Mr Practical:

You and I could have so many late night talks on the economy! You prespective is fantastic (i hate that word).

Completely agree with your assesment.

I guess the bottom line questions is: Will the powers that be recognize that risk, and reverse in a TIMELY manner to avoid a debasement?

Elias,

In my opinion, they already recognize the risk of dollar debasement and have always assumed that debasement was the only way out of the long term problems the US has with unfunded future entitlement payments.

The reason Gold is so strong and the dollar so weak over the past few days is because the rest of the world is beginining to realize this as well. The $12-$15 Trillon US Gvt deficit won't look so bad after a decade of 20% annual inflation.

Mr. Practical,

I guess we will try the other side of Mises' statement this time around:

Ludwig von Mises
“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

Instead of learning the right lesson from the great depression (don't expand credit recklessly) we have decided that not enough was done to fight it after the bubble burst. So whereas in the past we allowed private debt to be mostly destroyed "voluntary abandonment of further credit expansion" we are going for "total catastrophe of the currency system involved".

It looks like only hard assets (real estate, commodities) will have any value left. Even in that case government can make life miserable via taxation and possibly even confiscation.

This is looking like a hurricane. The front end, deflation, batters everyone who is overly leveraged. The back end, inflation, then wipes out the prudent who survived deflation. Survival will only be possible by switching from the deflationary to the inflationary side with the right timing and then having the strength to ride out the storm.

This is too much for an average person. In fact, it is too much for a financial expert. Panic......

It seems that most of the comments from the professors here, contributors, and else where in the media, mass and otherwise, seem to either predict a massive deflationary spiral (which we know the govt will do all it can to avoid) or some hyperinflation scenario.

I understand the fundamentals of both, but I dont hear anywhere of a middle ground.

Bushwhacked by Bushenomics

Pointing fingers!

Let's look at some reality. Banks lent money on homes that were priced double of what they should have been by historical averages. Home owners who put twenty percent down were in actuality putting down 40% of what the home was really worth. Mortgage fees were double what they should have been since they were priced by percentage and if the home owner was paying 6% interest on a house price twice what it should have been then in reality they were paying 12%. Top ends of all contracts generally go towards mostly interest. In six to eight years if a home owner could hold out that long then banks would have half the value of this over priced house paid for in interest, a down payment, mortgage fees and such. When the bank does foreclose they have a home worth 50% less but they have lost nothing it's the homeowner who loses everything. But many banks are foreclosing on homes after the market dropped 20% to repeat this process with new suckers who think getting a home discounted 20% is a bargain fleecing the next buyer who even with 20% down will soon be underwater again as prices continue to fall towards affordability.

Now we have the Feds out their pumping trillions into the banks fearing a collapse in our financial system, in effect rewarding them for fleecing America while they pack the cash out the back door with their huge salaries and bonus plans and stock options. Using this scheme they were able to also raise their share prices to ridiculous prices so as to fleece Americans again.

Who do we point our finger at? The banks? Wall Street? The Feds? Regulators? Our Government?

Bush pulled his head out of a cranial rectal inversion pose just long enough to tell the world with a sheit eaten grin that our economic situation was fine. Now we know he was full of it. Can anyone tell me again why we voted for this piece of ah never mind. Let's work on how we can fix it. One thing for sure it is not by pumping up the bonus plans for Wall Street and our banking system.

This problem would be easier to fix if we recognize it for the fraud it is and force transparency from all the banks. Legal action and clawbacks. After all if these folks are so calloused as to stomp on the American dream of owning a home knowing they will make homeless millions of families then they deserve nothing more then a cardboard box under a freeway overpass after they get out of prison.

You good Americans have a nice day. The rest better start ironing their prison garb so you will look good on initiation day.


JPM

Just another one of those "great" Republican last-minute money-grabs, except on a massive scale in tune with their "desperation" rhetoric. While not on quite the grand scale, I vividly recall the same money-grab at the end of Republican George Bush Sr's econominstrative failures in the recession of 1991. There is a pattern developing here... Could it be such that supply-side economics always result in abject failure, and then last-ditch desperation moves to bleed (steal) money in a perverse attempt to continue feeding the frenzied corporate machines? Tell me in 2 years it is not so.

