1-Jul-10 News -- World economy in deflationary spiral

[Higgenbotham]

I'm finally beginning to understand economics both from reading the posts here and, most of all, from reading many of Martin Armstrong's writings. Are many of you here familiar with Mr. Armstrong? His economic analysis appears to work from a Generational Dynamics theory - even if he doesn't quite say so. His historical analysis and how it applies to our current situation is quite interesting. He see's a coming great, great depression, but as he mentions, it will be nothing like THE Great Depression. OLD, in the last piece I read written by him he does provide a comparison to the depression of 1929 and as he mentions, unemployment was not that bad until the dust bowl came upon us. I highly recommend you google his name and read his writings.

One of the really important contributions Martin Armstrong has made to today's debate is the idea that interest rates don't need to be set uniformly across a wide range of economies and that historically this was not done (I think he said at one time the 12 branches of the central bank set interest rates independently). Why should the interest rate in a booming city like Austin, TX be set the same as in a city in a state of collapse like Detroit, MI, especially when we have the means to do otherwise? With the advent of computers, it should be very easy to create currencies tailored to local economies and set interest rates in those economies accordingly. Furthermore, and I think Armstrong says this too, a balance of trade can probably be established around every economic zone. There's no reason I can think of that monetary policy needs to be set by a committee of senile old men (and a few women, at least one of whom is even nuttier than the men) in Washington. The Fed is a dinosaur.

PS Thanks for the reminder about Armstrong. I found a list of his latest writings here:
http://www.martinarmstrong.org/economic_projections.htm

His latest entitled "Can the Euro Survive..." hits some of the points we have made about whether an increase in the money supply is inflationary. That discussion is down on the bottom of the page he numbers 5 where he talks about money velocity and lack of a closed domestic economy as being two simple reasons that an increase in the money supply is not necessarily inflationary.

[vincecate]

As far as what Bernanke can do, he can print enough dollars to destroy the entire credit market and cause our trading partners to reject dollars and replace them with another currency. In the process of doing that, he can also turn the US into a basket case third world equivalent economy with no mortgage market, no bond market, no means for conducting international trade, etc. Once that process is complete then he can create Zimbabwe style inflation to his heart's content. But I don't think political realities will allow him to complete the mission he promised in the helicopter drop speech.

The hyperinflation comes while partners are switching to reject dollars and the US is having a harder and harder time paying for imports. It is not something that comes after that process is completed. It is the period where the value of the dollar is going down fast. Hyperinflation is when people report inflation rates for periods shorter than a year. If the Arabs and Chinese reject dollars the US prices will be going up so fast people will report inflation rates per month if not per week.

[vincecate]

My summation of this and prediction in a nutshell:

Had Bernanke been correct, the initial evidence of market anticipation of inflation should have been seen in the exchange rate of the dollar. It would be expected that higher prices of imports (especially with higher prices then moving into other areas) would lag that initial evidence and there would be some resulting inflation.

The dollar did fall somewhat through 2009 as Bernanke had indirectly predicted, then it reversed in late 2009 and is back up near 2 year highs. Commodity prices lagged a bit as would be expected and oil and copper prices, for example, hit their highs this year before reversing.

As the sovereign dominoes in Europe began to topple, the US was given some breathing room in the government debt market as there was a "flight to quality" on a relative basis. It's likely that honeymoon will soon be over and US government bond rates will begin to rise as the US becomes like any other nearly bankrupt sovereign and the dominoes continue to roll. That will nail the second half of the coffin shut as far as having any further immediately easy and painless ability to generate inflation and "growth" goes, as ability to service the debt becomes the issue and further borrowing is out of the question.

Compounding this problem will likely be a widening of credit spreads back out toward 2008 crisis levels, which will have the effect of choking the economy harder than ever under the pressure of the increased debt load. Corporate profits and the stock market will likely plummet to below Q4 2008 levels (in other words, the S&P 500 as a whole will be losing money again). Unemployment will likely soar, but this time there will be no means for the government to borrow 10% of GDP as a placeholder and GDP will drop like a stone.

The country will get into anything can happen mode as there will be utter panic.

A second iteration of QE in a panic environment like this seems doubtful. To think that Bernanke or his policies will have any currency at that point seems unlikely because they will be considered to have failed. What seems more likely is that the private sector will tell the public sector to get their act together and cut spending. Things may get violent. Bernanke may get thrown out. Incumbents will get voted out.

My best guess is that by the end of this year, you will not recognize the United States of America. A corollary to that is there won't be much time to be posting on this forum because survival will take precedence over other activities.

I also believe things are going to get really bad, and so agree with much of what you say. I think Bernanke has tried to stop his QE around Feb and that, along with the ECB breaking its rules, has helped the value of the dollar. However, I think that the US government needs to borrow more than the current $1.5 trillion per year as things get worse and that the Fed will print money and give it to the government which will spend it and get it into circulation. Even if Bernanke realizes it will be bad for the dollar and the Fed to keep printing money so fast, I don't think the government will let the Fed stop. I think it is more probable that the government would do whatever it takes to get money from the Fed, including replace people or changing laws governing the Fed, than that they would get the deficit under control as things got worse.

So the US situation looks like the standard case of a government that can not control its deficit, so people stop lending it money, so it prints money like crazy, so it gets hyperinflation.

[Higgenbotham]

As far as what Bernanke can do, he can print enough dollars to destroy the entire credit market and cause our trading partners to reject dollars and replace them with another currency. In the process of doing that, he can also turn the US into a basket case third world equivalent economy with no mortgage market, no bond market, no means for conducting international trade, etc. Once that process is complete then he can create Zimbabwe style inflation to his heart's content. But I don't think political realities will allow him to complete the mission he promised in the helicopter drop speech.

