Canmo, you ask a good question and I think you suggested an answer. I don't disagree with your observation. It has been hard enough for me to get my mind entirely around these issues framed in the domestic context. Of course the international ramifications of our monetary policy, becuase we are the world's reserve currency, the world's largest economy, is very important. For good discussion of these issues, look at papers by Bob Mundell, who focuses on international monetary interactions and capital flows...he is now advising China. I have tried here to make my comments about monetary policy and money in this thread as clear and simple as possible, in order to communicate understandable principles and point out general misunderstandings....it is true as you say that all these issues play out in a more complicted international system. I don't use the international complex system in my discussion becuase it would quickly become imponderable and destroy my goal of simplicity in discussion. But, since we have come this far together, let me add a couple of points. The world financial system is of one piece now, so that many assumptions of old economics (20th Century), that consider a domestic system as a closed system, now no longer operate. We are now operating in a whole world system. U.S. deflationary monetary policy during the late 1990's collapsed the Asian monetary systems that were tied to the dollar. Our Fed was managing our large economy with no consideration how our domestic monetary decisions would effect smaller less mature and diverse economies that had pegged thier monetary policy to ours. The Fed, under Greenspan, then advised that it is simply not thier problem, and that these countries should let their currencies float and not tie to the dollar...so we saw the Argentina peso collapse, the Thai Bot, the Indonesian Ruppee, the Russian Ruble, all collapse (China suffered deflation during this period but stayed with thier peg)...we saw a generation of energy and strategic mineral investment and production capacity go into mothball, still limmiting our productive and distributive capacity today...all ramifications of our domestic monetary policy spreading like the Chilean earthquake energy impulse of Tsunami into Asia...only our effect was much more serious. Now we proceeding with a profound monetary policy adjustment to a credit collapse without the ability to predict the full effect throughout the world. After all, we were not able to predict that a small number of mortgage defaults largely confined to four U.S. states would collapse the value of all asset backed securities and so render the solvency of the whole world's banking system in question. It may be the nature of highly complex systems that they constantly border on disequilibrium and are so inherently unpredictable and vulnerable to outsized reactions to small failures. There is article about this topic in the present edition of Foreign Affairs, by Nial Ferguson that I recommend you take a look at. It is not clear how our current monetary policies will work out, and it is even less clear but more worrisome how our fiscal policies will work out but it is clear to me that there will be world wide effects...as we are now all of one system of capital, production and markets.
In my view, the mortgage defaults you mentioned were only symptomatic - not the cause of the crisis. What we are seeing is the natural progression of a fiat monetary system that is manipulated to maintain (in my view) an erroneous and faulty goal of perpetual economic growth at a certain arbitrary level. Furthermore, a fiat monetary system based on debt growth expands infinitely - and needs to do so or face collapse. In Mesopotamia, the Sumerians understood the concept of exponential growth and compound interest. In the second year of a new King, all debts were forgiven (debt jubilee) and the financial system began anew. Of course, it helped that the financial system was controlled and owned by the sovereign. We will learn the lessons of old the hard way. Or maybe not - we'll just wage war instead.
Ed, this time your answer looks much less clear , but I assume it's very complicated too.. What I liked in your previos 'simple answers' - how you illustrate a 'tarp' game and why it doesn't resolve 'lending&spending' problem. So, if I get it right, Fed just 'exchanged' non-performing loans for fresh piles of $ to banks, since banks are under threat of audit or clients run, and Fed isn't. Now banks start a 'new life' with Fed's $$, and Fed is OK too(since neither audit no client run on Fed is possible in near future).And, even leaving out the questions how FED is going to collect collateral of its 'toxic assets' or what if banks continue to create 'toxic assets' now same way and need one more 'tarp' round in next 2 years, banks still can't lend a new $$ ... oops , surprise-surprise. Even rates for new lending collapsing, netto lending is shrinking, because debt rates for nowdays is minor factor for borrowers, considering the rest of factors , like future profit outlook, counter-party risks, etc., and they decide to payoff old debt is a best investment now.. That actually what you call a deflation spiral(fix me if I miss it). But then - what a hell is going on with commodity prices, specially oil? Is that conspiracy or may be indication there is no deflation spiral(over the globe)? The real estate(except California, Florida , Michigan and Nevada) or cars arn't deflating too - if you take prices of 5-7 years ago, the current level is still and much higher. The prices of food aren't cheaper then 5 years ago.. May be there is deflation in some invisible- for me - areas, like heavy machinery, weapons, aircrafts? The services - like hair-cut, dentists, lowers, etc. - aren't cheaper than few years ago too.. So, all these graphs - of excess of $ - where we see it in everyday life? Clothes/electronics - that's really cheaper then 5 years ago, I agree. But is that so significant in % of overall spending that creates overall deflation?Or you suggest we will see a big sharp drop in prices on everything and his mother in coming months/years? But if it happens - a big sharp drop - with oil prices, all that bullshit 'green energy tech' - for example - will go bunkrupt a week after(which I personally want to happen) - and will bunkrupt many politicans too... I know, I ask your personal opinion now, not just basic description of fundamentals, but I'm just curious what you think.