You all need to re-read this guys post. -Your summation is well said and I agree totally.

The Professors in Minyanville should give us their insight and plan of action for survival ..."will only be possible by switching from the deflationary to the inflationary side with the right timing and then having the strength to ride out the storm."

What are the signals for timing the switch, and what are the preferred investment vehicles??

I suppose I should go back and read some Ludwig!

Well those people care less about facts than they do about power. The folks who voted for them cling to hope that the disappearing wealth will be spread on them before it is all gone - or at least that everybody will be brought down to their level.

Liberals openly desire that the USA be made to be more like Europe, clearly acknowledging that bringing Socialized Europe up to US levels is hopeless.

At the bottom line, misery loves company and the powers that be love power.

Capitalism obviates the need for political power and eliminates economic misery --- too bad it is no longer in vogue.

I appreciate your open mind. Could you explain what the middle ground would look like and how would it be accomplished?

As an intellectual exercise, we confront the devils of deflation and hyperinflation. As we observe reality, I suspect what we will observe is.. both at the same time, in different places and sectors. Seeing either monetary outcome will be harder than you would think.

Hope you don't mind if I opine but, I believe the middle ground could be a mixture of both -just like Farooq mentioned in an above post (and I tried to highlight):

-at first we see deflation accompanied (or caused) by credit contraction and deleveraging;

-later we see hyperinflation as the government tries to rescue the system and pour money into everyones pockets, while debasing the currency.

Currently, credit contraction is proving to be deflationary, no one is borrowing, and no one is lending. The government is trying to get those wheels moving but everyone is trying to deleverage so they are rejecting the credit.

Eventually the government will instead inject it's credit into the economy in "knew innovative" means, or by simply writing us all checks. -this is when hyperinflation kicks in.

...my two cents

I may be wrong on the tribute and the wording, but I think it was Professor Pepe Depew who coined the term for the middle ground... hyperdestagflationaryism. This is all too easy... long nursing homes, pharma and funeral parlors; short municipal & corporate bonds, Tech, Financials and commercial real estate. Why pay brokerage commissions!?

Great article.

It is clear the government is trying to reflate the economy.
The question in my mind is whether monetization will work now to reverse the slide, and how long it will take to work.
We have already had a credit bubble, and it is burst. For right now I don't see people spending the money, so I could guess that asset prices would continue to fall. I all depends on whether people will continue to get out of debt, or feel comfortable enough to start spending and investing (in assets other than treasuries) again.
Only when growth returns, and people feel confident, could I see inflation (and lots of it returning). It actually has to happen, given the levels of debt and promised benefits.

You may have seen what happened in Japan.
I would be interested in a comparison discussion, as our government is much more aggressive, but in both cases people stopped spending and investing. Maybe Obama can get them to spend?
My guess is they will save most of a stimulus.

I did see several analyses on bubbles, where historically the asset returns to 90% of its pre-bubble levels when all is said and done. If you do this with credit, you could take the SP500 chart (in log scale) and extrapolate a straight line (representing a non-credit fueled growth level) from 1980, and plot that line to present day. This would indicate we have further to go, if people change their habits and reject excess credit.

Just my opinion

i don't believe so. eventually they will debase the currency entirely leading to a hyperinflationary event. let's hope i am wrong.

there are three main differences between the u.s situation and japan's of the 90s. first, japan's savings pool is very large where the u.s. savings pool is nearly zero. this is a very big plus for japan. second, u.s. is/was the world's currency. this gives the u.s. much more flexibility in dealing with deflation at first. but that advantage is going away fast: because we don't have a savings pool we have to continually borrow to reflate. that is wearing very thin. lastly, it was japan's corporate balance sheets that were so bad; in the u.s it is the consumer. which is worse i do not know, but overall leverage in the u.s. is way higher than ever was in japan.

Yep.

from its peak of 88 versus a basket of other fiat currencies. Imagine the horror of it trading were it did six months ago.

