From a primary dealer

[stone]

Apparently the quote below (that Warren Mosler posted) was  from a primary dealer. It does indicate that the "market big boys" don't believe that they can set treasury interest rates by "going on strike". Seemingly it is only politicians who believe that "the market" can do that.
http://moslereconomics.com/2012/01/20/f ... /#comments

"Preface. I generally subscribe to the view that in free currencies, deficits are mostly self-funding, and ‘enormous’ deficits needn’t be accompanied by higher yields. Government builds a bridge, pays the bridgebuilder, who pays the grocer, who eventually either buys the Treasury or deposits in a bank whose reserves are fungible vs T-bills via the intermediating Fed. Government dissavings and private sector savings are equal and offsetting, as long as the Central Bank has a working spreadsheet and an interest rate target. Yields are just a function of duration needs of savers vs borrowers, but the AMOUNTS always match up. Likewise, I don’t believe that the creation of bank reserves is inflationary or hyper-inflationary; bank lending is capital – not reserve – constrained. Loan officers don’t check the vaults. There is always enough. I continue to marvel at the armies of deficit vigilantes who take aim at Treasuries and JGBs, armed with Gold Standard thinking or even the latest Reinhart/Rogoff, only to retreat 2-3 year later. It didn’t work shorting US Treasuries in 2009-2010 for the ‘money supply’ or ‘deficit spike,’ and that roadside is stacked with corpses. Even the Home Run deficit vigilante hitters who nailed Europe this year (and Europe is, for now, operating as a quasi-Gold standard and an entirely different set of risks) offset those gains with losses betting the other way on the US, UK, and Japan. It’s evident in the returns."

[moda0306]

I've come to the conclusion that inflationistas fall into 2 camps.  Honest, sometimes incredibly smart people who simply don't understand a couple of fundamental driving factors of monetary system (which are so simple that it can sometimes be glossed-over), and opportunists trying to sell you something.  I think certain aspects of macroeconomics and fiat currency are so counter-intuitive to someone who's spent their entire life analyzing USERS of currency, not ISSUERS of currency, that it can be a tough nut to crack to get them to change their perspective.

It's a shame because where Peter Schiff and Ron Paul have good points to make about the morality of government intervention, the completely fall flat on their face when it comes to understanding the drivers of inflation in our currency, and have proven so since 2009 & 1981, respectively. 

But of course, maybe Japan and the US will be left with some kind of debt-disaster and I'll be eating my words.  Glad I own a home and hold gold.

[MediumTex]

I've come to the conclusion that inflationistas fall into 2 camps.  Honest, sometimes incredibly smart people who simply don't understand a couple of fundamental driving factors of monetary system (which are so simple that it can sometimes be glossed-over), and opportunists trying to sell you something.  I think certain aspects of macroeconomics and fiat currency are so counter-intuitive to someone who's spent their entire life analyzing USERS of currency, not ISSUERS of currency, that it can be a tough nut to crack to get them to change their perspective.

It's a shame because where Peter Schiff and Ron Paul have good points to make about the morality of government intervention, the completely fall flat on their face when it comes to understanding the drivers of inflation in our currency, and have proven so since 2009 & 1981, respectively. 

But of course, maybe Japan and the US will be left with some kind of debt-disaster and I'll be eating my words.  Glad I own a home and hold gold.

The question that inflationists always must answer is "where will the consumers get the money to pay higher prices if wages are not rising in lockstep with prices?"

In the U.S. there is almost no upward wage pressure across the whole economy because so many other international labor markets are so much cheaper than the U.S.  Thus, it is very unlikely that there will be any significant rise in average wages any time soon, which means that price increases across the whole economy will be met with demand destruction, not a wage/price spiral.

There will clearly be some inflation--the question is whether it will lead to a recession (and a resulting fall in prices) or a wage/price spiral (and a sustained level of high inflation).  My bet is it will be the former.

[moda0306]

Well MT they simply jumpt to the rejection of currency, causing a hyperinflationary depression...

I wonder, too, how milk will cost $20 per gallon if we don't get huge raises (unless we have a mad cow disease epidemic or something).  Basically, unless we see a huge drop in our productive capacity, the idea that these prices manifest themselves seems far fetched.

One possible explanation is the rejection of our bonds/money from overseas, but do the inflationists really want to go down that road?  China (and the rest of the world) have 3 options with the cash they've acquired:

1) Buy our bonds, so they earn some interest, even if it's negative in real terms.
2) Hold the cash... even worse for them than buying ST bonds.
3) Buy stuff from the U.S... where we see the crippling return of cash from overseas to buy our products instead of the other way around.