The next time we're engaged in a BIG war (unlike the skirmishes currently in the ME), it will REALLY be about "an excuse to renege on our debts"...
I am afraid that is correct. Great Depression..........then WWII. As disgusting as it is war is good for the aggressor/winner. And yes I am quite aware the US wasn't the aggressor for WWII before I get flamed.
Canmo, thank you for the note. You do understand what I said and you recounted clearly. Itâs good to be understood. But then you ask what about deflation?...I don't see it in commodities and it is otherwise lumpy and inconsistent in other sectors. My view is that we are in a deflationary macro environment caused by a credit collapse and deleveraging response from the private sector. In response the Fed and other Western World CBs have attempted to reflate monetary policy to combat the deflationary trend. The price index that I follow most closely is the year on year core PCE (yoy Core PCE) that is published by the Bureau of Economic advisors. This is the index that the Fed pays most attention to...it is the best of the worst price index measure because it allows for substitutions. This index has been in a declining trend for a year now. Yesterday the January yoy Core PCE was published. It came in at 1.4%, down from a revised 1.6% in December back to September, 1.7% in August, 1.8% in July and 2% in June...you see the trend? This is in spite of all the Fed supposed monetary easing....which has simply resulted in a bloated balance sheet with no velocity. So, I say we are in a general deflation as reflected in the change of the yoy Core PCE that is being mitigated the attempt by the Fed and Western World CBs to prevent the deflation with low interest rates, QE of various sorts and a general injection of liquidity into the banking system that has not got out to the private sector but is simply funding an increase in sovereign debt or otherwise laying around as excess reserves. The phenomenon of excess reserves itself is an indication of deflation. The only predicates to our current level of excess reserves are the Long Deflation in Japan and the Great Depression...both deflationary episodes that followed a credit collapse. But you want to know how come this is not reflected in commodity prices. The reason is that monetary policy is only one cause of price change, it is not all causes of price change. Prices are also related to supply and demand imbalances. Monetary policy certainly has impacted investment in long term capital intensive projects of the sort required in the production and distribution of energy and essential mineral and chemical raw products...but the monetary antecedent cause is attenuated and deflected by other macro economic factors so that it is not an obvious cause of eventual price volatility in the energy, mineral and chemical markets. Today's volatility in these commodity markets is a result of a failure previous failure to invest in production and distribution infrastructure so that presently there is no capacity in these supply chains. Consequently these industries rely on price inordinately to mitigate supply demand imbalances. There simply is no longer any capacity in the system to absorb imbalances, so that the system functions more like an electric grid than a traditional energy or mineral supply chain. Consider that storage capacity for Oil today in the whole distribution system is the same as it was in 1980 even though the amount of oil in the system in increased by several factors. Right now, in the middle of a net world recession where demand for oil has fallen dramatically the oil industry never dropped below 96% capacity. On top of this problem there just are not enough long investments for investors. While debt assets are declining, sovereign debts are being written down, real estate securities are illiquid and may resume declining, commercial real estate is poised for a fall...what do you invest in. There is a tremendous shortage of long term investment assets that don't look like losers...and there are no short term yields. It is not a surprise that there is a demand for commodities that at least hold the illusion of tangible use value. Especially when they have become so easy to invest in by through ETFs. So, I say lack of capacity in the production and distribution of energy and strategic metals and other raw materials have created a situation where small changes in supply or demand are reflected in immediate price volatility. On top of this, I suggest that there is an intense demand for longer term tangible asset investments. This may be further driven in part by the liquidity injections of the Fed and Western World CBs that are all along trying to push money out the risk curve. I do not think the price volatility and increase in these commodities is caused materially and presently, by inflation or inflation expectation. I believe these prices are driven by supply demand factors exacerbated by investment capital flow imbalances that are themselves driven by the credit collapse and continuing deflationary macro trend. I don't think this comes to a good investment end though, for those who are buying these commodities now. As I expect this struggle between underlying deflation and CB sponsored reflation will eventually end on the deflation side. However, the struggle could go on for quite some time so it is hard to trade, especially when this view is not the market consensus and momentum seems to be going the other way. Then you