Impending Inflation? The Global 'New Deal' All but Guarantees It 24 comments
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By Dan Denning
In the spirit of humility, let’s take a moment to examine whether we’re simply wrong about our main investment thesis: that extraordinary measures adopted by central bankers and government officials will result in tremendous inflation, and thus boost commodities and resource shares.
The first strike against the theory is the global recession. It now looks like the global economy will grow a lot less fast in 2009, if it grows at all. Investors are busy re-pricing commodity stocks for a world where resource demand drops along with consumption in the developed economies.
But a cyclical recession in resource stocks is a manageable event. The bigger challenge to the inflation argument is, well, deflation. The argument here is that there was simply much more leverage in the system than even we expected. As that leverage disappears-hedge funds selling assets to meet redemptions, for example-all assets fall in value.
So far, it looks like the deleveraging of the global financial system is destroying wealth faster than central banks can create new credit to replace it. Europe organized US$1.7 trillion in guarantees on bank loans last week. And in the States, it won’t be long before every institution and every debt is guaranteed by the full faith and credit of the American government. This should lead to the first trillion dollar fiscal deficit in American history. Heck, it might even be two trillion.
South Korea guaranteed $100 billion in bank debt last weekend, and provided banks $30 billion in loans. The Dutch government “injected” $19.6 billion into ING last weekend. Yet as large as these government guarantees and capital injections are, they might not be large enough.
These amounts are small compared to the amount of value already destroyed in the residential real estate market and in the equity market. $20 trillion has already been wiped off global shares values. Real estate markets in the U.K. and the U.S. are imploding.
What we may have underestimated is how quickly this deleveraging and value destruction would spread to the commodity markets, which we thought would provide relative safety with the backing of tangible value. Resource stocks did not hold up for long at all. Why not?
On the one hand, it now looks like a lot of investors were long commodities with borrowed money. Those investments have been sold to raise cash and pay back loans. Secondly, when it’s a bear market in stocks, there aren’t too many stocks that do well, full stop.
But isn’t inflation in tangible assets just a matter of time as the global money supply grows to re-flate credit markets? And what about all the new government loan guarantees and capital injections? Don’t they have to be inflationary?
Well, if governments borrow to finance these various programs, they’ll issue new bonds. Bonds soak up the available pool of global savings. To that extent, the borrowing crowds out other ventures, which might put the savings to a productive use. But financing the scheme with bonds is not, at least, right away, inflationary.
However, if governments can’t find takers for the bonds they issue to finance the scheme, they will have to either raise taxes (not likely in a recession), or simply print the money. And here’s a hint. That’s what they always do, from Argentina to Zimbabwe. That is why we maintain the preferred response to huge debt levels is outright money-printing.
Besides, simply making credit more available by lowering interest rates stops working after a while (like when you can’t lower rates any further... zero bound.) How do you get available credit out of bank computers and into consumer wallets? It’s not easy. Bankers are suddenly quite shy where they were once promiscuous.
Then you have to get people to spend the money instead of stuffing in mattresses. The banks have been stuffing their money in mattresses (overnight accounts with Central Banks). So now, governments are simply taking over the banks. Let the new loans begin!
This government nationalization of the banks solves another problem with run-of-the-mill credit creation. You can make the credit flow, but you can’t always determine where it goes. But in these unusual times, the government is in the position of deciding where it wants the money to go. Right now, it’s simply shoring up bank balance sheets with more capital.
But to really “get things going again” and “fight the recession” the money will have to get back into the real economy. This is where we see the inflation coming. Not in asset prices for houses or equity shares. But in real goods. Why? If the government engages in massive public works projects as a way of stimulating demand in the economy and keeping up growth, it’s going to be resource intensive.
In a way, this is just another kind of phony boom, but with the free-market varnish stripped off to reveal it as an uber-lending program by some kind of pan-governmental agreement. We already had one simultaneous global credit bubble. Now we’re getting the mother of all government debt bubbles. Only this one will not simply be a collection of various national bubbles.
Instead, it looks like we’re going to get a kind of Global New Deal. Leaders from the world’s nations are already suggesting a system where the world’s top 30 banks will operate under the supervision of a government panel of some sort. You’ll see more “super banks” and greater control of the levers of global banking and a concerted program to flood the world with new fiat currencies.
How this prevents future bubbles or leads people away from their addiction to debt, we’re not sure. But we’re pretty sure it’s not a promising development on either score. And inflation? It’s coming...
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The US government isn’t going to simply print money and throw it out the windows of helicopters. As you point out in the article, the government expends the money supply by going into debt, but the much larger great credit super-bubble has popped. Will they issue enough bonds to balance the $20 trillion that has been lost? What about the next $20 trillion after that? I’m not saying that this is the end of the world, but I just don’t see hyper-inflation.
