PP = inflation

[Snowman9000]

The first concert I saw was AC/DC in 1983, and I believe that ticket was $12.75. 

Nice.  I didn't get around to seeing them until the Razor's Edge tour, which I think was in '92 or '93.

You guys are just kids!
I saw them when Bon Scott was the front man. 

Oh to be young again.  <sigh>

[MediumTex]

The first concert I saw was AC/DC in 1983, and I believe that ticket was $12.75. 

Nice.  I didn't get around to seeing them until the Razor's Edge tour, which I think was in '92 or '93.

You guys are just kids!
I saw them when Bon Scott was the front man.   

Oh to be young again.  <sigh>

Bon Scott was awesome.

One of the great front men in rock.  He was a gifted entertainer.

[brajalle]

I think Wonk did a great job of summarizing one of the better theories behind what's going on in our economy.  I do think one thing being missed is that there is downward pressure on the middle class' average wage.  The lower class already is around the floor, and those at the upper-middle and upper class have had strong growth.  Remove government employment (a large part of the middle class), and I suspect there are large swaths of both wage stagnation and declines.  That swatch of the middle class (the lower 2/3rds of the middle class) already saw household income stagnation the last 20-30 years, so downward trends are not entirely unexpected.  If people like Walker get their way, even the government (non-fed) sector may see declines.  The real untold story of the last 30 years is wealth redistribution. 

[Gumby]

Here's the kicker.  There's a mountain of cash piled up in the room next door.  For it to cause inflation, it has to find it's way back to our room.  Will it?  That's the million dollar question.

Harry Browne devoted some time to this on one of his investment radio show episodes. I'll see if I can figure out which episode it was... But, if I remember correctly, he said the idea of money leaving our shores was a myth. He stated on the show that there were only so many things that could happen to our money once it left our pockets and went to a Chinese company. When when we buy Chinese products, the money must always stay in the United States since it is always deposited in a US bank account (a Chinese company can't deposit US dollars in a Chinese bank). Then money either sits in that US bank account or:

• the money is traded for other currencies (Dollars still remain in the US)
• the money is invested in US companies (productive).
• the money is used to buy US Treasuries (less productive)

Even if the Dollars were used to purchase materials/goods, the Dollars would still never leave the US and would still wind up in one of the three choices above. So, unless I'm missing something, Harry Browne already answered the million dollar question. The money must always stay in our room because there is no pathway for the Dollars to get into the other room.

[AdamA]

What about foreign reserves in the form of US Treasuries?

[Gumby]

What about foreign reserves in the form of US Treasuries?

You mean the 3rd option?

• the money is traded for other currencies (Dollars still remain in the US)
• the money is invested in US companies (productive).
• the money is used to buy US Treasuries (less productive)

Where do the Dollars go? Follow the money. Treasuries can only be bought with US Dollars. Dollars always stay in the US. You can't have US Dollars in a Chinese bank. Think about it.

[Pkg Man]

I think Wonk did a great job of summarizing one of the better theories behind what's going on in our economy.  I do think one thing being missed is that there is downward pressure on the middle class' average wage.  The lower class already is around the floor, and those at the upper-middle and upper class have had strong growth.  Remove government employment (a large part of the middle class), and I suspect there are large swaths of both wage stagnation and declines.  That swatch of the middle class (the lower 2/3rds of the middle class) already saw household income stagnation the last 20-30 years, so downward trends are not entirely unexpected.  If people like Walker get their way, even the government (non-fed) sector may see declines.  The real untold story of the last 30 years is wealth redistribution. 

I think you may be confusing changes in the distribution of wealth with "wealth redistribution".  The total cost of all federal assistance programs - Social Security, Medicare, Medicaid, and various welfare programs - accounts for nearly one-half of all money spent by the federal government, doubling since the 1960s.  In addition, a smaller portion of the populace pay taxes now than 30 years ago. 

If you are counting on government to ensure a vibrant middle class, I am afraid you will be disappointed. 

[AdamA]

R

What about foreign reserves in the form of US Treasuries?

You mean the 3rd option?

• the money is traded for other currencies (Dollars still remain in the US)
• the money is invested in US companies (productive).
• the money is used to buy US Treasuries (less productive)

Where do the Dollars go? Follow the money. Treasuries can only be bought with US Dollars. Dollars always stay in the US. You can't have US Dollars in a Chinese bank. Think about it.

This is very interesting.  If true, I would think it greatly strengthens the argument against inflation...and for deflation, it today's economy.

