PP = inflation

[MediumTex]

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.

Okay, so let's say the U.S. government needs to borrow some money to continue its operations, and let's say this is the first money the government has ever had to borrow and that it's balance sheet is otherwise in good shape.

Normally, the government would issue a bond and someone would give the government his money and receive the bond in exchange.  The government takes this money that has been borrowed and then spends it. 

When the Fed is buying the bonds, it is apparently able to write checks out of imaginary accounts that can nevertheless be cashed by the government and then spent on whatever the government wants to spend it on (I'm leaving out the step where the primary dealer buys the bond and then sells it to the Fed, which is irrelevant as far as the process I am describing goes).

So I can accept that this process would normally be inflationary, since we are creating money out of thin air, but there is still the matter of how the money gets into circulation and how effective this process is in offsetting declines in asset values as a result of deleveraging.  Once again, I look to the example of Japan where this process was apparently attempted consistently for the last 20 years, and the end result was no inflation and no currency weakness.

I think that once credit starts contracting, assets start falling in value and the misallocations of capital from the boom times become obvious (e.g., we built too many mcmansions), it seems like that process takes a long time to run its course, and there isn't a lot that can be done to stop it (including the Fed's current actions).  I think that the demographic shift unfolding at the same time is just bad luck (though there is probably a symbiotic relationship between the two phenomena that is somewhat self-reinforcing).

Can anyone point to a situation where an economy had created a credit-driven asset bubble that popped at the same time that its population was aging that encountered any inflation for many years thereafter? 

When you look at these mega-bubble scenarios throughout history, asset values normally fall for a decade or more after the bubble bursts.  Since one of the characteristics of a bubble is overcapacity, it makes sense that there would be very little inflation pressure across the whole economy (though there will certainly be pockets of inflation here and there) in the wake of the bubble bursting. 

Will this time be different?  Will we get inflation in the wake of our burst housing bubble?  I don't know, we might, but history certainly suggests it would be an unusual situation if we did.  I think what is more likely is that the Fed's current policies will blunt the deflationary forces a bit for a while, but the trend toward falling asset prices will continue probably for another 5-10 years, at a minimum.

What will come after that?  I think that Japan will probably provide us with a peek into our future when and if they ever find themselves unable to borrow enough money to keep the "deflation blunting" process going.  But even if they at some point find themselves unable to roll over their debt at super-low rates, I'm still not sure it would result in rampant inflation because you still have a productive economy that is shrinking due to demographic factors, so you still find yourself with overcapacity year after year because of the graying of the population.

[HB Reader]

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?

I don't have a clue.  That's why we have most of our money in a 25x4 HB permanent portfolio.

My guess is that ultimately we have the functional equivalent of a deflationary crash.  But how fast that happens and how much monetary erosion (possibly punctuated by short periods of apparent prosperity) occurs before then is anyone's guess.  At the risk of sounding overly philosopical, it may simply depend on how long you live.

FWIW, in our VP we have some small gold stocks (~25%), dividend-paying US stocks (~40%), and shorter term US Treasuries (~35%).  That could obviously change at any time.  Having most of your money in a permanent portfolio makes pulling the trigger in a VP much less stressful.         
   

[MediumTex]

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

I don't have a clue.  That's why we have most of our money in a 25x4 HB permanent portfolio.

My guess is that ultimately we have the functional equivalent of a deflationary crash.  But how fast that happens and how much monetary erosion (possibly punctuated by short periods of apparent prosperity) occurs before then is anyone's guess.  At the risk of sounding overly philosopical, it may simply depend on how long you live.

I think that the one and only thing that could alter the scenario described above is a transformative technology.  Something along the lines of the automobile or personal computer could change the trajectory we are on.

When you look back at history, what is far more common than a transformative technology is just a really crappy economy for a long time, normally culminating in war and an across-the-board re-set of property rights and economic relationships in its aftermath.

Something in the energy space is my bet as far as where a transformative technology could come from (this also happens to also be where a crappy economy and war could come from as well).  I am not optimistic about the possibility of a transformative technology in the energy space any time soon, however, as Newton's laws are an obstacle that most alternative energy ideas cannot overcome. 

