Asia Times is one of the best sites for articles on global economics but I have a beef with an assumption by one of its authors. I see this a lot and I think it’s just wrong: “Were the adverse effects of excessive money creation and huge budget deficits not to appear at all, much of economic theory would have to be rewritten. It would mean that excess money creation could magically disappear, leading to no real world effects.”
If you assume that no change (currency stability) means no effect then yes, they’d have to rewrite economic theory. But if you assume the world is changing then you have to consider the possibility that incredibly loose monetary policy might offset natural deflationary forces. In other words, no change means something strange is going on.
In this case the pain felt by society would be the high prices relative to what they should be paying. So perhaps without all of the money printing gas would be $1 a gallon. We don’t see the fact that we’re paying $3 as a problem because we’re used to it. But that’s a real impact on society when jobs are vanishing.
If that is in fact happening it’s the perfect tax because standard of living goes down due to job loss, furloughs, etc. while prices are stable. The alternative is prices rising when wages and employment are stable. Scenario one is no less painful but it’s harder to point the finger because job losses probably feel like more of a personal failure than $6 gas.
Well, lots going on. I just moved, job is getting crazy, NewsDiego is getting more upgrades, time is short. I miss writing as much as I used to.
On the plus side, I got a new Moka Express Italian coffee maker which is why I’m writing this..
Hell of a stock market rally. Not convinced this is a bottom. The government could come in and surreptitiously mask the astronomical losses but it will cause inflation (eventually).
My theory from a few months ago was that you can’t really have inflation until the asset bubbles have all completely collapsed. It never felt quite right so I revisited it and came up with a better theory.
In my view, there are two types of asset bubbles. The first is of the housing bubble nature. Decreasing regulation, lending standards, and interest rates create irrational exuberance and excessive borrowing, gambling, and leverage. Prices shoot up and then crash.
The second bubble is harder to spot because there is no run up in prices. I’ve written about this before but the idea starting to get more mainstream.
“The problem of ‘good enough’ is a huge headache for the tech industry. When your computer isn’t good enough – when a slow processor, meagre memory and tiny hard disk struggle with even everyday tasks – you’ll buy a better model as soon as it becomes available.
Now, though, the weakest link isn’t your PC: it’s you.
Will a 200-core processor make you type an email more quickly, make you work more productively or make your Facebook status updates any more amusing?”
The second bubble was simply the side effect of an inefficient economy. It’s now deflating because hardware is good enough. The hardware industry will be the first to collapse as systems on a chip will eventually dominate. Netbooks are a step in that direction.
Software will continue on as a driver of growth but it too will eventually succumb to standardization and the open source movement. New ideas will require new software but the industry as we know it will probably grow and then shrink. The growth of the software industry will come at the expense of the jobs being automated by that software.
Innovation will spring from the social side effects of communication technology. In fifteen years rich people will not be founders of tech startups. They will be incredibly smart organizers and communicators and then there will be the artists. But I guess you could argue that artists are just smart communicators.
We will all be better off on average after these industries collapse but there will be a massive push to tax the wealthy to maintain a middle class. If we would just let asset prices track the fall of the second type of bubble I mentioned everything would be just fine. Wages would come way down but prices would be dropping even faster.
It’s pretty apparent that our rudimentary financial system cannot cope with the deflation of the first type of asset bubble. I doubt it will be able to cope with the second, larger type.
I think I just figured something out. If the government / treasury print money and mail checks to people it will only hasten the decline of the economy because inflation is hard to control and it creates inefficiency and uncertainty.
Insight:
The inflation vs. deflation debate is largely irrelevant. Standard of living can decline during inflation or deflation. Asset price to income ratios will normalize but real middle class income will necessarily decline as the 2nd great bubble deflates. Our banking system is not designed to cope with this sort of change.
So regarding stock markets. To the extent that prices are based on earnings they will decline. Inflation may actually happen on the way down which could push stock prices higher but if we get to that point the currently rally will have collapsed long before.
Inflation is the government’s tool to smooth out economic fluctuations. But they are attacking an albatross with a fly swatter and everybody is debating the brand of fly swatter.
The 3rd world isn’t sitting on a bubble of job creating inefficiency. Not only do they get to skip the installation of phone lines (they’re starting with cell towers) but they don’t have to deal with the collapse of a middle class employed erecting telephone poles.
The people who are saying this stimulus bill will work are the same people who said there was no housing bubble.
