If the 500 trillion dollars worth of derivatives collapse, I'm pretty certain that would be deflationary. I can't imagine hyperinflation resulting from that. That's like the law of gravity being defied. I think what's happening right now is deflationary: collapsing real estate prices, nosediving commodity prices, banks in turmoil, etc. I believe in the Prechter theory that we will have deflation first. What happens after that is anyone's guess. We could see hyperinflation once assets bubbles become fully deflated.
It's a myth that the fed is simply just printing money into thin air. The M1 has barely moved during the last couple years. What the fed has been doing is expanding credit and they do that by lowering interest rates and reserve requirements. It's the banks who's been doing most of the expanding. And right now the banks are having difficulty doing this.
I'm quoting this from Prechter's Conquer the Crash: "The Fed has four relevant tasks: to keep the banking system liquid, to maintain the public's confidence in banks, to maintain market's faith in the value of Treasury securities, and to maintain the integrity of the dollar... it is important to know that it is under no obligation to save the banks, print money or pursue any other rescue."
The Fed knows that hyperinflation would be far more devastating than deflation. The political repercussions would be huge. The idea of throwing money out of helicoptors and trying to maintain the value of our currency would conflict. Overseas governments including China own over half of our treasuries. Can you imagine the catastrophy if they started dumping them?
I can't imagine that that 500T in derivatives would be anything other than inflationary. If you "loan" out a zillion printed-up bucks, and that zillion bucks doesn't get paid back. That's inflationary, not deflationary. Housing is only the latest bubble, the commodities dip is purely temporary, the banks ... all the important ones will be bailed out or papered over. It's all inflationary. Look at the M3, it expanded 18% last year. Did the economy grow 18%? did trade and commerce? did factories and infrastructure? Nope, the fed is printing money, the "it's loaned" is just a book-keeping label, and that money can't be anything other than inflation. In fact, the slow relative increase in M1 - shows even more that the core of the debt problem is not real economy, but the paper one ... which means a paper "solution": inflation. The heroin addict might know that he had better quit or else, but that doesn't mean he will. Same with the Fed, China be damned, to them it is figure out a way to keep the money flowing, or die. Human creativity is boundless, they will figure out a way, they always do.
Ethan:The most devastating thing, arguably, for the value of the dollar is if Americans begin to spend less on foreign goods and services. When foreigners receive dollars they find their way eventually into the hands of the respective country's central bankers, who usually purchase US treasuries with them. With fewer new dollars going abroad, there will be less demand for US treasuries and the Federal government will not stop spending or borrowing so they will have to look elsewhere for financing. As they seek to borrow domestically there will be upward pressure on interest rates and downward pressure on the dollar. Should foreigners take the next step and diversify out of the dollar, even a little bit, the situation will get even worse. Additionally as a recession deepens here at home, US government tax receipts will shrivel quickly, this will put further pressure on the US government to borrow at a time when foreign lenders are getting harder to find. With a great deal of upward pressure on interest rates, the Fed could even be called upon to fulfill its roll as lender of last resort to the US government, but this does not need to happen in order to have further dollar weakness.
I think there is a problem with this analysis of the situation. For one thing, the US currently has a trade deficit. If the US increase spending on foreign goods then they will be increasing their trade deficit and thus, unavoidably, their total debt to the outside world (not just government debt, but the total of private and government debt more broadly).
Now, if I were an individual and I had a loan, and I never paid off the principle on that loan then it would increase exponentially (compound interest). If I throw fuel on the fire by borrowing even more (which is what you're suggesting the US nation needs to do to keep a strong dollar) then I'm only going to increase my debt. The are only two ways that this situation can persist:
1. If I use the money I borrowed to increase my income by more than my debt is increasing. However in the case of an entire country it's income is measured, in a broad sense, by the balance of trade - so a trade deficit implies a negative income.
2. If the amount my debt is increasing each year (due to the combination of my increased borrowing and compound interest) is less than the level of inflation... so although my nominal debt is increasing my real debt is actually decreasing.
The question then becomes, is the US trade deficit as a percentage of the account deficit plus the yeild on government bonds lower than the rate of inflation?