Four factors are in motion that will make the next several trillion in losses pretty much baked in.
1. Most asset prices are collapsing, not just real estate. Oil, precious metals, agriculture… all. Count ‘em and stack ‘em, nothing is safe and the tape doesn’t lie.
2. Incomes all over the globe are falling, jobs are being lost, and Joe the plumber is reacting by popping handfuls of Xanax and tightly hording his savings (that he doesn’t have).
3. Credit is much harder to obtain and will stay that way. Yes, the current credit freeze is thawing but still credit standards will be much stricter in the years ahead than they were during the last 15.
4. The world's economy is caught in several deflationary feedback loops due points 1 through 3 above. These dynamics all feed off of each other and they are even accelerating.
Also, will a New Deal necessarily be inflationary? It wasn’t during great depression 1, why would it be now?
Thank you for making both sides of the argument. However I think you made a much better case for deflation rather than inflation because it’s hard to see how government’s efforts can stop the super cyclone of credit and asset destruction.
Real value, like commodies or wealth in the ground, are fine for long-term wealth accumulation. But what about the day-to-day or month-to-month stuff? That's where the current economic crises seem to hurt the most.
Who the heck is going to borrow all this money and what are they going to produce with it and profit when the world is broke?
I keep hearing Jimmy Rogers and even Warren Buffet saying that the FED/Treasury moves are inflationary, but I have not heard a single explanation that makes any sense at all and no one asks them about it.
HELP!
If the US ( Dollar ) government was in budget surplus we could feel more at ease. But it ain't and here come the Crows home to roost !
mises.org/story/2901
And if one is inclined to read even further, the master link of related articles is below. If that is still not enough, I might summarize it myself, hopefully in a clearer way, in future.
mises.org/story/2901
Beyond that, the Fed and Treasury working together should be able to get inflation back on track. They destroyed 90% of the dollar's value so far, what makes the last 10% so special?
IMHO, a drop in the Discount rate of another 75 to 100 basis points is needed to make it onerous to hold onto the Infusions. The Fed is already Guaranteeing Money Market Fund Integrity so there wouldn't be another impolsion there. Treasury Yields would either remain Stable, drop further or rise. I doubt a drop below a Discount rate of .50 to .75 is likely. Thereby the Institutions wil finally be able to make loans at rates higher than their costs. This would start the Velocity Ball rolling.
Inflation won't come into play until commodities do. The thing about Recessions, the very first sector which begins to rise is Basic Materials, oil, etc.
However, in most ways the article actually argues in favor of deflation. Here are a couple of its more salient quotes:
“The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion.” Ludwig von Mises – 1949
And this one…
“However, banks' limited equity capital wouldn't allow expanding credit and money supply any further, whatever the amount of excess reserves. Perhaps even more important, a contraction of the means of payment, accompanied by a sudden stagnation of credit supply, can be expected to exert downward pressure on money prices, production and employment.”
At this point in the crisis, the government will attempt to rescue the banking system so lending can begin again. The first strategy is injecting peoples' tax money into banks. The second strategy is buying banks' risky assets, and the third is monetizing banks' risky assets.
We are now, or soon will be, doing all three, but here’s the key, credit will still continue to collapse. Even after the Fed’s efforts, banks and finance companies will not be willing to lend so extremely promiscuously again. As previously pointed out, lending standards will be much tighter in the years ahead.
Also, at least for a few years, individuals and business will not wish to borrow nearly as much again as jobs are being lost and prices for everything is in freefall. As JasonC so diplomatically puts it…
“No, prices are not going to trend up after a brief scare.
Earth to inflationary brainstorm clueless people, please write on a blackboard 500 times, "the demand for money is not a constant".”
will it be removed?
when and how will this be done?
if gov'ts do this, it would be rather novel in the annals of "fiat currencies".
even if this is successfully done, the USA is still bankrupt since there is not yet solutions for SSA, TRADE [UN]SURPLUSSES, MEDICARE[healthcare in general, ETC. ETC. ETC. all these new "thin air dollars" are atop the old problem set.
will it be hypertaxation or hyperinflation? or to the citizen, is there a difference between these two?
time will tell! but odds are on the article's ending premise.
sign me: GERRY MANDER
"There is no means of avoiding the final collapse of a boom brought about by credit expansion.” Ludwig von Mises – 1949
Wouldn't you know it, Greenspan missed the lecture!
Ludwig often used the following analogy to describe it:
"Imagine someone jumping from a plane at 15,000 feet without a parachute, the ensuing whistling noise as he plummets towards earth and finally, the ensuing S-P-L-A-T."
He frequently cautioned against becoming distracted by the whistling and to accept only the SPLAT as your cue!
When the US sneezes, the rest of the world catches a cold, right? Well, at least for now.
We're in temporary deflationary conditions now, but ultimately inflation will catch up and then come out with a vengeance.