[Gumby]

MT, That was a very helpful assessment. It makes the case for deflation much easier to comprehend as a larger historical phenomenon.

Healthcare costs appear to be the big question mark in my mind. Every year they seem to rise an insane amount. I don't see how anyone will be able to afford it once the demand for healthcare skyrockets with the aging population. The costs and annual increases are already obscene. I see that as the largest expense in the coming years. And then there's skyrocketing college tuition for colleges and universities that only seem to constantly expand thanks to large alumni donations (from wealthy Baby Boomers). Why on Earth are colleges still expanding when the economy is contracting?

I think that Japan will probably provide us with a peek into our future when and if they ever find themselves unable to borrow enough money to keep the "deflation blunting" process going.  But even if they at some point find themselves unable to roll over their debt at super-low rates, I'm still not sure it would result in rampant inflation because you still have a productive economy that is shrinking due to demographic factors, so you still find yourself with overcapacity year after year because of the graying of the population.

I'm just curious about your thoughts about how Japan has handled their deflation. I've seen some opinion analysis that characterizes the Bank of Japan as being purposefully impotent, by their constitution. If I understood the analysis correctly — and it's entirely possible that I didn't — it sounds like the Bank of Japan does not have the legal authority to significantly increase the money supply. Apparently they can temporarily inject money into their economy in short bursts, but not much beyond that. And even I am wrong, and the BOJ does have the authority to significantly increase the money supply, it sounds like they've been fearful to really try for real inflation. Have you a different understanding of the situation?

Something in the energy space is my bet as far as where a transformative technology could come from (this also happens to also be where a crappy economy and war could come from as well).  I am not optimistic about the possibility of a transformative technology in the energy space any time soon, however, as Newton's laws are an obstacle that most alternative energy ideas cannot overcome.

It's a long shot, but there are some small rays of hope on that front.

[HB Reader]

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

I don't have a clue.  That's why we have most of our money in a 25x4 HB permanent portfolio.

My guess is that ultimately we have the functional equivalent of a deflationary crash.  But how fast that happens and how much monetary erosion (possibly punctuated by short periods of apparent prosperity) occurs before then is anyone's guess.  At the risk of sounding overly philosopical, it may simply depend on how long you live.

I think that the one and only thing that could alter the scenario described above is a transformative technology.  Something along the lines of the automobile or personal computer could change the trajectory we are on.

When you look back at history, what is far more common than a transformative technology is just a really crappy economy for a long time, normally culminating in war and an across-the-board re-set of property rights and economic relationships in its aftermath.

Something in the energy space is my bet as far as where a transformative technology could come from (this also happens to also be where a crappy economy and war could come from as well).  I am not optimistic about the possibility of a transformative technology in the energy space any time soon, however, as Newton's laws are an obstacle that most alternative energy ideas cannot overcome. 

Well put MT.

More likely in my opinion (though still not probable) is that a transformative technology and/or some completely unanticipated economic or political events from right or left field would simply attentuate the credit cycle.  That wouldn't necessarily invalidate the observations and conclusions of the Austrian school economists, but could certainly influence how fast everything plays out.

[MediumTex]

I'm surprised that so few people talk about demographics when discussing economics and investing.

If economics is all about understanding the drivers of demand, it is odd that so few people seem to notice that, other things being equal, if you have more people you will have more potential consumers, and if you have fewer people the process operates in reverse.

I think that for the answer to the question about whether Japan has made a serious effort at creating inflation, you just need to look at its debt to GDP ratio.  Japan has been spending like a sailor having a manic episode for over 20 years and it has basically given it about 1% in average annual economic growth for the last two decades, with frequent recessions.  Among other things, the Japan experience should put to rest once and for all the idea that Keynesian stimulus can get a demographically impaired economy moving in the right direction again.

One thing that Japan does show us is that Bernanke's current course can be continued for FAR longer than anyone would imagine.  This is another thing that the treasury trash talkers seem not to notice--the Japanese have been doing the same thing as Bernanke for decades now and their 30 year bond is paying 2%, so this whole bond market narrative of interest rates rising in response to huge deficits is certainly not invevitable.

[Gumby]

This just in...

Japan's Bernanke Hits Out at His Critics in the West

[MediumTex]

This just in...

