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Minyan Mailbag-Inflation

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Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.

Dear Todd,

I read with interest the missive from Minyan Mish regarding inflation and his argument against Jim Puplava. However I would like to add a little take that I think you Americans miss: if you look at how major inflations developed in history you find some common characteristics: existence of a fiat currency (or drastic change in the availability of gold and silver, like in the late 16th century, which is the same) and the necessity of the government to accommodate something or somebody. This necessity has usually been a foreign or even civil war but not exclusively. Inflations in Latin America took place because the
governments exhausted their resources and still they had to pay the government employees. Think how inflation developed in Europe in the late 60s/70s (Italy being the best example, but England following) and think about a couple of curious countries named South Africa and Israel in more recent times.

Inflation remains sedate until productivity grows and...until productivity can grow. If real wages go down and this is compensated by asset inflation people remain happy...for a while; this is the honeymoon with the printing presses. Then when asset inflation moderates the majority of people start feeling the heat...wealth goes down. At the very beginning they can cut on expenses like DVDs, new cars or fancy clothes (where productivity has been growing), but it is much harder to cut on food, gas, education where productivity has not been growing that much. The guys start to get upset and they demand: they demand more income, they demand a better life, they demand income re-distribution, all the things that you can imagine from angry people. And since politicians are politicians these demands do not fall on deaf ears. Unions become more popular, the government raises the salaries of public employees, your employees go on strike and you cannot fire them, you grant them a salary increase (and the government tries to help by lowering the corporate taxes, devaluing the currency, etc...), and in the end productivity RECEDES. And China can not help, since a Chinese made toy at that point will be prevented to enter the U.S. by law or by outrageous tariffs. At that point a firm cannot lower the prices any more but demand continues to be sustained...and inflation runs. As you can see it is, again, an accommodation.

Now the famed argument that Japan had deflation notwithstanding the giant amount of money printed by the BoJ in the 90s; guys, come on, Japanese were
the biggest savers of the world (they saved 9% of their income and they had their nice asset inflation, after the stock market and the real estate, via the best performing bond market of the world) and they never got angry or hungry. You can print what amount of money you like until people do not need it. If the Japanese government really cared to avoid deflation in Japan they had to simply double the salary of government employees: in that way you create inflation in a second and a half. The point is that they wanted to create inflation while increasing productivity, quite a conflicting goal. In the end they chose to increase productivity, or better, international competitivity.

South Africa is a clear example of accommodation. The mining industry had to grant incredible salary increases, well in excess of productivity, to the workers (because of social and historical reasons). Inflation arose, the rand depreciated, the mining industry grew not competitive but protected by the depreciating currency until the government cheated and they tightened monetary policy. The current result is the majority of the mining industry in South Africa at the risk of existence.

America has huge resources and has always been the land of opportunity but the same held true for Argentina before Peron. Then the richest country in the world was destroyed in a decade by a socially irresponsible accommodative policy. The accommodative policy of the FED is doing exactly the same: difference in America is that you are still in the honeymoon of the asset inflation.

Minyan Valerio Lucchinetti from Italy

R.P.

No positions in stocks mentioned.

Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at todd@minyanville.com.

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