Financial topics

[John]

> John, here's a detailed argument for hyperinflation by John
> Williams, a respected PhD economist that worked advising industry
> for many years. He now produces a set of alternative measures of
> unemployment, inflation, and GDP growth, largely using current BLS
> raw data, but calculated using older formulas. The official
> formulas to calculate unemployment and inflation have changed
> several times since 1980, always in the direction of showing lower
> unemployment and lower inflation. His site has a thorough
> explanation.

> http://www.shadowstats.com/article/hyperinflation

> The United States has experienced two bouts of hyperinflation,
> where the underlying currency became worthless. The first the
> paper currency issued at the time of the Revolutionary war. The
> second was the paper currency issued by the South during the Civil
> war. The paper currency in the North wasn't far behind, although
> it was eventually redeemed many years later.

> The United States has experience one run of deflation, in the
> 1930s. During that time the domestic currency was unlinked from
> the gold standard, however, International Trade remained in gold.

This paper is so awful that it actually gives me a headache to read
it. (There are many published papers today in that category.) I'll
just comment on a couple of things.

Let's start with the consumer inflation graph, 1665-2007:



This is a typical trick of people who want to lie with statistics to
"prove' a particular kind of point.

The CPI is an exponential growth trend value, and to display it over 3
1/2 centuries with a linear y-axis is completely meaningless, but it
permits the author to claim that the CPI was essentially flat for 3
centuries, but then shot up in the last few decades.

You say that John Williams is "a respected PhD economist." So did he
post this graph because he doesn't understand exponential growth, or
did he do it to intentionally deceive? Is he a moron or a liar? Or
both? I report, you decide.

To show how the CPI should be displayed, here for example, is a graph
that I posted in 2003:



Using a logarithmic scale makes it much less dramatic but also shows
that most of what Williams is saying is nonsense. (My graph also
shows that the CPI has been above trend since the 1970s, and by the
Law of Mean Reversion is due to fall sharply.)

Now let's turn to his treatment of the "gold standard."

He says, "Aside from minor average annual price level declines in 1944
and 1955, the United States has not seen a deflationary period in
consumer prices since before World War II. The reason for this is the
same as to why there has not been a formal depression since before
World War II: the abandonment of the gold standard and recognition by
the Federal Reserve of the impact of monetary policy — free of
gold-standard system restraints — on the economy."

I've answered this gold standard nonsense many times.

It makes as much sense to talk about a policy based on a gold standard
today as it does to determine energy policy based on the supply of
whale oil, or to determine transportation policy based on the price of
horse feed.

A gold standard may have made sense in past centuries, when the only
money was minted coins or paper notes. But today, coins and paper
currency are only a tiny part of the the available money. There are
hundreds of trillions of dollars of securities in portfolios around
the world, and the Fed has only the tiniest effect on the total money
supply. So a gold standard is totally meaningless today.

Even in the 1930s, the gold standard was meaningless, because the US
was already creating money through debt. There's no way to enforce a
gold standard, because there's no way to prove the effect that a
change in the Fed funding rate will affect the money supply. There's
no way to say, "Such and such a policy violates the gold standard."
So the Fed in the 1930s could have done anything it wanted, and there
were no restrictions on the Fed.

Furthermore, even if there HAD been some restriction, the Congress
would simply have removed the restriction or repealed the gold
standard entirely. They would not have allowed millions of people to
starve and go homeless just because of some technical requirement that
could be easily removed or ignored.

If a country wants to inflate its currency, it just does so. If it's
on a gold standard, it just raises the price of gold, or it refuses to
convert currency to gold. FDR did both. Inflating the currency is a
political decision, and a "gold standard" is no more relevant than
whether or not it's raining.

Williams doesn't explain why inflation has been close to zero in the
2000s decade, when we've been clearly off the gold standard. By his
reasoning, we should have had high inflation, but we didn't.

Let's go on.

He says, "Although the U.S, government faces ultimate insolvency, it
has the same way out taken by most countries faced with bankruptcy. It
can print whatever money it needs to create, in order to meet its
obligations. The effect of such action is a runaway inflation — a
hyperinflation — with a resulting, effective full debasement of the
U.S. dollar, the world’s reserve currency. The magnitude of the loss
of the U.S. dollar’s purchasing power in the last 75 years now has the
potential of being replicated within a few days or weeks."

