Wednesday, October 20, 2010

Where Is The Hyperinflationary Tipping Point?

With all the money printing going on at the Fed, why is the Fed having trouble creating inflation in the economy?

One of the reasons is that asset values are rapidly declining. This leads to a collapse in available sources of consumer credit. For instance, now that home values have fallen, home equity lines are not available. Existing lines are gradually being paid down or defaulted on.

Fed liquidity programs such as TARP, which swaps cash for mortgage backed securities, is going into equities and not into new loans. It also seems to be about the only liquidity entering the system. The rest of the liquidity sits on the bank balance sheets, unable to find a home in an asset bubble. Bank lending needs an asset bubble to get into the economy because Banks are too conservative to lend like venture capitalists. They only really want to lend against assets, which are all falling in price due to the aftermath of the once great asset bubble. Since banks only want to lend against assets, decreased collateral values means decreased credit.

SO where is all this going? Bernanke will buy treasuries forever and the interest on the national debt will slowly drift higher until exactly what happens? What is the proper equivalent economic situation? Is it the Weimar hyperinflation, as so many pundits state? No, Weimar owed its debt to external creditors in foreign currency and its economy was largely destroyed by the French occupying the industrial region of Germany after non-payment of reparations.

The equivalent is actually Argentina in the 80s. Why?

* Excess government debt denominated in local currency
* No Currency Controls (Yet)
* Functioning, but inefficient economy
* Reasonably politically stable.

There's a great postmortem on all this over at the World Bank:

Public Sector
"Debt Distress" in Argentina, 1988-89

The most interesting parts of the paper:

6. common characteristicsof the Primavera and B8 Plans.

Many observers noted the parallels with the Primavera Plan
even at the outset of the BB Plan, and there are evident
retrospective parallels. Both failed because they sought to
stabilize a macroeconomy burdened with excessive, and exces-
sively expensive, public-sector debt by having the public sector
take on more debt. The architects of both plans were fully
aware of the contradiction:they felt their only hope of avert-
ing public-sector bankruptcy was to borrow time at high interest
rates, win sufficient confidence to bring down the interest
rates, and then carry out structural reforms quickly enough to
enable the public sector to pay the interest and, ultimately,
the principal.

The orders of magnitude of the aggregates involved made
this approach dauntingly difficult. With monthly interest rates
on the order of 5 per cent, domestic debt totalling US$7 bil-
lion, and monthly GDP running at US$5 to $6 billion, the monthly
interest bill of US$350 million was 6 to 7 per cent of GDP.

Even after the massive devaluation and public-sector price in-
creases of July 1989, the non-interest public-sector surplus was
barely positive at best. It may have reached 2 or 3 per cent of
CDP in November 1989. An additional increase of 3 or 4 percent-
age points in the non-interest surplus -- whether through ex-
penditure reductions or tax increases -- would have strained the
economy severely at a moment when it was emerging from the dis-
array induced by the hyperinflation. Even if successfully im-
plemented, such fiscal improvements might have had short-term
contractionary consequences so sharp that they might have dimin-
ished private saving, which might in turn have inc.reased
domes-tic interest rates. (The peculiar hydraulics of Argentina's
macroeconomy made this possible: demand for broad money depended
positijvel on interest rates and the public sector itself was
heavily indebted at high interest rates.)

Interest-rate determination in the Primavera and
BB Plan contexts clearly operated rather differently from usual.
In conventional settings, borrowers and lenders presumably come
to market with real "reservation"interest rates based on their
propensities to borrow and lend, then negotiate nomii4a!
rates by taking account of exogenous anticipated
reserva-tion interest
inflation. In a financial system as open as Argentina's, lend-
ers' opportunity cost is governed by anticipated devaluation and
external interest rates.
High interest rates induce private
lenders to ration, because high rates make borrowers more likely
to default. Where the public sector owes the debt, however, the
nature of the market changes. A public sector can promise any
nominal interest rate as long as it has unquestioned capacity to
inflate. Knowing this, private lenders can demand any interest
rate from the public sector they collectively wish. The public
sector can place debt at any interest rate the market demands,
effectively financing the interest by placing additional debt.