Japan's Bernanke Hits Out at His Critics in the West

Gumby,

That's a great article.

It's amazing that for such a seemingly intelligent man, he appears to be unable to see how impotent his policies have been.  Although he does seem to grasp that there is some connection between demographics and the health of the economy, he seems oblivious to the logical conclusions that would seem to flow from these demographic realities, primarily the fact that on the oldster side of the demographic curve there is a lot less borrowing going on than in mid-life, and no amount of easy money and low interest rates will change this reality.

It's interesting too that he seems to take pride in having studied under Milton Friedman in the 1970s, but then notes that the whole monetarist theory of inflation following increases in the money supply have simply not happened in Japan at all.  Friedman is another smart guy who for whatever reason seems not to have noticed that demographics play a strong role in the whole inflation/deflation story.

For a highly informative and unsettling look at Milton Friedman's legacy, check out The Shock Doctrine by Naomi Klein.  It's a very different take on the effect of Friedman's policies on the world.  If anyone has read it, I would love to hear your thoughts.

[Gumby]

It's interesting too that he seems to take pride in having studied under Milton Friedman in the 1970s, but then notes that the whole monetarist theory of inflation following increases in the money supply have simply not happened in Japan at all.

It is interesting. I think he was just trying to appear connected to Western economics. He does address this discrepancy in the full transcript of the interview.

In many ways the transcript is more interesting than the article.

For instance...

WSJ: How do you respond to critics who say you are not doing enough, and the purists who say you are doing too much?

Mr. Shirakawa: I'm afraid my answer to your question may be somewhat duplicative.

If the whole purpose is just to increase the inflation rate, then I'd like to refer to the famous Paul Krugman remark. He said that in order to overcome deflation, a central bank should credibly commit to be irresponsible. Credibly commit to being irresponsible.

And if a central bank behaves literally in that manner, the inflation could come. But the inflation rate will become quite high. Skyrocketing inflation. And if the inflation rate increases very rapidly, the people expect central banks to commit to be responsible. If that is the case, inflation cannot be delivered. Central bank is central bank. Then Krugman's famous dictum that central banks should commit to be credibly irresponsible is somewhat self-contradictory.

What we like to attain is sustained growth with price stability. Not just high inflation. And real side is determined by productivity and population. And therefore, the criticism toward the BOJ is somewhat unfounded.

Krugman did say that, but he has often believed that his comments have been misconstrued, to this day. Last year, he said....

Krugman: I’m starting to see another curious myth popping up in comments — namely, that I claimed that Japan’s policy of quantitative easing, which consisted simply of stuffing more reserves into the banks, would work.

So, just for the record, here’s the little wonkish paper (pdf) I wrote back in 1998 — the one that alerted me to the danger of falling into a liquidity trap, so that I was intellectually prepared for the mess we’re in. The whole point of that paper was that when you’re up against the zero lower bound, it doesn’t matter how much money you print — not unless you credibly promise higher inflation.

And of course, now we’re all Japanese.

And here's another clarification from Krugman about that paper, and how it now applies to the Fed: Nobody Understands The Liquidity Trap (Wonkish)

Krugman: The question is whether, at the zero bound, the Fed has the ability to increase aggregate demand — full stop. If it can increase aggregate demand, it can fight both deflation and unemployment; if not, not.

In a way, the problem with Bernanke’s speech was that he made increasing demand and fighting deflation sound too easy. The Fed can print money, if you increase the supply of something its price will fall, end of story.

But as I tried to point out a long time ago, this simple story breaks down when short-term interest rates are near zero.

Here’s one way to think about it: when the Fed conducts an open-market operation, buying short-term debt with newly printed money, this normally affects the short rate because bonds and money are imperfect substitutes: money yields less, but has the advantage of being something you can use directly to make payments, that is, it’s more liquid.

But when you have bought so much debt and created so much money that rates are near zero, the public is saturated with liquidity; from that point on, they’re holding money simply as a store of value, which makes it no different from bonds — and hence a perfect substitute for bonds. And at that point further open-market operations do nothing — they just swap one zero-interest asset for another, with no effect on anything.

So why not forget about open-market operations, and just drop the stuff from helicopters? Well, remember that at this point cash and short-term bonds are equivalent. So a helicopter drop is just like a temporary lump-sum tax cut. And we would expect people to save much or most of such a tax cut — all of it, if you believe in full Ricardian equivalence.

