he was telling the truth.

I am not a believer in True Money Supply and greatly prefer broader money supply measures. And I know what the Fed is doing is providing an inflation risk that they believe that they know how to handle when the time is right.

And I also know that inflation is starting to pop up in certain sectors and items. And why it is not a broad increase yet, which is what we might call inflation. With most of the increase in money supply flowing to a very few in the form of income, well, this is all understandable.

So what was the point of Paul bringing all this up? It was this.

"Here are the data — I’ve included commodity prices (IMF index) as well as consumer prices for the people who believe that the BLS is hiding true inflation (which it isn’t)"

Let's see. The BLS is not distorting inflation measures because the model is working, and we know the model is working because of the BLS inflation measures.  That seems a little shaky to me.  Especially in light of the other data that shows that certain price sensitive assets are rising in price, and sharply, in response to negative real interest rates, as some other models and theories would hold.

Yes the US is in a liquidity trap.  And yes, the actions of the Fed so far have not triggered a broad monetary inflation because of the slack demand, and the consequent lack of lending and real economic growth.

And yes some well targeted stimulus could help to break this self-perpetuating situation. 

And anything that does not agree with my model is a bubble, and anomaly, or someone else's fault.

The root causes of the problems in the real economy have not yet been changed, and the system has not been reformed.  And the model which Paul points to is really only one correlation in a broader model that has failed, and badly, because it is an abstraction that only has a tenuous relationship with reality.

It is not so much that Paul Krugman is wrong.  There are others who are much, much worse, the purveyors of austerity, and efficient market based deregulation, and supply side economics.  

But Krugman is swinging open the door for the Modern Monetary Theory crowd whether he realizes it or not, by going a bridge too far in his misplaced conclusions and triumphalism.  Extremism in defense of stimulus is no vice, but it is an offense to reason. 

Hey, we haven't blown up the economy lately, so why worry?

Don't get me wrong.  I wish Keynes was still alive, so Keynesian economics could evolve based on new data, which I am quite sure it would.  In response to new data, JMK changed his mind.  And I am sure he would do so again.  I find myself at odds with almost every economic school because I am not an economist by training, and their dogmas and models grate on rational minds.

I liked Roosevelt, because as a non-economist he was open to trying things, but changing them if they didn't work.  If he would have had a model, he would have beaten the country to death with it.  That was the difference between Hoover and Roosevelt, the lack of intellectual pretension.

Well, if we only had more stimulus it would have worked.  Yes that is a thought, except the system is BROKEN.  The only thing we are stimulating is more money for the wealthy, more jobs for China, and more debt for the people.  Yes I think there is some short term benefit for those in the most distress in some of the programs, and that is a good thing.   But pouring stimulus into a broken system is only going to mask the rot, and hasten the final reckoning.  I thought this is what Greenspan tried after the tech bubble collapse.  And here we are again.

Better for the Fed and the economists to proceed in fear and trembling, showing their work clearly, and engaging in honest and open discussion, than risk the final, utter and total repudiation of their profession when 'trust us' fails again.

And I think it is incredibly naive to make that case that since the Fed has not blown the economy up yet, that all is well, and that printing money in whatever amounts has no significant consequences.  No one believes that except a few economists who frighten me in their slavery to their models, and I would hope that you are not one of them.

Perhaps the most useful thing that Paul Krugman could do is go join Occupy Wall Street, and demand the Congress and the President take some serious action in reforming the system, because that is the only thing that is going to provide a sustainable recovery.

"Economic models are no more, or less, than potentially illuminating abstractions...The belief that models are not just useful tools but also are capable of yielding comprehensive and universal descriptions of the world has blinded its proponents to realities that have been staring them in the face. That blindness was an element in our present crisis, and conditions our still ineffectual responses.

Economists – in government agencies as well as universities – were obsessively playing Grand Theft Auto while the world around them was falling apart."

John Kay, An Essay on the State of Economics

and the associated essay of mine, The Seduction of Science in the Service of Power

Paul Krugman has been good at calling Obama and his advisors on their financial policy errors, and was roundly and unjustly criticized for it. I link to his columns frequently, because he is good at what he does, and he often speaks his mind with honest authority.  And compared to many others in his profession he has been a paragon of virtue. But when it comes to their models, most economists have a fatal attraction that leads them astray.