The hyperinflation comes while partners are switching to reject dollars and the US is having a harder and harder time paying for imports. It is not something that comes after that process is completed. It is the period where the value of the dollar is going down fast. Hyperinflation is when people report inflation rates for periods shorter than a year. If the Arabs and Chinese reject dollars the US prices will be going up so fast people will report inflation rates per month if not per week.

It's possible. I'd give the probability of it happening the way you state to be about 10%.

The world is already slowly rejecting dollars. Norway sold their US government bonds years ago. Russia increased the proportion of reserves in Euros maybe a couple years ago. And so on.

If that process were to accelerate to the point that it is able to overcome the deflationary forces before they play out, the result will be an instant and complete collapse of all systems worldwide. I don't define that as part of the 10% likelihood of hyperinflation because your gold will do you no good.

[vincecate]

I'll take a crack at it.

Sure, I can explain why I don't think Bernake can throw the world into inflation. It's actually simple enough, there is no mechanism in place to force dollars into circulation. If they don't circulate, they can't inflate. That's the wall he's run up against.

Now, in THEORY, Congress could change the laws to allow for simply sending every US head of household 3000$ twice a year. Essentially, to keep the boom going, that's what Bush did, on a smaller scale. Yes, that would throw us into inflation. Now, it is possible for Obama to pass such a thing? Answer is simple, of course not. Partisanship has reached a point that a divided government, even slightly divided, cannot act.

If deflation was a real problem, not just in housing, then Congress would get the will together to do something similar to what Bush did.

The government is the Gorilla/Elephant in the room that can put more than $1.5 trillion in new money into circulation each year. They can spend money like crazy. So getting money into circulation is not a hard problem at all.

Therefore, Bernake can create dollars most certainly, but they cannot cause inflation unless a mechanism can be put into place to force the money into circulation. The public wants savings not loans. And even if they did send out the cash, how much would just go into savings accounts and not circulate?

I think the hard problem is keeping it from circulating. Bernanke has to pay the banks interest on their "excess reserves" to get them to leave the money with him. It is the same as the government paying interest on bonds to get money out of circulation.

Going from deflation to inflation is a major change, and requires major changes to bring it about. Just printing dollars won't do it.

I am kind of amazed that people think dollars are different from everything else, where increasing the supply would lower the value.

Outside of housing and a government rigged CPI, what convinces you we are in deflation?

(PS: There are a number of instances in the past where inflation occured under the gold standard, even one where only pure gold was used.)

But this is like Spain taking all the gold from the New World and causing a modest inflation in Europe, right? Not like double digit inflation per year? With all this new money Spain, like the US, also became very dependent on imports.

[Guest]

The world is not rejecting dollars. Ten year Treasury yields are at historic lows.

[Higgenbotham]

The world is not rejecting dollars. Ten year Treasury yields are at historic lows.

You are correct.

My statement should have said something like a few countries here and there made decisions to reject dollars but overall the world is still fleeing into dollars.

The lower bond yield in the face of increasing supply of bonds is irrefutable evidence of that.

[vincecate]

It's possible. I'd give the probability of it happening the way you state to be about 10%.

The world is already slowly rejecting dollars. Norway sold their US government bonds years ago. Russia increased the proportion of reserves in Euros maybe a couple years ago. And so on.

If that process were to accelerate to the point that it is able to overcome the deflationary forces before they play out, the result will be an instant and complete collapse of all systems worldwide. I don't define that as part of the 10% likelihood of hyperinflation because your gold will do you no good.

I too think the world is slowly moving away from dollars. To me the hyperinflation and world moving away from the dollar will be the same thing. I think the collapse will be far worse for the US, which will then find it hard to buy oil or stuff from China, than for most other countries who never had the ability to print money that could buy international commodities.

To me the collapse is a fiat currency collapse, particularly the US dollar, but also others where the central bank reserves are in dollars. So after fiat currencies are collapsed, why would gold do me no good? If you mean food supply and guns are more important, I agree. But if you mean that gold and silver coins would be of no use at all, I am confused and ask why?

[vincecate]

The world is not rejecting dollars. Ten year Treasury yields are at historic lows.

"Rejecting dollars" is too strong for what we have so far. There is much talk and complaint about the dollar's exorbitant privilege, but only limited amounts of action so far. Some central banks have reduced dollar holdings, on average central banks went from selling gold to buying gold, and an oil producer or two that don't accept dollars as payment. But it might be enough to indicate the beginning of a trend.

[Higgenbotham]

So after fiat currencies are collapsed, why would gold do me no good? If you mean food supply and guns are more important, I agree. But if you mean that gold and silver coins would be of no use at all, I am confused and ask why?

It's because for some period under such a scenario, almost certainly for the rest of our lives, civilization will cease to exist. There will be no storage of anything, just day to day survival, and that implies barter at best.

The reason gold came into being as a form of exchange (I believe anyway) is farmers at some point were able to consistently store excess crops and that became a form of money. Then eventually farmers saw the logic of trading their excess storage for something that had better inherent qualities as money.

But under the scenario you are describing, a level of civilization which allows for some kind of widespread storage of excess is likely to cease to exist except maybe in isolated pockets here and there. Instead, the norm will be depopulation, breakdown, destruction, etc.

Example - Under such a scenario, you need a house. Plenty of empty houses, just pick one out. It's free!