To Understand Inflation, Follow the Money 9 comments
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In the current climate, where the overriding opinion of most mainstream financial commentators is that deficit spending is a good thing and the only thing better than one bailout is two bailouts, it is time to inject a bit of logic and sanity.
Sure, I made the argument in last week's edition that IF the Feds are going to throw over $8 Trillion at the financial system which produces nothing, why not throw Big Auto a bone? At least they produce something. However, this line of reasoning should not be taken as any kind of endorsement of our Bail-o-Matic Congress or its actions.
The thing that gets me is that we still haven’t gotten an answer from anyone in charge telling us where all this money is going to come from. Sure we know, but it would be nice to hear it. As the crisis deepens and bailouts become a common word, the real danger is that the American public will become desensitized to the sheer magnitude of these short-sighted, but long-lasting commitments. There was a time not too long ago when a million dollars was a lot of money. Someone who had a million dollars was thought to be set for life. The sad fact: today, a freshly minted (sarcasm mine) millionaire could earn a whopping $30,900/year on his money if he invested in 30-year Treasury Bonds. Or he could have put it into DOW index funds last year and would now have around $620,000. No, a million dollars certainly doesn’t seem like a lot of money these days.
More recently, we have shifted to discussing things in terms of billions. The Bear Stearns problem back in March cost us $30 Billion. The taxpayers were assured we’d get a good return on that money. However, as of 12/4, Maiden Lane, LLC which was created to house the Bear Stearns mess has seen its value drop from nearly $30 billion to just a tad over $21 Billion. The US taxpayer has lost nearly a third of its investment already. AIG started out at $85 Billion and has grown to double that in just a few months. All in all, Congress has pledged $700 Billion, and the Federal Reserve has, to date, cranked around another $7.6 Trillion at the problem. And that number gets bigger every day. Looking at news headlines, it would seem that even a billion dollars is not a lot of money these days.
Let’s take a second and put this into a perspective that everyone can understand. The analogy is especially fitting at this time of year. Let’s send the average family of 4 to the mall for a shopping trip. Let’s assume they can each spend $1000 every hour. If they set out to spend a million dollars, do you think they could finish before Christmas? Even if they shopped for 16 hours a day, they’d finish on 12/26 – too late!
How about the same family trying to spend a billion Dollars? Spending at the same rate, it would take them nearly 43 years, shopping 16 hours a day, 365 days a year, spending $1000/hour each. 43 years to crank through a billion dollars.
How about a trillion? We’d better add the aunts, uncles, and cousins for this one. Let’s say we can get 20 people spending $1000/hour each, 16 hours a day, 365 days per year. How long do you think it would take for them to spend $1 trillion? A whopping 85,616 YEARS.
To put it in perspective, the bailout of the S&L crisis in the late 1980’s was envisioned to cost around $80 billion total at the time. We have already pledged 100 times that amount to fix this mess, and if you’re thinking the same way I am, you know that this is nowhere near over.
Obviously, our government doesn’t have any of this money. The National Debt Clock has gotten quite a bit of publicity recently in that they had to shut it down for a while so they could figure out how to add another digit because we’d crossed the $10 Trillion mark. I made the rather snide remark at the time that they should probably just add a couple more digits while they were at it. Now it doesn’t seem so snide anymore especially given the situation that already exists with unfunded liabilities from Social Security and Medicare. We’re going to need an awful lot of money while having precious little of it.
Which brings us full circle to the news of the day. Oil demand will plummet over the next few years says the World Bank. So will the price of commodities. They are predicting a global recession that will be the worst since the Great Depression. And I totally agree with their prediction of a severe recession. However, it is very clear from their position on prices that these people with impeccable credentials, education, and status as world renowned economists don’t know the first thing about how money works. They don’t understand even the most basic immutable laws of economics, the most important being that inflation is a monetary, not an economic event. They fail to understand that creating money and credit from nothing causes general price levels to increase regardless of the level of underlying economic activity.
Demand alone cannot cause general price levels to rise. Sure, demand can cause the price of one or even a few items to rise, but in a disciplined monetary system, money to pay higher prices for one product must be taken from the price paid for somewhere else. So as one price goes up, the price of something else will fall because the money simply doesn’t exist to support higher prices across the board. Also, demand is relatively constant when you think about it. People will always want things. The check and balance is the supply of available money and credit. Monetize demand and prices will rise regardless of underlying economic activity. If you want proof of this, go to an auction sometime and start handing out millions of dollars then watch what happens to the prices paid.