As in all discredited professions, even if it has been due to the actions of a minority, the others must be beyond reproach, and take special care in choosing their words and their arguments.  I am sorry to say that is the case with other professions now, and it is also the case with economists.

As a great economist once said, "Economics is extremely useful as a form of employment for economists." As for the rest of it, well, they have their place. They just get giddy sometimes, especially when exposed to real power, and fawn all over it.

But don't most people. They just do it with a little more humility, and with more sense of uncertainty and attention to the downsides of risk, the so-called 'black swans' that economists' models do not describe or permit, and sometimes do not even acknowledge until face meets dirt.

Obama is failing, but the alternatives are worse. Small consolation. I think the US can do better.

A great leader in a similar crisis said,

"Confidence...thrives on honesty, on honor, on the sacredness of obligations, on faithful protection and on unselfish performance. Without them it cannot live."

If most leaders in Congress and the Administration stood up and said that today, the audience would be rolling in the aisles with laughter. And if anyone from the financial sector said that, well, I would not wish to be in the radius of a lightning strike, God's work notwithstanding.

And that points to the heart of the problem. We are caught in a credibility trap, in which the leaders are so complicit in the abuse and corruption of the system that they cannot even begin to speak to it honestly and plainly, with their pockets weighted down with corporate money.   And they are teaching the rest of us by their example.

October 7, 2011, 3:15 pm
Way Off Base
By Paul Krugman

I see some commenters reacting to the failure of major inflation to break out by insisting that inflation is defined as an increase in the monetary base — that is, the bank reserves plus currency that are what increases when the Fed “prints money”. As it happens, that’s wrong: very old dictionaries defined inflation as a rise in money and/or credit, but the modern usage is, of course, a rise in prices.

But that’s really a side issue. Nobody would care about the size of the monetary base except for the belief that increasing the base leads to a rise in prices. That’s not a question of definitions, it’s a question of your model of the economy. The underlying belief of all the people accusing Ben Bernanke of doing something dastardly is that “printing money” has caused or will cause high inflation in the ordinary sense.

The thing is, of course, that the past three years — the post-Lehman era during which the Fed presided over a tripling of the monetary base — have been an excellent test of that model, which has failed with flying colors. Here are the data — I’ve included commodity prices (IMF index) as well as consumer prices for the people who believe that the BLS is hiding true inflation (which it isn’t):

A couple of notes: for the commodity prices it matters which month you start, because they dropped sharply between August and September 2008. I use the IMF index for convenience– easy to download. (Thomson Reuters I use when I just want to snatch a picture from Bloomberg). But none of this should matter: when you triple the monetary base, the resulting inflation shouldn’t be something that depends on the fine details — unless the model is completely wrong.

And the model is completely wrong. You don’t get more conclusive tests than this in economics. By contrast, the model of an economy in a liquidity trap, in which big increases in the monetary base don’t matter, comes through just fine.

And this in turn tells you something about the people pushing this stuff. They had a model; it made predictions; the predictions were utterly, totally wrong; and they have just dug in further.

I do not know who 'the people pushing this stuff' are, but that last sentence applies to almost every economist and financial pundit that I can think of, with only a few notable exceptions.

A great economist would come up with something new from this, some variation on a theme, would have LEARNED something. The original thinkers are often geniuses, but their adherents are too often true believers and interpreters of doctrine. My graduate academic experience with economists of some years ago is that they lag reality, and especially the sea changes, by quite a few years, always making plans for the last war and crushing the data to fit their abstractions.

And this sadly is what may have brought the Austrian, Classical, Marxist and Keynesian schools into a type of relative stagnation, with a lack of original thought and an adherence to learned models and learned dogma.  Monetarism seems to be waning as well into an American obsession with statistics, often for hire.   Each of the schools have something to contribute.  I have long been convinced however, that out of this new experience we are having that a new school of economic thought would rise out of the ashes.    So far it is not apparent, just attempts to revive the old ideas.

Perhaps this 'digging in' is the natural reaction to a crisis. Who has the presence of mind to 'think differently.' But it is killing off the ability of the country to move forward, especially given the media's penchant for airing an issue for the public by bringing out two professional 'strategists' who throw lies and distortions and cartoon examples at one another for ten minutes, and then call it a discussion. Ok, time to vote.

No wonder the people are confused and afraid. And beginning to take to the streets. And I shudder to forecast the outcome.

