Inflation, deflation, gold and currencies

[vincecate]

Those graphs do not show a rational relationship of cause and effect. They seem to show what I said I had seen in all the figures I've tracked down in the past, that inflation did not follow a rational path during this period. IOW, there was a panic.
[...]
The interesting part of all this to me, is that it was actually beneficial in the long term, as it reset all the books to zero and removed overhangs of bad debt.

Sometimes what we call a "market panic" is rational. If you come to realize that the US dollar will soon be worthless the rational thing to do is convert all your savings to something else as soon as possible. If this past year you had 400% inflation how much longer are you going to hold on to your dollars? Are you going to slowly spend them with prices "rational" to the current money supply?

I think the German war debt was in "gold marks" and later loans in US dollars, so the debt was not cleared by inflation. It was the US, France, England that wiped out the debt with the US taking the big hit.

Most historians seem to say that this hyperinflation wiped out the middle class and helped Hitler come to power. So I don't think it was "actually beneficial in the long term". And to this day the Germans are more worried about inflation that just about anyone else, so I don't think they liked it.

[OLD1953]

Those graphs do not show a rational relationship of cause and effect. They seem to show what I said I had seen in all the figures I've tracked down in the past, that inflation did not follow a rational path during this period. IOW, there was a panic.
[...]
The interesting part of all this to me, is that it was actually beneficial in the long term, as it reset all the books to zero and removed overhangs of bad debt.

Sometimes what we call a "market panic" is rational. If you come to realize that the US dollar will soon be worthless the rational thing to do is convert all your savings to something else as soon as possible. If this past year you had 400% inflation how much longer are you going to hold on to your dollars? Are you going to slowly spend them with prices "rational" to the current money supply?

I think the German war debt was in "gold marks" and later loans in US dollars, so the debt was not cleared by inflation. It was the US, France, England that wiped out the debt with the US taking the big hit.

Most historians seem to say that this hyperinflation wiped out the middle class and helped Hitler come to power. So I don't think it was "actually beneficial in the long term". And to this day the Germans are more worried about inflation that just about anyone else, so I don't think they liked it.

That was pretty much my point there, that the reaction to the German inflation was not one of these rational market actions, it was a panic. It was the equivalent of a run on a very large bank. The austerity measures being forced on Greece aren't any worse than what Germany would have endured to last a few more years.

The debt would not have been wiped in that manner had the mark(s) not collapsed.

As for beneficial in the long term, I'm not addressing German or Russian or US actions in later years, I'm simply addressing the economic facts of Europe/Germany as they were at that time. From a total bankrupt wreck, Germany rose to be the powerhouse of Europe in a very short time. That's an impressive accomplishment, and can be admired without distressing oneself over how that power was used.

[vincecate]

That was pretty much my point there, that the reaction to the German inflation was not one of these rational market actions, it was a panic. It was the equivalent of a run on a very large bank.

In a fractional reserve system, a run on a bank is very rational. The first ones to the bank get their money out and the last ones don't. Rational to run fast. It is always rational to take your money out of a fractional reserve bank, it is putting it in that is not rational. In school they teach that a bank run or panic is not rational, but that is not true.

Again, "panics" can have very rational reasons behind them. When bulk of the population comes to understand something all at once they are all in a hurry to act and we call this a "panic". When people finally understand the dollar is falling it will be rational to bail fast. It will no doubt be a panic, but it will be a rational panic, as the German response to the rapid printing of money was. If you don't think it is rational to unload your cash when it is clear the dollar is crashing, then hold onto your dollars and tell us how rational that feels later.

[Higgenbotham]

In a fractional reserve system, a run on a bank is very rational. The first ones to the bank get their money out and the last ones don't.

Rational in a case like this to me means you can calculate the probability of something within a small margin of error and act on it. You can do that (in some cases I should probably add) before a run starts. Once a run starts, it is impossible because anything can happen. Obama could suspend the constitution and order the banks shut in the middle of a run, then order everyone who took money out to return it to the bank and pay a 50% penalty or face arrest. I mean, I don't think he would do that, but who knows. Anything can happen in a panic.

A couple comments from page 4 of the Financial topics thread. Generally, when the expected loss exceeds the expected return, then it is not rational to keep money in a bank. In the case where interest rates are zero, the following quote from one of my posts on page 4 is close to being true.

