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Archive for the ‘Inflation’ Category

Sometimes you just have to laugh….

The lackluster nature of the recovery is certainly the byproduct of the debt-infused boom that preceded the Great Recession, as is the excessive uncertainty surrounding the actions — or rather, inactions — of our fiscal authorities in Washington. But to borrow an analogy Rosenblum crafted, if there is sludge on the crankshaft—in the form of losses and bad loans on the balance sheets of the TBTF banks — then the bank-capital linkage that greases the engine of monetary policy does not function properly to drive the real economy. No amount of liquidity provided by the Federal Reserve can change this.

Note the idiocy here.

Who provided the debt-infused “boom”?  More to the point, was there ever any actual growth at all or was it all inflation?

There was no “growth.”  Not only was every dollar of new GDP acquired via more debt (that is, $1 in new GDP came with more than $1 in new debt) but since this debt was never removed from the system the inevitable additional interest cost meant that the transfer from production to debt-lenders squeezed investable capital surplus.

This is what ultimately led to the collapse, and the bad news is that the bailouts and “rescues” left the debt in the economy.  It is for that reason that no actual recovery has taken place.

Remember your Friedman?  Inflation is always and everywhere a monetary phenomena.  But to properly interpret Friedman one must first determine what is money — that is, what would you call “the monetary base.”  The common monetary theorists will all tell you it is defined by M1, M2, M3, etc.  They’re wrong; the common man knows damn well what “money” is — it’s everything he can spend right now.

Wait a second — that VISA card in your wallet, by that definition, is money.  It spends exactly like currency.  So does a PAL from your bank or credit union at the car dealer or the student loan voucher at the university.  You must include all available and circulating credit in the monetary base, and when you do suddenly the truth of the inflation monster becomes clear:

These aren’t my numbers — they’re The Fed’s numbers.  That chart is simply the percentage growth on an annualized basis of credit .vs. that of GDP.  Since all money is debt-backed in our system every dollar of additional spending power, whether credit or currency, is always reflected in debt somewhere.  Since the Fed Z1 provides us with all of this information comparing that against GDP gives us the actual inflation statistics we need.

Nothing more is required from a monetary perspective and when it comes to price changes nothing more is required either, since all new debt that shows up in the system only appears as a consequence of someone spending those funds somewhere.

We of course don’t call the acceleration in house — or stock — prices “inflation” but they in fact are.  Assets are something you acquire with economic production.  Debt is simply the promise to produce tomorrow so as to have today.

The Fed claims to have a policy of “price stability” but then only looks at prices it wants to count.  Asset prices are prices.  So why doesn’t The Fed count those?  That’s simple — if The Fed actually looked at its mandate as meaning something it would have disband tomorrow as it has intentionally and recklessly violated its mandate every year in the modern era, and Fisher is well-aware of this.

In short the lament is nice but it’s a misdirection.  The Fed no more cares about the law than did John Dillinger and Congress could care less either, as the mavens of Wall Street use the rise in “asset prices” as a means to both generate lots of bribes, er, “campaign contributions” while at the same time pointing at them and saying “look, prosperity!”

It’s all a lie folks.  Dividing the number of units of production by more units of currency doesn’t make you wealthier — in fact makes you poorer when your earnings in nominal dollars don’t keep up with the monetary inflation that is taking place.

Don’t kid yourself — your standard of living, unless you’re one of the banksters, has been in severe decline for 30 years.  Only when we force these bandits from office — all of them, including Fisher — and stop clucking and tutting when they talk about “TBTF” will we make progress.

Dallas Fed President’s Fisher may make good-sounding noises but The Dallas Fed still has to square the mandate in the Fed’s enabling law with the mathematical fact when it comes to regulation of credit on a systemic basis — a responsibility they have intentionally and willfully abused for 100 years.

The Market-Ticker

Discussion (registration required to post)

Time for the weekly economics update.

I’m going to spend the time today talking about some pretty basic stuff, but it’s material that none of our politicians seem to want to cover, and none of our wonderful mainstream media wants to pay attention to either.

