Financial topics

[stevendeklerck]

Dear John,

A quote from a book on Austrian Economics:

The third type of deflation we will consider results from the tightening of credit which normally occurs in the crisis and recession stage that follows all credit expansion. Just as credit expansion increases the quantity of money in circulation, the massive repayment of loans and the loss of value on the assets side of banks' balance sheets, both caused by the crisis, trigger an inevitable, cumulative process of credit tightening which reduces the quantity of money in circulation and thsu generates deflation. This third type of deflation arises when, as the crisis is emerging, not only does credit expansion stop increasing, but there is actually a credit squeeze and thus, deflation, or a drop in the money supply, or quantity of money in circulation.

Sounds familiar?!

Best regards,

Steven
Belgium

[John]

Dear Steven,

> I also read the article by Ambrose Evans-Pritchard.

> The most important sentence to me was the following:

> I’m afraid this is going to have a very deflationary effect on
> the economy of Western Europe. It is almost guaranteed that
> euroland money supply is about to implode.

> If the money supply is about to implode, doesn't that imply that
> the euro in real terms will become more valuable?

That sentence leapt out at me as well, so I included it in the
excerpt but didn't comment on it.

However, the real question is whether the euro will survive at all.
The present crisis is creating enormous strains by widening the
differences between individual countries, which is likely to force
some countries to return to their national currencies. Where this
leaves the euro currency remains to be seen.

> The Austrian School doesn't rule out a deflationary spiral.

> People like Peter Schiff are a little bit obsessed by
> hyperinflation.

> A quote from a book on Austrian Economics:

> >The third type of deflation we will consider results from the
> >tightening of credit which normally occurs in the crisis and
> >recession stage that follows all credit expansion. Just as
> >credit expansion increases the quantity of money in
> >circulation, the massive repayment of loans and the loss of
> >value on the assets side of banks' balance sheets, both caused
> >by the crisis, trigger an inevitable, cumulative process of
> >credit tightening which reduces the quantity of money in
> >circulation and thsu generates deflation. This third type of
> >deflation arises when, as the crisis is emerging, not only
> >does credit expansion stop increasing, but there is actually a
> >credit squeeze and thus, deflation, or a drop in the money
> >supply, or quantity of money in circulation.

> Sounds familiar?!

Very good!

And yet, whenever anyone writes to me about the Austrian school, it's
always in the context of a statement like "the dollar has been a fiat
currency since 1972 and will soon become worthless."

Sincerely,

John

[mosullivan]

> >The third type of deflation we will consider results from the
> >tightening of credit which normally occurs in the crisis and
> >recession stage that follows all credit expansion. Just as
> >credit expansion increases the quantity of money in
> >circulation, the massive repayment of loans and the loss of
> >value on the assets side of banks' balance sheets, both caused
> >by the crisis, trigger an inevitable, cumulative process of
> >credit tightening which reduces the quantity of money in
> >circulation and thsu generates deflation. This third type of
> >deflation arises when, as the crisis is emerging, not only
> >does credit expansion stop increasing, but there is actually a
> >credit squeeze and thus, deflation, or a drop in the money
> >supply, or quantity of money in circulation."

This (DEFLATION) makes perfect sense and is really simple to follow. Most inflationists or even hyperinflationists argue that the Fed's expansion of their balance sheet via backstopping Fannie, Freddie, AIG, etc and current bouts to liquidate the system, future obligations in SSI w boombers, coming fiscal stimulus package, increased pressures cominhg upon FDIC will cause a net increase in money supply and thus weaker dollar, higher gold.

I can see an argument for both cases. On the one hand the Fed is acting to stimulate an force banks to borrow. Yet I know of no one who is buying a new home, looking for a bigger car and who isn't cutting back on spending. Also, who can argue the absolute swiftness of this market decline and USD rise?

So, is the argument simply that the deflationists don't see the velocity of money getting going (hence, just sitting there "clogged") and inflationists believe otherwise as was the case in 02-03? I aologize if this was covered before but I am trying to grasp this as it clears up a lot of things.

