A 5th Economic Condition?

[moda0306]

Doodle,

Further, to contrast the dollar with the Euro & Greece, here's how they are in a bit of a pickle that we are not (not that you haven't already acknowlged the difference between our currencies):

Unlike us, there CAN be a net-divestment of Greek bonds without spending euros in Greece.  China could say, "these things suck," redeem their Greek bond when it comes due, and either buy a German car or a German bond in Euro's with the proceeds.  That means Germany received the economic benefit of the foreign net-divestment of the Greek bond.  Nobody, now, in that chain of euro sales has to spend in Greece or buy a Greek bond.

Not so in the U.S.  If the foreign community wishes to net-divest itself from the US bonds, it has to net-divest itself from US dollars (unless they want to earn zero interest and keep them)... and to do that, they have to spend their money here.

This sounds too simple for such a complicated system, but I can't see any other way around it.

[MediumTex]

You know why this forum is so unique? It is because it is about dialectic and not debate. It is like everyone here has been schooled in the Socratic method. Washington politicians would do well to observe the way that issues are hashed out here.

I'm going to digress here for a moment, but doodle's comment above reminds me of how often strangers on the internet can quickly move to being rude to one another.

It only takes a little extra effort to be polite, civil and respectful, and the benefits are enormous.

I appreciate everyone here who seems to share my belief in this style of discussion.

The search for truth is much more fruitful when people are in a rational (as opposed to emotional) frame of mind.

I think some people count it as a positive that they will get in a person's face and tell them they are full of shit if that's what they are thinking, but to me that sort of thing is really more like intellectual bullying and does nothing to further anyone's understanding.

I just think it is SO important to validate other's beliefs and opinions, not necessarily because you think they are correct, but because you hope to receive the same courtesy from them, and then the strength or weakness of the ideas can stand or fall on their own.

I like the practice in competitive table tennis of not accepting a point if you didn't think it was clean, even if the referee awards it to you.  I think that approaching discussions about controversial issues with this sort of mindset allows the right outcome to naturally emerge, assuming, of course, that you are engaged in a discussion with other who have similar beliefs about good sportsmanship.

I don't have many really good discussions like we have here with others in the real world, either because they aren't bringing anything to the discussion that I haven't already thought through, or because they are so obnoxious about their beliefs that I realize that nothing they could possibly hear would change their mind.  I'm always on the hunt for good discussion, though, and occasionally I do find it, often in surprising places.

Thanks to everyone here who helps to make this a friendly place to talk through all manner of interesting subjects.

[moda0306]

I still can't believe it to this day.  I can't have face-to-face conversations this productive 95% of the time.

How this exists with all the natural disadvantages of an internet forum (usually the most obnoxious somehow gain control of the debate and hijack the whole thread) is beyond me.

Also, it'd be one thing if we were on some hobby forum or somewhere where the membership walked to the beat of the same drum... no... it's an economic (and political) forum that has more diversity of thought than I've ever seen among smart people.  Smarts aren't everything though, and many here have a deep desire not only to articulate their own position, but to be open to other peoples' ideas and observations and learn from it all.

The nature of the PP really does lend itself to the membership make-up, but it's still kind of funny to see it all just "work," just like the PP itself.

[AgAuMoney]

Really? The money just happens to come rushing out of the Fed's ass in one gigantic money fart?

Really?  That's the best you can come up with?

You do realize there are dozens if not hundreds or thousands of ways to get new money into the economy, don't you?  It just has to become politically expedient to do so and it would happen.  To continue your metaphor, it would be money diarrhea.

As Bernanke himself said, we have the printing press, and money could be dumped from helicopters.

Or since it is the BEP that prints money, it could be delivered by the post office or national guard or active duty military with their choppers.

Or the president or congress could declare a withholding tax holiday plus have employers give their portion out with the payroll.

Or the Fed could direct all their member banks to pay large dividends to all account holders.

Or the gov't could decide to rebuild all gov't facilities in every city, not just Wash D.C.

Or the Fed could institute an ATM lottery at all member institutions -- every n'th transaction is a winner and you get 10x your transaction in cash!

etc.

In our FIAT monetary scheme there is no limit to the amount of money that can be created if it becomes politically expedient.  (Bernanke again, and Greenspan has said similar.)

[AgAuMoney]

"China has no choice but to keep buying," said Zhang Ming, an expert at the Chinese Academy of Social Sciences, a Beijing research group. "After all, U.S. Treasury bonds are still the largest and most liquid investment product in the world."

If you're the kind of person that believes that China can dump our bonds, read this article. It explains how difficult (if not impossible) that would actually be.