This stimulus legislation is an empty gesture/package. It’s too small to make a difference given the magnity/gravitude of the situation and the deficit left in its wake will only contribute to the decline of the dollar.
Local hero Rich Toscano recently chimed in with a great (but flawed in my opinion (because of China)) article that got me thinking. If the only thing that really matters is foreign perception of dollar weakness in this whole mess then it make sense to focus my prognosticating on the global mind-games that must be going on right now. So here are some thoughts on how this plays out:
Theory #1:
Governments and central banks around the world are delaying the inevitable devaluation of their currencies for as long as possible. If they’re the last currency standing then there is a chance that they become the world’s next reserve currency. This allows them to buy time by sticking other countries with the bill.
When the next reserve currency emerges, dollar, yuan, or otherwise, the central bank in charge of it will no longer have to constantly worry about flight to other currencies. This is when I think hyperinflation really becomes a possibility. This is also when I think it will make sense to buy real estate and maybe gold.
Theory #2:
I used to think that hyperinflation was paradoxical. If the economy is cratering, how is it that wages can go up? I have a new theory on this. Zimbabwe’s economy is currently suffering from hyperinflation. It is based on production of things needed for survival. Our economy largely consists of jobs and products designed to accommodate wants. In an economy based on needs production has to continue or people die. In an economy based on wants production can fall until it becomes an economy based on needs.
Theory #3:
A wants based economy creates service sector jobs. A needs based economy is largely automated (with the exception of 3rd world countries). If my theory is correct then job losses now should gather steam until they’re worse than during the great depression. This is the case because back in the 30s we were a country of farmers without robots. People kept their jobs because those jobs (literally) put food on the table. Now we’re a country of accountants, mortgage brokers, and life coaches.
Theory #3b:
Hyperinflation will not happen in the US unless and until:
a> We either lose reserve currency status due to a lack of fiscal discipline
b> Or we remain the reserve currency but our bought time runs out.
c> And we become a needs based economy (it’s hard to imagine how painful this would be).
Timeline:
So what happens next? Here’s my best guess:
2009 – People really start to understand that it is different this time. The stimulus package fails and job losses mount. Home prices continue to decline because rents decline and price to rent ratio reversion to mean works its inevitable magic. States like California begin to face insolvency, increasing the burden on the Federal government (including the Treasury).
2010 – Government failures in large European needs-based economies. We’ll be in nearly as bad shape but people don’t expect much from the government here in the US so the outrage will be a bit less severe. Those governments will respond by printing money and mailing stimulus checks to their citizens thus destroying their currencies and credit ratings. The Euro breaks down.
2011 – US vs. China showdown. The country with the happiest citizens wins the reserve currency war. China isn’t a democracy but they’re worried about social unrest just like we are. Democracy and accelerating change are mutually exclusive. I give the edge to China’s currency here.
2012 – The end of deflation. Buy land. The US begins its transition to a needs based economy. Productivity growth means that wealth redistribution is going to be massive. Out of necessity. The Republicans were right up until about 1990. They’re still right about free markets but they’re dead wrong on redistribution.
If you’re wondering why most economists didn’t see this coming it’s all explained right here on Economist’s View.
Part 1> The Injustice of the Correlation Between Ignorance and Pulpit
Part 2> Inflation vs. Deflation
Part 3> Investment Strategy
Part I – The Injustice of the Correlation Between Ignorance and Pulpit
“The fundamentals are strong”
“Debt is irrelevant”
“Whatever you do, don’t touch your 401k”.
“Ride it out”
“Nobody could have seen this coming”
I’m not frustrated about the economy melting down. In my eyes this was absolutely inevitable. I’m frustrated because of the horrible financial advice people are receiving on TV every day. Markets cannot work without good information and it is in short supply.
To prove that the saying “Nobody could have seen this coming” is completely without merit, here is one of the people I’ve been reading for the last few years. This is from 2006.
The older optimist in that video is likely to be on TV these days, calling the bottom and advising retirees that they should be investing in financials. Why he’s still on TV remains a mystery.
Oh, and here are the people in charge of fixing this mess:
Another blind optimist, Larry Kudlow, is watching his show slowing slip from his grasp. Jim Cramer’s ‘Mad Money’ is alive and well but Kudlow & Company has been turned into a generic roundtable of discussion about the economy. A few months ago, if the market was down, Kudlow would devote his show to the evils of the Democratic party (I’m not a Dem nor Repub). The evidence for his incompetence is now so overwhelming that CNBC had to do something. Kudlow wasn’t lying, he was simply unable to grasp reality.