Thanks, Mike

[Gordo]

I haven't had time to keep up with all the posts, I'll try to read them all this week. But I just noticed on the main "web log" you said "A forum member claimed that there would be no stock market crash because Fed Chairman Ben Bernanke would do whatever is necessary to prevent it. He quoted from a 2002 Ben Bernanke speech to prove his point..." I assume this refers to my comments, however I DID NOT say Bernanke's actions would prevent a stock market crash - I don't know where you got that from. I've been warning people about bubbles for years, I specifically said even though I expect a big countertrend rally (which would match the pattern of the '29-'32 era) that does NOT mean its safe to buy stocks, in fact I said it was the market's mechanism to destroy wealth (maximum ruin).

As far as the Bernanke quote - you STILL don't seem to get it. What he said he would do, is exactly what he is going to do, probably within the same timeframe that it happened during the Great Depression, or perhaps 1-2 years earlier since he is anticipating having to do it. Understanding what is going to happen is key to making a LOT of money though this debacle.

Dear Gordo,

> Just to recap what Bernanke said in 2002, because I think its
> important, and John has basically dismissed it:

> > "Although a policy of intervening to affect the exchange
> > value of the dollar is nowhere on the horizon today, it's
> > worth noting that there have been times when exchange rate
> > policy has been an effective weapon against deflation. A
> > striking example from U.S. history is Franklin Roosevelt's 40
> > percent devaluation of the dollar against gold in 1933-34,
> > enforced by a program of gold purchases and domestic money
> > creation. The devaluation and the rapid increase in money
> > supply it permitted ended the U.S. deflation remarkably
> > quickly. Indeed, consumer price inflation in the United
> > States, year on year, went from -10.3 percent in 1932 to -5.1
> > percent in 1933 to 3.4 percent in 1934.17 The economy grew
> > strongly, and by the way, 1934 was one of the best years of
> > the century for the stock market. If nothing else, the
> > episode illustrates that monetary actions can have powerful
> > effects on the economy, even when the nominal interest rate is
> > at or near zero, as was the case at the time of Roosevelt's
> > devaluation."
> > http://www.federalreserve.gov/BOARDDOCS ... lt.htm#f19

> If the "new depression" scenario really does in fact play out as
> most here expect, the above is exactly the policy response you
> should expect. Exactly how it will look, I don't know, but it
> will have its intended affect of forced inflation.

I'm sorry, Gordo, but you really have to wonder how Bernanke managed
to get through Economics 1.01, let alone become head of the Princeton
economics department.

He talks about inflationary measures that were taken in 1933-34.
Well, that was 4-5 years after the deflationary spiral had begun. By
that time, the deflationary spiral had run its course, and reflation
would have begun no matter what FDR had done.

By contrast, Bernanke has opened the liquidity floodgates right at
the beginning of the deflationary spiral, and it's done almost nothing
to stop the deflationary spiral today. Perhaps, if he's lucky,
President Obama can find a way to take credit for reflating the
currency when its time comes, around 2012-13.

Ben Bernanke is considered the world's leading expert on the Great
Depression, on economics and macroeconomics, but his understanding of
all of these subjects is so embarrassingly shallow, it's incredible.
He simply doesn't know what he's talking about.

The reason that I've dismissed what Bernanke has been doing is
because it's total, utter nonsense. I would think that, by this
time, you could see that as well as I can.

Let Bernanke try anything he wants. It will accomplish nothing.

Sincerely,

John

[John]

Here's an amusing take on the current capitulation fantasies:

> Market Outlook
> Markets Lack True Fear

> Joseph Hargett and Joe Sunderman, Option Advisor 10.27.08, 1:35 PM
> ET

> The Dow Jones Industrial Average finished another horrific week
> of trading, and is well on its way to logging its most infamous
> October showing ever. Currently, the Dow is off more than 22% for
> the month, vs. the roughly 23% declines logged in October 1987 and
> 1929. For the week, the DJIA lost 5.4%, the S&P 500 Index (SPX)
> shed 6.8%, and the tech-laden Nasdaq Composite (COMP) plummeted
> 9.3%.

