Inflation, deflation, gold and currencies

[John]

So say what you want and believe what you want, but I'm going to
say the same thing again that I said to your new girlfriend Lily:
There isn't a snowflake's chance in hell that the (hyper)inflation
scenario is going to occur. It just cannot happen.

Well, to me it looks like things are unfolding about the way I
expected as far as inflation. The prices on the international
commodities are rather high. And in any case, the price on my
silver options ($50 strike 2013) went up 18% yesterday alone. So
if this is what being wrong is like, I can deal with it.

And what do you think is going to happen when the stock market crashes?
Or do you think it will stay up above Dow 12,000?

John

[Higgenbotham]

Vince, here's how I look at the issue when we strip away all the technical terms and bullshit and get down to the nitty gritty. First, let's forget about government bonds in this paragraph and look at how debt is issued in the real economy. This is a house and car economy. Those are the big purchases. As it stands, houses and cars are priced such that people need to go into debt to buy them. The debt was made available to anybody who could fog a mirror and therefore the increase in debt supported house and car prices. Bernanke's inflationary policies no longer support a long term debt market. The average person is therefore unable to buy a house at today's prices because they can't get a loan. Increasingly, the same thing goes for cars. One of three things has to happen - the amount of short term cash in the economy available to house and car purchasers has to increase many fold (and quickly) for them to be able to afford these purchases at current prices OR house and car prices will have to come down (and quickly) so people can afford to pay cash OR the economy will collapse. Since in my opinion anyway it's really too late for options 1 and 2, the economy will just collapse and that's what's happening. Home sales are at 1963 levels or something like that and vehicle miles traveled have been stagnant for 4 years. And that's with an increasing population.

As far as government bonds, Tustian is talking about the whole debt market with his 120 trillion figure. There are still a lot of long term mortgages and corporate debts floating around and more of that will need to be eliminated before there is hyperinflation. But Tustian doesn't mention a couple ways to bump up that process. One is the Fed can pull that bad debt onto their balance sheet and put cash into the economy as they've been doing and the other is there can be defaults, both of which eliminate the long term debts quickly.

[vincecate]

Well, to me it looks like things are unfolding about the way I expected as far as inflation. The prices on the international commodities are rather high. And in any case, the price on my silver options ($50 strike 2013) went up 18% yesterday alone. So if this is what being wrong is like, I can deal with it.

And what do you think is going to happen when the stock market crashes? Or do you think it will stay up above Dow 12,000?

I have puts on the S&P, so I will do very well if the stock market crashes. I am expecting it to do so after interest rates start hitting new highs. I am expecting interest rates to go up because inflation is going up and because they are just printing so much money.

[John]

Dear Vince,

> I have puts on the S&P, so I will do very well if the stock market
> crashes. I am expecting it to do so after interest rates start
> hitting new highs. I am expecting interest rates to go up because
> inflation is going up and because they are just printing so much
> money.

OK, so you collect on your puts, and you do fine. But the people on
the other side of that bet will have to sell other assets (including
silver) to pay up. And people who are long will see their assets
wiped out. Everyone will stop spending, and prices will crash.

And then what do you think will happen next after that? Do you think
Bernanke will go out in a helicopter and rain money?

John

[vincecate]

OK, so you collect on your puts, and you do fine. But the people on
the other side of that bet will have to sell other assets (including
silver) to pay up. And people who are long will see their assets
wiped out. Everyone will stop spending, and prices will crash.

And then what do you think will happen next after that? Do you think
Bernanke will go out in a helicopter and rain money?

In other countries that went into hyperinflation the stock prices collapsed. There are a number of ways to understand this. You could note that stocks compete with bonds and if bond prices collapse when interest rates shoot up, stocks will too. You could also note that in hyperinflation the core problem is the government is spending about twice what it gets in as taxes, so it is desperate to raise taxes. Since the E in the P/E is after tax earnings, stock prices go down. Also, governments usually try price controls, which will wipe out many companies. You don't want to invest in a country about to get hyperinflation. Think about the first month of 5% increase in prices. This sort of increases the value of real things by 5%, but the 80% yearly interest rate means you move to a P/E like 1. So if we have a P/E of 16 now, you drop by a factor of 16 and then go up by 5% (noise).

As long as the government is spending $2 for every $1 in taxes, Bernanke will have to keep making up the difference. It is not really possible to stop at this point. When people stop rolling over bonds, Bernanke will have to make up the difference for that as well. With so much short term debt, and such a large deficit, this could be $8 trillion in the next 12 months (see post a few back). This is more like a tsunami of money than a helicopter rain. It will hurt bad.

[vincecate]

Vince, here's how I look at the issue when we strip away all the technical terms and bullshit and get down to the nitty gritty. First, let's forget about government bonds in this paragraph and look at how debt is issued in the real economy. This is a house and car economy.

There are around 1 million cars sold per month. If we guess $25,000 each that would be $25 billion/month.

There are around 20,000 new homes sold per month. If we guess $200,000 that would be $4 billion/month.

The Fed is buying $100 billion in government debt each month, and the government is deficit spending about $100 billion per month.

This is a print and spend economy far more than house and car economy. A print and spend economy, historically, ends up with inflation or hyperinflation.


http://online.wsj.com/mdc/public/page/2 ... sales.html

http://www.marketwatch.com/story/sales- ... 2011-03-23

As far as government bonds, Tustian is talking about the whole debt market with his 120 trillion figure. There are still a lot of long term mortgages and corporate debts floating around and more of that will need to be eliminated before there is hyperinflation. But Tustian doesn't mention a couple ways to bump up that process. One is the Fed can pull that bad debt onto their balance sheet and put cash into the economy as they've been doing and the other is there can be defaults, both of which eliminate the long term debts quickly.