How do we get from deflation to inflation? Just redeem US Treasuries with brand-new cash. Or alternatively, just print money instead of borrowing it. We're looking at a trillion dollar increase in the national debt next year (there's your REAL deficit). Where is that kind of money going to come from? It even exceeds our current account deficit.
Does ANYONE really think we are going to pay off our debts honestly?
No.
There are only 3 ways money can be created in the first place.
1. A bank makes a new loan which creates a new deposit in the borrower's account, which the borrower spends into the economy.
2. A bank sells a security to the Fed in exchange for Federal Reserve notes ("cash") or a credit in the bank's Fed account. Banks hold the cash to satisfy their depositors' cash withdrawal demands.
3. The federal governments sells securities to the Fed and the Fed credits the government's account, and the government spends the money into the economy.
Each of these actions (except banks holding money in their Fed account) increases the M1 circulating money supply. The point is, this is all the "money" there is.
When a borrower repays a loan the deposit (which had circulated around the economy until the borrower collected it back to repay the loan) ceases to exist and the money supply is reduced by that amount. When the government redeems its security from the Fed with money it collected by taxing the money it spent into the economy back out of the economy, that money ceases to exist.
L-Bow asks, "Who will borrow all the money that is printed to reinflate the economy?" If the government borrows money from the Fed to pay for infrastructure projects or more rounds of "stimulus" checks, that's one way to do it. Then don't tax it out of the economy until after a general recovery has occurred. This will not be inflationary because a lot of people will use the new income to pay down their personal debts and that debt-money will cease to exist.
If the government borrows money to buy up mortgages and other distressed assets, the banks who made the mortgages will reabsorb the loan money and it will cease to exist, so this is not inflationary. Actually this is deflationary, because the money supply decreases by the amount of the repaid mortgages.
Banks are at or near technical insolvency not necessarily because their cash reserves are too low, but because their capital value has dropped so much when bank share prices fell along with the rest of the stock market. Banks have a legislated upper limit of assets (loans) to capital (common and preferred shares and long term debentures they hold). I think the ratio is 20 to 1 but that might be outdated. By selling assets like mortgages to gov't they can get their ratio back in line with their reduced capital value. The government owes money to the Fed, but this debt can be treated as an accounting nicety and ignored as long as it is expedient to do so.
Banks don't "have to" fail, even if they are in technical default. The decision is up to the Comptroller of the Currency. It is in nobody's interest to destroy the US banking system so banks are being helped out of this hole.
I think the private sector will be pretty shy of new borrowing for awhile so I don't think there will be any inflation happening unless the federal government decides to inflate away US foreign debt. Paulson's $700 billion will just restore bank's balance sheets by reducing their assets to a level in line with their reduced capital. That money will never circulate.
But the original borrowers of that $700 billion spent it into the economy. The people who sold things to the borrowers still have that money (if they lost it, someone else has it). So there's a lot of "owned" money in the economy: the people who now own the money are not the people who owe that money to the banks. That money is sitting it out waiting to see what happens. Eventually it will get invested and spent, and the gov't can start taxing to collect the money to repay the Fed. It would take some working out, but the thing could be fixed in this way.
So if we do truly have a sort of Global New Deal where gov'ts start spending I think that will indeed get to the consumer sooner rather than later and spur growth and perhaps inflation.
There are many large scale initiatives that many would argue global gov'ts need to invest in now:
1. Improve Water treatment, clean water preservation
2. Clean coal technologies
3. upgrade grid technology
4. alternative energy developments
5. public schools & public hospitals
6. highways and bridges
I am also of the Austrian economic school persuasion, because they are right and Keynes is wrong. Too bad there are still many misguided people who believe that the monetary supply has nothing to do with it.
Great chart.
On Oct 24 10:04 AM Smarty_Pants wrote:
> OK. Limits on string lengths for posting don't help.
>
> Go to above link and enter "base" in the search box at the bottom
> of the page. Select the 10 year length of the plot that results for
> best perspective.
here: rkdpolitics.blogspot.c...
On Oct 28 01:02 PM akapital wrote:
> well, when I think of New Deal I think of FDR and the U.S. gov't
> itself spending loads of money on infrastructure (roads, bridges,
> schools, etc.). That was a catalyst that jump started the U.S. economy
> and the recovery from the great depression
>
> So if we do truly have a sort of Global New Deal where gov'ts start
> spending I think that will indeed get to the consumer sooner rather
> than later and spur growth and perhaps inflation.
>
> There are many large scale initiatives that many would argue global
> gov'ts need to invest in now:
>
> 1. Improve Water treatment, clean water preservation
> 2. Clean coal technologies
> 3. upgrade grid technology
> 4. alternative energy developments
> 5. public schools & public hospitals
> 6. highways and bridges