> Despite the selling, is there really the kind of elevated fear
> among traders and investors that is necessary for a bottom in a
> market like this? I have my doubts.

> On Friday, we saw a television commentator talk about her
> grandfather purchasing stocks in 1932 and 1987, something she said
> she keeps in mind during this period. We also saw a slew of
> headlines last week declaring that the situation could be worse,
> or that it isn't as bad as expected. All the while, we watched the
> market plunge significantly lower. Clearly, this is not the type
> of panic that you'd expect, nor the fear that we'd much rather be
> seeing at this point. Moreover, think of how many advisers have
> reminded you that the U.S. has been in a weak position before and
> has come out of these scenarios just fine, or how many times have
> you heard, "Why sell now?"

> Meanwhile, we are also seeing a fair amount of hope among
> traders, which could be preventing the panic necessary to force a
> market bottom. Put another way, how many commentators and
> strategists are advising you to buy portfolio insurance or sell
> stocks immediately? How many would you expect to hear urging this
> caution with the SPX down 40% in the past year? Keep in mind that
> during the 1929-1932 bear market, stocks fell 89%, a fact that the
> objective investor would do well to consider when debating the
> "Why sell now?" question.

> The most recent poll by the American Association of Individual
> Investors may better quantify the point I'm making. In last
> week's survey, 38% of those surveyed were bullish and another 38%
> were bearish. Putting this in perspective, the reading was 54%
> bearish and 27% bullish in mid-September when the SPX was trading
> 25% above its current levels. In mid-July, 58% were bearish and
> 25% were bullish. I find it mind-boggling that the recent downturn
> has not generated a level of fear among retail investors greater
> than the levels seen in prior months.

> http://www.forbes.com/finance/2008/10/2 ... k_inl.html

In other words, the farther the market falls, the more "bullish" and
hopeful everyone gets. I've noticed this myself, as pundits seem to
get more and more Pollyannish and excited every day that the market
falls.

The market was almost flat at 3:50 pm today, but in the last ten
minutes, the bottom fell out, and the market lost 200 points (2.5%).

Isn't that wonderful news? I have no idea. I'll have to wait and
see what the capitulation experts have to say.

Sincerely,

John

[John]

Dear Gordo,

> As far as the Bernanke quote - you STILL don't seem to get it.
> What he said he would do, is exactly what he is going to do,
> probably within the same timeframe that it happened during the
> Great Depression, or perhaps 1-2 years earlier since he is
> anticipating having to do it. Understanding what is going to
> happen is key to making a LOT of money though this debacle.

OK, let me try to summarize.

You're saying Bernanke is doing what he said he would do. I agree.
That's why I wrote all those articles with titles like, "Bernanke's
Historic Experiment Takes Center Stage."

You're saying that the only reason to mention that is so that you can
make money from it.

That's fine, but I also believe it's important for people to
understand that Bernanke's plan is going to fail. I would not want
someone reading this to think that my silence on this question means
that I think it might work.

So I'm not disagreeing with you. Go ahead and make money. But I'm
just making the point that I have to make as well.

Sincerely,

John

[John]

So, is the argument simply that the deflationists don't see the
velocity of money getting going (hence, just sitting there
"clogged") and inflationists believe otherwise as was the case in
02-03? I aologize if this was covered before but I am trying to
grasp this as it clears up a lot of things.

The velocity refers to the number of times a dollar bill gets
used/spent over time. If a dollar bill sits in your drawer at home,
then it contributes nothing to spending in the economy. If you spend
it, but then the person who receives it keeps it in a drawer, then
it's contributed $1.00 to spending. If the dollar bill keeps getting
used over and over again to buy new things, as it goes from one
person to the next, then one dollar bill can contribute many dollars
to spending. The number of times it's used is the velocity of money.

Economists like to tell you that inflation is caused by the amount of
money in circulation multiplied by the velocity of money. So if the
velocity of money goes down, then inflation goes down, and turns to
deflation.

I believe that the velocity of money was very high in the 1970s, and
has become very low in the 2000s, even during the credit bubble.