If inflation is low then the answer is clearly no... which would be negative for the dollar. If the answer is yes, that implies inflation is high (which should also be negative for the dollar). So essentially, a trade deficit should always count agains the dollar - which makes sense when you think about it because the further indebted someone becomes the less likely it is they'll be able to make good on all their IOUs.
It would seem to me then that the only way the US dollar could be rescued is if the US dollar strengthened not because other central banks are buying more of their bonds (why would they, as long as the trade deficit persists - a situation which is only excacerbated by other central banks buying US bonds) but because the US started exporting more products. So the US will have to be able to continue to increase exports at the same time as their dollar is rising in order to maintain a rising dollar trend. And exporting more products is also the only way they will be able to fix both the trade and the account deficit.
I've been thinking about what the recent bail out of various financial and quasi-financial institutions could mean for hyper inflation as well.
The simplest I can make it to myself is the following:
In bailing out these institutions the fed/government is essentially monetizing that debt... they're wiping the slate clean where losses would otherwise have been made and passed on to creditors. In doing this, they're not pushing more money into the economy (immediately). All they're doing is conserving the current level of reserves upon which other loans are made (and upon whose foundation a good deal of the existing money floating around in the economy depends).
As such, the bailing out of Freddie and Fanny does not immediately push more money into the economy and what would be required for the Fed to ensure continued inflation is continued monetary expansion... which requires the creation of new debt.
Certainly writing off existing debt makes the task of creating new debt much easier, since banks won't be collapsing or trying to claw their way back to positive reserve positions (which would typically be done by calling in loans or at the very least not making any more). However the creation of new debt and thus continued monetary expansion and inflation requires the banks find new people to extend credit to for new projects.
The banks (who extend that credit, and that's how they make money) see Freddie and Fanny, Bear Stearns and Northern rock being bailed out and see that it's impossible to make losses... you can only make profits. So they should start to extend credit, preferably lots of it as highly leveraged as possible so that if the credit defaults they'll be bailed out by the lender of last resort. In order to do that though, they need another bubble. The first one was the dot.com boom. The losses from that were covered by profits made in a housing bubble... which has clearly collapsed so it's going to be tricky to extend vast swathes of credit in that market. So the banks are going to need some other form of asset to lend people money to borrow, based on nothing more than the fictional valuation of that asset and some ponzi styled price increase.
Where's the next bubble then?
Clearly commodities are out - the government doesn't want a commodities bubble.
Stocks? The government would like another stock bubble - but are the stock markets going to make huge profits? They can't make them from financials any more (financials are relying on stocks to make profits remember - that would be two people standing on one another's shoulders). So a bubble in stocks would have either from soaring PE ratios or from increased sales, which would require an increase in individual expenditure. That would require either individual incomes to increase or for the banks to extend more credit to individuals. So perhaps one source of the next bubble might be a personal debt bubble (as if the housing bubble wasn't) but banks don't typically lend to individuals without capital. In the case of housing, the capital comes in the form of what they're purchasing - something that can't be said of most other personal expenditure (cars, yatchs etc. don't generally hold or increase their value). As such, it seems a fresh stock bubble could only come on the back of increased salaries. I'm not sure how that would occur since the only control that the Federal Government has over salaries and wages is in the form of taxes (they could drop taxes - that would be positive) or the salaries that they pay federal employees. I hardly think a federal employee salary bubble is likely though. In any event, even if they were able to get real incomes up by dropping taxes, we'd almost certainly see the wage price spirals of the 70s again.
They could perhaps create more derrivatives. For example, they could package up bonds in companies like GM and Delta Airlines into complex financial instruments which they vastly overestimate the value of or vastly underestimate the risk off, then sell off to massively leveraged buyers - creating huge counterparty risks that make GM effectively too big to fail. That's basically the same trick they pulled in the housing market though and I'm not sure the Norwegian primary schools are going to fall for it again so quickly.