6.4. As Argentina's public sector borrowed from the private
sector, a perverse distress cycle resulted. The public sector
rolled over its loans and borrowed increasing amounts from the
private sector to pay the private sector its interest; the pub-
lic sector then borrowed still more to service still more debt.
A regressive transfer resulted, from inflation- and convention-
al-tax payers to lenders. The process finally broke down be-
cause the capitalization of interest rapidly increased lenders'
portfolio holdings of austral-denominated assets: once they
elected to balance their portfolios by acquiring more foreign
exchange, they bid down the value of the austral and bid up in-
terest rates. At this point, higher interest rates could only
increase anticipated exchange-rate depreciation. In such cir-
cumstances, financial-market participants, observing higher in-
terest rates, are apt to conclude that the Government will soon-
er or later have to inflate to pay the interest, that everyone
else's inflation expectations are rising on similar reasoning,
and that hers or his should therefore rise as well.

In Argentina, when monthly interest hit between 6 and 7 percent of GDP, money started moving into foreign exchange very quickly causing a currency devaluation downward spiral.

Since money won't rush into Yuan because its pegged and the Chinese currency is not convertible, where will it rush into? Gold? Commodities? A Europe with raised interest rates? At some point though, there is going to be so much money being made passively on U.S Treasury interest that it won't be capable of being recycled into the U.S economy and will start to flow out to foreign exchange and into foreign property(?) and stock market bubbles.

Perhaps at some point, taxes and commodity prices will get so high that imports will slow to a trickle and the entire velocity of money will be absorbed in paying interest and non-discretionary budget items on the national debt. The fed will be buying all treasuries at negligible interest rates. Now what? Well then you might start to see a carry trade further weakening the dollar, but this isn't really the kind of thing that gets out of hand. It's more likely to create a long slow deflationary misery of the trajectory that Japan followed as the domestic market is starved for debt as the banks look to engage in the carry trade.

Over the following years, the yield on U.S assets continues to fall and investment money goes elsewhere as the long slow slog of wage and asset deflation and business decline continues. The other countries will handle the rise in commodity prices better because they are far more efficient per dollar of GDP. This will continue until production costs eventually equalize, which could be never, at least with how much debt there is to service.


Wednesday, September 15, 2010

The curious case of the Yuan and the Yen

Two curious pieces of news today:

Geithner Says U.S. Examining Ways to Push China on Yuan Rise

Treasury Secretary Timothy F. Geithner said the U.S. isn’t satisfied with the pace of yuan gains and is considering ways to urge China to let the currency rise faster.


Fed refused to comment on Japan weakening the Yen.

NEW YORK (Dow Jones)--The Federal Reserve Bank of New York declined to comment on Japan's intervention in currency markets that has pushed the dollar sharply higher against the yen.

So why are we perfectly happy, or at least neutral, with Japan, the #3 economy, weakening the Yen and are furious at China, the #2 economy, decreasing the value of the Yuan.

This is a good question for any would be political economist to ponder. The treasury is certainly in charge of the political aspects of the dollar's relationship to other currencies. The Fed's political objectives are somewhat murky but assumed to be largely the same as the treasury's.

Let's call this the Asian currency political paradox.

I have my thoughts, which I'll elaborate on in later posts.

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Thursday, August 05, 2010

Why there will be no hyperinflation

I have been reading the inflation/deflation debate for some time now on various parts of the web. The inflationists insist that we will collapse like Wiemar. The deflationists insist that we will collapse like Japan. The memory of the 1970s inflation is strong in many an old gold curmudgeon, so the inflationists seem to be more prevalent. I will in this essay attempt to argue that hyperinflation will not happen if global commodity markets remain priced in dollars. The reason for this is that if inflation increases, the rest of the world will bid commodities up drastically, especially oil, and severely throttle U.S economic growth, leading to a more restrictive monetary policy.

Hyperinflation always happens due to a foreign exchange crisis. The population, sensing a high level of inflation, rushes to change their earnings in for real goods or foreign currency. In the case of Wiemar, or Argentina, the rest of the world is largely unaffected. They see their currencies drastically appreciate against the hyper-inflating currency, but that has little affect on their internal economies. Consumption of oil and commodities remains relatively flat in these countries and existing relationships are largely preserved.

If Ben Bernanke were to fire up the proverbial helicopters and start dropping money over the country, the first thing that would happen would be the money would not go directly into foreign currency. Instead, it would go down to walmart and buy itself some imported goods. Then the money would go via walmart, to China and from China, back into treasury bills. Don't worry, there are plenty of treasury bills to go around. In China it would lead to more domestic currency creation and therefore increased production, and workers wages and from there, into domestic consumption.

China is currently the largest market in the world for automobiles. People who buy automobiles need to fill up gas tanks, especially Chinese workers with fresh new currency in their pockets. The increased consumption of oil and other commodities in China would necessarily lead to the price of these commodities increasing on the global market. China intervenes regularly with their dollar reserves to keep domestic prices of commodities stable.