wanted to know my opinion apart from explaining fundamentals. Well that is immediately above now, but let me make my opinion more clearly by telling you how I am trading this: I am short Oil through DUG, partly hedged by a long position in oil services. My present oil price target is $75...I add to short position/ reduce long position when oil is over $80 and I reduce short position/add to long position when oil is under $70. I have been doing this for almost a year with good results. I am short the European Banks through the EPV. Sovereign debt is a mess in both EU and US and the European banks are not as strong as the U.S. banks, the commercial real estate sector is much worse in EU and Middle East where Euro Banks are exposed, Club Med hurts banks either way, bailed out or not, austerity or default...itâs the same...the sovereign credits roll over but the private debt gets worse and eventually the sovereign roll over fails...so, I am short EU Banks for the long haul....may add to that position if Greek bail out pushes EU bank stocks up. I am short the Russell 2000 through TWM, because I expect domestic employment growth to disappoint, euphoria over inventory driven earnings to abate, and government revenues to continue to collapse driving fiscal fears and responses that are likely to result in a 'double dip.' As a hedge against these shorts I have some niche international longs...in China or selling infrastructure into Asia. All in all I am about 65/35 short.
In effect, yes. In my view debts are really a method to maintain or increase consumption of the world's limited resources. In the debt game, there are winners and losers. Some nations consume the economic output of others, other nations provide the consumption and their people get little in return. How? It all depends on your country's currency and military. Think about it another way - imagine a poker game with about 6 players - you're one of them. You're doing very well, three are losing a lot, and the other two are pretty even. Imagine if the one guy that was losing started making chips out of thin air to gamble with. All of a sudden, he starts taking your money. I'll interject: there are no formal international laws - just might. "International laws" are mere windowdressing, to be enforced when convenient by the powers. Back to the example: My prediction is the above poker game will not end peacefully. Just like in the wild west and in international affairs - when the game starts being rigged to one's benefit at the expense of the others - that's when the guns come out.
Ed, I admit I'm loosing a point . From one side - money excess in bank vaults, which is clearly indication of coming deflation(at list it was a case for 30's GD and 90's Japan. From other side - big question about oil prices to drop - because long-term investment demand, lack of oil infrastructure investment, etc.. But, oil prices affect all the industry, if it doesn't drop, the overall price decrease won't happen(or won't be sharp as in 30's) - which means no deflation. But, these 2 things can't coexist.. If you don't have money to pay, prices drop(or goods producer goes BK), but if prices don't drop (for those who stil have a money to pay), that means what? probably social unrest - in big - since many doesn't have money to pay and prices are still high(because of oil). Than what? Gov. guys know exactly what to do - they on one hand invest in oil(privately), other hand - extending unemployment - giving some money(from that excess $$ in vaults) to those who can't pay, and collecting 'oil tax' from everybody else who still cry but can pay(and, of course, finding some 'tarp' trick after to hide the debts somewhere in FED books)... Which is very easy solution for politicans, comparing one where they don't extend unemeployment . The only problem with that - it changes a country face at all in a couple of years - I personally hope it won't happen. But trading, specially short-time ,in this environment is a nightmare - imbalances are so big, every minor thing can be a trigger to investors to sell or buy.. The good point in all this - it's high probability(in my opinion) we will not see big growth in stocks for long term, and that is what we can bet on.
CR, you are payin attention...the latest money multiplier number published by the St. Louis Fed was .809...lowest in the history of the index. Here is some thing else, not so obvious, to ponder: deflation operates to make debt more expensive to pay off. This fact will be a hardship for the most leveraged economic agents, particularly sovereigns. Imagine you are Greece and you expect, you are driven, to reduce the ratio of Debt/GDP. So you agree to cut spending dramatically, agree to a program of dramatic austerity, in exchange for new debt and a higher price but not as high as it might have been, so you can roll over your old debt. What have you really accomplished with regard to your objective, your agreement to reduce your debt as a percent of GDP? The numerator of the ratio will remain the same...say 12.7 but the denominator will decline in response to the austerity...say from 100 to 90...So, even though you think you are reducing your debt you simply move from a debt/GDP ratio of 12.7% to a ratio of 14%, even though you reduced spending and raised taxes to the point of riots in the street, but you will not meet your agreement and you will actually increase you debt as a factor of your economy....pretty bad substitute for a growth strategy.