[Gumby]

R

What about foreign reserves in the form of US Treasuries?

You mean the 3rd option?

• the money is traded for other currencies (Dollars still remain in the US)
• the money is invested in US companies (productive).
• the money is used to buy US Treasuries (less productive)

Where do the Dollars go? Follow the money. Treasuries can only be bought with US Dollars. Dollars always stay in the US. You can't have US Dollars in a Chinese bank. Think about it.

This is very interesting.  If true, I would think it greatly strengthens the argument against inflation...and for deflation, it today's economy.

I'm not sure I follow that logic. With all of the money having to stay put in the US, wouldn't that make inflation even more likely? I suppose it depends on how much of those Dollars are invested in Treasuries.

I really do wish I could figure out which episode HB talked about this phenomenon in. He does an excellent job explaining it.

[AdamA]

I'm not sure I follow that logic. With all of the money having to stay put in the US, wouldn't that make inflation even more likely? I suppose it depends on how much of those Dollars are invested in Treasuries.

To me, it implies that the money is already here, and not being hoarded abroad, waiting to come back and cause mass inflation.  Seems like the bigger risk would be that foreign lenders may try redeem the bonds and take back the principle, which be would deflationary unless the Fed opts to buy this debt...

[Gumby]

To me, it implies that the money is already here, and not being hoarded abroad, waiting to come back and cause mass inflation.

Except that the money is being hoarded here in US bank accounts and in US Treasuries. And new money is constantly being created. QE III will very likely start this summer. The supply of money is constantly being increased. There's no way to know when and how much of that money will go into general circulation.

Seems like the bigger risk would be that foreign lenders may try redeem the bonds and take back the principle, which be would deflationary unless the Fed opts to buy this debt...

Again... I think you need to follow the money. Warren Buffet has spoken about this myth many times. Once US debt has been created, it can't be destroyed — each Treasury bond just lives on until it matures. Buffet has often said that even if the Chinese wanted to sell their Treasury bonds, they wouldn't be able to because they would never be able to find another buyer of their size. They would have to somehow sell their bonds to other large countries and then the Treasury bonds would simply be owned by those other countries.

And even if the Chinese could somehow find another buyer for all of those bonds — which is virtually impossible — what would they do with the money???

They would suddenly have trillions of US Dollars sitting in US bank accounts, earning 0.1% interest and still only have those three options:

• they can trade those Dollars for other currencies (those Dollars still remain in the US)
• they can invest those Dollars in US companies (generally a good thing).
• or they can buy US Treasuries

Foreign lenders don't buy US Treasuries because they love them. They buy them because sometimes there aren't any other better options. That's just the nature of trade imbalances.

Either way, the money supply is created by the Fed and the money always stays in the US. Those Dollars can still be hoarded in US bank accounts or in US Treasuries.... or those Dollars can go back into circulation. But there's no way to know if Deflation or Inflation is coming because it depends on so many things. The trade imbalance is just a part of the problem.

[AdamA]

The supply of money is constantly being increased. There's no way to know when and how much of that money will go into general circulation.

What happens to money that never makes it into general circulation?

[Gumby]

The supply of money is constantly being increased. There's no way to know when and how much of that money will go into general circulation.

What happens to money that never makes it into general circulation?

I suppose stagnant would be a better description of that money. Money that is invested in Treasuries or just sitting in bank accounts rather than out in the wild buying up goods. As I said, HB does a much better job explaining it then I can. I figured out which episode HB talked about it in. It was the November 13, 2005 episiode (his final episode... or at least the last episode that was archived).

https://web.archive.org/web/20160324133 ... -11-13.mp3

I recommend listening to the entire episode, but you'll get the gist of it if you fast forward to 17min:40sec, and listen to the rest of the episode from there.

[l82start]

I really do wish I could figure out which episode HB talked about this phenomenon in. He does an excellent job explaining it.

has anybody ever made a transcript of the HB shows and made them searchable?

[AdamA]

Gumby--

I'll definitely listen to the episode.  Thanks for the insight and the informative posts.

Adam

[Wonk]

The supply of money is constantly being increased. There's no way to know when and how much of that money will go into general circulation.

What happens to money that never makes it into general circulation?