This is utter nonsense. He uses the phrase "print money," as if the
government is going to print a trillion dollar bills to pay off its
debt, and deliver them on a boat to China.

That's not how money is created today. Money is created today by
creating debt. The Fed is doing that, but anyone can do it.

Suppose I have $1000 and you have nothing, so we have $1000 between
us. I lend you the $1000, and you give me an IOU saying, "Pay to
bearer $1000," with your signature. Then you have $1000 cash, and I
have a $1000 security, so we've both "printed" $1000 in new money.
The Fed plays only a small part in money creation.

This is why I have so little patience with people like Williams who
make money by purveying this nonsense. Is he a moron or a liar?

I'll take one more or his arguments, on the Weimar Republic and
Zimbabwe.

Williams has a 2010 addendum on this:
http://www.shadowstats.com/article/hyperinflation-2010

He has some tear-jerking stories to gain our sympathy: "It was
horrible. Horrible! Like lightning it struck. No one was prepared. You
cannot imagine the rapidity with which the whole thing happened. The
shelves in the grocery stores were empty. You could buy nothing with
your paper money."

And so we come back full circle. If they couldn't buy anything with
paper money, why not use a credit card? Oh yeah, they only "printed
money" in those days, and didn't create it through debt. That's why
this whole comparison is so moronic.

"Printing money" in the Weimar and Zimbabwe cases are like pouring
buckets of water into a bathtub (with the stopper in). Sooner or
later, the bathtub is going to overflow.

But the US dollar today is a worldwide reserve currency, with over a
quadrillion dollars in securities in portfolios around the world. The
Fed is not "printing money." It's using debt to create money, and
that makes it no different than any investment bank that uses debt to
create money. What the Fed is doing today is like pouring buckets of
water into the ocean -- it has no effect at all.

The reason for hyperinflation in Weimar and Zimbabwe is because there
was a strong political desire to hyperinflate. This was most obvious
in the Weimar case, where reparations were to be made in marks,
unadjusted for inflation. Obviously, the easiest way to pay
reparations was simply to print the marks and make the payments with
the printed marks.

As I mentioned recently in the web log, Ben Bernanke gave a good
reason why there's no real political motivation for inflating the US
currency: Because almost every major government expense, including
social security and medicare, is indexed to inflation, so inflating
the currency would change nothing.

John

[John]

Dear John,

> However, Bernanke is finally admitting to two things which
> together describe a fatal condition:

> 1. The debt levels are unsustainable
> 2. The fed can't inflate out of the problem

This is exactly right. The US will default, but that won't have
anything to do with dollar inflation. The two issues are linked, but
not identical.

John

[freddyv]

A lot of people were previously comparing the crash of 2008 to the crash of 1929, up until the rally out of the March lows. But if one looks at the big picture (bigger bubble; bigger timeline; bigger government involvement) it makes perfect sense that the market will retrace (close the gap left open from July of 2008) back to around 11,000 on the Dow and will take longer than the big bear rally into April of 1930.

I wrote that on January 9th of 2010.

For almost a year now I have been holding onto my theory that the DJIA had a technical "need" to retrace back to the July 2008 lows of around 11,000. Now that the stock market has hit and surpassed that point I await the confirmation of my theory or certification of its death in the coming weeks and months.

One strong piece of evidence for a falling market can be found at http://www.consumerindexes.com/

Another at http://home.comcast.net/~RoyAshworth/Mu ... Levels.htm

Current events regarding Goldman Sachs and the ongoing Greek tragedy are just a few of the issues that could precipitate sudden declines, leading the way to the resurection of the secular bear market.

BTW, please don't take this as investing advice.

Fred
http://www.acclaiminvesting.com/

[John]

Here's a site that's selling phony gold coins for $9.95 each:

https://www.50dollarbuffalo.com/?mid=658931

I cannot figure out why anyone would want to buy one of these phony
coins, unless he wants to resell it, pretending that it's a real coin.