As this dynamic continues, we will start to see the Baltic Dry Index go up as many ships merrily steam across the pacific delivering goods to happy American consumers. We will also concurrently see oil and other commodity prices shoot through the roof. As oil prices shoot up, the economy in the U.S will start to experience a very heavy drag, as it did in 2008, when oil hit $150 a barrel. These added costs will quickly send the inflation indicators out of control, even though FX rates will only be moderately affected due to the Chinese currency peg. At this point, Ben will probably hit the pause button on the printing machine and we'll have a late 2008 style deflationary crash.

Recently, Bullard at the Fed was talking about doing an instant-refi of all mortgage holders at lower rates. This will provide another temporary boost that might last a year or two. It would annoy the lenders, who would have to accept a lower coupon and might be outside the fed's mandate. It's not the kind of hyperinflation generating event though that would precipitate a scenario like the one above, mainly because I don't think it can start another asset bubble as all the loans in question are still underwater.


Wednesday, July 02, 2008

Keeping up to date on China Stock/Economic news

I have been trying to get a daily reading list together so I can more closely follow economic developments in China. I was trying to stay as far away from western viewpoints of China as possible. Reading western news sources is like reading about science in newsweek vs reading china business based and focuses news sources -- which is more like reading the actual technical journal articles.

Ok here's my notes on the topic so far:

-Decent - basically Xinhua's (Official Chinese News Agency) business section

-brief gov news agency business headlines.

-Not bad with a lot of original information! for example:

"Tax treaty benefits
In this article, we shall analyze the process of adopting a Mauritius company as a holding vehicle. The China-Mauritius tax treaty offers some tax benefits in structuring a tax efficient holding structure for PRC investment."

- This is an example of what I didn't want to read. It's all about what other countries think of China and not what is actually going on in China. Every article has political overtones and implied western criticism of China. This is just a bunch of noise IMHO.

Looks good but you have to subscribe.

Oh you bears will like this site :). Not bad stuff...No new original content for a while...
The accusation of endemic, pervasive corruption that foreign critics of China, particularly Americans, level at it is now rendered passe, unfashionable in light of the systemic, widespread and criminal fraud that defines the American financial system and its manipulations of securitized mortgage debt.

Pretty Focused

More to Come....

Sunday, November 18, 2007

Behind the "Global Savings Glut"

A recent article in The Arab Times seems to shed some light on where all the money sloshing around the world creating asset bubbles is coming from:

We in Kuwait seem to have run out of ideas for the time being and our past generations were more creative and looked deeper into our human resources to give their best. The overseas investments have their limits and it is time to seriously think of ways of making and creating new job opportunities for our youngsters and improve their capabilities and abilities. This is the only way to move forward as our financial resources are beyond our abilities and capabilities. It may take some time to come with the right answers but this will not happen without passing some laws through our parliament. Most importantly the land utilization law and liberalization laws to allow the private sector to move forward. The government owns more than 95 percent of the Kuwaiti land and with the BOT law still under revision almost all projects have been shelved awaiting the new laws to be approved.

Sunday, October 21, 2007

The Super SIV? Will it work or are there one too many holes in the dike.

The Super SIV appears to be on it's way to sanitize all the sub-prime CDOs.

Will it work?

Probably Not... Why?

Hole in the Dike #1:

The Chinese and the Japanese aren't buying it anymore as outflows of capital show:

Asian Investors Dumping Treasuries

Asian investors dumped $52bn worth of US Treasury bonds alone, led by Japan ($23bn), China ($14.2bn) and Taiwan ($5bn). It is the first time since 1998 that foreigners have, on balance, sold Treasuries.

Mr Ostwald warned that US bond yields could start to rise again unless the outflows reverse quickly. "Woe betide US Treasuries if inflation does not remain benign," he said.

See that chart above? That's the August data, before they lowered rates!

Hole in the Dike #2:

The worst isn't even here yet! See below for a timeline of when rate resets are going to hit. It starts in January 2007.

No foreigners want to buy our debt and there are going to be a ton of people defaulting on their mortgages in the coming months. So all that debt, wherever they hide it is going to be worth WHAT Now?? The U.S financial system has suffered an epic mortal blow. The blow is to the credibility of the system is now totally shot. Bernanke is a smart guy and a well trained economist but I don't think he realizes that we are operating in a vastly different economic climate than 20 even 10 years ago where suddenly the U.S isn't the only place to invest anymore. The world has caught up to the U.S in many ways but we aren't anymore cautious.

Saturday, October 20, 2007

SIVs ..... financial panics, august credit crisis, etc, explained...

Financial BS is so entertaining when you actually try to take it seriously.