Saturday, January 3, 2009

Questions: Deflation and "Keynes"

A reader posed two questions which I find interesting (thanks Tiago). I will try to answer them below.
  • Do you expect the current "quantitative easing" to convert the deflation scenario to an hyperinflation one?
First of all, deflation is no longer a "scenario" but a reality. Real estate, commodities, shares, capital assets of all kinds are all experiencing sharp price declines. Even consumer goods are being offered at unusually reduced prices (aka "sales").

But let me answer the question..

No, I do not expect hyperinflation. The reason is that the dollar is the de facto global reserve currency, providing America with historically unprecedented global power. I cannot imagine the United States will give up its dollar imperium - at least, I do not think that it will do so willingly.

But can it happen unwillingly? That's not easy, either. There are vast sums of dollars being held abroad which cannot be converted quickly into another currency as one could do with, say, Zimbabwean dollars. The US economy is vast, comprising approximately one quarter of global GDP. Until and unless another country or entity can assume this global role America will maintain it and so will its currency. Whilst the EU does possess the combined economic size to rival the US, it does not have the political and strategic unity necessary to form its own empire - and won't have it any time soon.
  • What do you think about the "keynesian" approach being followed by almost everyone (Germany seems to be the single possible exception)?
It's what one would expect, given established academic thinking, past experience and historical references. The "establishment" will first and foremost attempt to perpetuate itself - that's only logical. Nevertheless, I believe this will ultimately prove wrong.

We are fast reaching the limits of the Permagrowth (i.e. establishment) economic model: the signs are everywhere from environmental and climatic crises, to resource depletion - to name but a few. Keynes was a brilliant fellow. If he was around today, facing today's challenges, I'm sure he would be coming up with very different proposals.

22 comments:

Thomas Pindelski said...

I agree that the US dollar will remain the reserve currency of the world for some time yet.

This raises the question why we spend so much money on our various efforts (mischaracterized as ‘defense spending’) to purportedly inculcate democracy in the world’s many dictatorships.

Imagine if, say, China, were to become a representative democracy. Given that its people display most of the characteristics which inspire trust, such as hard work, high savings rates, frugality, healthy eating, low energy consumption, modest expectations and low pay, the addition of democracy to the mix would make the yuan the preferred reserve currency for all and sundry, democracy or dictatorship, and most of the world’s free reserves would depart the US for China, destroying America in the process. America would literally suffer a ‘run on the bank’

Stated differently, it is very much in our interest to ensure that anything but democracy remains the dominant system of government in the world’s dictatorships.

So, given your propensity for clear explanations of complex issues, please explain to me why we waste so much of our resources in a quixotic pursuit of world peace and freedom when, were such nirvana ever to occur, it would bring with it the seeds of our own destruction.

Thai said...

Great post as always Hell.

Thomas, I for one want to buy you a beer on honesty alone (though I am not sure I agree with your sentiment)

My own personal answer to your question, which comes from my propensity to see everything thru the lens of evolutionary psychology is probably just as cynical as your post: we do it not to control (or even really help) 'other' people, we do it to control ourselves.

That and all ideas can become bubbles in their own right.

Greenie said...

"why we spend so much money on our various efforts (mischaracterized as ‘defense spending’) "

Because there is no coherent group called 'we' in America. All those efforts are meant to transfer wealth from productive sectors to unproductive ones.

Do you think people would be happy, if government just implemented a tax called 'pay the rich' and took millions of dollars to pay few selected individuals?

However, when the tax is named 'promoting democracy in Pakistan' or 'protect our banks' or 'no child left behind', people may reluctantly oblige, even though the net effect is the same - taking money from the population and enrich a few.

Greenie said...

"Greenie, since Dink is not here, I'll take up his role today: why do you have to be such a putz? Do you speak for everyone with whom you may have some political agreement regardless of whatever they do?"

Dear Thai,

Your host may be a nice fella, but he is either a committed commie or does not know what he is talking about. 'Sustainable growth' is commie lingo promoting Malthusian ideas. Do your own research and tell me.