In other words, this web site is not perpetrating fraud, but it's
openly selling products whose only purpose is to perpetrate fraud.

Am I missing something?

John

[ridgel]

You say that John Williams is "a respected PhD economist." So did he post this graph because he doesn't understand exponential growth, or
did he do it to intentionally deceive? Is he a moron or a liar?

The non-log chart makes a strong point. There was no net inflation until the Federal Reserve act of 1913. There was strong inflation ever since. The log chart you posted shows the same thing - even during the depths of the depression the price level didn't get back to where it was 15 years earlier.

So the Fed in the 1930s could have done anything it wanted, and there were no restrictions on the Fed.

Wrong. When the Fed was created they had to hold 40c of gold for each dollar issued, and that was still true in 1932.

Even in the 1930s, the gold standard was meaningless, because the US was already creating money through debt.

Half wrong. It was still the standard for international trade. We would not have lost 3/4 of our manufacturing jobs to foreign competition in the 1930s, because there would not have been the gold to support it.

Williams doesn't explain why inflation has been close to zero in the 2000s decade, when we've been clearly off the gold standard. By his
reasoning, we should have had high inflation, but we didn't.

Williams explains this very clearly - the government has changed the way they calculate CPI in a way that consistently lowers the published number. The only thing that's really fallen in price since 2000 is electronics and labor subject to foreign or immigrant competition. Commodities, medical, education, government, utilities, and even housing on net have all gone up in a significant way since 2000.

That's not how money is created today. Money is created today by creating debt. The Fed is doing that, but anyone can do it.

Quantitative Easing. If the Fed creates new money and uses it to buy U.S. treasuries, that's new money into the system. Whatever interest the Treasury pays the Fed goes right back to the Treasury.

This was most obvious in the Weimar case, where reparations were to be made in marks, unadjusted for inflation.

The U.S. also owes its creditors in dollars, giving it every bit as much incentive to inflate. However, as long as creditors will roll over debt there's no need to inflate it away. So the U.S. will keep borrowing from foreigners and "investors" as long as they keep the faith. The moment they lose faith and want their money back, the inflation machine will start full bore.

Almost every major government expense, including social security and medicare, is indexed to inflation

Social security and many other government obligations are indexed to CPI-U. Conveniently, CPI-U is also calculated by the government. So they have every incentive to inflate and then under-measure CPI, which is what they have been doing. And when bond investors finally lose faith, the promised payments to S.S. recipients and government unions will be so far down the list of priorities that it wont even come into play.

As far as the credibility of Williams goes, I don't think you're in a strong position to knock it. He posts numbers and graphs along with his calculations every week showing measured aspects of the economy. You on the other hand have an interesting but completely untestable theory. You are very tenuous in finding news from around the world which supports your theory, and that's what makes your site interesting to me. But you completely ignore anything which doesn't match your preconceptions, which is why I certainly wouldn't rely on your predictions for my own security and prosperity.

[JLak]

Dear John,

> However, Bernanke is finally admitting to two things which
> together describe a fatal condition:

> 1. The debt levels are unsustainable
> 2. The fed can't inflate out of the problem

This is exactly right. The US will default, but that won't have
anything to do with dollar inflation. The two issues are linked, but
not identical.

John

I'm willing to accept that, so long as we can accept the intermediate steps. Specifically, the fed will make a decision to stop open market operations (buying US debt) and let bond yields (and interest rates) grow to unheard-of numbers. This will obviously cause a stupendous credit market deflation along with government default. This is reasonable, although there will certainly be huge political pressure to keep buying the debt and hold down yields. Will the fed support the dollar or the government? Let's say they choose the dollar and stop buying debt.

Okay then what? There is no longer 'legal tender' status for the dollar, but the credit bureaus and ratings agencies and huge amounts of commercial paper still exist with no 'de jure' enforcement. Is the 'de facto' enforcement strong enough to keep the dollar's status? This is a big question.

I don't think you can conclusively answer 'yes' until treasury debt yields are no longer the lowest in the overall market. At that point, we can be fairly certain that you are proven right against the prevailing wisdom that fiat derives from the state, but I think it's still in question today. Also, if you are right, you may want to consider the possibility that the euro will also survive for the same reasons.