So the only way that foreigners can reject the currency we've sent them is to send it back in exchange for our productive capacity.  That sounds more like "economic recovery" than "hyperinflationary depression" to me.

[MediumTex]

So the only way that foreigners can reject the currency we've sent them is to send it back in exchange for our productive capacity.  That sounds more like "economic recovery" than "hyperinflationary depression" to me.

And wouldn't that mean that the value of the Chinese currency would rise as the value of the dollar fell, making U.S. manufactured goods far more competitive in the largest emerging market in the world (i.e., China)?

Isn't that precisely what China is trying to keep from happening by keeping the value of its currency low relative to the dollar?

It's a shame that there aren't people out there telling more nuanced versions of the inflation story.  There is more to it than most people think.

[moda0306]

It's a shame that there aren't people out there telling more nuanced versions of the inflation story.  There is more to it than most people think.

This sounds counter-intuitive, but I find it's almost letting our government off too easy to preach and buy into hyperinflation.  If you think hyperinflation will be the result of all our government's mistakes, the presription is relatively simple, so anyone who believes it can simply buy some real estate with a 30-year fixed mortgage, foreign bonds, a bunch of gold, and avoid LT bonds and they're set... brain: off.

But if you realize that our government can screw up, and the results are far more complicated than hyperinflation or even high inflation... and that our government may not be punished for its mistakes like a corporation would (higher bond yields), then it becomes a much more interesting game of truly trying to figure out what it is our government has done wrong, what sectors will pay the price, and how to protect yourself.

Who would have thought that the best way to protect yourself from a housing slump is to bet on the bonds issued by the very same government that you believe caused the housing crisis to begin with!!??  It's counterintuitive, but if HB understood it, then I think all hardened libertarian gold-bugs should at least give pause, in respect of one of the best champions of their cause.

[stone]

I guess the very real danger would be for the USA to fall into the role of being good for nothing apart from exporting commodities into a depressed commodity market. China might never choose to spend the USD on US manufactured goods. They might choose to spend them on grain and oil and iron ore etc. Milk might be $20 a gallon and the US median wage might be much the same as now and the milk might all get exported. Basically Africa, South America and Asia were in that position for the 1980s and 1990s. If all technological prowess gets abandoned and most of the US population gets cast aside then really there is nothing stopping that from happening.

[moda0306]

stone,

I see what you're saying but can we really imagine a world where China's using dollars to buy up short-lived commodities for something other than fundamental reasons?  Imagine China uses their dollars to buy up tons of food commodities...  I guess that could bring us to sectoral inflation due to the lack of our economy's ability to supply to that one area, but what's China going to do witha bunch of corn and wheat, if not feed people?  These aren't the best stores of value.... I guess they could run them through processing plants and have canned food that will last a very long time.

We have to get kind of creative here, don't we?  Would China really want to bid up the price of food to astronomical levels just to get some to store as a store of value, after which demand levels off again and prices collapse?

It just seems like we have to get to some really stupid decisions by China to result in inflation on our shores... decisions that they've been making the opposite of for decades to keep their economy running.

[stone]

moda, I'm not saying they would buy food to use it as a store of value. I'm saying they would buy it to cook it and fail to sell it in restaurants just as the USA etc currently does. China would turn its farm land over to horse paddocks and golf courses and import food etc in exchange perhaps for Chinese manufactured goods or perhaps by then just for Yuan treasury bonds.

[moda0306]

stone,

I see what you mean... well that would indicate to me a fundamental change in the preferences of the real economy, not some kind of hyperinflationary side-effect of QE.

You and I probably aren't arguing here... I just want to make clear that if this were to take place it would be a supply/demand phenominon that would have manifested itself as a result of Chinese prosperity no matter what.

[stone]

moda, I think such a scenario would be much more about what the USA (or UK or France or wherever) had done to itself rather than about increasing Chinese prosperity. I don't think it is unconnected to the increasing government debt/NFA phenomenon. It is all about the transition away from an economy based around everyone being an important customer. Basically the reason why the wealthy nations are wealthy nations is all down to wealthy nations having economies where everyone is an important customer. I think that financialization of our economy is causing that to break down and the financialization process is fed by the growing government debt.

[BearBones]

The question that inflationists always must answer is "where will the consumers get the money to pay higher prices if wages are not rising in lockstep with prices?"

In the U.S. there is almost no upward wage pressure across the whole economy because so many other international labor markets are so much cheaper than the U.S.  Thus, it is very unlikely that there will be any significant rise in average wages any time soon, which means that price increases across the whole economy will be met with demand destruction, not a wage/price spiral.