By the way, Robert Reich has a nice description that touches on the credibility trap in Occupiers of Wall Street and the Democratic Party.

And Michael Hudson does a fine job describing the heart of the Occupy Wall Street phenomenon and their desire for reform and their resistance to being used and diverted as has happened to the Tea Party. As he goes into his own economic prescriptions, I obviously do not agree with all his views, but he certainly makes some interesting points.

The system is broken. It needs to be reformed. People are tired of being used and lied to. They voted for change and were ignored when they expressed their views and quite strongly. And when they complain, they are ridiculed. And now they are getting really angry. And the powers-that-be are trying to figure out how to play them for their own ends.

As Dr. Zoidberg would say, 'Wow, the President is gagging on my gas bladder. What an honor.'

Bernanke and the Banks Say 'Trust Me' and for Many Gold Is the Answer

Gold = 1 / T,
where T stands for the Trust that people have in the fiat Monetary System and the financial complex running it. Jim Grant points the finger at the central bankers, but they are merely creatures, albeit powerful actors, in a system of privilege and legalized looting.

In other words, the price of gold will run higher in response to the opacity, crony capitalism, insider dealing, abuses of power, and arbitrary valuations in the financial system and the overall system of governance.

Gold, and to a growing extent silver, are the safe havens for the world. This flight to safety is the fundamental driver of the precious metals bull market.

And I think that the ownership of gold and silver is still highly selective, based often on culture, financial sophistication, or a general predisposition against trust in monolithic organizations.

As a recognition of what is happening penetrates more deeply into the public consciousness, the spike in the price of precious metals may be much more impressive.

Is this weakening of confidence justified? One must ask themselves, how deeply has the corruption in the system been reformed?

Has transparency been restored, and the confidence of the members of the system been regained by things other than public relation campaigns, forced choices, subtle coercion, market manipulation, and even blatant propaganda?

These crony capitalists are so inward looking and corrupt that their policy response is to continue the looting and intensify the deception until confidence in the system is restored.

There is plenty of free choice to be had in this brave new world, from 401k's to the election ballot, as long as one chooses from what they give you.

That is the answer, the fundamental driver of the valuation.

"A bubble is a bull market in which the user of the word "bubble" has not fully participated. You can think of gold as a stock that went from 2⅝ to 18 in a dozen years. I'm not sure that's a bubble. It is the nature of gold that its valuation must forever be a mystery. It earns nothing. It pays no dividend. No conference call, no management to call up and complain to.

What I do think is gold is simply the reciprocal of the world's faith in the institution of managed currencies. It is one divided by T, where T stands for trust. And trust is a shrinking number and will continue to shrink. Therefore, I am still bullish on gold.

If a bubble connotes absurdity, what is absurd are the monetary conditions that supported this gold bull market. Gold is an expression of the world's justifiable distrust of the way our central bankers conduct their affairs. The poetry of it is that it can't be quantified. The central banks are unworthy opponents. The Fed has pledged 0% money-market rates for the next two years, so that's not much competition. And the governments of the world are taking under advisement this notion called financial repression—short-circuiting market mechanisms, capital controls, punitive taxes or intrusive taxes and the like."

Jim Grant: Gold Still Looks Good, Japan Still Doesn't - Barron's

"The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks." Lord Acton

But before the people finally come to reform the Banks, the monied interests will throw quite a few patsies, traditional scapegoats, and red herrings on the fire in their stead. And if they have their way, they will burn down society rather than give up their seats at the top of the hill.

About Those Falling Interest Rates and the Fallacy of Monetary Deflation at the Zero Bound

Liquidity Trap, Straight Up, with a Twist

I think we are all familiar with the recently popular viewpoint that as the financial economy crashed, what people called 'money destruction' would follow. Well actually the destruction of credit which some considered the same as money, as money itself. There were many detailed and complex thought experiments to explain why this must happen, involving monetary theories.

This would result in a much stronger dollar, since in fewer dollars would result in an outsized dollar demand, especially to pay off debt, a simple equation resulting from what might best be described as pidgin monetarism, favored heavily by non-economists, using what passes for common sense. Unfortunately these are uncommon times.

In this monetary deflation interest rates would fall, and commodities would be crushed, including gold and silver, falling before the almighty dollar.

The example most often cited was that of post-bubble Japan. America was doomed to decades of a stronger dollar and slack demand.

