Financial topics

[vincecate]

Can you imagine the Congress doing anything like this?

Nope, I can not see Congress really doing a 25% budget cut. I can see the Fed making more than $1 trillion in new money each year and giving it to the Treasury to spend. Do you see any problem with this? What do you see going wrong?

John, here is something to think about. The Fed already owns more US government debt than China or Japan and will probably have more than both combined within a year. Suppose at some future time the US government does default on their debt. Do you see how this weakens the Fed's balance sheet as all those dollars it paid out never come back? Do you see how that weakens the dollar? Perhaps it is easier to think about the ECB having trouble when Greece and Ireland default. See how it would weaken the Euro?

[Higgenbotham]

The Fed already owns more US government debt than China or Japan and will probably have more than both combined within a year. Suppose at some future time the US government does default on their debt. Do you see how this weakens the Fed's balance sheet as all those dollars it paid out never come back?

I hadn't thought of this, but that probably explains why the Fed is buying 5-10 years out. They don't want to risk owning 30 year bonds either. The Fed has professed to wanting to buy bonds to lower interest rates which would in turn lower mortgage rates. If their behavior were consistent with that reasoning, then they should be buying the 30 year bonds, not the 5-10 year notes.

On another note, my grocery store, believe it or not, is the best leading indicator of market trends that I know of. For the past 2 years, prices have been bouncing up and down quite a bit. The other day, 5 of 10 items were down in price. Yes, down. Some items were at the lowest prices they have been in 5 years while some were just down from higher prices.

[John]

Dear Vince,

> John, here is something to think about. The Fed already owns more
> US government debt than China or Japan and will probably have more
> than both combined within a year. Suppose at some future time the
> US government does default on their debt. Do you see how this
> weakens the Fed's balance sheet as all those dollars it paid out
> never come back? Do you see how that weakens the dollar? Perhaps
> it is easier to think about the ECB having trouble when Greece and
> Ireland default. See how it would weaken the Euro?

You're a huge, massive ball, a jumble of garbled concepts. If you
want to argue inflation, then you have to talk about the CPI. If you
want to argue a weak dollar, then you have to say why the dollar will
weaken and the euro won't, and not say that both will weaken.

You still don't have a single credible historical example to support
you. How about Germany and the UK during the 1930s? Both of them
were big debtor nations, but neither suffered mass inflation. There
are many other countries that suffered during the 1930s. Surely you
can find one that had high inflation, can't you?

John

[John]

Dear Higgie,

> On another note, my grocery store, believe it or not, is the best
> leading indicator of market trends that I know of. For the past 2
> years, prices have been bouncing up and down quite a bit. The
> other day, 5 of 10 items were down in price. Yes, down. Some items
> were at the lowest prices they have been in 5 years while some
> were just down from higher prices.

The news about Best Buy today is that they kept getting screwed
by lower prices of competitors and on the internet.

John

[vincecate]

You're a huge, massive ball, a jumble of garbled concepts. If you
want to argue inflation, then you have to talk about the CPI. If you
want to argue a weak dollar, then you have to say why the dollar will weaken and the euro won't, and not say that both will weaken.

It is very possible for both the dollar and the Euro to weaken compared to real things like commodities, gold, silver, oil, etc. You need to look at more than the relative strength between fiat currencies. The absolute strength really is what matters when they are all racing to the bottom. You need to be able to think of gold and silver as the two oldest currencies. That these two are never printed at high speed and so will not be racing to the bottom. If you can understand that central banks are weakening their balance sheets you can see inflation coming before it shows up in the CPI. Seeing further helps make good investment decisions.

Since many of the central banks back their fiat currencies with US dollars, if the dollar is racing to the bottom it will tend to bring down all the fiat currencies together. This is very obvious for currencies that are pegged to the dollar but even others that are supported by central bank reserves will go down as the dollar goes down.

Why would you think it is not possible for both the dollar and the Euro to go down at the same time?

You still don't have a single credible historical example to support
you. How about Germany and the UK during the 1930s? Both of them were big debtor nations, but neither suffered mass inflation. There are many other countries that suffered during the 1930s. Surely you can find one that had high inflation, can't you?

I asked you first. Do you know of a single time where a country with debts in their own paper currency, which they could print, defaulted on those debts?

If you look in this book, "Monetary Regimes and Inflation: History, Economic and Political Relationships" you can find many countries where the government debt got over 80% of GNP and deficits over 40% of spending and if they kept this for a few years then went to hyperinflation.

http://www.amazon.com/Monetary-Regimes- ... 213&sr=8-1

As you have pointed out, none of these were the world reserve currency, so they are not exactly like the US, so far. But they are credible historical examples that support my view. On the reserve currency point, we should be very afraid if it looks like the US is not going to keep being the world reserve currency. I think it is becoming more and more clear that dollar dominance is coming to an end. China and Russia just started trading their currencies. Many other similar things are going on.