So I guess that means it falls to me.

Let’s start with the basic economic equality:

MV = PQ

This is a tautology, or something that is true no matter the interpretation.  The reason is quite simple — “PQ”, or “price times quantity”, is otherwise known as GDP (in nations where GDP is defined as the goods and services sold, not produced.)  We can thus rewrite the equality as:

MV = GDP

and it works just as well.

“M” is the amount of money and credit in the system, and “V” is the velocity, or the number of times each unit of money or credit is used in a given time period (in this case, per year.)  Since GDP must be purchased with funds of some sort, this equality must be true.

Now let’s look at the next aspect of things — all money in modern economies is in fact debt.  That is, for each unit of currency or credit, someone has gone into debt for the exact same amount.  This too is a tautology in these nations.  (Whether it should be is a different discussion!)

Therefore, we can measure the total amount of money and credit (that is “M” by looking at the amount of debt in the system.

Now let’s take the next step.  For each unit of production (GDP) in the system to be purchase some number of units of money (or credit) must be used.  If the ratio of units of credit and currency (in whatever units you wish to use, say, dollars) to GDP (in units of production) then the economy is in balance and neither inflation or deflation is taking place.

If the units of currency and credit are increasing faster than is GDP, inflation is taking place.  It requires more units of currency or credit to buy each unit of GDP — it must by definition, since the equality at the top of the page must always balance!  That is, we are simply changing the divisor when we emit more money and/or credit into the system.  If this “stimulates” the production of more “stuff” (that is, makes GDP go up) then that’s fine provided that GDP rises at least as much as does the new money or credit that is emitted.

So what do we know about the last 30 years?

We know that debt, that is moneyness, has risen much faster than GDP has.

This is where the “MMT” clowncar brigade goes off the rails.  They try to claim that government borrowing is somehow “special.”  They’re wrong, because all units of credit and currency are fungible — once they get into the economy exactly how they got there is of no consequence at all.  That is, one $20 spends the same as any other $20, whether it was first spent by the government on social programs or by someone who borrowed it to buy a car.

The government at all levels — Federal, State and Local — spend more than it taxes provided that it limits same to the growth in economic output, and it prohibits private entities (e.g. banks) from lending against nothing.  That is, provided “One Dollar of Capital” is enforced at all times and government controls its spending to match deficit or surplus against change in GDP there is neither inflation or deflation in a monetary sense.

What most people call “inflation” is an increase in the price of things you buy.  But notice that nobody counts the price of all things.  Specifically, stocks tends to be left out, as do houses and most capital goods.  It’s called the “consumer price index” for a reason, and when it comes to the biggest single piece (houses) the government uses “owners equivalent rent” instead of actual house prices.

Why?

Well, the reason doesn’t matter.  The impact does, however — low interest rates translate into lower payments which means lower rents.  Therefore, in times of low interest rates house prices are understated and in times of high interest rates house prices are overstated!  That’s exactly backwards in terms of how it should be, and this is not the only distortion.

Even using the government statistics, however, the consumer price index over the last 10 years has risen a little over 30%.  Median family income, on the other hand, is only up about half that — 17% or so.  In other words, in real terms, which is all that matters (how much “stuff” can you buy) family income has actually declined.

Now here’s the bad news.

If we chart the difference between debt (“moneyness”) growth less output (GDP) growth as a percentage of GDP to determine monetary inflation, this is what we get:

That, my friends, is the truth.  That little spike downward is what freaked Bernanke out but in order for what he did to “work” we would have to move toward establishing an even higher imbalance — a higher high — and to do that someone would have to borrow all that new money!

That isn’t going to happen folks.  The fact is that this excess credit creation has to come back out of the system and those who wrote that unsecured credit must be forced to eat it.

Those firms will collapse.  That’s not bad, it’s good.

More to the point, it’s necessary, and if we don’t do it and keep trying to insist that we can lard up more and more of the economic deficit on the government through ever-higher deficits, we will become Greece.

There is a limit to this stupidity, and we’re there.