[Higgenbotham]

Even if the credit market deflation dwarfs the debt, won't that turn the other direction as soon as the supply of dollars exceeds demand? The FOMC can easily multiply the monetary base with these deficits, not to mention private treasury sales and dollar repatriation. In fact, I'd almost say that they are being forced to!

If the FOMC doesn't buy the debt, the government will fail. If it does buy the debt, a vicious cycle leads to hyperinflation and government failure.
Historically, I think we can point to revolutionary coup as the most likely resolution of similar problems.

If I follow, you're saying if we get private credit market deflation (as in decreasing private market debt levels due to default and paydown of debt), then what happens if the government and the Fed continue to increase government debt and monetary base levels after the process of private credit market deflation is complete? I suppose that is theoretically possible as the Fed may not recognize the process as being complete and may at the time of completion be buying government debt in exchange for newly created dollars. If that's the case, then I think you're right, as you stated, a vicious cycle leads to hyperinflation and government failure. But I think we have to take this a step at a time. The process of private market debt deflation is likely to be a very long one and during that process our institutions will undergo changes that will likely make it impossible to hyperinflate. The mechanism by which that happens, my guess anyway, is that state (as in US states such as Texas, etc.) or private forms of money will be introduced and compete side by side with Federal Reserve Notes. Another possibility, which is already happening to a limited extent through Everbank, is depositors will be able to readily switch their accounts into more stable foreign currencies should a particular central bank get out of control. A third possibility between now and then is, since many fear the outcome you are describing, there will be restrictions placed on the Fed that prevent it from hyperinflating, or the Fed may be abolished entirely.

Generally speakng, the large currency blocks such as the EU and the US are running into trouble partly because one centralized economic policy and currency cannot fit the needs of a highly diverse area. At the same time, the new technologies make it feasible to create and administer alternative currencies that meet the needs of particular geographic areas. I don't think it'll be too long before the lighbulb goes on inside some desperate state government that this is the solution to their problem. Once that happens, the floodgates will open and the revolution will be in full swing. As long as that alternative exists, it seems to me that a coup in the traditional sense can be headed off through this means.

http://www.cbsnews.com/8301-503544_162- ... 03544.html

Somebody is beginning to think in this direction, but it doesn't seem that gold and silver coins would be the right solution. One of the Strauss and Howe scenarios was that a governor would lay claim to Federal tax monies (page 272). My guess is this is very likely, along with a plan to establish an alternative digital fiat currency that would promise to be strictly limited in terms of inflation and tailored to the needs of the particular state instead of the crooks on Wall Street.

[JLak]

Even if the credit market deflation dwarfs the debt, won't that turn the other direction as soon as the supply of dollars exceeds demand? The FOMC can easily multiply the monetary base with these deficits, not to mention private treasury sales and dollar repatriation. In fact, I'd almost say that they are being forced to!

If I follow, you're saying if we get private credit market deflation (as in decreasing private market debt levels due to default and paydown of debt), then what happens if the government and the Fed continue to increase government debt and monetary base levels after the process of private credit market deflation is complete?

Not exactly. What I'm saying here follows the theory that Bernanke uses in his quantitative easing, that increasing monetary base will increase incentive to hold and increase debt by rational expectation of rising rates, and increase incentive to lend by holding down treasury yields. It's important to note that in the long run, credit can't really decrease unless the reserve ratio changes, it can only migrate to treasuries. Once rational expectation flips, it will force credit out of the treasury market out of fear, yields will rise dramatically, and deficit spending will continue to force the fed to keep inflating the monetary base. When? I don't know. However, my concern is not inflation based on credit supply, which can be huge but doesn't really have that large of an effect on CPI, for instance.

The concern is about collapse of the currency (including a short hyper-inflationary phase) by lack of confidence as was seen historically in the collapse of many fiat currencies. Generally this occurs in times of massive 'secular' or credit deflation but the fiat currencies die because their power is based on confidence in the state.