Seemingly the only way that the central authorities have of pumping more money into the market is increased government expenditure (or stable government expenditure with decreased taxes)... since the extension of credit to the government has never presented a problem. If government expenditure does not increase, then perhaps deflation is to follow... If government expenditure increases and/or taxes decrease, perhaps we'll see continued inflation - but they would have to keep cutting taxes and keep increasing their expenditure to maintain those levels of inflation.
All of what I've said up until this point, of course, only focuses on one side of the equation - which is the money side of the equation. If the production of goods and services should fall drastically then you would have a situation where the same amount of dollars was chasing fewer goods and services - which could also trigger inflation. And that IMHO is a much more likely catalyst for inflation than monetary expansion... especially with the Fed going around centralizing control of the productive apparatus in the economy.
To be honest, I don't think there's any crystal ball here though. What happens will depend on lots of factors - foreign willingness to continue to by bonds, public policy etc. and all you can do is either hedge your bets or double up one way or the other. It's a 50/50 gamble, so flip a coin!
And then there's the other wildcard to throw into the mix: War with Iran.
Base model cars of the world unite! You have nothing to lose but quarter-mile races.
Yeah, I re-read my post and it certainly sounds like I was advocating increased borrowing and spending, but let me assure you that I do not believe this and would not recommend this course of action.
Let me begin instead by saying that I think the dollar is way over valued and interest rates artificially low in large part because of the years of foreign central banks purchasing our government treasuries. Our government is addicted to spending and I don't see this trend changing, in fact if tax revenues are reduced during this recession then it is probable that the government will be required to borrow more. This then should have been the starting assumption of my argument. In this situation if foreign governments purchase less of our new government debt, fail to roll over existing debt that comes due or even unload some current US treasuries in the interest of diversifying reserves, then the dollar's exchange value would be pulled down.
The added upward pressure on interest rates due to the Treasury needing to encourage a smaller pool of lenders to finance a potentially larger deficit, might also encourage the Fed to try and "take the edge off" in the only way they know how, but this further Fed action would not be a requirement for the above mentioned dollar weakness.
I don't think the dollar will be rescued here, but on the bright side with this world reserve currency status, clever PR and a great credit-creating counterfeiting operation we have been able to enjoy an unprecedented transfer of real savings and services at rock bottom prices from the third world in during the past 80 odd years. Third world profits might have been invested back into production facilities and infrastructure (privately would have been the best means for doing this of course) but instead much of the wealth found its way back to the biggest and "safest" market on earth. Our "only game in town" status has served us all very well, but it is not natural and it will end at some point. The biggest surprise to me is that no other nation has succeeded in competing with our insanely profitable counterfeiting scheme. But I am certainly open to the possibility that this correction is not due for a few more decades.
Jimmy, does this clarify my point, or am I simply restating the same thing I said before and missing a more fundamentally glaring error in my analysis?
Ethan: Jimmy, does this clarify my point, or am I simply restating the same thing I said before and missing a more fundamentally glaring error in my analysis?
All seemed to make sense to me.
One clarification of my argument (that dollar strength would be better served by stong exports than imports) is that essentially you only need exports from people that accept US dollars for their products/services to see a strong dollar. If the dollar were backed by something and were a genuine guaranteed claim on something (e.g. IOU silver or IOU gold) then the situation might be different. As it is presently, however, the dollar is an IOU for future products and services rendered by those accepting US dollars, which is presently quite a few people as it happens.
Most of the petrol producing nations (excepting Russia) peg their currency to the US dollar so buying their products implicitly creates demand for the US dollar (they use the influx of foreign capital to buy US dollar bonds in order to maintain their currency peg) and even the otherwise free market stalwart - Hong Kong - maintains a currency peg with the US dollar... and China not allowing it's currency to float up too fast no doubt contributes to US dollar strength as well.
If the US imports Oil from Qatar it probably doesn't impact the US dollar whatsoever in the immediate term. That purchase implies a trade of US dollars for petrol (pushing up the price of petrol and down the price of US dollars) but Qatar have a currency peg with the US so they'll react by purchasing US government bonds, which implies a trade of Qatar dollars for US dollars (pushing back up the price of US dollars and pushing down the price of Qatar dollars to achieve their peg).