Well it didn't happen, despite the resurgent hope that the expected deflation will finally occur. There are even fresh definitions of what deflation really is, in Clintonesque manner, to accommodate it to the unexpected outcome we see today.   Unexpected at least by those theorists and their true believers.

When you have no model and are a little right by accident, it is fairly easy to adapt your forecast to what is really happening. But you simply cannot explain it. One might have successful investment results, and my congratulations to such flexibility, but it is the result of momentum following and not from a deep understanding of what is happening.

Let me give you three things to think about.

First, credit is NOT money. Money can be created from a number of sources throughout an economy. The expansion of credit at the business and banking level, often involving savings and fractional reserve leverage, is the major organic source of money, the point of its creation from economic activity or transactions themselves.   It is the most utilitarian form of money, because it is directly tied to what one might ordinarily expect to be productive investment and economic benefits.

Sometimes this mechanism is distorted and abused, in the case of fraud or reckless lending for speculation as an example, and then the money supply begins to decouple from the real economy.  It is the job of the regulators and the Fed to control this.

Like gold or any other asset or liability, credit must be transformed into a utilitarian form of wealth, or money, in order to effect the exchange. You may HAVE a million dollars in credit somewhere, but at some point someone must agree to transform that credit into actual money for you to use it. If an unused million dollar credit line expires, we do not see ourselves as a million dollars poorer.

When organic credit expansion fails to create money, the Fed or the Treasury can step in and create money non-organically, that is, not as the result of economic activity. In the case of an external standard, the Treasury can formally devalue the currency, as the US had done in the first half of the 1930s. Monetary authorities do not like to do this, because it makes their activity more transparent, and therefore more controversial.

By the way, Roosevelt did not have to take the US off the gold standard, or disallow the holding of gold by US citizens, in order to devalue the dollar as he did. This was a more complex arrangement designed to recapitalize the banking system, which I covered in some detail in an earlier blog.

Money is created from the assets on the Fed's balance sheet. These include various forms of credit, forex, and gold. The money as notes and reserves is held on the liability side of the balance sheet, in banking fashion.

The second thing to remember is that the extent of inflation or deflation is a policy decision in an otherwise unconstrained environment.

Greece does not have such a choice, for example, because the ECB controls their currency.  The US probably has the most choice of all, because it not only owns its currency, but the dollar is also still the world's reserve currency. While the audience is not captive, it is at a disadvantage.

The third thing is that the creation of money from the Fed or Treasury may result in more money, but it may not result in a sustainable recovery.    Money created by the Fed is high powered money, created as it were from the will of the monetary authority's policy.

Money creation, or monetary stimulus, works well in situations wherein the economy has fallen into a temporary slump, especially because of some exogenous shock or a slack period that is cyclical in nature, such as seasonal variation.

But in the event of a secular crisis or problem, monetary stimulation is a palliative, but no cure.   The remedy lies generally on the fiscal and political policy actions, with the aim of correcting or repairing whatever had caused the problem in the first place.  

Monetary stimulus alone, without the will to effect political reform for example, results in very uncommon economic conditions, one of which Keynes described as a 'liquidity trap.'

In this case now in the US, we see a lack of political will to reform the outsized and corrupt banking system, and the nation's flows of funds.  The stagnant median wage is a major impediment to sustainable recovery.  Most of the economic benefit for the last twenty years has flowed to the top one percent of the population. 

How that is remedied is another matter, and will be subject to a great deal of political debate as the various interests fight for their portion of the pie as they say.

But in the case of monetary stimulus coupled with a lack of organic recovery, and the sort of slack aggregate demand that comes from economic imbalances, too much money in too few hands, what we will see is money being hoarded in safe havens of wealth, especially short term Treasuries, gold and silver, and bank reserves.   It really makes perfect sense.

Can this go on indefinitely?  No way.  Unless the system is reformed, it will resolve in one of three ways, or a combination of them: a hyperinflation, an authoritarian oligarchy with grinding stagflation, or a civil insurrection with a fascist response. 

I don't think a true deflation is in the cards unless the US becomes isolationist, or mercantilist, and it is forced upon the  population through a policy of austerity.   Then we might see that authoritarian oligarchy with a grinding deflation instead of stagflation.

It should be noted that all three are variations on a theme of the breakdown of the market system and individual economic liberty.