State default will cause bond values to drop to zero creating something like 80% M1-M3 deflation, but if the fiat is based on confidence in the state, it will still be worthless. However, I'm fairly certain that we're not going back to gold, and the commercial institutional strength may be unique in history to allow the dollar to survive. There is also the question of whether the fed would be forced to take extreme measures to prevent default, which will be impossible. So which force is greater? I am truly asking because I do not know and do no pretend to know, but I don't think the answer is simple.

I suppose that is theoretically possible as the Fed may not recognize the process as being complete and may at the time of completion be buying government debt in exchange for newly created dollars. If that's the case, then I think you're right, as you stated, a vicious cycle leads to hyperinflation and government failure. But I think we have to take this a step at a time. The process of private market debt deflation is likely to be a very long one and during that process our institutions will undergo changes that will likely make it impossible to hyperinflate. The mechanism by which that happens, my guess anyway, is that state (as in US states such as Texas, etc.) or private forms of money will be introduced and compete side by side with Federal Reserve Notes. Another possibility, which is already happening to a limited extent through Everbank, is depositors will be able to readily switch their accounts into more stable foreign currencies should a particular central bank get out of control. A third possibility between now and then is, since many fear the outcome you are describing, there will be restrictions placed on the Fed that prevent it from hyperinflating, or the Fed may be abolished entirely.

Generally speakng, the large currency blocks such as the EU and the US are running into trouble partly because one centralized economic policy and currency cannot fit the needs of a highly diverse area. At the same time, the new technologies make it feasible to create and administer alternative currencies that meet the needs of particular geographic areas. I don't think it'll be too long before the lighbulb goes on inside some desperate state government that this is the solution to their problem. Once that happens, the floodgates will open and the revolution will be in full swing. As long as that alternative exists, it seems to me that a coup in the traditional sense can be headed off through this means.

http://www.cbsnews.com/8301-503544_162- ... 03544.html

Somebody is beginning to think in this direction, but it doesn't seem that gold and silver coins would be the right solution. One of the Strauss and Howe scenarios was that a governor would lay claim to Federal tax monies (page 272). My guess is this is very likely, along with a plan to establish an alternative digital fiat currency that would promise to be strictly limited in terms of inflation and tailored to the needs of the particular state instead of the crooks on Wall Street.

So, you say the dollar will be replaced, but you expect it to hold and increase its value up until that day. I'm not saying that you're wrong, but I'm just not so sure things will go smoothly. Future expectation drives present value.

I do think there's a quantitative answer here somewhere that will give the best guess possible as to the bounds of rational expectation, but quite frankly I'm not smart enough to figure out all the variables. I'm somewhat convinced that Bernanke understands the full situation better than anyone else, but his job is to stabilize the banks, not to inform the people. Therefore, I implore members of this forum to think through it a bit more and break the situation down instead of holding to dogma with broad generalizations.

Thank you all for making this forum what it is. -JLak

[Higgenbotham]

Not exactly. What I'm saying here follows the theory that Bernanke uses in his quantitative easing, that increasing monetary base will increase incentive to hold and increase debt by rational expectation of rising rates, and increase incentive to lend by holding down treasury yields. It's important to note that in the long run, credit can't really decrease unless the reserve ratio changes, it can only migrate to treasuries. Once rational expectation flips, it will force credit out of the treasury market out of fear, yields will rise dramatically, and deficit spending will continue to force the fed to keep inflating the monetary base. When? I don't know. However, my concern is not inflation based on credit supply, which can be huge but doesn't really have that large of an effect on CPI, for instance.

Bernanke's theory as I understand it is that he needs to add money to the system because there is not enough. In other words, there is a liquidity problem and adding liquidity will free up the system and stabilize it so the debt will continue to grow. I think Bernanke has it dead wrong. The lack of liquidity is a symptom of a larger problem and that is that the system is operating at a loss. That began around the 4th quarter of 2008 when the S&P 500 operated at an overall loss. Adding additional liquidity into the sytem will increase the rate of loss, but not immediately. Hence, the economy will appear to improve for a time and there may temporarily be an incentive to hold and increase debt. Once that dissipates and the increased rate of loss begins to eat capital again, then we are back into deflation.