However, I haven't been using velocity of money in my discussions of
the deflationary spiral.

** What's coming next: Understanding the deflationary spiral
** http://www.generationaldynamics.com/cgi ... 27#e081027

What I'm saying is that the actual amount of money available is
decreasing by $1 trillion or more per week, thanks to the leaking of
the credit bubble, and that this factor is causing the deflationary
spiral. Any decrease in the velocity of money would only add to the
deflation.

Sincerely,

John

[9_eU4oMpoNP]

This article describes P/E 10 quite well:

http://www.marketwatch.com/news/story/v ... atrick.net

[John]

From a web site reader:

> I have a retirement account, which is in a S&P 500 Index fund.

> The value is minimal at around $25K.

> Would you recommend switching the fund to their Treasury Money
> Market Fund / Government Money Market Fund, or fully liquidating
> the fund into cash (paying tax penalities, since my age is mid
> 40's).

> If there is a Treasury default, it seems the account would be
> worthless even in the Money Market account.

Unless it's indicated by further disastrous events, I'm not seeing a
Treasury default as likely for the foreseeable future.

On the other hand, you're certain to lose a great deal of money in an
S&P 500 Index fund.

Whether you transfer your funds to Treasuries or cash depends a lot
on personal situation, and your need for as much safety as possible.

Sincerely,

John

[John]

From a web site reader:

> I just noticed something interesting.

> As you pointed out, US and Japan's early 20th Century financial
> crises, 1919 and 1929, were offset by a decade. The more recent
> financial crises are offset by an even larger time length, 1990
> and 2008.

> And then looking back into the 19th C, it would appear that
> candidates for Japan's economic crisis date would be limited to
> 1837 when there was a one day rebellion by peasants which freaked
> out the leadership so much, or possibly Commodore Perry's first
> visit of his Black Ships in 1852, whereas the US financial crisis
> was 1857.

> Why does the time length vary? Why did Japan's 1919 financial
> crisis come so much earlier than their launching war? Was their
> crisis era prolonged by something?

I'm not familiar enough with details of Japan's history to address
these questions specifically, so I'll just give more general, more
theoretical answers.

The financial crisis timeline and the crisis war timeline are
independent of each other, although they tend to reinforce each
other. Furthermore, a crisis war is highly regional, while a
generational financial crisis almost always involved entire
continents. However, Japan and China have been relatively isolated
in the past, so their generational financial crises have tended to be
independent of the rest of the world.

Because of this global/regional mismatch, it's not necessarily the
case that financial crisis eras coincide with war crisis eras (fourth
turnings). For example, the 1930s were a Great Depression for
Mexico, but it was in an Awakening era.

I have no idea why Japan's financial crisis occurred in 1918, well
before WW II, but the reasons you gave may well be right. This could
be determined with a detailed study of Japan's history in the 1800s.

I believe that there are some specific factors that can delay a
crisis war: a country with money, a country that's not densely
populated. I don't think it's a coincidence that the three major
current examples of countries with long-delayed crisis wars --
Mexico, Saudi Arabia and Russia -- are all countries that received
plenty of money from oil.

I'm far less certain that there are factors that can delay a
financial crisis. A crisis war can be delayed if there's no suitable
belligerent partner to fight the war with, but a generational
financial crisis does not require a partner. It only requires credit
bubble, and the model that I have in mind says that a bubble will be
created by any population, as soon as the survivors of the previous
financial crisis are gone.

So why did the Japanese-Western financial crisis period separations
lengthen (1929-1919 = 10, 2008-1990 = 18)?

One possibility is that the separations didn't lengthen at all. The
Western crisis could be said to have begun in 2000, with the bursting
of the Nasdaq bubble, so it was still a 10 year difference. In this
theory, the financial crisis was extended by the credit bubble that
began in 2003.

I actually don't believe that theory, since it raises a number of
theoretical problems in generational theory. However, it's really
hard to get a clear answer, since we have so few examples to look at,
while I've been able to look at dozens (perhaps hundreds) of crisis
war examples.

Sincerely,

John