"dump" as in quickly, no they cannot do that without hurting themselves immensely.  But if the choice is between "get a little bit by dumping now" and "get nothing by waiting" I'd be shocked if they did not dump.

Let current holdings mature and not renew, yes they can.

"slow" or stop purchasing, yes they can.  And they have.

In spite of allegations to the contrary in the NY Times article, the math and numbers I've seen do not add up to china purchasing at previous or more than previous levels, but they do indicate a sharp reduction in US Treasuries purchased over the past few years.

It is well documented by the Chinese themselves that they are buying other things with dollars rather than U.S. gov't securities.  It is well documented by the Treasury and the Fed that the Fed has been buying $Billions in treasury auctions because nobody else was.  And yes, I've seen analysts report that the 3rd parties have been buying on behalf of the Fed so Fed buying may be even larger than officially documented.  (It's true, but I had to throw it in there especially because that's what the NY Times did.)

[MediumTex]

I always thought that it would have made a lot of sense to just send out checks to everyone in the U.S. of about $5,000 or so quarterly until things started to improve.

A lot of this money would have been used to pay down debt, which means that it would have contributed little to price inflation and by going to the banks it would have helped them to repair their balance sheets.

Once this approach started creating serious inflation (which might have been quite a while given the overall deflationary effects of deleveraging) it could have been stopped.

Who knows how well it would have worked, but it couldn't have turned out a lot worse than what we have now.

[AgAuMoney]

There are manifestly not enough dollars to allow banks to honor their "promise" to hand you a FRN on demand since banks are allowed to leverage their deposits by about 10-1 (100-1 for CDs) against (usually long term) loans.  What this means is if more than 10% of a bank's depositors want their cash back the bank must run out of available cash (90% of the depositors' money exists only in the form of loan balances owed to the bank). If this were to happen, the action the government would take would be to close the bank under the auspices of the FDIC and (typically) sell its assets (the loans) to a "stronger" bank (stronger is in quotes here, since ALL banks are leveraged 10-1 against their deposits). 

It's actually MUCH WORSE than 90% loaned out.   

And if you look at the terms for any accounts you have other than a traditional checking account, you will notice that they claim the right to keep your money for some number of days after you notify them you would like it back.  That delay is there for the specific purpose of getting more currency available for you should it be needed.

[moda0306]

I always thought that it would have made a lot of sense to just send out checks to everyone in the U.S. of about $5,000 or so quarterly until things started to improve.

A lot of this money would have been used to pay down debt, which means that it would have contributed little to price inflation and by going to the banks it would have helped them to repair their balance sheets.

Once this approach started creating serious inflation (which might have been quite a while given the overall deflationary effects of deleveraging) it could have been stopped.

Who knows how well it would have worked, but it couldn't have turned out a lot worse than what we have now.

I agree, MT.  Also, I think a neat stimulus project would have been a switch to the metric system.  I often hear how difficult/expensive the initial plunge would be.  What better time to put engineers & sign post pounders alike to work?

[MediumTex]

Also, I think a neat stimulus project would have been a switch to the metric system.  I often hear how difficult/expensive the initial plunge would be.  What better time to put engineers & sign post pounders alike to work?

What a beautiful idea.

That would be a very elegant way of wasting an enormous amount of money.  Sort of like a thinking man's version of having one team dig holes and another fill them in.

The EU, in turn, could do a stimulus in the form of switching from the metric system to feet, inches, yards, miles, pounds, gallons, etc.

We could have exchange programs where people from the U.S. went to Europe to teach them about their new system and Europeans could come here to teach us about the metric system.  It would be a great cultural exchange.

[AgAuMoney]

The original quote talked about cash on hand, speculating (incorrectly, in my view) that banks have no more than $25k-$50k physical cash in the vault.

Yeah, that $25k-$50k business is nonsense.  Cash on hand depends on the size of the bank and bank policy.  And yes, some branches will have different amounts on different days depending on deposits and on payroll habits of nearby businesses -- some people and especially those doing certain kinds of work do seem to prefer cash on payday.

I used to bank with a credit union that explicitly did not have cash available for withdrawal.  However they did accept cash deposits.  For a couple of years I was making a twice monthly cash payment on an "owner will carry" deal and my teller friend almost always had thousands of dollars in the till (in hundred dollar bills no less).  If he didn't have it then, he would call me in a few days that he had the cash.  All I had to do was use the ATM to get cash out of my account ($20's) and he would exchange it for 100's.  Some times I wondered if the guy I was paying used the same credit union, because my teller friend would often call the day of or the day after I made my payment "just got a bunch of 100's in deposit, need any?"    Never did try to track serial numbers...