I don't know if this is apparent to people or not, but when deflation hits (interest rates go to zero), there is almost no logical incentive to keep money in a bank if the following conditions hold:

1. The bank cannot afford to pay interest on your balance, and
2. There is the slightest risk of failure of the bank.

The problem with the above, as someone had pointed out earlier, is factoring in the possibility that your money could get stolen if you withdraw it. So it would seem that if interest rates are zero AND (one believes the risk that there will be a run or default AND the FDIC will not pay off) is higher than the risk your money will get stolen if you take it out, then it is irrational to keep money in the bank. Something like that anyway.

[vincecate]

Rational in a case like this to me means you can calculate the probability of something within a small margin of error and act on it.

In Wikipedia it says, "In economics, sociology, psychology and political science, a decision or situation is often called rational if it is in some sense optimal, and individuals or organizations are often called rational if they tend to act somehow optimally in pursuit of their goals."

I certainly think each of the Germans was trying their best to deal with the inflation and that it was very rational to minimize their own exposure to the falling paper money in any way they could.

Rational does not necessarily mean predictable. Weather is still rational even if Chaos Theory says you can't tell if the butterfly is going to cause a hurricane or not.

[Higgenbotham]

Rational in a case like this to me means you can calculate the probability of something within a small margin of error and act on it.

In Wikipedia it says, "In economics, sociology, psychology and political science, a decision or situation is often called rational if it is in some sense optimal, and individuals or organizations are often called rational if they tend to act somehow optimally in pursuit of their goals."

I certainly think each of the Germans was trying their best to deal with the inflation and that it was very rational to minimize their own exposure to the falling paper money in any way they could.

Rational does not necessarily mean predictable. Weather is still rational even if Chaos Theory says you can't tell if the butterfly is going to cause a hurricane or not.

By the Wikipedia definition, the organizations that could be called the best example of rational would be the publicly traded corporations, as their objective is to optimize shareholder value. And if we take a look at what those corporations are doing with their funds, we can see that they keep their money in financial institutions, not in cash or gold. Why do they do that? (1) Is it because they thought about the optimum place to keep their funds and decided that financial institutions were the best place to keep their funds? (2) Or is it because they thought about the optimum place to keep their funds and did nothing because it was impossible to determine? (3) Or did they never consider the question and continue to do what they've always done; in other words, follow the herd?

If the correct answer is (1), then the most rational organizations in the world have studied this problem and we can conclude that the most rational place to keep money is in a financial institution, despite the problems we are talking about.

If the correct answer is (2), then my quote above holds water because the most rational organizations took a look at the problem, could not make a rational determination, and therefore opted to take no action.

If the correct answer is (3), then it shows that the most rational organizations tend to follow the herd; in other words, they are making emotional decisions. I once read that 90% of all human decision making is emotional.

Which do you think it is?

I've just discovered there is a body of research that discusses decision making processes as they relate to bank runs, so we're probably starting to cover ground that has been covered by researchers who've devoted a lot of time to this subject.

Also, going back to page 4 of the Financial topics thread, there was a poster who said the best thing to do with your money was to lock it into high interest rate CDs in the riskiest banks. That was back in September of 2008. He said to do that because there was very little chance of a bank run and the probability the FDIC would not pay off was zero. At that time, he was locking money into CDs at 5%. He's been right so far.

[vincecate]

And if we take a look at what those corporations are doing with their funds, we can see that they keep their money in financial institutions, not in cash or gold. Why do they do that?

If a corporation buys gold do they pay sales tax? And if they sell gold do they pay sales tax again? They pay state and federal income tax on any increase in the value of the gold even if it was mostly due to inflation. It is easy for taxes to make it not rational for them to keep their wealth in gold. If there were no taxes on gold, and no "legal tender laws" making them use paper money, then I think they would use gold.

Also, I am not convinced most executives are really focused on shareholder value more than their own pockets. Seems like many US public companies these days are run for the benefit of the executives.

I note that China, India, Russia, and Saudi Arabia are all increasing gold reserves (like doubling the number of tons, with each ton worth 4 times what it was 10 years ago). And European banks have stopped selling gold. This is after decades of central banks selling gold. Why this change?

http://www.chinamining.org/News/2010-06 ... 37099.html

[Higgenbotham]

And if we take a look at what those corporations are doing with their funds, we can see that they keep their money in financial institutions, not in cash or gold. Why do they do that?

If a corporation buys gold do they pay sales tax? And if they sell gold do they pay sales tax again?

No, they do not pay any sales tax. Corporations generally buy and sell gold through the futures exchanges where transaction costs are for all practical purposes zero and there are no sales taxes. I know because I've done it. There are probably other ways to do it that I don't know about.

