Inflation, deflation, gold and currencies

[Higgenbotham]

> Would Printing $50 Trillion Tomorrow Do Anything?

> Ignoring interest on excess reserves (a proviso I mentioned),
> printing $50 trillion dollars tomorrow might not do anything.

> Indeed, if $50 trillion printed tomorrow sat as excess reserves
> (the most likely event), it would have the same effect as if it
> was buried in the ground, or not printed at all. Such is the
> nature of a credit-based economy, and a point that has caused
> hugely inaccurate inflation forecasts from many Austrian
> economists.

> As previously mentioned, such massive printing might briefly cause
> a temporary attitude change accompanied by a brief asset bubble of
> some sort (especially in long-dated treasuries given banks would
> put some of it to that use).

> However, massive printing would collapse treasury rates, further
> destroying those on fixed income, and make it even harder for
> pension plans to meet assumptions.

> Since printing $2 trillion did not spur credit expansion, pray
> tell why would $50 trillion?

Mish is framing the debate in terms of the conditions that previously mattered.

The important conditions now are that:
1. The credit quality of the US Treasury Bond remains superior.
2. The Federal Reserve not become too large a percentage of the US Treasury Bond market.
3. The money not be distributed in a disproportionate manner such that the productive, tax generating capacity of the economy is diminished relative to the speculative or investment capacity of the economy.

The credit quality of the US Treasury Bond can become inferior for a period of time without triggering "hyperinflation" if the quantity of superior reserves are not sufficient to meet needs. However, it is only a matter of time before either there will be a sufficient quantity of superior reserves or the world financial system will devolve into chaos. Even if the money sits as reserves, that serves to "zombify" a financial system and an economy that can no longer operate at a profit and has no incentive to do so. If the economy in which a fiat currency operates is on average bankrupt and corrective measures aren't taken to separate out the bankrupt entites and remove them, then eventually that currency will become worthless. A couple years ago, I made the point that Bernanke wouldn't be able to stop deflation unless he ate through the entire US bond market. He's now well on his way.

[gerald]

> Mish posted about hyperinflation and I posted trying to explain
> where I think he is wrong.

> http://howfiatdies.blogspot.com/2012/08 ... ation.html

Actually, I really have to thank Vince for pointing out Mish's column.
This column is very close to my own thinking, and very powerfully
makes the deflationary spiral case that Generational Dynamics has been
predicting for almost ten years.
http://globaleconomicanalysis.blogspot. ... ation.html

However, I want to focus on one particular section that opens up a
potential area of research:

> Would Printing $50 Trillion Tomorrow Do Anything?

> Ignoring interest on excess reserves (a proviso I mentioned),
> printing $50 trillion dollars tomorrow might not do anything.

> Indeed, if $50 trillion printed tomorrow sat as excess reserves
> (the most likely event), it would have the same effect as if it
> was buried in the ground, or not printed at all. Such is the
> nature of a credit-based economy, and a point that has caused
> hugely inaccurate inflation forecasts from many Austrian
> economists.

> As previously mentioned, such massive printing might briefly cause
> a temporary attitude change accompanied by a brief asset bubble of
> some sort (especially in long-dated treasuries given banks would
> put some of it to that use).

> However, massive printing would collapse treasury rates, further
> destroying those on fixed income, and make it even harder for
> pension plans to meet assumptions.

> Since printing $2 trillion did not spur credit expansion, pray
> tell why would $50 trillion?

What particularly caught my attention was the phrase "credit-based
economy."

The thought is this: What if "printing money" is irrelevant to or only
indirectly responsible for hyperinflation? What if the only thing
that matters is money created through debt, and the only effect of
"printing money" is to make more debt available?

This would provide an additional generational explanation for why
there was near-hyperinflation in America in the 1970s, but no
inflation today when there's a lot more "printed money" in the system.

In the 1970s, a rising Boomer generation was only too willing to go
into debt to buy things for themselves and their Gen-X kids.
Businesses too were only too willing to borrow and hire lots of
employees, providing a route by which debt-created money worked its
way into inflated salaries, and from there into the general economy.
Today, those same Boomers, as well as their Gen-X kids, have been
badly burned and are becoming debt-averse, resulting in no inflation,
or a deflationary spiral. (This argument can also be related to the
velocity of money.)

So the difference between the 1970s and today is that there's less
debt-created money, even though there's a lot more printed money, and
it's the debt-created money that's affecting the inflation/deflation
rate.

The research project would be to go back to the Weimar inflation, and
see whether or not the hyperinflation fits the debt-created money
model.