Finally, and this is directed primarily at the Modern Monetary Theorists, while one can create money without using a debt based system, the money creation must act as though it is governed by some restraint.  Traditionally this had been gold and silver, and in the case of a national bank, the debt markets.  Government may indeed print on their own volition, in those areas wherein they lack legal tender controls, most notably international trade, they are beholden to those parties in the manner of debtors to creditors, since the dollars are really promissory notes based on the full faith and credit of the government.

Hyperinflation is no certain outcome by any means at all.  Furthermore, it is not even likely yet except for a further string of remarkable policy errors.  It is therefore somewhat of a policy decision of incompetence.  But as things progress, the latitude of the policy makers becomes increasingly constrained by the sustainability of the real economy in particular and the social fabric as a whole. 

It should also be noted that there is a growing and largely unreported overhang of eurodollars around the world.  If at some time the world begins to repudiate US dollars and debt in a de facto devaluation, the resolution may not be in the hands of policy makers, and the progress of change could accelerate, dramatically.

Endnote:  People like to send me things that are basically chicken and egg examples with regard to money creation, wrapped in lots of accounting language.

These so called proofs are largely word plays, and mostly misunderstandings of the system because of lag times and complex relationships crushed into meaningless by overly simplistic models.

So, in other words, I have looked at most of them, and please don't bother. They are just rationalizations for reasons why certain things that have happened could not happen, and are thus a bit outdated.

I am not interested in resurveying the same real estate that I have already been over many times since 1996, when this current cycle of economic history began in earnest. Some of those dead horse theories have already been beaten thoroughly into glue, so it is time to move on.

And I am becoming somewhat indifferent to those who will not, since they obviously wish to live the destructive experience to the fullest. It must be some perversity in human nature, or the will of God, or some combination thereof that is beyond my power to affect or obtain value from any more.

But it is necessary to understand how things work, and what went wrong, to reform and recover from a crisis such as the Western world is undergoing, and so I leave you with this summary of where I am to date.

The economy will not enjoy a sustainable recovery without a significant improvement in the media wage, if you wish to look at some simplistic indicator. Those reforms that people propose, if any, since continuing to steal from the weak seems to be in vogue in some vocal circles, will be effective to the extent that they increase it.

Of the outcomes outlined above, America seems to be flirting with the path of an authoritarian oligarchy with a grinding stagflation, which has also been called financial repression in other quarters.  It is a monetary inflation in the face of slack aggregate demand, with an unreformed financial and political sector.

 This could look a bit like the mercantilist command economy of Japan, dominated as it is by a deeply entrenched oligarchy that honors its social contract with the mass of its people however.  I expect China to go down this route when their time comes.  I am not suggesting outright fascism except as a response to civil insurrection.

But in the case of the much larger and more open US economy, that is going to produce some interesting anomalies, and a mix of disinflation and soaring price inflation. I am not sure how long the aggregate demand slump will be able to hold its ground against the tide of paper.

And quite a few people seem to favor that, if they think it benefits them. So the things we see happen might well perk along as they are, at least for the time being, until the anger of the broader public reaches critical mass, and action with reaction intensifies.

The Great Flaw in the Free Trade Theory And Other Vain Beliefs, Hoaxes, and Follies

There are several economic models and political memes that rely on an underlying belief in the natural efficiency and goodness of 'free trade' and 'efficient markets.' One can question whether these ideas promoted certain behaviours, or if certain parties promoted these theories to serve as justification for their policy objectives.

Whatever the case may be, let's take a look at the theories that seem to underpin the virtue of 'free trade,' meaning international commerce with very light national regulations and a centralized semi-autonomous authority as arbiter.

One of the theories in favor of free trade is the idea of comparative advantage, that is, that one country might have a natural advantage which they can exploit for their own benefit and the general benefit of the world. I am sure we all learned this in business school. I myself was quite a fan of Michael Porter in my day.

This theory is a universalisation of the idea that the naturally gifted pottery maker, for example, has an inherent talent that can be exploited, and can create and exchange pots for food, let's say, from a farmer who has the advantage of owning suitable farm land and has the talent and tools to exploit it.

Makes common sense does it?   Everyone does what they do best, and through the free exchange of  products the aggregate good is increased.  A nice simplistic maxim that underpins a broad economic and social philosophy, such as 'from each according to their abilities and to each according to their needs.'