Part II – Inflation vs. Deflation
Even before I knew the details of credit default swaps and commercial paper I knew that we were going into a nasty housing led recession and that the outcome would be either inflation or deflation. It is the only real question at this point. Over the next year stocks will trend down regardless (punctuated by insane rallies if history is any guide).
As I’ve been focusing more on this problem of inflation vs. deflation the issue of timing is key. It’s not a question at this point of which will we see. The outcomes are these:
1) Deflation followed by rapid inflation
2) Deflation followed by more deflation
I’ve always been in the deflation camp but I’m starting to turn. The Fed has a can of starch now. Pushing on a string to prevent deflation is no longer impossible. Bernanke may be ignorant but nobody will argue that he’s not crafty. I’m now more confident that he can destroy our economy using inflation. He referred to the printing press as a “technology”. The man is fiscal technologist.
The following paragraphs are the most important I’ve read in a very long time. Someone at the Council on Foreign Relations turned on a microphone and transcribed a discussion between some of the best minds thinking about these problems.
QUESTIONER: Thank you. I’m Jeffrey Rosen from Lazard. What you suggest for fiscal policy and monetary policy, massive stimulous deficits, low interest rates, implies an inflationary risk in the future. What you described for the asset market, a real estate market, commercial real estate market perhaps, certainly the residential real estate market, suggests an asset deflation risk. And I’m just curious which of the two you think is more serious and whether you think there are implications for what’s happening now, for asset deflation in the future which brings back to mind the Japanese type of scenarios. And if I’m allowed and he’ll take a minute, I’m just curious what Mort’s views are on the impact of all of this on the political season.
STEIL: I think both of them are serious, and the RTC fund I put forward with Mark Fisch in December was meant to address precisely that problem. But the inflation risk is also serious and we know that we can experience the two together in some combination. And the 1970s was a particularly bad period. I think in many senses the next five to 10 years are going to look like the 1970s; in other words we’re going to have at best very sluggish growth, we’re going to have elevated real interest rates, elevated inflation rates, elevated commodity prices. It’s going to be a painful period that’s going to involve both asset depreciation and an element of higher inflation.
ZUCKERMAN: Anybody else want to — ?
SETSER: I guess both of us.
ZUCKERMAN: Go ahead.
SETSER: I would put slightly more emphasis on the risk of asset deflation in large part because I think the process by which loose U.S. monetary policy was producing, super loose monetary policy in places like China and the Gulf that were pegging to the dollar and generating globally loose monetary policy, I think that process is about to go into reverse and that you’ll see a much stronger contractionary element from the global economy from the emerging world which will take some of the inflationary pressure off.
ZUCKERMAN: Nouriel?
ROUBINI: I don’t know. I think like in the cycle of 2001, 2003 in six months we’re going to start worrying about deflation, where suddenly asset deflation, slacking good labor and commodity market means inflation’s going to be the least of the problems the Fed has to worry.
You’re right about one point, if you’re going to essentially monetize all the fiscal deficit, that’s going to be made eventually inflationary. But I think that the way it’s going to be financed is going to be by public debt which is going to increase interest rates, but it’s not going to be monetized. Of the liquidity injection in the short run are satisfying a demand for liquidity that you can take away once the demand for liquidity goes away, so that’s not inflationary. And most of the — what the Fed does with the swap line doesn’t increase the money supplies, that’s the swap of bad assets for good assets.
So if we were to monetize, reduce the fiscal problem, absolutely, we’ll have a massive inflation problem down the line. But even–(inaudible)–said what Bernanke cannot afford essentially is throwing the inflation kind of expectation rise then because if inflation expectation comes out of the bottle then to bring it back you’re going to need a nasty bulk of this inflation, and we have a severe inflation. And even a–(inaudible)–Fed cannot afford to essentially monetize this problem. Then if we’re going to fiscalize it, we’ll have to raise taxes, cut spending, pass them onto the next generation. I think that’s the way that this crisis is going to be resolved, not with inflation.
ZUCKERMAN: I’ll just make a brief comment about the last part of your question. I believe if the election had been held two weeks ago, that McCain would’ve won. He was ahead in all of the key battle ground states as a quota. It’s amazing to me how close the election — the polls are to this moment. And since I don’t believe that the polls accurately reflect where the votes are going to come out and that votes will be much more than the polls indicated in McCain’s favor, it’s still a close election.