If Japan since the early 1990's is the rough model for current US economic situation, doesn't it appear that we'll have a long wait for the postulated hyper-inflationary cycle to assert itself? Japan has been in a deflationary recession for almost 20 years now...

Just shooting a question (somewhat hypothetical at the moment)

If one KNOWS 100% that we were to jump to hyperinflation in one month-- wouldn't it be wise then to increase your personal/business debt?

It stands to reason that if you new that hyperinflation was coming tomorrow, you should borrow as much as you can today. If you borrow $100 today at 5% and tomorrow rates go up to 15% due to hyperinflation, the value of that loan drops dramatically.

That's why I don't understand the tenet of this article. If you expect the dollar to drop, you will never experience deflation, you will immediately be faced with inflation. The author says so himself with his example of the rise in the price of a stock when currency devalues. A rise in prices is not deflation. Countries are often forced to devalue currency to pay off insurmountable debt. Think of it. You lend someone $100 of today's dollars. Tomorrow the $ tanks and is worth half of what it yesterday, but you are still going to get repaid $100 that now can only buy half of what they did yesterday. You are screwed and the borrower is saved.

[because we don't have a savings pool we have to continually borrow to reflate. that is wearing very thin. ]

The question then becomes borrow from whom? Only the Gulf states and a few other places have money.

The FED is printing, but assets are deflating. So can we print faster than what is being destroyed? I think for the short-term the economy will not respond to the stimulus, if peoples moods have shifted.




[lastly, it was japan's corporate balance sheets that were so bad; in the u.s it is the consumer. which is worse i do not know,]

The consumer is 70% of the USA economy


[but overall leverage in the u.s. is way higher than ever was in japan.]

So we have to de-lever, while we try and monetize our way out of it.

I guess it comes back to whether or not there is any real net economic growth, as debt fueled growth will not exist in a de-leveraging situation. Which is why I wonder at least for the short-term if net deflation with negative or zero growth the only possibility.
Then when all the stimulus finally starts to work, one gets weak growth with inflation. And finally slightly stronger growth with higher levels of inflation limiting growth

Just my opinion

I think there have to be limits to how much you can debase the currency.

If we assume that the de-leveraging process cannot be stooped, and that leverage will eventually return to normal levels then this is the first force acting -deflationary.

Now given the above, the FED can not allow net deflation to occur, so it will likely monetize. -inflationary

But I argue, it will target a small net rate of inflation, and not go beyond that. Why? Because if you have de-leveraging (assets falling in price) and you over monetize, the value of assets in real dollars gets destroyed (Example: Your investment goes down in price due to de-leveraging(and lack of demand), and the FED destroys the value of the dollar more than it has to. The real value of your asset becomes peanuts). All of this assumes the FED cares about the USA.

Of course once real growth returns, the inflation takes off.

mr. p,

first, i think there's a lot of salient points in your post - i stopped looking at equity indices many months ago and have only been watching the dollar index, yen/euro cross, and TED spread. i also think you hit the nail on the head - equities don't matter anymore, all of the action really is in the currencies.

but having said that, i can't help but think (kind of like elias' view) that there's a middle ground - but i wouldn't even call it a middle ground because i think the de/hyperin flation analysis is too simplistic, at least from my sensory deprivation tank. call me a cynic.

i do think there's tremendous value in looking at japan, though. i realize we have no savings and they had a very large savings cushion, but look at what happened: "carry trades" sprung up. because they still haven't had a meaningful increase in aggregate demand and velocity of money there still hasn't improved much over the last 20 years (has it really been that long?), their currency financed asset purchases in other countries - only because relative yields around the world have been better than japan's.

but we're all headed down that route - no aggregate demand and wads of cash sitting around dormant - but with no relative yield advantages since everyone is moving in the same direction - to quantitative easing and rates at/close to 0. yields everywhere on everything would get compressed, so where's the demand to buy/invest going to come from in such a scenario?

that's the thesis i'm going to pose - now your homework assignment is to poke holes in it. tell me why it's wrong. take it to toddo, macke, mish, pep - whoever. it's another scenario across a distribution of scenarios that i haven't seen posed or thought about.

thanks as always mr. p, hope all is well.

