17-Nov-10 News -- Anger at Germany boils over

[Higgenbotham]

The point I might make regarding that is, according to a very long term chart I have of the 10 year treasury note, there was a spike in the yield on the 10 year treasury from about 3% to about 4.3% in late 1931/early 1932. That spike occurring at that time would not be due to inflation fears.

There were at least some people who during the 1932 campaign expected FDR to devalue the dollar or go off the gold standard if he got in. England had gone off already and gold was coming out of the Federal Reserve System which only had enough gold to pay off at best 40% of the people with paper money. As I recall FDR denied both during the campaign and did both soon after getting in office. Dollar went from $20/oz to $35/oz of gold. Anyway, there was some inflation fear in 1932 and it was well founded.

On September 21, 1931 Britain went off the gold standard. I'm showing bonds taking a steep drop from September of 1931 through May of 1932 (interest rates up). During the same September through May time period, the Dow dropped from about 150 to 45 and several thousand banks closed. After that, bonds rose pretty sharply through June, July and August (interest rates down) and regained more than half of what they lost. I don't know the answer, but if I had to guess, I would guess those rumors started floating around late May of 1932 (the election would have taken place in November), but do you know the exact months?

This looks about right:

In an effort to create an air of urgency, Roosevelt broke with tradition and did not wait for formal notification of his nomination from the convention. Instead, he boarded a plane and flew to Chicago, where on July 2 he delivered an acceptance speech in which he stated, "I pledge you, I pledge myself, to a new deal for the American people."

[Higgenbotham]

Quote from A Bubble That Broke The World:

Take a text from the news as it was printed in the
New York Times on Monday, June 23, 1931: "Led by
New York, tremendous buying enthusiasm swept over the
security and commodity markets of the world yesterday
in response to week-end developments reflecting the favorable
reception of President Hoover's proposal for a one year
moratorium on war debts and reparations. The
world-wide advance in prices added billions of dollars
to open market values, with stocks, bonds, grain, cotton,
sugar, silver and lead in heavy demand. Pronounced
strength developed in the German bond list, the gains
ranging from 2 to 1 3 ^ points. . , . United States government
bonds failed to participate in the move, all of
them closing behind minus signs."
The last line fell obscurely at the end of a paragraph.
And that was all the notice any one bestowed upon the
most significant fact of a delirious day, namely, the fact
that everything in the world went up with the single
exception of United States government bonds. And why
was that? United States government bonds were telling
why, and telling it loudly to such as would listen. They
were telling it in the language of quotations, and this is
what they were saying:
"Again this business of saving Europe with American
credit! Do you ever count up what it has cost you already?
It is becoming more and more costly; and, besides, you
may not be saving Europe at all. You may be only inflating
her. Better may turn out to be worse."
As it did. The world-wide rise in everything but
United States government bonds was fictitious, a momentary
delusion. Worse was to come.

Comments? I'm seeing the following:

If we were to substitute "QE2 announcement" for "Hoover's proposal" market behavior was the same. 30 year bonds fell in the days following the QE2 announcement while metals and stocks rose for a few days.

From a time standpoint, June 23, 1931 was about 17 months after the 1929 stock market low. The QE2 announcement occurred about 18 months after the 2009 stock market low. In September, 1931, the stock market decline really began to pick up speed. But in Britain, where the gold standard was suspended, the stock market bottomed in late 1931 (I'm not sure which month but it could have been September).

[vincecate]

If we were to substitute "QE2 announcement" for "Hoover's proposal" market behavior was the same. 30 year bonds fell in the days following the QE2 announcement while metals and stocks rose for a few days.

From a time standpoint, June 23, 1931 was about 17 months after the 1929 stock market low. The QE2 announcement occurred about 18 months after the 2009 stock market low. In September, 1931, the stock market decline really began to pick up speed. But in Britain, where the gold standard was suspended, the stock market bottomed in late 1931 (I'm not sure which month but it could have been September).

Hoover gave the debtor nations a break at the expense of the creditor nation. When Bernanke prints money it steals value from creditor nations and gives it to the US, the main debtor. So there is a real similarity between the two cases.

To me the US dollar has gradually took steps away from a real gold standard to get through a crisis.
1) 1914 - Ponzi Gold standard that is only 40% backed - could fund WW1
2) 1933 - US citizens can't hold gold but dollar convertible for foreigners - saved the Fed
3) 1971 - Dollar not convertible for anyone - US would have run out of gold
4) 1980 - Sold some government gold at high prices - saved the dollar but less gold left

In each of these situations the US moved further from "honest gold money" to be able to get through a crisis, but still had some looser tie to gold. Only next step I see left for the USA is hyperinflation till gold is 30 times more and can back the paper again.

[Higgenbotham]

Hoover gave the debtor nations a break at the expense of the creditor nation. When Bernanke prints money it steals value from creditor nations and gives it to the US, the main debtor. So there is a real similarity between the two cases.