They pay state and federal income tax on any increase in the value of the gold even if it was mostly due to inflation. It is easy for taxes to make it not rational for them to keep their wealth in gold. If there were no taxes on gold, and no "legal tender laws" making them use paper money, then I think they would use gold.

Corporations pay tax on all profits anyway and have the in-house expertise to handle any tax situation like this at little additional cost. Through the futures exchanges, gold holdings can either be margined so little cash is required or electronically converted to the needed cash. The same thing can be done with GLD as you pointed out on page 12:

It is easy enough to keep wealth in SLV or GLD and then sell some to pay bills at the end of the month. So it is already easy to basically have electronic currency simplicity while keeping wealth in gold. I would not be surprised if there were brokers or bankers that would let you have a visa debit card where your account balance was in GLD and they automatically sold some as you spent money in dollars.

Given the danger of the US government confiscating GLD if things get really bad, this has risk. But it is not hard technically.

There are probably cheap ways to hedge any currency to the gold price, just as there are ways to hedge currency risk (against other currencies).

Also, I am not convinced most executives are really focused on shareholder value more than their own pockets. Seems like many US public companies these days are run for the benefit of the executives.

True that the executives seem more concerned with maximizing profit on a short term basis so they can skim more off the top. But I don't see how that would prevent them taking a few minutes to have some of their subordinates take care of something they perceive as a catastrophic threat to profitability. They buy insurance, hire security personnel, and things like that.

[vincecate]

If a corporation buys gold do they pay sales tax? And if they sell gold do they pay sales tax again?

No, they do not pay any sales tax. Corporations generally buy and sell gold through the futures exchanges where transaction costs are for all practical purposes zero and there are no sales taxes. I know because I've done it. There are probably other ways to do it that I don't know about.

But if a company or individual bought some gold rounds from a local coin dealer, do they pay sales tax? Can you get physical gold from a local source without paying sales taxes? Is gold exempted from sales tax in any of the states with sales tax? If you want to buy over state lines is shipping large amounts of gold safe? In Anguilla none of the shippers (FedEx, DHL, UPS, Post Office, other private shippers) will ship more than $500 worth of gold with insurance. I am told the US post office will ship/insure larger amounts inside the US.

If there is sales tax, and shipping large amounts is risky or costly, then it is not very practical to use gold coins. Also, there seems to be a significant overhead to buy physical gold coins and then sell them back. I suspect that this is in part due to the danger of counterfeit coins and that is part of why I am looking at ways to make it very hard to counterfeit my non-coins. I will be able to buy them back with basically no risk of counterfeit, I think.

It is easy enough to keep wealth in SLV or GLD and then sell some to pay bills at the end of the month.

This is easy for me as there is no income tax here (though Anguilla just decided to have a 5% wage tax today!@?!!).

My point was that technically keeping wealth in gold and having electronic simplicity is doable. There are legal/tax issues in most places.

True that the executives seem more concerned with maximizing profit on a short term basis so they can skim more off the top. But I don't see how that would prevent them taking a few minutes to have some of their subordinates take care of something they perceive as a catastrophic threat to profitability. They buy insurance, hire security personnel, and things like that.

There are certainly many famous investors and billionaire types that are investing in gold. And a number of hedge funds.

[Higgenbotham]

But if a company or individual bought some gold rounds from a local coin dealer, do they pay sales tax? Can you get physical gold from a local source without paying sales taxes? Is gold exempted from sales tax in any of the states with sales tax? If you want to buy over state lines is shipping large amounts of gold safe?

No corporation that deals in large blocks of cash would want or need to buy from a local dealer. If an individual wants to buy from a local dealer in the US, state sales tax laws vary. Some states do charge sales tax; most don't. If anyone wants to buy over state lines, shipping is no problem. Some of the largest dealers in the US include insured shipping in their price quotes.

But all of this is really irrelevant to the topic at hand. Large corporations can buy gold through the futures exchanges tax free for very little transaction cost. That's what the futures exchanges are for and that's why exchange approved depositories exist. None of this is complicated at all. But as I stated above, the rational actors who run large corporations do not maintain their funds in this manner, but instead keep them as dollar deposits in US financial institutions.

This is easy for me as there is no income tax here (though Anguilla just decided to have a 5% wage tax today!@?!!).

My point was that technically keeping wealth in gold and having electronic simplicity is doable. There are legal/tax issues in most places.

There are no legal issues in the US that prevent anyone from doing this. Taxes are a matter of paying capital gains taxes on any profit and can be less than the tax rate on regular income if it can be structured as long term gain.