Great article and great posts! Many things to think about.

Here are my questions---

Wouldn't it be in the interest of Japan and China to have a stronger dollar? They could thus maintain some level of exports to the US and keep some value in their large holdings of dollar debt. I'm no central banker but couldn't the Japanese and Chinese print currency and exchange it for US dollars, or buy US debt or equities? They would result in some inflation at home but right now that doesn't seem to be their biggest problem. In this scenario one could have rising US equities, falling US long-term interest rates, and a rising US dollar. If the Chinese and Japanese bought US dollars and assets for a long enough time, while the US pumped money into the hands of consumers (through tax rebates, cheap loans, loan guarantees, asset purchases, and make work jobs), we might actually get one more round of the “same ole, same ole” consumer driven recovery and asset bubbles. I'm on thin ice in my understanding of all of this, but couldn't the Chinese and Japanese in coordination with the US do something like this, and if not, why not? I will add my own personal leaning here, which is that I somehow sense that China has far greater bad debt exposure at home than most people realize, which may give them much less flexibility to help maintain the dollar than I have assumed, i.e. they may need their excess funds for more spending at home.

Thank you! Bill

Tony,

Japan was financing its deficits internally. Japan remained a net exporter and BOJ was trying to keep the Yen down to stimulate exports. Hence Japan's currency was never under any threat externally. The Japanese conumer seems to always have had a saving mentality. They saved even when BOJ dropped interest rates to 0%.

For the US to go down the Japan route, the US consumer has to change her stripes, start saving and stop consuming. If that were to happen and our trade balance turn flatish, we can wind up in the Japan situation. The Fed will print and the money will sit in accounts as savings. The government will stimulate and once the stimulus is spent by the government it will appear as savings in the consumer/corporations balance sheet. Rinse and repeat. We have perpetual "deflation".

What do we have instead? A US government/consumer addicted to debt and spending and a massive trade deficit. Looking from the outside, why should anyone continue to provide vendor financing to the US? The US is flooding the world with dollars. The outside world has too many dollars and supply and demand will assert itself sooner or later.

Can collusion among the central banks perpetuate the current system for some additional time? Perhaps. The US government substitues sovereign debt for poor quality consumer debt, gives handouts, creates stimulus packages, prints dollars. The mercantile FCBs keep buying dollars and keep the vendor financing going. Eventually something will trigger a demand (rationaility asserting itself?) for more dollars for the same amount of goods and the dollar collapse starts. Once dollar goes down, the prices of everything in the US start to increase and the US enters an inflationary spiral similar to all countries that depend on external financing. The dollar loses reserve status at that point.

So the breaking point is when the world decides that it has enough dollars. When will this happen? I don't know. Note that a similar situation exists with Britain as well as other Western countries.

Also imagine the situation 10 years from now. The US national debt stands at $20-$30T assuming 1-2 trillion deficits for the forseeable future. Medicare and social security are in trouble. States are bankrupt. Pension plans are bankrupt. The entitlement mentality almost ensures that we will monetize our problems. What is likely at that time, a debased currency or a strong one?

Sorry for the disjointed and long message. Just trying my best to peer through the fog.

.........by definition, an improbable event yet here we are..........

The Wiemar Republic writ large......ultimately wheel barrows of currency for a loaf of (farmer subsidized) bread.

............much more serious than collectively the country realizes.

I just heard on Bloomberg that the 99 cent cheeseburger is going up to $1.19.

I have been asking for the very first sign of inflation rearing its head-- though I though it would come as a formal economic indicator- I guess this _could_ be a sign.

???? Is this a prelude to higher food prices-- Wheat being the first????

I moved to West Palm Beach, Fl in 2001. The average price of a nice home was approx. $100,000. One year ago it was approx. $350,000 but prices are dropping now.
Our county commisioners (some are in jail) did the developers work and 5000, 8000 home plots etc were developed by them.
Now traffic is terrible, I95 is bumper to bumper also. But we have a Walgreens and othe drug stores on every other corner and a McDonalds and other fast food places all over.
Just what we needed. I fail to see any good that came from that expansion, especially for the paople that lived here when it al began.
To me, this is the way our country is going.