You probably never lived under communism. I know them too well to remain silent. The article about Oregon was posted to show you the real nature of the commies, and I saw the pattern so many times in my life that I lost count. Commies always start with bad economics. When it hits their paycheck, they come up with another theory. At the end it may be that they are saying the exact opposite of what they started with.

In June, when crude oil price was over 150 and Hell was using that to say something must be done to avoid 'peak oil', I asked him at what price of oil would he consider himself wrong? Now it is almost 80% down and I am still waiting for an answer.

Edwardo said...

The odds are high that the dollar will remain the world's reserve currency for a time as the rest of the world lacks the will, and in some cases, the wherewithal,to challenge U.S. primacy, most of which, at this point, is due to fear of our military.

This guarantees continued U.S. profligacy to the point, where, for a whole slew of reasons I can think of, our currency collapses. Bank on that happening. So, in truth, the only reason that the dollar stays afloat (for the time being) is the existence of a vacuum. But nature, as you all know, abhors a vacuum. Can you hear the sucking sound? It's getting louder with each and every smidgen of quantitative easing, bailout, and fiscal stimulus.

Greenie wrote:

"In June, when crude oil price was over 150 and Hell was using that to say something must be done to avoid 'peak oil', I asked him at what price of oil would he consider himself wrong? Now it is almost 80% down and I am still waiting for an answer."

I have an answer for you which is oil will be knocking on its '08 highs sometime during Obama's first (only?) term. Sustainable growth isn't commie lingo, but it is an oxymoron, and according to the late, great and admittedly controversial ecologist, Garret Hardin, a rubbish idea.
But, it is no more a rubbish idea then the idea of persistent growth which crosses the border from terminally stupid to just plain old bat shit crazy.

Thai said...

Greenie- you are part of a 'we right now' even if you don't see it

And there are three ways of looking at Malthus- he was correct, he was wrong or a bit of both. I tend to take the 'bit of both' view. Malthus' fundamental idea of boundaries was not wrong at all as I think this anti- Malthusian video of Hans Rosling clearly illustrates (by the way, do you notice how fractal his software is? Way cool!)

Hans might say things are getting better (which they clearly are) BUT ONLY from a clear reduction in population growth rates (itself a result of improvements in health care with a corresponding improvement in the probability that any given child will survive thru adulthood). So the gain in third world wealth has clearly comes at the expense of shrinking family sizes. And while to many this may not seem a cost to many, I know quite a few people that would beg to differ and prefer not pay this price if at all possible.

... interestingly there is an odd 'self similarity' to what America is doing right now- accepting materialism today at the expense of tomorrow's children.

Anyway, Malthus' fundamental observation of limits clearly remains intact, even if the extremes he foretold have not materialized so far (mostly because he too misunderstood the power of cooperation).

Edwardo, good to see you back. And while I am loath to disagree with Hardin, I will in this particular instance.

I know you know Hardin is the father of my favorite dilemma The Tragedy of the Commons. But the truth is Hardin did not write at a time when the theoretical framework of how we cooperate in order to successfully compete was as well understood as it is today.

Further, Hardin's Malthusian views had a fundamental flaw based on a kind of linear logic view of humanity- that we are all the same. To Hardin, all people were equally impacting on the environment and our problems simply scaled up with growing populations.

The obvious flaw in his logic was that not all people require the same resources, etc... and a growth or shrinking of 10% of some people can have a much larger or smaller impact on the collective's resource utilization than a 10% growth of other people.

To make a biologic analogy in your own body: neurons, adipocytes (fat cells) and myocytes (muscle cells) have very different metabolisms (neuron's consume far and away the most resources). And there is a big difference in the quantity of adipocytes a 400lb person has and a 140lb person has.

The area where IMHO Hardin was spot on was in his use of the term 'aesthetics'- at some level the issues always got back to whose 'aesthetics' wins? And Greenie has every right to disagree with Hell's asthetics.

And I still buy the credit crunch argument. There has been a lot of quantitative easing so I guess a less deflationary credit crunch is probable and that is somewhat positive for gold- considering we still haven't hit a S&P of 600 yet (Hell's original projection) I guess it is a lot better place to park your money than the market.