To me the US dollar has gradually took steps away from a real gold standard to get through a crisis.
1) 1914 - Ponzi Gold standard that is only 40% backed - could fund WW1
2) 1933 - US citizens can't hold gold but dollar convertible for foreigners - saved the Fed
3) 1971 - Dollar not convertible for anyone - US would have run out of gold
4) 1980 - Sold some government gold at high prices - saved the dollar but less gold left

In each of these situations the US moved further from "honest gold money" to be able to get through a crisis, but still had some looser tie to gold. Only next step I see left for the USA is hyperinflation till gold is 30 times more and can back the paper again.

The difference I see is, as you implied, Hoover and the banks willingly loaned money to Europe, whereas the US is forcing QE2 down China's throat. The current situation between Germany and the rest of Europe seems very similar to that between the US and Europe in 1931. At some point in 1931, the US bankers told Britain to balance their budget and roll back socialism before they would get any more loans. That appears to be the role Germany is playing now.

I see Britain going off the gold standard in 1931 as being equivalent to Bernanke's QE binge. The difference I see is that Bernanke is coming in a bit earlier in the cycle than Britain did. If these actions have somewhat similar effects on the equivalent creditor nation, China may implode. Zero Hedge is reporting tonight that Knight Research is making that call. That may be a reversal from their previous stance, but I'm not paying enough attention. I try to do my own thinking during the day and scan the blogs at night.

We had that exchange about whether the Fed can go bankrupt. There's another idea out there that the Fed has the gold on their balance sheet and can revalue it to $8000 per ounce to prevent a Fed bankruptcy. Not saying I think that by itself would work, but it could be part of a solution.

Anyway, I looked over some charts and the markets are behaving very similarly post the Hoover announcement and post the QE2 announcement. The US in 1931 is not the US today, but the bond market isn't taking it any differently. There's a possibly different dynamic today and that's the idea that the Fed is a creditor/lender of last resort to the US banks and it's game over for the banks as the real estate decline is picking up again and the bond market is saying "no more, where are you going to get the money?".

[OLD1953]

I had to think this one over a bit before I could say anything.

Higgs, I certainly agree with you that at some point people revolt against further aid to those who choose to take risks for profit. This is apparent in everything I've read about bubbles, often with comments about "just a little more would have saved it all", which was usually ridiculous. Extreme prices for anything CANNOT be supported, be it tulips, gold, silver, houses, pearls or whatever.

At some point, the decision is made to cut the chute and let her drop, be it early (as in the tulip game) or late as in our mess now or in the 30's. I'm not aware of any rescue attempt in history that successfully kept a failed bubble inflated. After the final bubble pops, revulsion against what WAS common business practice grows rapidly.

I'm not aware of any bubble popping that was not deflationary in a real sense. The real world of money uses the junk of the bubble as a real asset against loans, which means real property values must decline or remain unsold for extremely extended periods.

In our current situation, however, the important question is, who fails first? It does not seem to me the US is going to "fail" in terms of being unable to service it's debt. We may have a stagnant economy for a long while, but the bankers, while still willing to gamble and still keeping a lot of trash on the books, are not exposed as they were to foreign debt.

YES, we have revulsion towards further vast increments of the public debt. However, in terms of debt held outside the US, we are not at a terrible figure, not a lot over 50%. While I do not expect any huge decrements in the actual federal budget from the new congress (actually, I'll be shocked silly if they shrink the official budget AT ALL, I fully expect increases), I do believe they'll back down on budget SUPPLEMENTALS, which are responsible for the bulk of the increase over the last ten years. That will cause a lot of pain, but will also cause the increment of the debt to drop.

Europe, OTOH, is tied together by the chain of the EURO. If Europe fails in banking, then what happens? Who goes down and who lands on top? If China looks good, there'll be war for a certainty.

And such a war will be nuclear at some point. The Russians seem to realize this, as they are offering a degree of cooperation on that missile shield.

And that's the extent of my thoughts right now. A bit mixed, but I'll post the reason for that later if it shows up in the papers.

[vincecate]

I'm not aware of any bubble popping that was not deflationary in a real sense.

In general an asset bubble popping would be deflationary. The one case it is not is when a bond bubble popping is the start of people fleeing a currency that leads to hyperinflation.

When debt is over 80% of GDP, and deficits are over 40% of spending, and money is being printed about as fast as the deficit spending, and commodity prices are going up, it seems hyperinflation always follows. The US is in that situation. As John has pointed out, this time might be different because the dollar is the world reserve currency. So the normal formulas might not apply. A good book on this subject is "This time is different: 8 centuries of financial folly". My feeling is that countries will "diversify their reserves" as US hyperinflation starts, some before and some after. So things won't really be that different.

I also view the US government outlawing gold in the 30s as saving the Fed from failing and hyperinflation. So I sort of count each of the last 3 generational crises in America as having hyperinflation and really expect it this time as well.

http://howfiatdies.blogspot.com/2010/11 ... ndard.html

[Higgenbotham]

In our current situation, however, the important question is, who fails first? It does not seem to me the US is going to "fail" in terms of being unable to service it's debt. We may have a stagnant economy for a long while, but the bankers, while still willing to gamble and still keeping a lot of trash on the books, are not exposed as they were to foreign debt.