I suppose stagnant would be a better description of that money. Money that is invested in Treasuries or just sitting in bank accounts rather than out in the wild buying up goods. As I said, HB does a much better job explaining it then I can. I figured out which episode HB talked about it in. It was the November 13, 2005 episiode (his final episode... or at least the last episode that was archived).

https://web.archive.org/web/20160324133 ... -11-13.mp3

I recommend listening to the entire episode, but you'll get the gist of it if you fast forward to 17min:40sec, and listen to the rest of the episode from there.

I had a listen to the episode to find out what Harry said because I had a hard time believing he would make such a mistake.  I have so much respect for him and everything he's contributed to humanity, but he most definitely made a mistake in this episode. 

US dollars most certainly reside outside U.S. borders.  They're called "eurodollars."  http://en.wikipedia.org/wiki/Eurodollar

Also, one point about the trade deficit.  When a foreign exporter gets paid by a U.S. importer in U.S. dollars, it goes in a commercial bank account.  In this case, let's say it's a Chinese exporter.  So in order to repatriate the funds back home, the exporter exchanges USD for yuan through the Chinese central bank.  Since there is a net deficit, the Chinese central bank creates more yuan.  What should happen is the CCB sends the USD back onto the currency exchange markets and purchases yuan--which would allow the yuan to appreciate (less supply) and the USD to depreciate (more supply)--which would clear trade advantages over time.  Instead, the CCB has been accumulating USD and converting into the bond market to hold as a reserve asset.

It's true that China would have a hard time finding a buyer in size if they wanted to rid themselves of USD assets.  I think that's why they've been banning gold exports and accumulating precious metals on the sly.  When they can accumulate enough gold to emerge as a real player on the international stage, I think we'll see a profound change of course.

[Gumby]

Thanks for the clarification, Wonk. I certainly make no claim to expertise in this matter. I was just trying to repeat what HB and Buffet have publicly said on the matter. I'm constantly learning from this forum.

I can only suspect HB excluded Eurodollars because he felt they weren't relevant to his main argument — that Dollars must eventually be used in the US no matter where they go. He did get a bit political in that episode, so it's possible he glossed over the details to prove his point.

HB lived in Switzerland for six years, and even wrote a book titled, "Harry Browne's Complete Guide to Swiss Banks (1976)," so I'm sure he was very familiar with Eurodollars.

[Pres]

The supply of money is constantly being increased. There's no way to know when and how much of that money will go into general circulation.

What happens to money that never makes it into general circulation?

Banks use much of it to speculate in Asian markets and commodities, for example. Politicians hoped QE-money would flow into domestic enterprises but much of it is creating bubbles elsewhere. It's making food and energy more expensive, which brings us inflation, and causes famine and revolutions in countries that were until recently Arabian dictatorships and monarchies protected by the US.

Printing money like there's no tomorrow and doubling national debt in three years has all kinds of consequences and there's no end in sight.

(I'm no enemy of the US, I'm just a guy who reads Mish, ZeroHedge, GEAB, etc.)

[HB Reader]

Hi everyone,

This is my first post on this forum.  I've been reading it for quite a while, but have been too lazy to post anything.  The discussions are very good.

I had the enormous good fortune to begin reading HB's books back in 1974.  He was the most intellectually honest and consistent writer I ever encountered.

HB was correct in both a legal and accounting sense about the dollars never leaving the US.  The only way dollars can truly leave the US is as actual banknotes.  The Eurodollar market as we know it developed in the 1950's as a Soviet attempt to make their dollar deposits less succeptible to US intereference.  They were not really successful as every dollar deposit they held in London was covered by a corresponding dollar deposit in the name of the British bank on the books of a bank in the US.  They only made actually asserting US jurisdiction over the money a little more complicated in a practical sense.  In short, dollars never leave the US -- only the ultimate beneficial owners change through a series of debits and credits in bank correspondent accounts here.

I'm not a true expert on banking, but I did deal with this issue in a number of different contexts while administering asset freezes at the US Treasury Department from 1979 to 2003.         

[AdamA]

I'm not a true expert on banking, but I did deal with this issue in a number of different contexts while administering asset freezes at the US Treasury Department from 1979 to 2003.         

So what's your opinion...inflation/deflation or neither?

[Storm]

I kind of like this analogy - as the banker making deadbeat loans, I can't lose.  I either get paid back by the homeowner or I get paid full face value by the Bernank! 

[MediumTex]

Wonk,

Below are comments about your interesting analogy...

Think of it like this...