I'll try to go through more of your response later but this gets down to the fundamental reason why I think deflation will not be stopped according to Bernanke's theory. There are various other ways to say the same thing. In another response to someone I had noted that wages will be unable to support the temporary increase in real estate values that the Fed created by propping up the mortgage backed securities market. That amounts to the same thing in more specific words. The general trend toward more unemployment and lower wages is indicative of an economy that is operating at a loss.

Anybody else feel free to add comments, especially if they don't support this view.

Something else probably needs to be added here as the first response to this from one who keeps up with news would be, "What are you talking about, the S&P 500 companies are back to making big profits now." This is true, but it was done on the backs of the taxpayers with $2 trillion in new government debt which is papering over the losses that would otherwise be occurring. Also, about 1/3 of the so-called profits are in the financial industry.

[John]

Dear John,

> I'm willing to accept that, so long as we can accept the
> intermediate steps. Specifically, the fed will make a decision to
> stop open market operations (buying US debt) and let bond yields
> (and interest rates) grow to unheard-of numbers. This will
> obviously cause a stupendous credit market deflation along with
> government default. This is reasonable, although there will
> certainly be huge political pressure to keep buying the debt and
> hold down yields. Will the fed support the dollar or the
> government? Let's say they choose the dollar and stop buying debt.

> Okay then what? There is no longer 'legal tender' status for the
> dollar, but the credit bureaus and ratings agencies and huge
> amounts of commercial paper still exist with no 'de jure'
> enforcement. Is the 'de facto' enforcement strong enough to keep
> the dollar's status? This is a big question.

> I don't think you can conclusively answer 'yes' until treasury
> debt yields are no longer the lowest in the overall market. At
> that point, we can be fairly certain that you are proven right
> against the prevailing wisdom that fiat derives from the state,
> but I think it's still in question today. Also, if you are right,
> you may want to consider the possibility that the euro will also
> survive for the same reasons.

As I've said many times, Generational Dynamics tells you where you're
going, but doesn't tell you how you're going to get there. So I can
tell you with certainty that we're headed for a sharp deflationary
crash, but I can't tell you what the scenario, or the "intermediate
steps," will be.

So all we can do is speculate on what the intermediate steps might be,
subject to the understanding that a chaotic event somewhere in the
world could change everything except the final destination.

The Weimar Republic hyperinflation seems to dominate a lot of these
discussions, and so once again we have to look at why today's
situation bears no resemblance at all to the Weimar example.

In the Weimar example, Germany was required to pay annual reparations
to France and other countries. Those reparation amounts were
denominated in marks, and so they could be paid simply by printing
more marks, thus creating hyperinflation.

In today's world, I cannot imagine any scenario where the U.S. would
be required, for example, to pay China $100 billion per year to pay
off the debt we owe China. Perhaps if we were crushed in the Clash of
Civilizations world war, then something like that might happen in the
2020s, but nothing in the time frame we're discussing makes that
scenario even conceivable. If such a scenario WERE conceivable, then
the hyperinflation argument might have some validity. But in the
current circumstances, no such scenario is conceivable.

I believe that a lot of people get confused by the debt owed to China.
They think that we can't repeat what happenen in the 1930s because we
were a creditor nation then, and a debtor nation now. But the past
debt was/is irrelevant in both cases, since those debts were never /
will never be paid.

In the case of the US debt to China, the future is really very simple.
As long as China keeps lending us money, then we'll continue to repay
the debt; If China stops buying Treasuries, then we won't repay the
debt. Conversely, if we stop repaying the debt then China will stop
buying Treasuries. But the existence of the debt per se is irrelevant
in future speculations.

So I would say the following: If you want to speculate on what's
coming, then look to the lessons of the 1930s and apply those lessons
to what's happening today, but ignore the debt owed to China, since
it's irrelevant.

If you absolutely can't bring yourself to ignore the debt, then
compare what the US does today to what Germany did in the 1930s, and
compare what China does today to what the US did in the 1930s.

Remember that being a creditor nation in the 1930s did us absolutely
no good whatsoever. During a generational Crisis era, past
commitments are forgotten, and the only thing that matters is
survival.

John