Long term, perhaps countries like Qatar and Hong Kong will eventually run into issues as a result of US fiscal policy that really wasn't made with them in mind (exporting inflationary and deflationary problems) and decide to abandon the dollar peg. That would have a huge impact on the dollar. Until then though, perhaps more important for the US dollar would seem to be exports/imports from the US dollar using nations (not just the US) to/from nations that use a currency which isn't pegged to the dollar.
Interest rates no doubt play a role as well... they certainly can't go much lower though - so I can't see much further weakness coming from there.
edit wrong thread.
<< If you "loan" out a zillion printed-up bucks, and that zillion bucks doesn't get paid back. That's inflationary, not deflationary.
If you printed $500T in money and then handed it out, that would in fact be inflationary - probably hyperinflationary. But we're not talking about $500T in money, but $500T in IOUs. That's an important distinction, because IOUs aren't the same as money. Cash doesn't get "paid back". Loans do. If the loans don't get paid back, then they become worthless. The creditor loses out.
Looks like we know which way the wind is blowing now.
Gary North has revised his prediction.
As of Monday, September 15, the Federal Reserve has reversed course. It is now inflating. So are other central banks. The story is here. When the major central banks reverse their policies in 48 hours, due to coordination among them, we must assume that we are in a new cycle. Commodity prices will fall (recession), but gold's price may buck this trend. It has this week.
The real question is this: Will gold hold its value in the middle of a worldwide depression better than any other commodity? I think it will. Better than silver? Yes. Why? (1) central bank buying; (2) Arab billionaire buying; (3) "last train out" buying; (4) central bank inflation.
It will be most likely be stagflation
Murray N. Rothbard was obviously in the inflationist camp. These samples could have been written during a couple of last years, so relevant are they for the ongoing debate:<i>Thus, for over a decade I have been arguing with economists and investment analysts who have been predicting imminent deflation, that is, a general fall in consumer prices, or rise in the value of the dollar in terms of goods and services. For over the same decade, these predictions have been proved patently and 180 degrees wrong. Inflation, whether steep or slightly less steep, has marked every year during this period. Yet never have I seen the slightest faltering in the enthusiasm or the absolute self-confidence of the deflationist soothsayers. Often they will use the fudge factor: "Look, zinc prices have fallen over the last six months. 'Deflation' has already begun." Or, "Deflation is here at last. It has just been 'masked' by the expansion of bank credit." </i><a href="http://www.lewrockwell.com/rothbard/rothbard44.html">[Kondratieff Cycle: Real of Fabricated (1984)] </a>His position is interesting because his main thesis in <i>The America's Great Depression</i> was actually the incapability of central bank to inflate during that crisis. But, like we know, the institutional framework was very different during that period. He deals with this problem at few paragraphs in his brilliant essay <i><a href="http://mises.org/econsense/ch70.asp">Lessons of the Recession (1991)</a></i>.<i>"Inflationists," of whom the present writer is one, have been maintaining that the Fed, having been freed of all restraints of the gold standard and committed to not allowing the supposed horrors of deflation, will pump enough money into the banking system to prevent money and price deflation from ever taking place."Deflationists," on the other hand, claim that because of excessive credit and debt, the Fed has reached the point where it cannot control the money supply, where Fed additions to bank reserves cannot lead to banks expanding credit and the money supply. In common financial parlance, the Fed would be "pushing on a string." Therefore, say the deflationists, we are in for an imminent, massive, and inevitable deflation of debt, money, and prices....What deflationists always overlook is that, even in the unlikely event that banks could not stimulate further loans, they can always use their reserves to purchase securities, and thereby push money out into the economy. The key is whether or not the banks pile up excess reserves, failing to expand credit up to the limit allowed by legal reserves. The crucial point is that never have the banks done so, in 1990 or at any other time, apart from the single exception of the 1930s. (The difference was that not only were we in a severe depression in the 1930s, but that interest rates had been driven down to near zero, so that the banks were virtually losing nothing by not expanding credit up to their maximum limit.) The conclusion must be that the Fed pushes with a stick, not a string.</i>The whole essay is actually very relevant, because it deals also with bank collapses and FDIC and other relevant subjects.
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