YES, we have revulsion towards further vast increments of the public debt.

That is an important question. Yesterday I mentioned the CDS rates on Bloomberg. This is a bit esoteric, but back when the subprime crisis was building, the Markit indices of the various MBS tranches were good leading indicators that things were going to crack and where. A few people were looking at those and now a few people are looking at the CDS rates. There's an outfit you can buy these quotes from, and I've found a way to access this information through Bloomberg by doing a google search as follows:
http://www.google.com/search?q=site:www ... art=0&sa=N
That'll bring up all the CDS quotes on Bloomberg with some interactive charts. Maybe there's another way to get this information, but I don't know. Anyway, these quotes tell where the market thinks the failures will occur first and it's Europe by orders of magnitude.

Getting to your second sentence, these CDS quotes are saying the market believes that any failure of the US government bond market over the next 5 years is a very low probability event. However, at the same time, the CDS market is saying that it views the probability as having risen since January and since 30 year bond prices have started falling in the past 2 weeks (yields rising). I'm trying to interpret what that means, if anything. Maybe there's not enough data yet. I think it means that if the market believed the US would just inflate the debt away CDS rates would go down because there would be no loss of principal. Someone could insure the principal and be confident that it doesn't matter, Bernanke will just print enough money to cover it. The CDS market is saying it believes that less than it did 2 weeks ago and less than it has any time this year.

Regarding your last sentence, I'd be really worried if we weren't seeing revulsion. I was beginning to wonder whether it would ever happen or if we would just drift blindly into QE infinity. Revulsion is likely a symptom of coming responsibility, but it's not assured. Between the time revulsion occurs and more responsibility appears, the bond market will likely fret.

[vincecate]

Regarding your last sentence, I'd be really worried if we weren't seeing revulsion. I was beginning to wonder whether it would ever happen or if we would just drift blindly into QE infinity. Revulsion is likely a symptom of coming responsibility, but it's not assured. Between the time revulsion occurs and more responsibility appears, the bond market will likely fret.

Revulsion is a step in the right direction, but this alone is not enough to save the bonds or the dollar. The real problem is the deficit is 40% of spending and does not really seem fixable. With that deficit the Fed will have to print. With the printing bonds and the dollar are doomed. If they fix the budget with a bunch of taxes America is doomed. I doubt they can really make the cuts needed as fast as needed.

The bond crash, capital flight, and increase in velocity of money that kick off hyperinflation seem to hit suddenly and hard. It is nearly impossible to save things once it starts.

[Higgenbotham]

Revulsion is a step in the right direction, but this alone is not enough to save the bonds or the dollar. The real problem is the deficit is 40% of spending and does not really seem fixable. With that deficit the Fed will have to print. With the printing bonds and the dollar are doomed. If they fix the budget with a bunch of taxes America is doomed. I doubt they can really make the cuts needed as fast as needed.

The bond crash, capital flight, and increase in velocity of money that kick off hyperinflation seem to hit suddenly and hard. It is nearly impossible to save things once it starts.

The question is one of sequence of steps and timing, but I believe in the long run only the program I outlined a few weeks back is workable (competitive economic zones, etc.). As proof of that, here is part of a letter I received from my "fiscally conservative" Congressman today:

Many thanks for your recent letter about the Federal Reserve's decision to purchase $600 billion of U.S. Treasury securities. I appreciate knowing of your concerns.

The goal of this plan, known as "quantitative easing," is to stimulate investment by lowering interest rates and the cost of borrowing.

We agree that this monetary policy approach risks eroding the long-term value of the dollar and injects more uncertainty into the market for investors. Another side effect of expanding the global supply of dollars is a depreciating exchange rate relative to currencies of our trade partners. With today's globalized supply chains, devaluing our currency could result in higher input costs of products made in other countries and increase prices for American consumers.

Instead, Congress should enact pro-growth fiscal policies that will remove uncertainty from the market and encourage economic growth in the private sector.

Be assured that I will keep your thoughts in mind as related legislation progresses through Congress.

When debt is over 80% of GDP, and deficits are over 40% of spending, and money is being printed about as fast as the deficit spending, and commodity prices are going up, it seems hyperinflation always follows.

These figures were exceeded in the US during World War II. The concern I have is not so much what the debt levels are now. Rather, my concern is that at this point in the generational cycle, a reservoir may be needed that is not there. Also, with the disruptive event potential that exists with today's technologies and their dependence, the response time of government will likely not be swift enough. I doubt the financial folly guys have done an estimate of a repeat of similar magnitude earthquakes that have hit Japan for centuries, for example. If one were to hit tonight while everybody is crunching their numbers and doing their projections, global market collapse would be nearly instantaneous in my estimation. And that really is different this time.

[vincecate]

These figures were exceeded in the US during World War II. The concern I have is not so much what the debt levels are now. Rather, my concern is that at this point in the generational cycle, a reservoir may be needed that is not there.

The spending was for military. Once the war was over it was very easy to cut the spending. Now it is nearly impossible to cut 40% of spending.