Another friend is a retired banker (just don't get him going on how lax standards are now with the big banks and the Fed vs. when he used to manage a small local bank).  When he was a small local bank ca. 1980 they used to keep about 10% of daily total cash flow in cash.  (Total NOT the NET cash flow is the amount of deposits added to amount of withdrawals.) He said they never even came close to running out of cash.  When they sold out to a big national bank the big bank cut the limit to less than half of that (I think it was 3% of daily cash flow) and they still never came close to running out.  (Most cash handled is business deposits.)  Sometimes they didn't have the exact bills wanted by the customer, but could make do or get it from other local branches in a few hours or else send the customer to another branch near by.

[AgAuMoney]

Anyhow, hyperinflation requires a severe loss of faith in the currency (well beyond my "Gee, fiat currencies are kinda silly, huh?" smirky objections.)  I am certainly not expecting this for the United States so long as the Fed maintains some semblance of reasonableness and independence.  Still, the Fed's Board of Governors is a very, very small group of people to put absolute faith in, so nothing's ever totally off the table!

Yup, but I would add that the Fed is only one party who could kick the legs out from under the US$.  China is obviously another.  And the US president is another, as is the US Congress.  I'm sure there are more.  (Look at how george soros and other large pools of money have been able to cause currencies to collapse.)

[AgAuMoney]

I know you were exaggerating a bit with the 18% but if long term rates were to even double you would have to question the survival of the system because at that point nearly 1/2 of tax revenues would be taken up servicing the debt.

That would be a "game over" scenario.

Really?  Would the U.S. not still be the largest economy in the world with the largest military, a relatively stable political system and enormous domestic deposits of natural resources?

With those structural advantages, I would say it's not game over, but rather GAME ON!

Probably if only 1/2 of tax rev were needed to service the debt.  But if rates went up enough that it becomes necessary to borrow to service the debt (rates at 4x to 5x over the next 12 months would do it, I think), then I expect the U.S. would default on its debt.

I LOVE the idea of a long term portfolio....a permanent portfolio but the home country bias to the US whcih is currently very vulnerable and exposure to LT treasuries after 30 years of declining rates are two issues that I see as dangerous.

Whoa!  The PP doesn't have home country bias, it has world reserve currency and safest bond market bias.  We just happen to be living in that country, which makes the PP an especially appealing option for the U.S. investor.

Harry Brown said many times and it has been repeated here and on Craig's site, that holding the US$ and US Treasuries and US Stocks is for US investors and that you should own similar things in your local economy if you are not an US investor.

[AgAuMoney]

Don't forget that all of that those Treasuries would still have to exist, held by someone, somewhere. They won't just disappear in a cloud of smoke.
...
Or I suppose China (and others) could stop buying US Treasuries, but that would mean that they aren't doing any business with the United States anymore. That would be detrimental to the world economy. End of the world as we know it.

The treasuries would not exist if the US were to default on the debt.  This default might be an outright repudiation (thanks for the money, sorry you won't get it back), partial repudiation (economic collapse and all that, we'll pay back 25cents on the dollar, you understand, don't you), or the more tricky hidden default thru devaluation of the dollar (easily cutting the debt burden by 50% if not 90% over the life of a 30yr treasury).

As for the world being devastated if China stops buying treasuries, I think you are too full of your own importance.  China could buy other things with their dollars or exchange them for other currencies.  Oh wait, they've already started doing that (stockpiling oil, gold, other commodities, buying mines and shares in mines, buying land and businesses, etc).  China could demand payment in other than U.S. dollars for some or all of their exports.  Oh wait, they've already doing that too!  China could diversify trading partners so the U.S. isn't life or death.  Oh they already did that!  (in 2010, china exported almost $1.6trillion but the U.S. was less than $400Bill of that:  http://en.wikipedia.org/wiki/List_of_th ... c_of_China, http://www.uschina.org/statistics/tradetable.html)

[AgAuMoney]

If we continue to depend on trillions in bond sales every year to prop up our deflationary economy and these bond sales are not well received by the rest of the world because they are interested in other more lucrative avenues for their money, then we have an issue. Is the Fed going to continue to expand its balance sheet?

This same process is unfolding all over the industrialized world. 

The EU, UK and Japan are in the same boat as the U.S.

How is the U.S. different from any of these other countries, other than having larger natural resource deposits and far more military power?