The Market-Ticker

Discussion

This is an interesting op-ed in the morning edition of the WSJ:

We’re now in the 37th month of central government manipulation of the free-market system through the Federal Reserve’s near-zero interest rate policy. Is it working?

Business and consumer loan demand remains modest in part because there’s no hurry to borrow at today’s super-low rates when the Fed says rates will stay low for years to come. Why take the risk of borrowing today when low-cost money will be there tomorrow?

Why borrow at all, in the main?  Borrowing is the taking of leverage — “gearing.”  It magnifies both gains and losses, and it is the losses that turn into trouble, as often they wind up being borne by someone other than the borrower.

They’re supposed to be borne by the borrower and lender, incidentally.  But the lender rarely actually eats them, especially when things get “really bad” — then the taxpayer gets soaked, directly or indirectly, as we have seen.

Federal Reserve Chairman Ben Bernanke told lawmakers last week that fiscal policy should first “do no harm.” The same can be said of monetary policy. The Fed’s prolonged, “emergency” near-zero interest rate policy is now harming our economy.

It always was Charles.

The Fed policy has resulted in a huge infusion of capital into the system, creating a massive rise in liquidity but negligible movement of that money. It is sitting there, in banks all across America, unused.

No.  Capital and borrowing are not the same thing.  They spend the same, but they’re not the same.  Capital is economic surplus — that which you have after you earn and pay the necessities of life (or to run your business.)  Borrowing is leverage — “mechanical advantage” if you will, but it is always a negative-sum game as not only does it have to be paid back but the interest expense means you must earn even more to pay it with.

The multiplier effect that normally comes with a boost in liquidity remains at rock bottom. Sufficient capital is in the system to spur growth—it simply isn’t being put to work fast enough.

The paradox of debt is that due to the negative sum nature of it there is always less of a multiplier than the liquidity increase would suggest.  That is, mathematically it is a negative game for the borrower in every case.  This does not mean that a borrower cannot turn that disadvantage into advantage, but it does mean that the odds are against him or her in doing so.

The poker player in Vegas is at a similar disadvantage due to the house “rake.”  If six similarly-skilled players sit at a poker table in Vegas and play long enough they will all wind up broke, because the house rake will consume all their money.  It is a certainty if the game goes on for long enough, the skills are evenly-enough matched, and their luck is reasonably even.

The only way for such a player to win is to be better than the other people at the table by a sufficient amount to overcome the house rake.  He must also stop playing when he has amassed enough winnings and depart.  This means that for the player of superior skill he is incented to play at a higher level of wager, becasue he wants the fewest number of hands dealt to make his money to keep the rake’s “rape” of his stack to a reasonable level.

We’ve also seen a destructive run of capital out of Europe and into safe U.S. assets such as Treasury bonds, reflecting a world-wide aversion to risk. New business formation is at record lows, according to Census Bureau data. There is still insufficient confidence among business people and consumers to spark an investment and growth boom.

Business formation comes from capital formation which is the product of economic surplus.  That’s all.  Since capital formation is born of savings, that is, economic surplus, zero interest rates destroy the incentive to do so.  Low interest rates tend to cause people to borrow for uneconomic purpose, just as inflation provides incentive to buy things that aren’t really needed right now “because they’ll go up in price tomorrow.”  This is all malinvestment of one form or another and it’s destructive to the health of the economy.

Just look at SYSCO, which reported results this morning.  They showed that food inflation was 6.8% over the last year, contrary to the government lie that “inflation is non-existent.”  Uh huh.

What Mr. Schwab is missing here is that The Fed is hardly an “independent” central bank.  It is in fact beholden to Congress, which has pumped up $5 trillion in debt over the last three years.  That debt has a servicing cost, and it is the “ultra low” interest rates that make this temporarily affordable.

How is Congress going to service this debt when the rate of interest rises?  More to the point, where are the adults in the room in Washington DC?  We’ve had this on both sides of the aisle — “we must stimulate the economy!” — with borrowed money.

Outright bribery of the electorate both hasn’t and can’t work to lead to a durable recovery.  Instead, it has backed Bernanke and Congress into a corner.  When rates rise to just a blended 4% Congress will be facing a $600 billion annual interest bill.  From where will the money come?

This is the trap into which Japan fell and what we are facing today.  It is an extraordinarily destructive cycle that is very, very difficult to break, because it requires pulling the liquidity support at the same time Congress dramatically raises taxes, cuts spending (real cuts, not the imaginary cuts from “baseline” budgeting) or both.  In short it requires admitting that we took fiscal heroin to avoid pain and accepting the accumulated damage for a period of time, accepting the “deferred depression” that we all tried to hide.

Charles Schwab leaves this unsaid, of course, but then again he’s running a brokerage.  Were people to think this thing through they’d realize that the mathematical conundrum presented by Schwab has no resolution that doesn’t ultimately result in that contraction asserting itself.  There is always the matter of timing, but not outcome — that which is fueled by nothing other than fiscal methamphetamine either leads to a nasty crash when you stop taking or heart failure.  Pick one — both suck but while one is nasty the other is fatal.

This Sunday Funnies cartoon is courtesy of Merle Hazard who says “We Can’t Go On Together with Suspicious Minds, Because Were Leveraged too Much Baby”

Concept by Merle Hazard, Art by Grey Blackwell. The cartoon also appeared on Jon Shayne’s Blog.

Here is a list of Songs and videos by Merle Hazard, not to be confused with Merle Haggard.
Inflation or Deflation?

Link if video does not play: Inflation or Deflation
Mike  “Mish”  Shedlock  – Global Economic Analysis

This sort of thing has gone well beyond “policy” and in my opinion borders on criminal incitement:

The truth is, right now the U.S. economy needs a little more inflation, not less. It’s sacrilege, I know, but our slavish devotion to low-inflation policies is keeping us mired in a depression.

The truth is that such policies (intentional inflation) amounts to theft of earned capital from the prudent.

Theft is a crime.  In the case where the amount in question is large enough (and that threshold is surprisingly small in reality) it is a felony for which one can imprisoned for a term of many years.

Even better, an organized conspiracy – that is, two or more people combining their efforts to commit a predicate felony – likely meets the definition of Racketeering.  Indeed, one of the predicate offenses in the RICO law is robbery.

I think it’s about time that we stop this nonsense and as the citizens of this nation start demanding the criminal investigation, indictment and prosecution of each and every person who advocates, advances, promotes or intentionally causes inflationary policies, given that:

1. They are, at their core, nothing more than common theft.and
2. The Federal Reserve Act of 1913, as amended, explicitly states that one of the goals of monetary policy is Stable Prices (and the word “Stable” is defined in Websters as “unchanging.”)

The original Coinage Act (of 1792) provided that the penalty for intentional debasement of the currency was death.

It’s time to bring that law back onto the books and start enforcing it; the gallows can be erected right in front of the Wall Street “bull” or in front of the Washington Monument – pick one.

Systemic causes of global financial instability include the “normalcy bias,” super-low interest rates, central-bank induced inflation and loss of faith in institutions.

Some causal factors of global financial instability are mental constructs, others are pernicious policies. Money is the ultimate mental construct, of course; it is our faith in the promises issued by central banks and governments that gives paper money its value.

The same can be said of markets: it is our faith in their transparency which makes them “free markets.” Once we discern that a market is manipulated, then we lose trust in it and exit that market for good.

The most pernicious policy is central-bank engineered inflation, which rewards debtors and punishes capital accumulation, a.k.a. savings. Push these incentives to debt hard and long enough, and you get a crippled, top-heavy economy like the U.S. economy, crushed by debts so staggering that the only way to service the debt is to borrow more money at insanely low rates of interest.

This is an excerpt from my new book An Unconventional Guide to Investing in Troubled Times which has just been issued in Kindle ebook format; a print edition will follow in September. (You can read the ebook now on any computer, smart phone, iPad, etc.–see below.The 30% discount expires tonight.)