In my simple 1998 model, there’s only one way the Fed can affect things at all: by promising, credibly, to print more money in the future, when the zero lower bound no longer binds.

In practice, things are more complicated, because long-term bonds aren’t perfect substitutes for short-term — so the Fed can get some traction by buying at longer maturities. But I always felt than Ben was overstating the effectiveness of such purchases. It’s worth noting that in his “it”? speech Bernanke’s more-or-less specific proposal was to set a ceiling on the yield on two-year securities. How much would that accomplish now, when even the 2-year yield is only 0.67 percent?

Anyway, back to the original point: it’s depressing to realize that two years into liquidity trap economics, the WSJ still doesn’t seem to understand the basic point of why the zero bound is a problem.

[MediumTex]

Gumby,

That's terrific stuff.

Thanks for posting.

[Lone Wolf]

Loving this discussion.  It couldn't be any clearer why it's a good idea to "hold all the assets" in the Permanent Portfolio.  Under the best of circumstances, the interplay between all of these forces and factors is very hard to sort out.  Throw in the possibility of unforeseeable black swans \ white swan type events and you can appreciate what a wonderful thing diversification truly is.

For a highly informative and unsettling look at Milton Friedman's legacy, check out The Shock Doctrine by Naomi Klein.  It's a very different take on the effect of Friedman's policies on the world.  If anyone has read it, I would love to hear your thoughts.

I haven't read this because frankly my impression was that the book is just... bad.  For one thing, conflating the pro-free market beliefs of Friedman with the anti-free market practice of corporatism and\or warmongering is such a basic error that I'm not sure what kind of useful conclusions could possibly follow from it.  A true free market and the application of force are incompatible concepts.  After reading Tyler Cowen's review where he calmly ripped it to shreds, I didn't have much interest in torturing myself.  Is there a hidden virtue in it that I'm missing out on?

Keep in mind that I'm very much from the "free markets \ free minds" sort of Harry Browne school of thought so it's probably pretty expected that I wouldn't click intellectually with someone as left-wing as Naomi Klein.

[MediumTex]

For a highly informative and unsettling look at Milton Friedman's legacy, check out The Shock Doctrine by Naomi Klein.  It's a very different take on the effect of Friedman's policies on the world.  If anyone has read it, I would love to hear your thoughts.

I haven't read this because frankly my impression was that the book is just... bad.  For one thing, conflating the pro-free market beliefs of Friedman with the anti-free market practice of corporatism and\or warmongering is such a basic error that I'm not sure what kind of useful conclusions could possibly follow from it.  A true free market and the application of force are incompatible concepts.  After reading Tyler Cowen's review where he calmly ripped it to shreds, I didn't have much interest in torturing myself.  Is there a hidden virtue in it that I'm missing out on?

Keep in mind that I'm very much from the "free markets \ free minds" sort of Harry Browne school of thought so it's probably pretty expected that I wouldn't click intellectually with someone as left-wing as Naomi Klein.

I shouldn't have had any interest in it because I share almost none of Klein's ideological beliefs.  When I began reading it, though, I couldn't put it down.  She is a good writer and her ideas are intriguing, even if they aren't completely persuasive.

Even if you disagree with her thesis that Friedman's recommendations have simply not delivered on their promises in most of the developing economies where they have been tried, her ideas about applying 1950s-era research on interrogation methods (i.e., sensory deprivation, sensory overload, and creating a sense of disorientation and filling the vacuum with an alternate narrative) to entire societies is interesting to consider.

The degree to which Friedman's free market ideology was used as a pretext for the U.S. government to meddle in other countries' affairs is also eye opening.

[Lone Wolf]

The degree to which Friedman's free market ideology was used as a pretext for the U.S. government to meddle in other countries' affairs is also eye opening.

Thanks for the thoughts.  To me, a "non-meddling" approach is of unparalleled importance in peaceful and prosperous human relations.  The free market is just what naturally emerges when we stop trying to use force on each other and simply trade.

This means that it is senseless for any nation to try to impose a "free market" on any other.  That would just be corporatism (essentially crony "capitalism" and government lobbying dressed up in free market drag.)  I'd certainly reject that.