It's well known that the Weimar government printed money, but how did
that money make its way into people's salaries, so that a person would
have the wheelbarrow of money to buy a loaf of bread? Did the
government provide it to the banks, which then lent the money out to
businesses to pay inflated salaries? Then the debt-created money
model would apply.

John

John:

You ask how the money printed by the Weimar government got into general circulation?

In my humble opinion it seems fairly easy to explain.

National governments need to pay their bills for employees, suppliers, etc. If the government does not have the money , from taxes etc. it prints the money to pay it's bills. The government employees and suppliers then spend the new money into the economy. Banks are really not needed.

It was not too long ago that many/most debts were settled in cash. I had relatives, now dead, who purchased homes with cash -- not checks, cash, they counted the cash on a table at closing.

[gerald]

John:

Also, it should be noted that in 1929 the United States issued high denomination bills in the amounts of $500, $1,000, $5,000, $10,000, and $100,000. Those were substantial amounts of money at the time.
http://en.wikipedia.org/wiki/Large_deno ... s_currency

[John]

Dear Gerald,

> You ask how the money printed by the Weimar government got into
> general circulation?

> In my humble opinion it seems fairly easy to explain.

> National governments need to pay their bills for employees,
> suppliers, etc. If the government does not have the money , from
> taxes etc. it prints the money to pay it's bills. The government
> employees and suppliers then spend the new money into the
> economy. Banks are really not needed.

> It was not too long ago that many/most debts were settled in
> cash. I had relatives, now dead, who purchased homes with cash --
> not checks, cash, they counted the cash on a table at
> closing.

Maybe there's an answer along those lines, but this doesn't really provide
an answer. There was a lot of debt-created money in the 1920s, as described
in

** The bubble that broke the world
** http://www.generationaldynamics.com/cgi ... rett071009

As I've been writing for years. securitization of debt has been a
part of every major asset bubble -- tulip futures, South Sea shares,
"assignats" based on lands confiscated from French clergy, railway
shares in 1857, stock shares in 1929, and CDOs in the 2000s.

So to state that everything in Weimar Germany was paid in cash is not
entirely satisfactory. Maybe it was, but that would have to be shown.

Furthermore, even assuming it was all cash, you really haven't stated
how printing money turned into hyperinflation. As far as I
know, Germany had enough money to pay its bills, or could have
met its obligations with only a small expansion of the money supply,
not a million to one expansion.

I'd still like to know how that guy with the wheelbarrow got all
that cash, if there was no debt-created money involved.

> Also, it should be noted that in 1929 the United States issued
> high denomination bills in the amounts of $500, $1,000, $5,000,
> $10,000, and $100,000. Those were substantial amounts of money at
> the time.
> http://en.wikipedia.org/wiki/Large_deno ... s_currency

And yet there was no inflation of any sort in the United States at
that time.

[gerald]

Good points. That is a lot of paper, -- where did it come from?

Regarding the US in 1929, paper money could be converted into silver or gold at a fixed price, that kind of restricts money printing by the government. Just like China's experience with money printing, starting around 600's AD. When paper is backed by metal, government's are more disciplined. When government's debase and print -- trust is lost. http://cij.inspiriting.com/?p=135#

[Higgenbotham]

Here is a scenario by which something resembling hyperinflation could happen in the US. Let's say the collapse of the Euro begins to accelerate and first there is a panic out of Euros and also there is a panic out of stocks and into US dollars and government bonds. The value of the dollar and bonds rise. There is deflation. Once this occurs, as has been stated before, the profits of US corporations go negative and there are mass layoffs. Tax revenues fall. More people go on unemployment, food stamps, Medicaid, etc. The deficit widens. This is now the point of maximum deflationary pressure. Next, the demand for US government bonds falls. The reason demand falls is some combination of the following: the market perceives there is already too much US government debt and there is not room under existing conditions for the market to absorb more debt, the market perceives that tax collections are too low and are not likely to improve, the market perceives that the US government has behaved irresponsibly by failing to cut spending in the past and will not now cut spending when it needs to, holders of US government bonds need to get their hands on cash to pay bills, one or more primary dealers are bankrupt. The scenario for all this to happen may be approximately one year out in the future. Interest rates start to rise, and since the debt level is too high, interest starts to consume most of the remaining tax revenue. The US Treasury conducts an auction and there are not enough bidders. Against its mandate and as a "temporary" emergency measure, the Federal Reserve steps in and buys the bonds to prevent a failed auction and gives newly created cash to the US government as a book entry. This is now the point at which the Federal Reserve is "printing money" and this is a response to the failure of the bond market. Technically, up to this point, it cannot be proven that the Fed has "printed money" consistent with hyperinflation because it cannot be proven that there would have been a failed bond auction without Fed intervention, as interest rates have remained low and by all indications demand for US government bonds has remained strong. This should remain true until the bubbles collapse to their final resolutions. When that happens, the past 16-24 months or so have laid the groundwork for something that will look more like hyperinflation than a continuing deflation.