I don't see how long term mortgages or corporate debt figure into hyperinflation. Nothing I have read indicates that has anything to do with it. The problem is money creation to cover government obligations (deficit and government debt coming due). How do you figure other debt could delay hyperinflation? I can see how the Fed or government buying up private debt can make hyperinflation sooner, but how could private debt delay hyperinflation?

[vincecate]

OK, so you collect on your puts, and you do fine. But the people on
the other side of that bet will have to sell other assets (including
silver) to pay up.

Right. Part of the plan is to buy up more silver at really good prices after the market crashes. Then as it becomes more and more clear we are headed for hyperinflation the silver will go way up. At that point daddy gets to build his dream floating home.

[Higgenbotham]

There are around 1 million cars sold per month. If we guess $25,000 each that would be $25 billion/month.

There are around 20,000 new homes sold per month. If we guess $200,000 that would be $4 billion/month.

The Fed is buying $100 billion in government debt each month, and the government is deficit spending about $100 billion per month.

This is a print and spend economy far more than house and car economy. A print and spend economy, historically, ends up with inflation or hyperinflation.

http://online.wsj.com/mdc/public/page/2 ... sales.html

http://www.marketwatch.com/story/sales- ... 2011-03-23

At current prices, there is about $20 trillion worth of real estate in the US and about $10 trillion in mortgages. To sustain those values in an economy that is failing (and your numbers prove that sales figures are collapsing and the house and car economy is failing), the Fed must get cash into the hands of potential buyers "now". If the Fed is unable to do that (and so far they have not been able to) then sales will continue to collapse. There might be $2 billion in car sales and $2 billion in house sales or even zero. If potential buyers can't get loans, then they need $200,000 in cash (or whatever the median price is) in their hands "right now" from the Fed to sustain prices. The Fed can print trillions of dollars but if it doesn't get into the hands of actual purchasers then the economy will just collapse. And that's what is happening.

I don't see how long term mortgages or corporate debt figure into hyperinflation. Nothing I have read indicates that has anything to do with it. The problem is money creation to cover government obligations (deficit and government debt coming due). How do you figure other debt could delay hyperinflation? I can see how the Fed or government buying up private debt can make hyperinflation sooner, but how could private debt delay hyperinflation?

We have $10 trillion in mortgage backed securities and mortgages that are now like government bonds because the government has guaranteed them. Plus we know that the government stepped in and took over corporations and their debts and guaranteed those. That's long term debt. Most of the mortgage debt is marked to myth at present but the problem becomes what happens if the long end of the treasury curve skyrockets as it has done in the past 4 days because then the value of all this long term mortgage and corporate debt will collapse. The Fed will have to decide whether to take all the bad debt onto their balance sheet or to let some of it potentially default. Or maybe the Fed won't decide and somebody will decide for them. Even so, when we look at the steepness of the 30 year yield in the past week, if that were to accelerate and blow its cork, I'm not sure it would be humanly possible to move fast enough to salvage things. But I guess the main point is there is trillions in long term debt that the government has explicitly or implicitly guaranteed and it is being treated like long term treasuries or the market is assuming it is like long term treasuries. I don't know if Tustian actually says that but would assume that's what he must be thinking.

[John]

Dear Vince,

> As long as the government is spending $2 for every $1 in taxes,
> Bernanke will have to keep making up the difference. It is not
> really possible to stop at this point. When people stop rolling
> over bonds, Bernanke will have to make up the difference for that
> as well.

This is all fantasy. None of this is going to happen. A stock market
crash will cause huge domestic and international changes, many of
which can't be predicted. But some things that will happen are
massive unemployment, a sharp fall in world GDP, a sharp increase in
risk aversion, a sharp collapse in trade and transportation, a sharp
fall in commodities prices, unrest throughout the world, lots of
unrest in the Mideast, rebellions in China, etc. All of these things
are interlocked.

"It is not really possible to stop at this point." No, it won't be
possible to continue. There will be no choice but to stop.

I constantly hear the following on tv: "Blah blah blah has happened in
every recenssion since 1945 (and therefore it's going to happen now)."
Economists assume that their 1950-1990 macroeconomic models still
apply, and that's why economists have gotten nothing right for most of
the last decade. You can't assume that anything you learned in
economics 1.01 applies today. You have to look at what's happening in
the world as a whole, not just narrowly focus on Fed policy, because
everything is interlocked.

John

[vincecate]

As long as the government is spending $2 for every $1 in taxes, Bernanke will have to keep making up the difference. It is not really possible to stop at this point. When people stop rolling over bonds, Bernanke will have to make up the difference for that as well.

This is all fantasy. None of this is going to happen. [...]
No, it won't be possible to continue. There will be no choice but to stop.

Congress fought for weeks to cut 1/2% from the budget. That seems to be all they can manage for the next 6 months. They would need to make substantial reduction in the 40% deficit to get to where they did not need Bernanke to print money. How will they have "no choice but to stop" before hyperinflation destroys the currency? Why can't they print for one more month? And one more month? Etc.

After hyperinflation destroys the currency then governments fix their budgets. But when they get to this point of deficit 40% of spending and debt over 80% of GNP they never seem to stop till the currency is destroyed.

My guess is that after this tiny budget cut if congress raises the debt ceiling the market may give up on the dollar. We could see gold and silver going up and the dollar going down fast. There is no reason to think they can stop the spending.