The fallacy that is repeated over and over by the non-scientific thinker (like too many economists and politicians for example) who use these simple examples and sayings is that one can extend things that might make sense anecdotally into general, almost universal principles writ large on the face real world, or more properly OVER the face of the real world, that at the end have little real fundamental connection with reality and the expected outcomes.

This was Mandelbrot's great criticism of the neo-liberal school of economics, notably the Chicago School, for example. Their broad assumptions crushed the reality out of the math, and the application of their theory made the markets inherently unstable by miscalculating the risks which were allowed to grow to enormous levels, and then crash at the under-expected event, colloquially known as 'a black swan.'

There is some validity to this. Some nations, for example, are blessed with great natural resources such as coal and oil, and they can sell these items to other countries and regions in exchange for items like food, for example.

But like most efficiency arguments, most notably the efficient market hypothesis, these ripples in distribution or market anomalies are quickly exhausted, and in the classic impetus and peril of successful capitalism, the player start to create monopolies and other artificial advantages, such as frauds, which they can exploit more fully.

So for example, a nation such as China can devalue its currency substantially in the 1990's against the world's reserve currency, and thereby set up a set of artificial import barriers and export subsidies, simply by manipulating their currency.

By the way, this is basic math. There are plenty of people who were denying it, and most of them stood to benefit from this charade. But it is true. Anyone who travels internationally and changes money understands it.

The underlying basis of the currency wars is the ability to artificially manipulate one's currency, or even establish a pseudo-monopoly, for the advantage of one to the disadvantage of the others.

There are other methods to accomplish this and they are usually lumped under the title of industrial policy or mercantilism. A country has a set of laws and regulations that foster a certain stance towards issues such as worker's rights, environmentalism, savings and consumption, wealth distribution and even human rights.

The more trade becomes independent of public policy and regulation, the greater the movement of all countries to the least common denominator of the broader policy stances of the mercantilist nations.

In a very real sense, if you control the issuance and terms of money, you care not who makes the laws locally. And the exchange of trade mechanism is a subset of the control of a medium of exchange, which is the trade system, both international and domestic, the who and how people can buy or sell.

This principle seems to be the basis of the inclusion of gold and silver in the money system series of essays written by my friend Hugo Salinas-Price, and the age old understanding of the balancing mechanism of a harder and higher standard of exchange to manage the tendencies of various participants manipulate the rules, and to 'cheat.'

Anyone who believes that believes that markets and society do not require clear laws and impartial referees because people are naturally inclined to know and do the 'right thing' has obviously never driven on a modern American freeway.

If, for example, we were in a gold standard system for international trade, and the governance had allowed China and its multinational capitalist friends to game the system as they are doing now, eventually the flow of gold from the US to China would compel the US to devalue its currency against the Yuan, and thereby persuade China to release more of its reserves as gold back into the system by purchasing other things. If they used it to buy US debt for example, the dollar would continue to devalue in a cycle which would hamper and ultimately defeat the currency mercantilism.

It would have also restrained the US from manipulating the world by 'owning' the world's reserve currency and the 'exorbitant privilege' therein. It would have curtailed unfunded wars, and the exporting of jobs and production in favor of a 'service economy' that consists largely of pushing the reserve currency around the plate, and skimming the greatest portion for an elite group of policy leaders.  No standard is perfect, and there are ways to subvert some external standard like gold, but it is more difficult to do, and it is more easily seen and exposed if the standard is resolute and robust.

We see a similar principle in action in the theory supporting efficient markets. On paper they sound good, but they are deeply flawed because of the nature of the assumptions they make about people and their rationality and selflessness.

As most gardeners can tell you, there is rarely such a thing as a naturally beautiful and weed free garden, especially the ones that look 'natural.' It takes a great deal of forethought, adjustment, and continual work to make anything sustainable in this world of ours. And so it is with markets, both local and international.

There are those, like former Fed Chairman Greenspan, who argue that the fiat regime of the Federal Reserve works if the Fed 'acts like a gold standard,' that is, with an unapproachable virtue.  A similar theory underpins the World Trade Organization's function in international trade.  But like all human systems, they tend to fall to the great truth observed by Lord Action some years ago, that "where you have the concentration of power in a few hands, all too frequently men with the mentality of gangsters get control. History has proven that."

I am not promoting a gold standard per se and understand the problems inherent with it, and do not wish to discuss that here.