My understanding is the process of hyperinflation in Weimar Germany was not much different from the above. On the Weimar timeline, late 2012 could be about 1920 or so(?)

[vincecate]

My understanding is the process of hyperinflation in Weimar Germany was not much different from the above. On the Weimar timeline, late 2012 could be about 1920 or so(?)

Right now few people take hyperinflation serious enough to put in a few hours to really understand it. Once it starts, the internet makes it really easy to find lots of good information in a few hours. The blogs will be a buz with hyperinflation explanations. People in Germany did not understand what was going on for years, so it could go on for years. People now will understand in days or weeks. As fast as people understand what is going on they will get out of dollars. I think this currency failure will happen with record speed.

[OLD1953]

Actually, from what I remember of reading about IGFarben, they would pay workers twice a day. At noon, wives or relatives would come to the offices, where people would have just gotten paid, and they'd wrap their money in brown paper with twine, and write their names on it. They'd throw it down to the folks below, who sorted it all out and took off to buy something and beat the evening price increases. Then they'd get paid again before COB, and take that money at spend it at once, to beat the morning price increases.

So the cash got into circulation as quickly as possible, as it was a sort of hot potato that nobody wanted to hold. It seems amazing that shopkeepers would sell anything in such circumstance, but they did. I'm not sure when hoarding laws were passed, but they were certainly in existence soon afterwards.

[Reality Check]

Here is a scenario by which something resembling hyperinflation could happen in the US. Let's say the collapse of the Euro begins to accelerate and first there is a panic out of Euros and also there is a panic out of stocks and into US dollars and government bonds. The value of the dollar and bonds rise. There is deflation. Once this occurs, as has been stated before, the profits of US corporations go negative and there are mass layoffs. Tax revenues fall. More people go on unemployment, food stamps, Medicaid, etc. The deficit widens. This is now the point of maximum deflationary pressure. Next, the demand for US government bonds falls. The reason demand falls is some combination of the following: the market perceives there is already too much US government debt and there is not room under existing conditions for the market to absorb more debt, the market perceives that tax collections are too low and are not likely to improve, the market perceives that the US government has behaved irresponsibly by failing to cut spending in the past and will not now cut spending when it needs to, holders of US government bonds need to get their hands on cash to pay bills, one or more primary dealers are bankrupt. The scenario for all this to happen may be approximately one year out in the future. Interest rates start to rise, and since the debt level is too high, interest starts to consume most of the remaining tax revenue. The US Treasury conducts an auction and there are not enough bidders. Against its mandate and as a "temporary" emergency measure, the Federal Reserve steps in and buys the bonds to prevent a failed auction and gives newly created cash to the US government as a book entry. This is now the point at which the Federal Reserve is "printing money" and this is a response to the failure of the bond market. Technically, up to this point, it cannot be proven that the Fed has "printed money" consistent with hyperinflation because it cannot be proven that there would have been a failed bond auction without Fed intervention, as interest rates have remained low and by all indications demand for US government bonds has remained strong. This should remain true until the bubbles collapse to their final resolutions. When that happens, the past 16-24 months or so have laid the groundwork for something that will look more like hyperinflation than a continuing deflation.

My understanding is the process of hyperinflation in Weimar Germany was not much different from the above. On the Weimar timeline, late 2012 could be about 1920 or so(?)

Wow, I see a number of real problems with this scenario. It appears to fly in the face of what is happening right now in the real world and what happened in the 1920s and 1930s.

[Reality Check]

... Let's say the collapse of the Euro begins to accelerate and first there is a panic out of Euros and also there is a panic out of stocks and into US dollars and government bonds. The value of the dollar and bonds rise. There is deflation. Once this occurs, as has been stated before, the profits of US corporations go negative and there are mass layoffs. Tax revenues fall. More people go on unemployment, food stamps, Medicaid, etc. The deficit widens. This is now the point of maximum deflationary pressure. ...

Why would this be the point of maximum deflationary pressure? What you are describing is the start of an economic death spiral into severe depression, not the bottom. I might buy the argument that some currency other than the U.S. dollar would gain favor, but the deflationary pressure would continue to grow, meaning demand for real assets would continue to decrease, and thus the real price of those assets would continue to decrease.