You, me and 8 other gyroscopic investing forum members are in a closed room with $100 in each of our wallets.  We all have backpacks filled with cool stuff and unique skills to trade.  Our economy starts to drag because moda can't pay his mortgage to Storm, who is the banker.  Moda is torn because he really wants to buy stuff, but he also wants to keep his house.  Ultimately, he makes a decision to stop paying...and feels much better.  Storm is pissing his pants because he's got many more Modas out there.

Okay, stopping right here, isn't it important to know what the ratio is of the value of goods in our backpacks to money in our pockets?  If I have $10,000 worth of goods in my backpack and $100 in my pocket it seems like it would be a lot different than if I have $10 worth of stuff in my backpack and $100 in my pocket.

Fearing trouble, the door busts open and in walks The Bernank.

If The Bernank is walking into our room that suggests he was previously in another room.  I think that the analogy would be more accurate if we assumed that The Bernank was in our room all along.

Storm pleads his case, The Bernank says he'll accept Moda's garbage note at par from Storm.  Storm stays solvent, Moda is out from under the debt and can now spend money in our economy again.

But wait, if we assume The Bernank was in the room all along, doesn't that mean that we have just shuffled bad debt from one pocket to another within the same room?

Additionally, The Bernank agrees to buy the government's bonds in an effort to create inflation for all 10 of us and keep asset prices high.

But what is The Bernank buying the government bonds with?  Isn't it just IOUs based on future production from our room?  In other words, all of the transactions have still only occurred in our room.  We may feel better, but no new money has entered or exited our room.  We now just have more future bills to pay.

Let's say he adds another $1000 of fresh cash to our room.

I assume you mean fresh debt, no?

So we should have $2000 in cash to chase the same goods and services.

Yes, there is $2,000 more floating around the room, but isn't there also $2,000 more debt floating around the room as well?  From a balance sheet perspective, aren't we in exactly the same position?  We added a debit and a credit to our room's balance sheet in the same amounts.

Added to that, the government issues another $1000 in bonds and spends it on God knows what to stimulate economic activity.  So now we're at $3,000.

What room was the government in?  Presumably our room--if so, wouldn't that be the same balance sheet dynamic of adding $1,000 in new debt, which means $1,000 more floating around to spend, but another $1,000 claim on future production? 

Prices should rise, right?

Why would prices rise if there is a drag on future consumption in the form of more debt to be paid off in the future?  In other words, we may have more money today, but by definition we will have less money tomorrow because we will have to service the additional debt (including the interest), which will pinch future consumption and thus we might expect to see a short term surge in inflation, followed by a longer term deflation, sort of like what we saw in early 2008.

But wait a minute!  Why aren't prices rising?  It turns out Pkg Man is a retailer who sources product from China.  He walks out of the room with $500 in cash, walks into the next room over and hands it to Mr. China.  Mr. China accepts his cash, hands him new product and Pkg Man walks back into our room to sell his goods.

Pkg Man has some packages. 

So.....what's going on in the next room over?  Well, Mr. China is printing money like mad to buy up all of the new money coming over from Pkg Man in an effort to keep room #2's currency peg advantageous for exports back to our room #1.  Turns out there's $100,000 worth of Bernank cash swirling around room #2, bidding up prices from commodities to labor.  But in our room, we only see a few things going higher, while our assets continue to deflate.

Are prices of labor in China rising?  How did The Bernank get in room #2?  Isn't there every reason to believe that the same dynamics that have driven down asset prices in our room (i.e., easy credit, misallocated capital and overcapacity) also poised to drive down asset prices in room #2 in coming years?

Here's the kicker.  There's a mountain of cash piled up in the room next door.  For it to cause inflation, it has to find it's way back to our room.  Will it?  That's the million dollar question.  The Bernank has committed to creating as much new cash is necessary to cause the inflation he wants.  Will it be orderly or will the room next door get fed up and send all of that cash back quickly?  Time will tell.

Isn't China in the identical position that Japan was in the late 1980s with enormous holdings of foreign currency and debt?  Wasn't the U.S. in the same position in the late 1920s?  When those situations unwound no one saw any inflation.

No doubt there are incredible deflationary headwinds.  What matters is The Fed's willingness to create new money at any cost (buying questionable debt from both private and public balance sheets) and the willingness of investors to accept fresh debt from the government to overcome the private sector losses.  If the will is lost in either case and the choice is to remove the floor, the party is over for asset prices.  Then I accept the deflation thesis.  If, however, the pedal stays on the metal, stagflation is a go and if not managed properly, a much worse scenario after that.