Here are six systemic causes of global financial instability. (Here is yesterday’s list: The Coming Global Instability, Part I.)

1) The human mind has a number of default settings which have proven advantageous as “short cuts” in most circumstances, one of which is called “the normalcy bias.”  As events spiral out of control and dangers rise exponentially, our tendency is to underestimate the risks and potential losses. As long as a few shreds of normalcy remain intact, we view these as evidence that “it’s really not so bad.”

Most of the time, this trait pays off as most systems are self-correcting and catastrophe is avoided. But when self-reinforcing negative trends take hold, this complacency is ultimately self-destructive.

2) The financial Status Quo, already discredited in the eyes of most well-informed observers, will eventually lose all credibility, and global stock markets will languish as participants abandon them.

If this sounds farfetched, recall that 70% of all shares traded in the U.S. stock market are exchanged in opaque “dark pools” operated by Wall Street and “too big to fail” banks, and high-frequency trading executed by “black box” algorithms account for the majority of the remaining 30% of publicly traded shares.  This means that some 90% of stock market activity is hidden from non-insider investors.

The idea that we can rely on opaque markets for our financial security will increasingly be discredited.  As  heavy-handed interventions fail to restore stability, public faith in these institutions will decline. This delegitimization will further destabilize global markets, and those who accepted the implicit guarantees of stability, transparency and liquidity may find instead that their financial security has vanished in a cloud of “impossible” disruptions and dislocations.

This loss of faith is already evident.  As the U.S. stock market doubled from its March 2009 lows, U.S. households withdrew hundreds of billions of dollars from domestic equity mutual funds, and quadrupled their holdings of “safe” U.S. Treasury bonds.  If you look at a 10-year chart of volume in U.S. stocks, you will see a steady erosion of participation in the stock market.  These are the actions of people who have lost faith in the stock market, the nation’s financial and political institutions and the official “story” of permanently rising prosperity.

Once trust is lost, it cannot be won back easily or quickly.

As the financial authorities attempt to keep the system from crumbling beneath their feet, they will take increasingly drastic actions as markets destabilize: investment rules that were presumed to be eternal will be changed overnight, without warning, and then changed again. Decades of low volatility that encouraged people to buy long-term bonds, annuities and dividend-paying stocks will be upended by unprecedented financial and political volatility.  Seemingly permanent low interest rates that lured investors to pile into high-risk gambles will suddenly leap up, wiping out gamblers who weren’t even aware they were playing a game rigged in favor of the “house.”

Such expectations are well-grounded in history. Most investors have forgotten that the U.S. stock market was summarily closed for months during World War I, and that in 1933, the Federal government seized “hoarded” privately held gold.  These actions were, at the time, considered necessary and prudent by the authorities. More recently, in 2008 speculating that banking stocks would decline (that is, shorting banking stocks) was summarily banned. The rules governing the market were changed to defend the Status Quo, and speculation was only allowed if it flowed in one direction—the one favored by the financial authorities.

3) Stripped of mumbo-jumbo, central banks and States have only two buttons to push: Keynesian fiscal stimulus, i.e. governments borrowing and spending vast sums in an effort to stimulate demand and the “animal spirits” that drive private borrowing, and monetary easing, i.e. lowering interest rates to near-zero, and printing or creating credit electronically to flood the economy with “liquid,” easy-to-borrow money.

Central banks and States are hitting these two buttons like frenzied laboratory rats, but the machine is out of cocaine-laced pellets.  In effect, central banks and Central States are both addicted to exponential expansion of credit, intervention and Central State borrowing and spending. Each is only exacerbating the system’s risks, and as the authorities ratchet up these interventions to ever-higher levels, they’re insuring an even greater collapse.

There is a pernicious agenda at work in setting interest rates near zero while  boosting money supply and deficit spending to create inflation. By robbing savers of any return on their savings and sparking “sustainable, orderly” inflation of around 4%, central banks are in effect transferring 4% from the owners of cash to reduce the debt of the central bank/State by this same amount every year.  In a decade of this monetary scheme, savers’ wealth will be reduced by roughly 50% while the debt created by the central bank/State will decline by 50%.