The U.S. is the world's reserve currency today, which means we are more dependent on other countries to hold our debt.  We have as much debt out there as the worst of the developed nations and the only thing holding us up is the reserve currency backed by our military.  (Natural resource deposits aren't going to help us much unless we exploit them, which if you following mining, timber, petro, etc. stocks you know what a negative climate the U.S. is for that sort of development compared to Canada or Mexico and points south.  We even paid incentives to Brazil (I think it was) to drill for oil off their coast instead of ours.)

[AgAuMoney]

Follow the money... if they're not buying the commodities from us, that means they're buying them from, say, Russia.  Now Russia has our dollars and has to buy the same bonds that China just redeemed.

Great point.

On the whole I do expect most of the dollars to be invested.  But why would you expect it to be into bonds?  Why not stocks, companies, land, etc?  Or are you of the school that every dollar that exists is only because of a U.S. Treasury?  (Some people do believe that and they have a cogent argument.)

[AgAuMoney]

Not so in the U.S.  If the foreign community wishes to net-divest itself from the US bonds, it has to net-divest itself from US dollars (unless they want to earn zero interest and keep them)... and to do that, they have to spend their money here.

There are quite a few other countries in the world using the U.S. dollar instead of their own system.  They are all small and I'd guess probably the sum total of their economies is hardly significant...  rather like the smaller countries using the Euro whether as part of the EU or independent.

Again, I don't understand your fixation on US bonds.  There are many other places to stick dollars where they can earn a return.

[moda0306]

MT,

I was actually serious... I guess I think/thought that our non-conformity with a metric system causes inefficiencies that it's been thought should be wiped out by having everyone on the same system accross the world.

[AgAuMoney]

I agree, MT.  Also, I think a neat stimulus project would have been a switch to the metric system.  I often hear how difficult/expensive the initial plunge would be.  What better time to put engineers & sign post pounders alike to work?

Been there, done that.

It was in the 1970's. 

[AgAuMoney]

2. Sustained upward inflation requires wage growth, even if the wage growth reflects no real wage gains, and even if the wage growth doesn't even keep up with rising prices.  ...

With respect to the second point, I am surprised at the number of people who openly scoff at this point of view, even though it is perfectly consisted with and supported by reality.

That would be me, except I've found it isn't consistent with and it is not supported by reality unless you use non-traditional definitions of "wage growth" and "sustained."

wage growth is per-capita.  And I think 10years is plenty sustained and even 5 years really hurts.  What definitions do you use?

Sustained inflation has been supported when the society experiencing inflation has no or even negative wage growth, but sufficient buyers in other societies increase spending sufficient to support prices.  (weimar)

Sustained inflation has been supported by consuming savings and by increasing debt.  (weimar, argentina, brazil, zimbabwe)

Sustained inflation has been supported by declining standard of living (fewer and then no luxuries and even descending into starvation).  (weimar, argentina, brazil, zimbabwe)

Sustained inflation has been supported by people working multiple jobs and/or putting more people to work (women then children instead of school and/or partnerships and co-ops) instead of supporting idle hands.  (argentina, brazil, zimbabwe)

Sustained inflation has been supported thru the support of family and friends in other areas.  (zimbabwe)

These are reality and have been experienced dozens of times in the 20th century, and innumerable times before that in countries of every size and stage of development.

Don't count on wage growth to warn of or as a requirement for sustained inflation.  It may happen, it may not.

[moda0306]

AgAu,

Ok even if it's not bonds, let's just look at money-flow.  Dollars in foreign hands can only be used for so many things... the options for that are for foreigners to 1) buy our treasury or corporate bonds, which are always in some sort of equilibrium with each other based on duration and default risk, 2) buy stuff from us to get rid of their cash (our steel, products, tanks, etc), or 3) invest in our stocks, buy some land, open a factory in the US, etc.

To decide whether they'll do option 2 vs option 3, they'd probably try to figure out how healthy our economy is going to be in the future... the foreign investment would not necessarily assume no inflation, but the disastrous mass-divesting of the dollar and collapse of our economy probably wouldn't happen alongside China using their dollars to try to spur on economic growth in the US buy investing here.... kind of like to hedge against disastrous inflation you and I buy gold, not US stocks.

The foreign investment in the US, in a way, is just another form of their consumption of US goods.  Whether China sends $1 Billion to the US to build a factory or $1 Billion to the US to buy our widgets, I'd imagine, are both going to have the same general effect on our macro-economy in the medium-term.

[doodle]

AgAu, that was a crushing counter-attack! It was like an online Tet offensive from out of the blue.

Moda,

What happens if the Chinese just use their dollars to buy productive assets? Could a country make a hostile bid for Google, GE, Boeing, or Nike? Could they buy Pebble Beach?.....or did the Japanese already buy that?