It still seems as if we are talking about spraying a fire hose into a tidal wave.  It may mitigate the damage a bit, but the idea that the fire hose could ever overcome the tidal wave is mistaking the strength of the opposing forces by orders of magnitude.  What is The Bernank doing today that the Japanese central bank didn't do in the 1990s?

The key, to me, is whether the consumer is interested in levering up again.  I don't think the consumer is in any kind of mood to get right back into debt.  The reasons for this are many, but one of the strongest is the historic demographic shift we are seeing right now--people entering their golden years simply have much lower spending needs than they had when they were in their peak earning years with growing families.  This dynamic alone is very deflationary (see Japan); when you add to the demographic shift the deflationary forces of credit contraction following a debt-based bubble bursting, you have a formidable deflationary one-two punch.

Note that every country in which we are seeing strong inflation right now has the opposite demographic situation that we have--they have TONS of young people relative to the oldsters, which translates into a very different consumption profile across those economies.  Who has the largest demographic bulge of people entering their peak earning years right now?  China, of course.  Is it an accident that China also has the world's hottest economy right now?  Nope.

[Storm]

Once US debt has been created, it can't be destroyed — each Treasury bond just lives on until it matures.

Actually, that's not really true.  If you read the speech that the great Bernank gave... all hail the great Bernank...  ::) he talks specifically about how they can reduce the money supply once inflation returns to the fed target rates.  Basically, when he wants to put on the brakes, to take money back out of the system, the Fed basically takes all of those US treasuries that they have been buying from themselves (QE) and destroys them, rather than cashing them in to buy more debt.  I'm not saying this is a good idea - I don't like QE, however, I'm just pointing out that a Central bank can both print money by monetizing the debt, as well as destroy money by taking it out of circulation.

If you subscribe to the belief that this monetary policy is good (and I don't), then a central bank's main job is to inject liquidity into the system in times of recession by monetizing the debt, and to take excess liquidity out of the system during times of prosperity by destroying it.

[moda0306]

MT, I really love 95% of the way you phrase things, but here's where I tend to view it differently.  The fed, when it "purchases" treasuries, you consider paying debt with more debt.  I see it as being able to have your cake and eat it too.  They paid the debt down with a keystroke.  The same government that had a liability on its books now has a liability on its books in one part of the room and an asset in the other part of the room.  Single-entry accounting indeed seems possible when you have an electronic "printing press."

I think the question comes to this: How is the fed's printing of money to purchase bonds issuing of new debt?  I simply don't see the logic in the accounting of that.

[Gumby]

HB was correct in both a legal and accounting sense about the dollars never leaving the US.  The only way dollars can truly leave the US is as actual banknotes.  The Eurodollar market as we know it developed in the 1950's as a Soviet attempt to make their dollar deposits less succeptible to US intereference.  They were not really successful as every dollar deposit they held in London was covered by a corresponding dollar deposit in the name of the British bank on the books of a bank in the US.  They only made actually asserting US jurisdiction over the money a little more complicated in a practical sense.  In short, dollars never leave the US -- only the ultimate beneficial owners change through a series of debits and credits in bank correspondent accounts here.

I'm not a true expert on banking, but I did deal with this issue in a number of different contexts while administering asset freezes at the US Treasury Department from 1979 to 2003.          

Thanks for clarifying this further. Makes me feel better that HB didn't end his final show with a gaffe.

Once US debt has been created, it can't be destroyed — each Treasury bond just lives on until it matures.

Actually, that's not really true.  If you read the speech that the great Bernank gave... all hail the great Bernank...  ::) he talks specifically about how they can reduce the money supply once inflation returns to the fed target rates.  Basically, when he wants to put on the brakes, to take money back out of the system, the Fed basically takes all of those US treasuries that they have been buying from themselves (QE) and destroys them, rather than cashing them in to buy more debt.  I'm not saying this is a good idea - I don't like QE, however, I'm just pointing out that a Central bank can both print money by monetizing the debt, as well as destroy money by taking it out of circulation.

If you subscribe to the belief that this monetary policy is good (and I don't), then a central bank's main job is to inject liquidity into the system in times of recession by monetizing the debt, and to take excess liquidity out of the system during times of prosperity by destroying it.

Right, right. That's technically true. But that's only for Treasury Bonds that the Fed buys/sells to the Primary Dealers that take part in the Fed's Open Market Operations — that's a very specific situation with a very specific purpose. It doesn't apply to China's Treasury Bonds. The Treasuries that China bought from the US Treasury cannot be destroyed, and will live on until maturity.