But what I am attempting to do is expose some of the fallacies of the zombie economic theories that have led the world to the place where it is today, with too much discretionary power concentrated in too few hands, with a propensity to act in secret and with an excess of latitude behind the cover of those artificial constructs known as 'corporations.'

This notion that government and regulation is the problem is true only to the extent that government has become weakened and corrupted by gross abuses. Effective government takes planning, continual hard work, and the adjustment of renewal and reform.

Human constructs, if not continually managed and repaired and occasionally renewed, tend inevitably into disruption, dysfunctionality, and corruption.

To say, let's just get rid of it and things will somehow become naturally good is to attempt to build a castle in the clouds. It will not and has never worked to promote a harmonious and productive society on a large scale, ever, in all of human history. It is the law of the jungle. But it has its continual appeal to sociopaths, misfits, the naive, the frustrated, and psychopaths. 

It is a tool of the false dialectic of extremes, that argues that the choice is between no government and bad government, and that if government is not perfect it is inherently evil.  Because they are driven to extremes, those who argue this cannot see the great middle ground, of an imperfect government that nevertheless is capable of maintaining justice and order within the context of freedom.   Failure is only certain at the extremes, of authoritarianism and anarchy, when by two different paths one turns society over to the wolves.

The longer this artificial construct of natural goodness and perfect rationality is maintained, the greater the forces against it will build, until countries and nations explode into revolution and wars, as a consequence of folly. 

The model in my forecast says that meaningful reform to the status quo will not be readily accepted by the power elite  They will promote a 'new normal' which will span a leisurely 'five to ten years' for economic recovery, while they are comfortably standing above it all on other people's necks.  The ability to set oneself aside and apart, as separate and above, from the rest of humanity is served in many ways and by many things. It is a dangerous delusion to feel naturally privileged for whatever reason. It can only be maintained through power, and power is a deadly narcotic.

We can be thankful that other crackpot theories have not become mainstream, such as eugenics, or the marginalizing and then disposal of the weak, the disabled, and the different to serve the economic advancement of the state. Or groupthink, and profound belief in national or racial exceptionalism that tends to lead groups to quick utilitarian solutions and Pyrrhic ends. So there is some room for optimism.

Change may not come until the powerful are standing in ashes, and therein lies a tragedy yet to unfold. Let us work on with hope that reform comes well before then.

Financial Times
Swiss central bank considers euro peg
By Peter Garnham

The Swiss National Bank, which has been waging battle to rein in the strength of the currency, has left open the possibility of pegging the Swiss franc to the beleaguered euro.

Thomas Jordan, vice-president of the SNB, said a temporary franc peg with the euro was within the range of options that policymakers might use to stem the Swiss franc’s strength. “Any temporary measures to influence the exchange rate are permissible under our mandate as long as these are consistent with long-term price stability,” he said.

Mr Jordan added that the central bank could employ other tactics, however, raising speculation that the central bank could impose penalty rates on non-resident franc deposits for the first time since the 1970s.

“We still have, at the moment, possibilities to make monetary policy more expansive without intervening in the Swiss franc,” he said.

The comments came after the SNB launched a fresh assault on what it has described as a “massively overvalued” franc on Wednesday by flooding the Swiss money market with liquidity to meet demand for the currency. The Swiss franc pulled back from record highs on Thursday after the bank’s latest action.

The Swiss franc has been driven higher in recent weeks as investors have sought a haven from concerns over eurozone and US government debt and worries over global growth...

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.

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.

US Monetary Aggregates

It is easy to be misled by short term trending in money supply charts, especially those showing year over year growth as a percentage.  Money supply changes are seasonal and often very volatile, but nevermoreso during a credit collapse and quantitative easing.

A look at the longer term trends is most useful. And if necessary a review of Money Supply: A Primer.

The last chart is an index where 100 equals the M2 supply around the end of 2007, and the onset of the credit crisis. Since then it has grown almost twenty percent. 

Has GDP or the population grown 20 percent? So money per capita or per unit of productive effort is growing.   All one has to do is look at some reality based metric of money supply growth and negative real interest rates to understand the ten year bull market in gold and silver, and commodities in terms of US dollars. 

I understand people like to look at the various independent M3 estimates, but since the Fed no longer reports Eurodollars I have not seen what I could consider a credible recent estimate. And I doubt VERY much that M3 is underrunning M2 given the dollars that the Fed has been spreading around the world's banks.