Once they own the asset, what is our country left with? We just have tons of dollars.

If everyone is looking to exchange dollars for hard assets because Bernanke is making it rain money from aboard his helicopter...isn't that precisely the conditions that lead to hyperinflation?

I see no end to fiscal deficits on the part of the government. Even the most extreme austerity plans (the Ryan plan) still have us running trillion dollar deficits for another decade. Who is going to be buying all of these bonds? Where is the market at current negative yields?

[doodle]

What happens if we remove the international element for a moment and look at this issue just from a domestic perspective.

Let's say we have an economy that produces 10 units of something.

At the same time there are 10 units of money in the system.

In this system 1 unit of money = 1 unit of something.


Lets say that the real economy (production of services, stuff, etc) grows at 2 percent every year, but the units of money grow at 10 percent every year.

Year 2:  11 units of money will equal 10.2 units of stuff.

Year 3: 12.1 units of money will equal roughly 10.4 units of stuff.

year 4: 13.3 units of money equals roughly 10.6 units of stuff.

So in four years you have 30% inflation more or less. If growth of money supply is at 10% and economic growth of products is at 2% doesn't this cause inflation?

Under this scenario wouldn't interest rates have to rise from present levels?

[MediumTex]

Sustained inflation has been supported when the society experiencing inflation has no or even negative wage growth, but sufficient buyers in other societies increase spending sufficient to support prices.  (weimar)

Sustained inflation has been supported by consuming savings and by increasing debt.  (weimar, argentina, brazil, zimbabwe)

Sustained inflation has been supported by declining standard of living (fewer and then no luxuries and even descending into starvation).  (weimar, argentina, brazil, zimbabwe)

Sustained inflation has been supported by people working multiple jobs and/or putting more people to work (women then children instead of school and/or partnerships and co-ops) instead of supporting idle hands.  (argentina, brazil, zimbabwe)

Sustained inflation has been supported thru the support of family and friends in other areas.  (zimbabwe)

These are reality and have been experienced dozens of times in the 20th century, and innumerable times before that in countries of every size and stage of development.

Don't count on wage growth to warn of or as a requirement for sustained inflation.  It may happen, it may not.

In the U.S. people have little to no savings to draw down and credit is contracting, so the basic tool to respond to rising prices here will be wages. 

If wages are not rising, I don't know where the money will come from to pay higher prices.

With respect to big ticket items like houses, I also see zero catalysts on the horizon for increasing prices.

In general, how do you see a period of deleveraging accompanied by economic contraction leading to a sustained upward spiral in prices?

I see cyclical periods of inflation leading to more economic contraction, which will bring prices back down, as we saw in the first half of 2008.

As far as women and children going to work, in an economy that already has 9%+ unemployment, I don't know how much success these groups would have entering the workforce.

Can you point to a prior experience with a modern industrial economy in which a credit fueled asset bubble burst and created basically deflationary economic conditions in which there was a sustained upward spiral in prices?  I am not aware of any, but you may know of one.

What would it take to convince you that we are in a multi-year deflationary period in which there is likely to be lots of slack in the economy and not much pricing power for anyone?

I agree that there is inflation here and there, but if the amount of money available for people to spend across the entire economy is static or declining (due to static wages and increasing unemployment) I don't see how high prices will get any traction.

What would you say are the key economic differences between the U.S. and Japan today and the U.S. today and the U.S. in the 1930s?  I'm trying to rationalize how we would get inflation in the U.S. today when Japan today and the U.S. in the 1930s encountered deflationary conditions following the bursting of their respective credit fueled asset bubbles.

[MediumTex]

Whoa!  The PP doesn't have home country bias, it has world reserve currency and safest bond market bias.  We just happen to be living in that country, which makes the PP an especially appealing option for the U.S. investor.

Harry Brown said many times and it has been repeated here and on Craig's site, that holding the US$ and US Treasuries and US Stocks is for US investors and that you should own similar things in your local economy if you are not an US investor.

I wasn't suggesting that non-U.S. investors should use treasuries and U.S. stocks.  What I was saying was that the PP only has an inherent home country bias because that's the way it is designed.  For the U.S. investor, though, the PP probably works best, since it is able to use the world's reseve currency and the world's safest bond market for its assets.

[doug6zj9]

What I was saying was that the PP only has an inherent home country bias because that's the way it is designed.  For the U.S. investor, though, the PP probably works best, since it is able to use the world's reseve currency and the world's safest bond market for its assets.

Harry specifically said; the US $ was the worlds #1 currency and gold was the #2.  Still true I think.