There will clearly be some inflation--the question is whether it will lead to a recession (and a resulting fall in prices) or a wage/price spiral (and a sustained level of high inflation).  My bet is it will be the former.

OK, while I too would bet on recession ahead, I just don't get how you consistently equate lack of US jobs (in a world economy) with deflation. I can see deflation in that which is bought with debt (houses, autos), and I can see deflation in that which is purchased with discretionary spending (iPods, TVs). But with 7 billion (going on 10) mouths to feed in the world combined with mounting energy costs (the easy stuff is being exhausted), why can we not reach a state where prices of such necessities as corn, wheat, rice, gasoline, lumber, and steel rise even when the US in in a slump? Too many people + too few resources to go around = inflation.

I'm not challenging you. I'm just missing a big link. Explain.

[stone]

Bearbones, I think the point is that for an advanced wealthy country such as the USA, commodity prices actually do not make up much of final consumer prices. The cost of milling, baking, transporting and selling bread means that the international price of wheat has much less impact on the bread price than the cost of US labour etc. So unemployment can depress wages and depress prices even whilst international commodity prices increase in USD terms.

[stone]

If you were to have looked just at raw commodity prices, then 2010 would have had near hyper-inflation with some 30%+ increases.

[MediumTex]

If you were to have looked just at raw commodity prices, then 2010 would have had near hyper-inflation with some 30%+ increases.

Most raw commodity price spikes are followed by price collapses as the market is flooded with new supply in response to the perception of easy money.

The only time this doesn't happen is when you have a true bottleneck on new supply such as the world has seen with oil beginning around 2005, where price signals no longer generated new supplies on world markets, and that's why world production of conventional oil has basically been flat for several years now even though any new supply can be sold into a market that will pay $100+ per barrel.  The fact is the world has the oil spigot wide open and what is currently being produced is about all we can do.  New supplies will come online, but the new supplies must outpace the decline rates of existing fields, and this is the race we have been losing for several years in the conventional oil space.

[BearBones]

Bearbones, I think the point is that for an advanced wealthy country such as the USA, commodity prices actually do not make up much of final consumer prices. The cost of milling, baking, transporting and selling bread means that the international price of wheat has much less impact on the bread price than the cost of US labour etc. So unemployment can depress wages and depress prices even whilst international commodity prices increase in USD terms.

But the cost of production, milling, baking, transporting, and selling bread is significantly impacted by the price of energy, isn't it? So if demand continues to increase with world population growth, and if energy prices continue to rise (as it invariably eventually will), why should inflation and recession remain mutually exclusive?

One would think that bread would be less expensive since there should be plenty of millers, bakers, transporters, and merchants seeking jobs. But my experience has been one of inflated food prices over the past few years despite the miserable state of the economy.

[MediumTex]

OK, while I too would bet on recession ahead, I just don't get how you consistently equate lack of US jobs (in a world economy) with deflation. I can see deflation in that which is bought with debt (houses, autos), and I can see deflation in that which is purchased with discretionary spending (iPods, TVs). But with 7 billion (going on 10) mouths to feed in the world combined with mounting energy costs (the easy stuff is being exhausted), why can we not reach a state where prices of such necessities as corn, wheat, rice, gasoline, lumber, and steel rise even when the US in in a slump? Too many people + too few resources to go around = inflation.

I'm not challenging you. I'm just missing a big link. Explain.

I'm not saying that we are definitely going to get a long period of deflation.  What I'm saying is that the conditions that would be necessary for sustained high inflation in the U.S. are more farfetched than many believe.

The argument that there will be a general shortage of all commodities in the face of billions of new humans coming into the world is more involved than it may at first appear.  The important consideration with population is not necessarily how many people there are, but what standard of living those people are going to live at.  The world could probably support 50 billion people living in poverty and doing the "nasty, brutish and short" thing, while the world could probably not support much more than 2 or 3 billion people living like the typical American.  What seems to be actually happening is that the total human population is continuing to grow, but in the countries with the highest levels of productivity the population is flat or declining.  Thus, you have a deflationary demographic tailwind in the economies with the highest levels of productivity, while you have an inflationary demographic tailwind in the economies that are growing quickly but which are still much less productive than the more stable and mature economies. 

2008 showed us that when you see a crisis in the developed world it easily spills over into the developing world.  Thus, if the major economies of the world are facing deflationary pressures, I can easily see this overwhelming inflationary pressures in poorer economies, but it's obviously very hard to say which direction this will all go.  It's easy to imagine a situation with simultaneous deflation in the developed world and inflation in the developing world for many years.