Hellasious said...

re: sustainable growth and Peak Oil

OF COURSE "sustainable growth" is an oxymoron. That's why I say "sustainable" - period.

Peak Oil, in capitals, is pretty much a subject for minutiae-loving, hyper-ventilating self-styled "experts". If you had followed any of my comments on The Oil Drum some time ago you would know what I mean.

I am, however, convinced that peak resource extraction and utilization is a major problem. Please see Michael Klare's "Resource Wars".

I believe high price volatility is definitely associated with such inflection points. Small changes in marginal supply/demand have outsize effects on price.

jkiss said...

The treasury will shortly be in the position of borrowing more dollars than the ROW has, suggesting that interest rates will climb even as we continue with deflation. The only way out is for the us to print money (the fed buys treasuries); the increase in money supply will simply compensate for the dollars hoarded by various participants, presumably exactly what the treasury wants and the economy needs.

THere is no obvious reason why this wont work... and, US debt probably wont reach the level we were at at the end of WWII as % of gdp.

Joe said...

I do not think the USD will see the light of a 2010 day. The FED has put up almost 9 trillion to prop this mess up. The problem is, they don't have the money.

Foreigners got suckered by Wall Street corruption that has brought the global economy to its knees. As such, I do not believe they have the stomach for 9 trillion more phoney-fiat-dollars or the economy for it either.

This leaves only the printing press and hyper=inflation and a worthless USD. History is replete with examples of this. The US will fare no different.

Joe M.

Edwardo said...

Thanks, Thai, for the refinement of Garret Hardin's ideas. Yours seems a valid and pertinent point, namely that some of us tap the resources of the planet more deeply than others. But I wonder if even when such an idea is taken into account, if globally, things are, as they say, a wash, and therefore Mr. Hardin was/is still more or less on target about the idea that sustainable growth is unachievable even absurd. I hope you are correct that on this question, Mr. Hardin's work is incorrect due to new developments in our understanding of how humans behave.

Regarding gold, I would direct you to Jim Willie's latest at Financial Sense. He doesn't write well, but I think you will still be able to parse what he is saying with respect to the inflation/deflation debate and gold.

Now excuse me while I rant briefly:

Gold must be the most misunderstood single commodity in existence. It's quite something to witness the ignorance (I am not speaking to anyone in particular) regarding its monumental importance.

It is, for a whole host of reasons that I have discussed here before, the only tether we have to honest dealings where money is concerned and that's just for starters. The U.S. government is profoundly aware of the importance of gold which is why they employ, among others, J.P. Morgan as the Treasury's whore of choice to suppress the paper gold market. In the meantime, as the good ship U.S.S. Dollar totters just above the abyss, bright people around the world keep looking about for something to challenge the dollar as the world's reserve currency and yet they need look no further than gold itself.

Allow me to define money in the only way that matters, and in a way that I have not heard anyone else do:

That item which maintains its value. That item which can purchase the same or more of other commodities (refined or not) over time. Stability is the sine qua non of a monetary unit, or it should be.

Name one commodity, or monetary unit over the last decade that has performed this function better than gold? You can't.

The deterioration of the planet's monetary setup is in its death throes and not owning physical Gold is simply not an option. Here in the west supplies are dwindling as I write, so you'd better act fast.

Edwardo said...

A Refinement on my definition of money.

That item which maintains its value. That item which can purchase the same or more of other commodities (refined or not) over time. Stability is the sine qua non of a monetary unit, or it should be.

Instead of the word purchase let me substitute the world exchange. I can not go into any store and use my gold coin to "buy" an item. I must first exchange my gold coin for local currency and then I can by aforesaid item. A mere technicality for those who need such things.

P.S. Thai I replied to your latest over at my site.

Thai said...

Edwardo, at some level you are correct, it depends on how you define 'growth'. If you take a more 'stuff' oriented definition, some growth never works. If you tend to think of it in terms of 'change', we will always grow.

And remember, it is very rare to see a driver from oncoming traffic swerve on to your side of the road and collide with you VOLUNTARILY. It is ultimately the reproductive consequences of actions that determine whether we see more of them or not over the long term.

Edwardo said...

Yes, Change can always be relied on. That is not what I have in mind, as I'm definitely more "stuff" oriented.