John, right before QE2 you were sure that it would drive bond prices up. I said that for bond prices to go up yields have to go down, and that they were so close to zero that was unlikely. I said bonds are a bubble that will pop. For the record, QE2 has not driven up bond prices. Yields are going up fast. The problem with printing money to drive down interest rates is that it can easily work short term, or a little bit for a long time, but to do it in a massive way for a long time will inflate the currency, which will drive up interest rates. A trillion new dollars a year, going on the 3rd year, counts as massive and long term.

http://www.generationaldynamics.com/for ... t=20#p6986

As we go forward it will become increasingly clear that the real reason the Fed is buying government debt is to help the government handle its huge debt. This will eventually scare most of the bond buyers away. The Fed will become about the only buyer of government debt. The US is still firmly on the path toward hyperinflation.

[John]

Dear Vince,

> I asked you first. Do you know of a single time where a country
> with debts in their own paper currency, which they could print,
> defaulted on those debts?

Here's a list of major post-war sovereign defaults:

1981 * Pakistan Poland Rumania
1982 * Argentina Cuba Dominican Republic Ecuador
1983 * Brazil Chile Costa Rica Philipines Yugoslavia
1985 * Vietnam
1998 * Pakistan Russia Ukraine.
1999 * Ecuador. Indonesia. Pakistan.
2000 * Ivory Coast.
2001 * Argentina.
2003 * Paraguay Uruguay
2010 * Dubai

The Dubai example is very recent.

I believe that in almost all cases, the country had its own paper
currency, with default but no significant inflation. Having a paper
currency doesn't mean that you're free to inflate it at will. I
believe that in a number of these cases, the IMF imposed conditions on
the country that would forbid them from inflating away their debt.

Your whole theory is based on the assumption that a country will do
anything to avoid default. In fact, many countries will do anything,
including default, to avoid hyperinflation. Many countries will see
default as a "painless" way to get out of debt, but hyperinflation as
very painful, so they'll prefer to default. In my view, this is the
direction that U.S. policy is going. In my view, the US government
will increasingly find default acceptable, but will never find
hyperinflation acceptable.

OK, your turn. Give me a debtor country in the 1930s Great Depression
that successfully hyperinflated its currency to avoid default.

John

[vincecate]

Dear Vince,

> I asked you first. Do you know of a single time where a country
> with debts in their own paper currency, which they could print,
> defaulted on those debts?

Here's a list of major post-war sovereign defaults:

1981 * Pakistan Poland Rumania
1982 * Argentina Cuba Dominican Republic Ecuador
1983 * Brazil Chile Costa Rica Philipines Yugoslavia
1985 * Vietnam
1998 * Pakistan Russia Ukraine.
1999 * Ecuador. Indonesia. Pakistan.
2000 * Ivory Coast.
2001 * Argentina.
2003 * Paraguay Uruguay
2010 * Dubai

The Dubai example is very recent.

I believe that in almost all cases, the country had its own paper
currency, with default but no significant inflation.

I don't think that in a single one of those cases was the debt that was defaulted on in the local currency. These are not like the US case. I fully agree that a country that owes money to foreigners in a foreign currency has a high probability of default. Argentina defaulted on foreign debts in US dollars and still got hyperinflation in their local currency. Dubai also owed money in British pounds, US dollars, and German Deutchmarks.

I have checked into several of those and do not believe any of your examples are examples of what I am asking for. Can you show one of them where you are sure the debt that was defaulted on was in the local currency, which the country could print?

Your whole theory is based on the assumption that a country will do
anything to avoid default. In fact, many countries will do anything,
including default, to avoid hyperinflation. Many countries will see
default as a "painless" way to get out of debt, but hyperinflation as
very painful, so they'll prefer to default. In my view, this is the
direction that U.S. policy is going. In my view, the US government
will increasingly find default acceptable, but will never find
hyperinflation acceptable.

OK, your turn. Give me a debtor country in the 1930s Great Depression
that successfully hyperinflated its currency to avoid default.

No, no, no. My belief is that the generation in power in Japan, Europe, USA does not really understand hyperinflation. So they are working into it without ever realizing that is what they are doing. Congress does not get that having a deficit of 40% of spending is heading toward hyperinflation. The Fed does not get that printing a trillion dollars a year is headed toward hyperinflation. Holding interest rates so low that people stop buying bonds means more printing money, but they don't get that. Bernanke may really think that since he is doing it on a computer it will not cause hyperinflation (as you seem to). When it hits 99.9% of the people will think it just came out of nowhere. I think nobody chooses hyperinflation on purpose.