[BearBones]

The fact is the world has the oil spigot wide open and what is currently being produced is about all we can do.  New supplies will come online, but the new supplies must outpace the decline rates of existing fields, and this is the race we have been losing for several years in the conventional oil space.

Exactly. Then add numerous "emerging markets" with their natural desires for increased living standards. Then add population growth; more demand for food, land, and other resources. Might throw in some catastrophes due to disruptions in the Middle East or in farming due to draught and the like.

Deflation?

[BearBones]

I'm not saying that we are definitely going to get a long period of deflation.  What I'm saying is that the conditions that would be necessary for sustained high inflation in the U.S. are more farfetched than many believe.

The argument that there will be a general shortage of all commodities in the face of billions of new humans coming into the world is more involved than it may at first appear.  The important consideration with population is not necessarily how many people there are, but what standard of living those people are going to live at.  The world could probably support 50 billion people living in poverty and doing the "nasty, brutish and short" thing, while the world could probably not support much more than 2 or 3 billion people living like the typical American.  What seems to be actually happening is that the total human population is continuing to grow, but in the countries with the highest levels of productivity the population is flat or declining.  Thus, you have a deflationary demographic tailwind in the economies with the highest levels of productivity, while you have an inflationary demographic tailwind in the economies that are growing quickly but which are still much less productive than the more stable and mature economies. 

2008 showed us that when you see a crisis in the developed world it easily spills over into the developing world.  Thus, if the major economies of the world are facing deflationary pressures, I can easily see this overwhelming inflationary pressures in poorer economies, but it's obviously very hard to say which direction this will all go.  It's easy to imagine a situation with simultaneous deflation in the developed world and inflation in the developing world for many years.

Well put. Between many of your posts and all of the head-spinning dialogue about MMT, I am increasingly unwilling to extricate all bonds from my portfolio.

[MediumTex]

Bearbones, I think the point is that for an advanced wealthy country such as the USA, commodity prices actually do not make up much of final consumer prices. The cost of milling, baking, transporting and selling bread means that the international price of wheat has much less impact on the bread price than the cost of US labour etc. So unemployment can depress wages and depress prices even whilst international commodity prices increase in USD terms.

But the cost of production, milling, baking, transporting, and selling bread is significantly impacted by the price of energy, isn't it? So if demand continues to increase with world population growth, and if energy prices continue to rise (as it invariably eventually will), why should inflation and recession remain mutually exclusive?

One would think that bread would be less expensive since there should be plenty of millers, bakers, transporters, and merchants seeking jobs. But my experience has been one of inflated food prices over the past few years despite the miserable state of the economy.

Here is a question for you: If it cost you over $100 in gas per day to drive to a job that only paid $100 per day and driving yourself was the only way you could get there, would you continue working there?

Increases in energy prices are ultimately deflationary, as they ultimately pinch all productive activity until there are no more surpluses in the economy to facilitate further economic expansion.  Ultimately, there is less of everything (including credit and disposable income) because many economic activities no longer make any sense when energy prices reach a certain threshold.  What happens in such a situation is that lots of people lose their jobs because the work they do is no longer capable of producing a profit with energy prices above a certain level, and this widespread unemployment means that there is less money available to spend across the entire economy, which leads to general softness in demand, which puts downward pressure on prices, etc.  In such a situation, it's obviously possible to get inflation if the government suddenly starts printing gazillion dollar bills like Zimbabwe did, but when you have financial interests as deeply entrenched in the political process and in setting monetary policy as we do, I just don't see that happening in the U.S.

I guess what I am trying to say is that the inability to produce oil within a certain price range is going to create more problems than just some potential currency devaluation.  In the early stages, it is likely to create some inflation as it did in early 2008, but the demand destruction that follows these energy price spikes tend to have more of a lasting deflationary effect than inflationary effect, especially when there is little upward wage pressure in your economy. 

In the longer term, of course, I think that energy prices above a certain threshold will begin to invalidate core assumptions on which the entire world economic system is premised, chief among them the idea that it is possible to have economic expansion into perpetuity when the resource inputs for that economic growth are of a finite nature.  In other words, finite resources can't be combined with human ingenuity to create infinite growth, even though it may have seemed that way for the last century or so. 