Also, I too am convinced that significant change (for good or ill) usually follows upheavals, conflicts, and times of general distress and surprise.  The United States alone provides plenty of examples with the Patriot Act, the New Deal, Sarbaynes-Oxley, Frank-Dodd, etc.  I think that's been true throughout human history.  It'd be a different thing, though, to suggest that something like the Falklands War was initiated as pretext for Utopian experimentation.

[MediumTex]

Also, I too am convinced that significant change (for good or ill) usually follows upheavals, conflicts, and times of general distress and surprise.  The United States alone provides plenty of examples with the Patriot Act, the New Deal, Sarbaynes-Oxley, Frank-Dodd, etc.  I think that's been true throughout human history.  It'd be a different thing, though, to suggest that something like the Falklands War was initiated as pretext for Utopian experimentation.

Are you aware that Klein argues in her book that the Falklands war was very much used by Thatcher to impose her brand of free market capitalism on Britain?  (I'm not saying that Thatcher didn't have good ideas, or commenting on whether Thatcher was successful, I'm just noting that without the Falklands war, the later Thatcher-influenced configuration of the British economy would probably have not been possible.)

Before the Falklands war Thatcher's popularity was in the basement and she was months away from likely losing her PM post.  She was sort of in the position Guiliani was in in New York pre-9/11.  Along with the wave of nationalism that accompanied the Falklands war, Thatcher was able to undertake her Friedman brand of frontier capitalism at home and her legend was born.

Argentina also had reasons based upon domestic politics for provoking the Falklands war that had little to do with the islands themselves, which were of almost no value to either side.  One Argentine commentator at the time noted that the Falklands conflict was like "a fight between two bald men over a comb."

[Wonk]

MT, this has been fun.  I thought I should condense and number each relevant area for quick reference:

1. 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.

2. 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?

3. 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.

4. 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.

5. 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?

6. 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.

7. 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.

My thoughts:

1. I probably should have articulated a value in the beginning, but I was thinking more along the lines of $10, not $1000.

2. Not really.  I didn't say the Treasury was buying the paper--The Fed was buying the paper.  Big difference.

3. Only if The Fed releases said bonds back into the market in the future to unwind the position.  Official story is they will, reality says they won't.

4. Absent inflation, yes.  Substantial inflation will make the debt servicing easier.

5. Yes.  http://www.chinapost.com.tw/business/as ... .htm.  Bernank didn't get into room #2, People's Bank of China (PBC) has been recycling USD into the US bond market for years, effectively trapping USD from currency exchange markets.  By printing more yuan in exchange for USD, inflation rages in China.  The China deflation thesis has one important difference from the U.S. scenario: no easy market to export labor.  Chinese labor is either near or at the floor of the labor market.  I agree there are asset bubbles forming in China, though.

6. China shares the fast-growth story with 1980's Japan.  Key difference between now and 1920s US is lack of gold standard.  Asset bubbles seek the refuge of safety.  Nothing safer than gold (no counterparty).  Fed can make 2 dollars out of 1 in a nanosecond, which debases currency, which supports nominal value of assets even though real value takes the hit.  Other valid point was a major bout of inflation from 1933-1934, when the USD was devalued by 70%.

7. The credit forces are strong, but not insurmountable.  Consumer credit only represents 25% of the total U.S. credit market (source: http://www.federalreserve.gov/releases/ ... /z1r-4.pdf).  If we are going by the premise that net increases of money and credit typically produce price inflation, why would it matter who's balance sheet it's on--whether consumer, financial, corporate, farming or government?  If the 25% segment is contracting, but the 75% segment is expanding--resulting in net expansion for the sector--I just don't buy the deflation thesis at the moment.  I will only buy the deflation thesis when money and credit expand by 2% or less p.a. (as in the case of Japan).  Speaking of, Steve Saville had a good article on the Japan issue, M3 and TMS

http://www.safehaven.com/article/13964/ ... japan-myth

Rich Toscano with another solid article comparing U.S. and Japan:

http://www.pcasd.com/us_not_going_down_japans_road

The interesting thing about the 2% number is it corresponds pretty closely with historic annual gold production, which--under a gold standard--would mean stable prices, or 0% inflation.  My take on Japan is that we have not seen a currency event in the country because Japan is able to service it's debt at low yields.  Yes, the economy suffers, but at least they can service the debt.  Reminds me of African monkey traps.  They got into the deep debt smoothly and easily.  Getting back out is not going to be so easy.  When debt service is no longer possible at low yields, it's game over for Japan.