Greenie said...

"Instead of the word purchase let me substitute the world exchange. I can not go into any store and use my gold coin to "buy" an item. I must first exchange my gold coin for local currency and then I can by aforesaid item. A mere technicality for those who need such things."


If I am Rip Van Winkled and dropped at an unknown place in the world 20 years later, I would like to have a bit of gold in my pocket than few US dollars (or other current currency) or a piece of copper. Gold is more exchangeable internationally than almost every other currency barring few, and there is no guarantee those currencies will be as acceptable few years later as now. That is the kind of calculation that makes governments and central banks hold a bit of gold in their portfolio. We, the small people, are just here to take a ride with them.

Greenie said...
This comment has been removed by the author.
Greenie said...

Thanks for the Jim Willie article Edwardo. I thought of buying physical gold for the last six years, but never acted on it. I bought paper gold and gold stocks from time to time, but did not get delivery of the thing at home.

Finally in the last three months, I figured that the time has come.

Thai said...

Hell said "...I believe high price volatility is definitely associated with such inflection points. Small changes in marginal supply/demand have outsize effects on price."

Hell, your flaw in using this statement to support at least the implications of the Peak Oil hypothesis is a classic Bayesian error (actually it the same trap the people who got us into trouble with CDS and CDO's made when their models had fixed assumptions). Were physicians to use this same logic they would end up in the lawyer's office every day.

Your statement may be absolutely true, it is the underlying assumptions that you bring into the statement that get you in trouble- what in medicine we call "pre-test probability:"

I am not opposed to using caution when it comes to wildly using resources generated over millions of years, and I am certainly in favor of conservation in all its 3 dimensional forms, but call a spade a spade.

Greenie and Edwardo, why not buy GLD?

wkwillis said...

I favor the rebar standard over the gold standard.
Business booms, rebar gets scarce, interest rates go up, etc.
Business slumps, rebar piles up, interest rates go down, etc.
Predictable rates of money production because anybody can produce rebar and anybody can figure out what the costs are going to be.
And if your country wants to produce cheaper rebar because you are subsidizing it, the rest of the world will thank you instead of complaining. They will even sell you the iron ore, coke, scrap, rolling mills, etc, and accept payment in rebar!

yoski said...

"But can it happen unwillingly? That's not easy, either. There are vast sums of dollars being held abroad which cannot be converted quickly into another currency as one could do with, say, Zimbabwean dollars. The US economy is vast, comprising approximately one quarter of global GDP."

1. The US GDP numbers are more a product of creative accounting. Shoveling debt from one pile to another might increase GDP but it doesn't add value to an economy. It's smoke and mirrors and stupid foreigners will eventually figure it out.
2. Better have no world reserve currency that one that's being abused to the detriment of everybody else. Maybe gold or a basket of commodities will substitute for the dollar.
3. It all depends how far the FED and government will push the envelope. If they stop now the dollar will be fine. I doubt they're going to. They are getting addicted to debt. Everything and everybody will be bailed out. First with borrowed money, later with printed money. Even the dumbest foreigners will eventually catch on.
We might be in a dis-inflation period for many years but ultimately the dam will break unless we restore financial discipline.

Camabron said...

All roads lead to hyperinflation through the crossroads of deflation.

Edwardo said...

Thai, in a realm as crooked as the paper gold market, one is playing with fire investing in an instrument like GLD, which may, someday, like Mr. Madoff's now infamous hedge fund, be found to not have that which almost everyone assumed was always there. In fact, there are some who make a reasonable argument that GLD is being used to suppress the price of physical. I am agnostic on that issue.

One's best best with paper gold is, in my view, not an ETF, but a junior producer with a good management team and proven assets. And if we do get hyper-inflation in full, the more levered they are, the better.

But the safest bet will always be, owning physical, but if one doesn't want to be bothered with all that try http://www.bullionvault.com/ I prefer them to the Perth Mint which is another storage outfit.

Anonymous said...

Dear Hell,

Robert Reich's blog today reminds us that far fewer people, (as a %, one presumes) now even qualify for unemployment insurance than used to.

Does that change your thinking?