Another thing to keep in mind is that all inflation is transitory in that the value of the inflating currency will reach zero very quickly under any kind of sustained high inflation, while the underlying economic problem driving the inflation may remain.  In other words, over the course of a 100 year period starting around, say, 2000, it may be that by 2100 people will be sitting around saying "remember back when inflation was the biggest thing we had to worry about?" and they will all laugh nervously.

It may seem counterintuitive, but if you really think it through the idea of long term shortages of key commodities such as oil will ultimately lead to deflation, if you define deflation fundamentally as sustained economic contraction, and if you assume that in a contracting economy no one has much pricing power for anything, other than perhaps commodity producers, but even these businesses are normally nationalized or quasi-nationalized in a time of crisis.

Lots of moving parts in all of this. 

[MediumTex]

The fact is the world has the oil spigot wide open and what is currently being produced is about all we can do.  New supplies will come online, but the new supplies must outpace the decline rates of existing fields, and this is the race we have been losing for several years in the conventional oil space.

Exactly. Then add numerous "emerging markets" with their natural desires for increased living standards. Then add population growth; more demand for food, land, and other resources. Might throw in some catastrophes due to disruptions in the Middle East or in farming due to draught and the like.

Deflation?

All that is really necessary, I think, is to see how deflation could occur.  Once you see how it could occur, you see that inflation is not necessarily inevitable (especially in the developed world).

I'm not really arguing for any one outcome, I'm just trying to emphasize that no particular outcome is inevitable.

[BearBones]

In such a situation, it's obviously possible to get inflation if the government suddenly starts printing gazillion dollar bills like Zimbabwe did, but when you have financial interests as deeply entrenched in the political process and in setting monetary policy as we do, I just don't see that happening in the U.S.

Really? I thought that was the US policy toward deflation. Print until it goes away (OK, Moda and Stone, don't use this as another attempt to educate me about MMT).

It may seem counterintuitive, but if you really think it through the idea of long term shortages of key commodities such as oil will ultimately lead to deflation, if you define deflation fundamentally as sustained economic contraction, and if you assume that in a contracting economy no one has much pricing power for anything, other than perhaps commodity producers, but even these businesses are normally nationalized or quasi-nationalized in a time of crisis.

Lots of moving parts in all of this. 

Yes, I do see how shortages lead to deflation as defined by "economic contraction." You have explained that very well. But I also see how the "price" of the most valuable and necessary goods might increase at the same time, just as liquor might have in the early 1930s despite staggering unemployment. That price might be in dollars, euros, renminbi, bitcoins or just plain old human toil, but it increases nonetheless if demand outpaces supply.

So, to answer your question, I would not drive to work. But I would still need to eat, buy some clothes, have meager shelter, and feed my mules. And so would everyone else in the world.

Lots of moving parts in all of this. 

Too many for me. I'm a one cog man.

[stone]

Bear Bones, I think you have hit the nail on the head as to how inflation and deflation can act simultaneously. I suppose a bit like someone having a "mixed episode" of mania and depression. Some items such as anything exportable may become totally unaffordable whilst at the same time other things may become dirt cheap. Consider a typical person in Kenya today. For them a tank of gasoline would be an unimaginable expense BUT they could easily afford to pay a night watchman to stand guard all night outside their shop. Kenyan labour is worthless in monetary terms. For us, the danger is that US or UK labour becomes worthless in monetary terms. If labour retains its value then resource constraints will be delt with IMO. When oil runs out we have a choice, either people stand idle in poverty or they build renewable energy systems to provide all the energy everyone needs.
Perhaps, oil reserve scarcity doesn't really change things. Even if there was plenty of oil the choice then would be between having people standing idle in poverty or digging more oil wells. Saudi Arabia does still have lots of oil. They set the World oil price to be whatever they want it to be by either switching oil wells on or off. I guess the difference in the 1980s was that then US production was able to limit the Saudi's ability to do that.
When Medium Tex talks about "productive" nations I think that boils down to countries where labour has value because everyone is an important customer. That is just an issue of what the wealth distribution is. If someone is pennyless, then there is no point in providing supplies of energy etc for them as they won't be able to pay for it. By contrast if someone is wealthy then it will make financial sense to employ unemployed people to build systems to provide them with energy. We have a simple choice. Either we can be wealthy and employ each other to provide each other with what we need or we can "tighten our belts", "suck it in" and stand idle.

[BearBones]

Bear Bones, I think you have hit the nail on the head as to how inflation and deflation can act simultaneously.

Thanks for your replies, Stone and MT. Since this is getting off of the original topic and off of the topic of bonds, I started a new discussion:

http://gyroscopicinvesting.com/forum/ht ... ic.php?t=8