Mr Practical, this last point "... nothing really matters anymore besides currency, so watch them closely. Governments are systematically destroying stock markets and changing how they work." Can agree more.

But if most of the G7 is planning to go deep into deficit to "spend" their way out of this deflation - same with the BRIC countries, then is the Yen the yardstick to measure the coordinated currency debasement?

Are the Japanese least likely to debase given their ZIRP, past reflation efforts, corp and private balances sheets, willingness to borrow?

Btw, anyone notice that recently oil and gold are moving in response to monetray inflation but that oil % moves are bigger. Is oil the new gold given its a much bigger and more liquid market? Gold meant something when we had a gold standard but now is it just a commodity?
Rich.

Foreign governments are wising up to this fact. There has already been discussion of Japanese suggesting the Treasury accepts bonds denominated in Yen or other currencies. Our currency-specific debt may not be convertible to local inflation if more foreigners wise up.
Creating enough panic where others let the USA flood the world with dollars, and sell ~zero-return Treasury bonds is wickedly effective for the USA - as long as they can get away with it (again). Short to medium term, all the opinions here hold. Long term, national fiat currencies just aren't adaptive.

"Governments are systematically destroying stock markets and changing how they work. They are being replaced with socialism and determined pricing." - The New (Stock) Market

I guess the real question is why are voters allowing governments to try this? It won't work, long term. Isn't debasing markets and currencies an indication of Central Banks and fiat $ debasing their regime?
If not national fiat currencies, the only question is what should markets rely upon next? Precious metals won't be adequate denominators for all inter-party credit demand, only better/faster/cheaper credit transaction processing will be. Right now, that looks like Government Bonds, but they're denominated in a nations currency.
Ultimately, it looks like we're headed back to barter contracts, with the "currency" being efficient, computer records of credited goods and services.

Real long term? Buy stock in whomever owns PayPal and GoogleMoney? Invest in local currencies? <http://www.lietaer.com/>

Is it possible that the central banks could put just enough new money into the system to replace the money that has evaporated because of declining asset values and defaulting debtors?

If so, could we end up see-sawing our way to a situation where there is a recession, but not a deflationary depression, and no hyperinflation?

I saw the crash coming in about 2003 (so I missed out on the boom) but my understanding is only at the level of common-sense. I don't understand the detail of the economic mechanisms involved and therefore I don't know whether a middle ground outcome is possible.

Does anyone think a non-apocalyptic outcome in the middle ground is possible?

Rather terrifying to think what is going to happen to people on fixed income. At some point, I really think there will be a flight back to real estate.

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I'm not sure I can add any further insight, just a few more questions that hopefully provoke some more thoughts.

it seems to me that the US government is going to increasingly have to rely on debt to fund not only the endless & apparent bottomless bailouts, but also their own government operations - tax revenues most certainly are going to take a hit due to the declining economy and government payouts for unemployment, welfare, etc. are going to go up, thus making annual deficits even worse for the foreseeable future.

if foreigners are funding most of that debt now, and the only ones able & willing to do so in the future and they start seeing the risk of US currency devaluation or debasement as too high, isn't that going to force US interest rates up and make the chances for an economic recovery in the US that much (s)lower?

and surely foreigners see the hazard of US printing presses running 24/7/365 to fund increasing pension & health care and other social costs (security, etc.) that are only going to go up as the median age increases and companies (and their private pensions & insurance plans) increasingly find themselves unable to afford to pay promised benefits...

I just don't see foreigners hanging on to their trillion dollar in $US reserves just to bail out a government/country increasingly seen as mismanaging first their economy and now their currency - and not having a realistic plan that involves the necessary domestic sacrifices to truly turn things around...

rather I see them as diversifying and using some of those $US reserves to stockpile currently cheap commodities, especially strategic ones like oil & gas, basic materials and even foodstocks for their own domestic use.

in any case, i see the US is going to increasingly become a slave to their creditors if they don't start making the hard choices themselves...

in any case, the US is in for a very rude awakening that really hasn't hit the masses yet...tho I think the alarm bells might be starting to ring.