I cannot imagine that the impact of this crisis, which is going to make the economy the dominant issue from now until the end, unless there was some enormous gaffe or differential effect of the first debate, I just don’t see how Obama loses. If he does, it will really say something very, very serious about race relations, I have to say, because I think that’s the only issue that would defeat him if it were a generic poll. If it were any other Democrat, I think it would be a walk-away.
Part III – Investment Strategy
I’ve been advising all cash and 5 to 10% gold since the beginning of ’08. I think 5% gold is a good bet until the Fed Funds Rate hits zero, which could happen soon. At that point the Fed will have to get really creative in propping up markets using inflation.
This is almost unknowable. If inflation gets out of hand interest rates go through the roof (thanks to China selling dollars). That kills housing and bad mortgages are the cause of our problems. This is a hard problem because hyperinflation is a real threat but we’re the world’s reserve currency. I’m pretty sure nothing like this has happened in the history of human kind.
For the first time the Fed has the tools to actually fight deflation. Whether or not they will risk it remains to be seen. Bottom line – In my opinion now is a horrible time to buy stocks or housing. This ain’t the bottom. I really hope I’m wrong.
Many seemingly credible arguments are out there that say inflation is inevitable. There are also people who say deflation is coming. Please tell me if I am seeing this correctly, specifically as to why “experts” cannot even agree as to which direction these two diametrically opposite possibilities our economy will take.
The main things that are on the side of the scale of deflation are declining home prices and the credit contraction. The main thing on the side of inflation is all the money the Fed has been printing to support our noble and rational war in Iraq (yeah right) as well as stimulating our economy and bailing out these finance companies, among other things that the Fed dilutes our dollars for by printing more monopoly money.
Were are basically weighing two very heavy weights against each other on the scale. Given the uncertainties in these weights, some people think more mass is on the side of deflation, and others on inflation. In any case, we know that it is going to tip to one side or the other, since given two large, more or less random weights, it is highly unlikely that they will closely balance each other out.
This is how I see the situation (though I am personally more convinced of the inflationary argument). Is this roughly correct? Or am I totally misguided?
My reply:
Our Fed chairman Ben Bernanke in the article above jokes about dropping money from helicopters to prevent deflation. Hence the nickname “Helicopter Ben” the bigger picture as I see it is that when people start hoarding money after a credit bubble pops neither the banks nor government can force people to spend to boost the economy.
I imagine in the near future we’ll see rates cut to zero followed by a series of stimulus checks. I don’t think people realize how much money the government would have to create to counter the Trillions lost as housing declines approach 50% in places like California. It’s going to get ugly but this needed to happen after a Credit bubble of this size.
There are bigger issues at play here, namely the deflationary force of exponential technological growth and resulting automation on all sorts of jobs. People like to place all of the blame on globalization but it’s only part of the cause. This country is going to be a lot more humble in ten years but hopefully our economy will no longer be run entirely on debt and dreams of real estate tycoonery. People are going to actually have to do something productive again.
On my list of people I admire to the right if you click on the two black and white pictures you will learn about the economists who basically laid out the school of thought that predicted this mess we’re in.
The real issue here is “too big to fail”. We can choose moderate socialism and keep the system alive or we can choose to let Fannie, Freddie, et. al. fail at which point we’ll have full blown Socialism.
When you peel back all of the layers of the onion, you’re left with two competing philosophies. Wealth redistribution with all of it’s consequences vs. accountability. The irony of modern life is that accountability is now seen as a relic of our idealism. I don’t think that’s necessarily a bad thing. In a Democracy, wealth re-distribution may be the only way to ensure productivity growth.
Unnecessary taxation is a violation of law enforced by law according to Bastiat. In a Republic that’s one thing. In a Democracy it’s an entirely different can of worms.
As far as inflation vs. deflation, my thinking, summarized, is simply that the Austrian School of economics is the only school which gets notion of credit bubble collapse. Simplified, there is no free lunch, hence my deflation call.
Any self respecting believer in Moore’s law will be hard pressed to justify sustainable money printing based inflation. I’m not banking on oil pricing staying this high much longer.
Asia Times is one of the best sites for articles on global economics but I have a beef with an assumption by one of its authors. I see this a lot and I think it’s just wrong:
Part 1> The Injustice of the Correlation Between Ignorance and Pulpit
Matt (a former co-worker) writes: