Inflation, deflation, gold and currencies

[vincecate]

I remember John saying something like, "everyone seems to be predicting hyperinflation". I would just like to point out that if it were really true that everyone was predicting hyperinflation, then interest rates on 10 year bonds would not be 3.5%. When people are rushing to dump their bonds, then you can say everyone is predicting hyperinflation. But not yet.

http://www.fxstreet.com/rates-charts/bond-yield/

[richard5za]

if it were really true that everyone was predicting hyperinflation, then interest rates on 10 year bonds would not be 3.5%.

Vince,
Negative real interest rates are not uncommon in inflationery environments; even in medium high inflation situations, and are a given for hyperinflation. e.g. Both UK and South Africa for periods in the 70's and Zimbabawe during their inflationery period. I seem to recall that for part of the 70's USA had negative real interest rates but may be wrong. You have negative real interest rates now, I reckon, and the Fed doesn't seem to be in any hurry to fix that.
If you are sharp you can use this to make good real wealth in an inflationery environment e.g. by acquiring additional real estate.
As I said yesterday I would bet that the Fed is taking USA into inflation but aren't ever prepared to admit it. The alternative is perhaps that cartoon that John posted, but I suspect that they know exactly what they are doing. They are telling lies and acting dumb as a diversion to the truth.
Richard

[richard5za]

Is deflation a necesaary condition for generational theory?

Dear John,
In the past at generational crisis points of economic ruin deflation seems to have accompanied the crisis e.g. deflation during 1930's Great Depression. Is that coincidental? Or is it a necesaary condition?

Just thinking, you can have a devastating economic crisis on hyperinflation. I'll give it more thought.
Reagrds
Richard

[richard5za]

I invested in silver 2 years ago based on this re-monetization theory.

Excellent. Interesting lateral thinking. I wish I had thought of that.
Richard

[vincecate]

I invested in silver 2 years ago based on this re-monetization theory.

Excellent. Interesting lateral thinking. I wish I had thought of that.
Richard

Silver has yet to pass the nominal high from 31 years ago and they are printing paper money at least 100 times faster now than back then. If silver re-monetizes it has a long way to go yet.

[John]

Dear Vince,

> I remember John saying something like, "everyone seems to be
> predicting hyperinflation". I would just like to point out that if
> it were really true that everyone was predicting hyperinflation,
> then interest rates on 10 year bonds would not be 3.5%. When
> people are rushing to dump their bonds, then you can say everyone
> is predicting hyperinflation. But not yet.

That's not true. Lots of people are buying Treasuries now because
they're considered safe, and that keeps yields down. Investors
believe they can quickly sell if yields begin to increase.

> John wrote: Gold and other commodities would skyrocket, so under
> this hypothetical scenario, those commodities would be even more
> risky than the dollar.

> This logic is missing the point. If you believe we are on the path
> to that scenario, and that gold will skyrocket in that case, you
> should invest in gold, or silver, now.

No, you're missing the point. The hypothetical scenario I'm talking
about is that 10% inflation has already occurred, not that you and
others believe it's going to occur (which is not hypothetical at all).
If 10% inflation has already occurred, then the gold bubble would
increase even more, making it even more risky than it is now.

John

[John]

Dear Richard,

> You would flee the dollar into what is called "inflation hedges"
> as we did in the 70's with pounds and rands etc to protect the
> value of our money. That was a period of little economic growth
> and quite high inflation, which came to be called stagflation. ...

> Let me recount a real life story of myself. I am not blowing my
> trumpet; I was very well advised by some caring and knowledgeable
> people. I am not an American so some of this story may be
> culturally a bit different to your experience. I finished all my
> studies in 1968 and secured employment with a successful British
> multinational group. In 1971 the "big boss" said to me "Boy, do
> you own a house?" ...

Thanks for recounting your story, which is very interesting.

I'm having trouble dealing with this hypothetical scenario of 10%
inflation because it's so impossible today that it's hard to know how
to describe that world. It's like trying to describe a world in which
the earth's gravity were suddenly cut in half. Everything would have
to be different.

Since you and I are the old guys here, let me try to recount a story
of my own from the 1970s, and try to show why your 1970s inflation
hedging strategy wouldn't work today.

When I was working for Digital Equipment Corp. (may it rest in peace)
in the 1970s, there was a girl who has an entry level job as a
computer operator. After she'd been there a couple of years, she left
DEC and went to Data General (RIP) with a good salary increase. After
a few months, she left DG and went to Wang (RIP), with a good salary
increase. After a few more months, she left Wang and came back to
DEC. The net effect is that in the space of a year she had changed
jobs three times and almost doubled her salary at DEC.

There were lots of stories of that kind in the 1970s. It was well
known that anyone with good skills and willing to work hard could
change jobs and get a good salary increase.

You talk about stagflation in the 1970s, but I don't agree with that
characterization. There was plenty of inflation, and it's true that
the stock market fell during the 1970s (which I believe is why people
use the word 'stagnation'), but the economy was extremely vibrant in
the 1970s. Everyone knew that people who had bought IBM or DEC or
Xerox stocks had made out like bandits (to use a phrase I heard at the
time) -- not because speculators had created a stock market bubble,
but because these companies had scored some real technological
achievements.

In the 1970s, almost every company was still "young". Almost every
business had gone bankrupt in the 1930s, and the ones that didn't had
to totally restructure. By the 1970s, all of these businesses were at
their peak of robustness and productivity. New products and
technologies were coming out all the time. Skilled workers were in
high demand, and even unskilled workers had no trouble getting a job.
There were plenty of job openings, and not enough workers to fill
them. As a result, salaries increased -- based on merit, not based on
social skills -- resulting in inflation.

The other thing about the 1970s is that everyone was worried about
a new stock market crash. You could walk into a bookstore and find
several books on "How to survive the next Great Depression." Your
boss was actually quite prescient, since he correctly worried about
inflation rather than a crash.

Now today, all of those indicators are flipped on their heads. Each
job opening gets hundreds of applicants. If you change jobs, then
you have to take a salary cut. Jobs in the last decade have fled
overseas, seeking low salaries rather than high skills.

Today's businesses are no longer "young." This is something I haven't
written about lately, but I used to call it the "crusty old
bureaucracy" effect, using a phrase that I'd seen in a description of
some company. Lots of employees do little or nothing but sit around.
Salaries are increased based on longevity only, with little
relationship to skills. There's little innovation going on, with
something like the iPad providing a rare exception. Today we have
REAL stagnation.

In the 1970s, people worried about a new Great Depression, because
that's what they remembered from the 1930s. Today, people are worried
about a new Great Inflation, because that's what they remember from
the 1970s. A new Depression couldn't have occurred in the 1970s
because the wrong generational constellation was in place, and a new
Great Inflation can't occur today for the same reason.

Everything is in a bubble. Stocks have had historically high valuations
since 1995. Real estate has been in a bubble internationally since
1995, and has only partially recovered. Gold's trend value is about
$500/oz, but now it's in a bubble at three times its trend value.

So now returning to the hypothetical scenario of 10% inflation, where
you put money into other assets, you're talking about assets that are
already in a bubble, and by the time that 10% inflation is reached (as
if that's possible), the bubble would be much bigger. With huge
amounts of liquidity flowing into gold, for example, the price would
go from 3 times trend to 10 times trend.

And this is where you run into the logical contradiction. You said
investors would flee from dollars, I asked flee to where?, and you
mentioned these inflation hedges. But they're already in a bubble,
the bubble would be growing even larger, investors would realize that
these hedges are way overpriced, and many would stay in the "safe"
dollar rather than risk a bursting bubble.

Of course you can always invest in real estate or gold, knowing that
its price will eventually go up. But you could have invested in
stocks in 1929, and you would have made money by the mid-1950s.

So now, to close the circle, the businesses with a "crusty old
bureaucries" are going to be destroyed or forced to restructure, like
similar businesses in the 1930s. With layoffs increasing and salaries
decreasing, there's no chance of anything close to 10% inflation.
Investors will not flee the dollar.

> In the past at generational crisis points of economic ruin
> deflation seems to have accompanied the crisis e.g. deflation
> during 1930's Great Depression. Is that coincidental? Or is it a
> necesaary condition? Just thinking, you can have a devastating
> economic crisis on hyperinflation. I'll give it more thought.

The only way that I can imagine dollar hyperinflation would be
in a disaster of almost unimaginable proportions. It would mean
Higgenbotham's scenario of destruction of electronic records,
to undo the value of being the reserve currency, and then it
would require the US losing the war with enough destruction that,
out of desperation, whatever government is left would inflate
the currency by ACTUALLY printing money.

Other than that, no, you can't have a generational financial crisis
that leads to inflation. A generational crisis, at its core, is based
on widespread abuse of credit, creating a huge bubble. When the
bubble bursts, there must be deflation. It can't happen any other
way, as far as I know.

John

[richard5za]

It can't happen any other
way, as far as I know.

Dear John,
I feel you have got the generational thinking mostly right, but the money, and finance, and economics need a bit of fixing.
I have an unwelcome mild bronchitis at present so will be indoors this weekend and I will put together sets of data to make my points. I will use USA data only so that you can verify the data easily enough, and also personally relate. I will be going back to 1900 probably through to current date; lets see.
So until then.
May I wish you a very happy Easter weekend.
Richard

[vincecate]

Other than that, no, you can't have a generational financial crisis
that leads to inflation. A generational crisis, at its core, is based
on widespread abuse of credit, creating a huge bubble. When the
bubble bursts, there must be deflation. It can't happen any other
way, as far as I know.

If they had not taken everyone's gold in the 30s, the paper money would have failed as the Fed really only had 40% of the gold needed to back the Federal Reserve Notes, and people were taking out their gold. When paper money is failing you could theoretically get some abrupt bankruptcy, but the normal way is hyperinflation over some period of time. The previous US crisis before that was the Civil War, and they had hyperinflation. The US crisis before that was the Revolutionary War, which had hyperinflation.

So 2 of America's last 3 crisis included paper money failure, and the 3rd only avoided paper money failure by outlawing ownership of gold. Looks to me like part of an American generational crisis is failure of paper money.

[vincecate]

And this is where you run into the logical contradiction. You said investors would flee from dollars, I asked flee to where?, and you mentioned these inflation hedges. But they're already in a bubble, the bubble would be growing even larger, investors would realize that these hedges are way overpriced, and many would stay in the "safe" dollar rather than risk a bursting bubble.

The average joe is just buying extra canned food and dry food. These prices are not in a bubble. The more money that is printed the more expensive these things become. The price of cans of tuna really can go up 5% every month and never go back down at all. If they are printing 5% more money every month there is nothing safe about storing your wealth in paper money. There is no logical contradiction. It has happened many many times. Really.