“Purchasing power” is a concept while helps us understand the results of low interest rates and “politically benign” inflation: the owner of cash will find their money buys only half of what it did ten years before, while the government debt has also fallen in half.  The net result of this slight-of-hand is that government debt that was crushing becomes manageable again as savers’ wealth was invisibly transferred via carefully engineered inflation.

The key phrase in this sub rosa agenda of transferring private wealth to reduce government/central bank debt is “politically benign:” since the loss of wealth and the rise in consumer prices is “only” 4% a year, the consequences are not severe enough to trigger political resistance.  Financial and political authorities know that people quickly habituate to an “orderly” reduction in wealth and an “orderly” inflation in prices; that is, this erosion of purchasing power soon becomes “the new normal” and people plan around it.

The purpose of this central bank/State agenda is to avoid the two endgames that would destabilize the Status Quo: outright default on the Status Quo’s staggering debts, and hyperinflation, or loss of faith in a paper (fiat) currency. Either of these events would destroy the credit markets that form the foundation of the global economy.

We can see how successful this strategy of engineering orderly, “normal” inflation has been: 30 years ago, a Federal debt of $15 trillion would have unimaginable. Today, it is accepted as “sustainable” because it will never be paid back in today’s dollars, and low interest rates insure that the carrying costs of that debt remains small enough that no other government spending need be sacrificed to pay the annual interest.

This agenda has worked like magic for the past 30 years, but beneath the apparent success, the foundations of the current system– cheap energy, globalization, financialization, monetary expansion, fiscal stimulus, opaque markets and constant State/central bank intervention–are all eroding. As they dissolve then so too will the Status Quo’s implicit promises of permanent stability, low interest rates and limitless growth.

The point here that the levels of intervention required to create inflation in a  deflationary, deleveraging-of-debt era are not just stupendous– they must ratchet up to ever higher levels to maintain superficial stability as the system becomes increasingly precarious.  Ironically, increasing the heavy-handed centralized interventions only  increases the system’s precariousness—the exact opposite of the Central Planners’ intentions. This is the result of trying to manage non-linear systems with linear-system tools: all that manipulation can achieve is to extend surface stability at the cost of a more severe system crash later on.

4) The investment world is keen on probabilities as reliable guides to the future. But low-probability events occur with remarkable regularity, so it’s prudent not to put too much faith in statistical or probabilistic reassurances. All such models are based on the idea that the recent past is a reliable guide to the future. But if the thesis that the next 20 years will necessarily be very different from the previous 60 years, then this faith that the recent past offers a roadmap of the future is dangerously misleading.

5) The uneven, unpredictable process of destabilization and devolution will play out over many years as periods of apparent stability are punctuated by the re-emergence of crises which were supposedly resolved in the previous cycle of central bank/government intervention. Every era of stability will be less enduring than the last, and come to rest at a lower level of security and prosperity than the last. Every intervention will be larger, more desperate and more intrusive than the last, and much less effective.

6) Periods of creative destruction are inherent to Capitalism, indeed, essential  to its long-term success. Just as we cannot fool Mother Nature for long–for example, by reckoning we can eliminate forest fires–we cannot manipulate the global economy to eliminate creative destruction.  All the unprecedented efforts of central financial authorities to eliminate risk and instability are simply piling up more deadwood in an already tinderbox forest.

Financial risk is like water in a closed system: it cannot be compressed. As pressure mounts, the risk builds up and eventually escapes, often through whatever part of the system was considered “safe.”

Periods of great transition in which existing systems are consumed by creative destruction and a new paradigm emerges offer great opportunities as well as great risks.

If I had to summarize this book in a few sentences, I would say this: Money is a  tool; make it work for you. Don’t invest in Wall Street’s false promises, invest  with an unblinking eye on systemic risk. Invest in your own life and in the lives of others. This book explores how to do just that.

Of Two Minds

Charles Hugh Smith’s new book An Unconventional Guide to Investing in Troubled Times is available in Kindle ebook format.