Can the Fed keep this QE up? Will deflation set in, finally? It is a policy decision in a purely fiat currency. That could change, and I will know what to look for when it does. The Fed could be subjected to some external force, either from foreign creditors or domestic politics.   I expect that foreign shock to be inflationary rather than deflationary however.  As for the domestic forces, a choice for third world status is always an option.

The top five percent of Americans hold by far most of the country's wealth. And deflation may be in their short term interests, as in the case in the UK which seems to be going down that path. These policy decisions bring up a different set of considerations, many of which will stress the social fabric to the breaking point.  But a people grown coarse by war and ideology have done much odder things before. 
But for now the trend has not changed, and it would probably take a global economic collapse to change it. That is possible. And in such an event everything will get sold, for a time, as they were in the market crash of 2008.

Those who have been betting on deflation for the past five or ten years have been wrong. They could be right some time in the future. But one can be wrong on a mistaken principle for a very long, long time.

US Bonds have been in a long term disinflationary rally. There seem to be a number of 'name' people now looking for a trend change. That is the crux of Bernanke's short term focus, and the target of QE^n.

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.

Why the Official Antipathy to Gold and Silver? The Second Oldest Profession

Every so often someone asks, 'Why do the government and the banks manipulate the price of gold and silver?'

There is a great deal of circumstantial evidence to support this, even some blatant quotes pertinent to the topic from the likes of Volcker, Greenspan, and Bank of England governor Eddie George. Of course it can all be denied. People can deny anything, even well known historical events with many witnesses, if it suits their bias and purposes.

But putting aside the operational aspects, what is the motive?

Most recently a correspondent from India asked the question 'why do the banks wish to control silver from the short side? Why would they not blow it into a bubble like they do with stocks and make their profit there? Why do the banks wish to hold these prices down and make people think badly of silver and gold which we here value so much?'

When asked this, I will usually attempt some explanation that begins with the fact that the banks involved are the Primary Dealers for the most part, and very involved with the Federal Reserve and the government on a variety of levels in the issuance and arbitrage of official US debt.

The motive therefore involves aspects from an 'official' monetary perspective. It will often include a reference to Gibson's Paradox, a paper by Larry Summers involving the price of gold and its perceptual relationship with the long end of the curve. It might include Volcker's and Greenspan's comments about the price of gold casting a negative light on the stability of the currency if it rises too high or too quickly. I may even get into the Second Bank of the United States, and Andrew Jackson's populist role in exposing its frauds, and refusing to renew its Charter in favor of constitutional money.

But if I am ever asked about this in the future, I can think of no better, no more concise statement of a possible motive for the manipulation of gold and silver than this:

“The central economic problem plaguing this country since 1913 has been the presence of the Federal Reserve System. Without the Federal Reserve System’s debt-currency scheme having effectively supplanted the constitutional monetary system based upon silver and gold, it would have been impossible - not simply improbable, or difficult, but impossible - for politicians in the public sector and speculators in the private sector to have amassed the staggering level of unpayable, unconstitutional, and unconscionable debt that now bears down upon this country.”

Dr. Edwin Vieira, Jr., Going to the Roots of the Problem

It's enabling the fraud, always and everywhere, and the power obtained in controlling the supply and issuance of money.  There are those who are involved in productive labor, and those who wish to unproductively tax it. It is an old story with deep roots in history.

And once again, the government and the financiers seem to have formed an unholy alliance to harness the real economy with excessive, unjust, and unproductive taxes for the private benefit of a privileged few, protecting and promoting their schemes when they win, and covering and subsidizing their losses when they do not. In either case the money is coming out of the real economy, and like a paraiste is starving it of its vitality.

So there is your motive, from what might be called the second oldest profession. Find out what people need to have, and then seek to control it to obtain your wealth by exacting a tax on it, but without having to deliver anything for it, a mere exploitation of informational and procedural advantage.

There is a difference between amassing capital, building a business, and assuming the risks for its success and failure, and this modern form of banking which is nothing more than an enormous tax on the productive economy granted by a corrupted government that turns a blind eye to fraud and abuses. And when its schemes go wrong, it obtains subsidies and relief from its partners in government.

As Andrew Jackson noted of the Second Bank of the United States, the predecessor to the Fed which came back into being 80 years after:

"Gentlemen, I have had men watching you for a long time and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I intend to rout you out, and by the grace of the Eternal God, will rout you out."