Now, consider the monetary environment within which we are operating at the present time. Much like the yields on short-term Treasury bills there is zero discipline. None. Money is being created on a massive and unprecedented scale. This is precisely why the banks are sitting on it. If this money were released en masse into the real economy, we would have hyperinflation at the precise time when economic activity is grinding to a halt.
The most useful thing that can be taken from the World Bank’s forecast is that they expect this money to remain penned up in the banking system for the foreseeable future. While this prediction, if true, would bring welcome relief in terms of prices, it is a rather dire prediction in that our economy relies on cheap money for its growth.
Disclosures: None
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This article has 9 comments:
We're much better off playing games with intergenerational debt and the value of our currency. Look at the risks of doing nothing!
/sarcasm
I call financially illiterate BS.
Maiden Lane LLC assets are lower by $2 B (with a quarter billion interest received), not 9-10B. JPM takes the first B and change of hit on those. Maiden Lane III, lower by 0.5 billion, Fed share 3/4 of it.
The article writer apparently confused the amount outstanding for the AIG loan in the latter, with the older Bear Stearns figure for the former. For comparison, in a typical recent year the Fed had profits of $30 billion and paid $29 billion back to the Treasury.
There is no inflation. Prices are in fact dropping, and treasury auctions are four times oversubscribed at yields of zero.
As for what treasury rates can do, from 1934 to 1954 the average rate on 3 month T-bills was 61 basis points. For 20 years. There was some inflation in that period, coming out of WW II and during Korea - the price level doubled, and the average rate of inflation works out to 3.6% a year, taking years of flat or lower prices early, with years of increases later in the series.
The T-bill rate was under 1% continually for those 20 years. It didn't move above 2% and stay above it until the late 1950s.
Over their entire history since 1934, T-bills have averaged 4.4%, exactly equal to average CPI inflation over that period. But the relationship is *not* one to one each year, only overall and on average.
As for the illiterate comments at the end, hyperinflation without transactions is a round square and a misunderstanding.
For the millionth time, the *demand* for money is *not* a constant, it can and does fluctuate violently, the price of any commodity, including money, depends on the demand as well as the supply, and deflations can and do last decades.
All your inflationary brainstorms, are belong to us.
Pipe down Mr. Jason.
What I think gets lost on most of the public is the concept of the velocity of money. This seems to get glossed over in the discussions of inflation/deflation lately.
en.wikipedia.org/wiki/...
> While this prediction, if true, would bring welcome relief in terms of
> prices, it is a rather dire prediction in that our economy relies on cheap
> money for its growth.
... which pretty much negates your entire story. Our economy does indeed rely on cheap money for its growth. Herro? Where have you been for the past 200 years?
But the perceived value of money is not just determined by the amount of it. It is also "the trust" that people put into it.
US has this enormous leverage, because the rest of the world considers USD a "reserve currency." As good as gold. It took a long time to build that reputation.
However, that trust is lost more easily than some people believe. And once it is lost, it takes forever and a day to regain the trust, if possible at all. Sort of like a priest who gets caught with his pants down in a room with a teenager.
No inflation? Is that why the Dollar has lost over 95% of its value since the Fed started printing currency and decoupling us from real money?
Yep!
"And I totally agree with their prediction of a severe recession."
Yep!
"Money is being created on a massive and unprecedented scale. This is precisely why the banks are sitting on it."
That may be one of many reasons. I think another is the huge debts and write downs banks have on their books. Lenders just got burned, they're a bit wary. Plus, going into a recession and falling home values means everyone is a credit risk. And with job losses rising, borrowers are a bit wary, too.
Any economy, other than China...a command economy...relying on a devalued currency for prosperity is, well, mistaken.
The printed money is pushing a noodle, has no where to go.
If too much, then for awhile it will look like the 1930s but some large entity, likely a foreign "wealth" fund will move toward the exit, buying physical oil, resource-rich corrupt governments, or any portable US assets (likely ships and weapons). The price of guns outside the US, denoted in US$ is the early warning sign that the goldilocks point was overshot and inflation will roar like a T Rex with an abscessed tooth.