I gave you a book full of examples were high debt and deficit results in hyperinflation. My examples are all real. There was lots of hyperinflation after WW1 so the generation in power in the 30s understood hyperinflation much better than the generation in power today. Why do you request an example from the 1930s and not recognize the 30+ examples in the book?

In moving off the gold standard most countries really defaulted and got inflation in the 30s. Their notes said they owed gold, and they defaulted on that obligation. This is really like defaulting on a currency that you can not print. So it is not like the current situation. Getting both default and inflation is a possibility. But not my prediction for the US now.

Again, 99.9% of the people won't see hyperinflation coming. After it hits, defaulting would not help much. Defaulting would mean absolutely no more bond sales, except to the Fed. They still have to print for the 40% of the budget that is deficit and when things get bad people will be rushing to buy real things. The velocity of money will shoot up and you will get hyperinflation. When prices start going up the deficit that is now 40% of spending becomes much higher, as all the government union members get COLAS (cost of living increases). So the deficit/printing will shoot up, velocity of money will shoot up, the economy will fall apart (you can almost count on the government to put in price controls which will shut down all kinds of business). The only possibility to stop hyperinflation is to cut government spending in half, and that is no real possibility.

[Higgenbotham]

Bernanke may really think that since he is doing it on a computer it will not cause hyperinflation (as you seem to).

Paper dollars and electronic dollars are very different indeed. I can think of many scenarios where electronic dollars either get jammed or wiped out, either by natural or man made forces, and have mentioned that. Once a paper dollar is printed and in somebody's hands, it is quite safe from being destroyed. In no way is that true for an electronic dollar.

[vincecate]

Bernanke may really think that since he is doing it on a computer it will not cause hyperinflation (as you seem to).

Paper dollars and electronic dollars are very different indeed. I can think of many scenarios where electronic dollars either get jammed or wiped out, either by natural or man made forces, and have mentioned that. Once a paper dollar is printed and in somebody's hands, it is quite safe from being destroyed. In no way is that true for an electronic dollar.

Do you think we are safe from hyperinflation because they mostly keep track of money on computers and don't bother printing all of it?

Do you have a scenario for electronic base money to be destroyed or wiped out that is not the Fed selling an asset for electronic money? So I mean the "bank reserve accounts" on the computer at the Fed. The Fed makes money and buys assets and when it sells those assets it can take money out. Also, if it collects interest on an asset that interest payment could result in less base money (if they wanted, but today they "reinvest" the payments they get in more bonds). These two things (selling assets and collecting payments on assets) are the Fed's mythical "exit strategy" that we will never see. What other way would electronic money get jammed or wiped out by natural or man made forces? If anything, money in accounts in the Fed's computers that are backed up seems safer than a paper dollar that might be burned up somehow.

I am sure you know this, but for any other readers, I don't count "notional value of options" as "base money", nor is "present value of real estate" base money. Nor is the "new money" when a bank loans out a long term loan against a demand deposit. If a loan of this type is paid off then this type of "new money" does go away. But this is not "base money".

So my question is, is "base money" on a Fed computer any different than base money printed on paper? Since a bank could withdraw whatever is on its account at the Fed, and get physical paper money, I don't see how it could be different.

More on "base money" from wikipedia: "The monetary base is highly liquid money that consists of coins, paper money (both as bank vault cash and as currency circulating in the public), and commercial banks' reserves with the central bank."

http://en.wikipedia.org/wiki/Monetary_base

[John]

Dear Higgie,

> Paper dollars and electronic dollars are very different indeed. I
> can think of many scenarios where electronic dollars either get
> jammed or wiped out, either by natural or man made forces, and
> have mentioned that. Once a paper dollar is printed and in
> somebody's hands, it is quite safe from being destroyed. In no way
> is that true for an electronic dollar.

Actually, I'm flirting with a completely different concept.

For almost ten years now, the gold bugs have been predicting that low
interest rates would cause inflation or hyperinflation, but it never
happens, as the economic data always points to deflation.

In the old days, when money was always physical, if the government
"printed money," where would the money go? It could go into banks,
and then get into the hands of local businesses or local people.
There isn't much that they could do with this money except purchase
goods and services from other businesses. Hence the CPI went up at
inflationary or hyperinflationary rates.

But the rules are completely different today. When the government
"prints money," it's electronic and it can go anywhere. Whereas a
Weimar Republic banker couldn't do much with a stack of marks except
give it or loan it to another local business, a banker today can use
it to invest in anything around the world. Hence we see the
commodities bubble, the stock market bubble, and various other bubbles
(although, ironically, no new real estate bubble).

The concept that I'm flirting with is that under today's rules, it's
not only true that hyperinflation WON'T occur, it's also true that
hyperinflation CAN'T occur. The reason that it CAN'T occur under
today's rules is that the money will always flow (like water) to the
best investment opportunities in the world, and will not and cannot
contribute to the local wage and price increases related to
hyperinflation.

John