That does not mean the U.S. path needs to be the same.  In the end, it may be the same, but it doesn't have to be.  My main point is that deflation is not definitively in the cards.  For the last 2 years, inflation has been on.  The defining issue is whether The Fed will stop at nothing to create substantial (>2%) money and credit expansion in the future.  If they do, we're watching that 70s show at a minimum.  If it gets out of hand, it could be worse.  If the Fed fails or is not willing to create substantial money and credit growth, then I buy the deflation argument.

Btw, I think it's advisable to track both traditional (Keynesian/Monetarist: MB,M2,M3) and non-traditional (Austrian: TMS) money supply levels.  Everything--including Austrian measures--has been expanding.

[Lone Wolf]

Are you aware that Klein argues in her book that the Falklands war was very much used by Thatcher to impose her brand of free market capitalism on Britain?  (I'm not saying that Thatcher didn't have good ideas, or commenting on whether Thatcher was successful, I'm just noting that without the Falklands war, the later Thatcher-influenced configuration of the British economy would probably have not been possible.)

Yeah, I'd heard that the book argued that the war was initiated for this purpose.  This simply seems like a conspiracy theory to me, particularly since it was the Argentinians that struck first.  It's inconceivable to me that the "iron lady" would have let this go unchallenged, regardless of the circumstances.  (Note that I make no comment on who was correct about ownership here, just that this is how it was viewed.)

While it's important to look at who benefits, I think that overemphasizing that can lead to conspiratorial thinking.  It's sort of like how Obama benefited greatly in the campaign of 2008 from the financial crisis and Giuliani gained a windfall of political capital after 9/11.  But neither of these men wanted these terrible things to happen and certainly would have moved heaven and earth to stop them if they could have.

[moda0306]

I still think a part of the discussion that has to be settled is exactly how printing money to pay off debt is issuing new debt... it may create bubbles, but to simplify it lets pretend there is no seperate fed and treasury (like you did) and just a fedtreasury.

If the fedtreasury prints money to pay off debt it issued, even if the internal accounting is that it owes itself that money, they went from having $x Billion in Liabilities to China or the public, to that same amount in liabilities and an equal amount now in assets (you bought the bonds back, so you have both the bonds and the promise to pay the bond back... it's like owing yourself money... no matter how much it is, it doesn't really equate to any net liability).

Now when that bond comes due, of course the "paying" of that bond back by destroying dollars it collected from the public would then initiate a deflation, but we've already established the very simple ability of that very entity to continue to print money.  It's like having a counterfeiting printing press in your basement.  If you print from it all night, you may have done something unfair and illegal, and you probably have made some irrational purchases because you have that thing in your basement, but you're certainly better off in terms of paying off your creditors than you would have been without it.  Your balance sheet is IMPROVED for having that machine.  You have NOT incurred more debt for having printed a dollar in your basement.

[MediumTex]

Yeah, I'd heard that the book argued that the war was initiated for this purpose.  This simply seems like a conspiracy theory to me, particularly since it was the Argentinians that struck first.  It's inconceivable to me that the "iron lady" would have let this go unchallenged, regardless of the circumstances.  (Note that I make no comment on who was correct about ownership here, just that this is how it was viewed.)

I agree completely that it wasn't initiated with some purpose in mind (or any purpose at all), but when it happened, it created a new political environment that was conducive to the achievement of goals that had nothing to do with the conflict.

While it's important to look at who benefits, I think that overemphasizing that can lead to conspiratorial thinking.  It's sort of like how Obama benefited greatly in the campaign of 2008 from the financial crisis and Giuliani gained a windfall of political capital after 9/11.  But neither of these men wanted these terrible things to happen and certainly would have moved heaven and earth to stop them if they could have.

Again, I agree completely.  As I have said before, the best I think we could say is that certain events resemble what you might call "self-organizing" conspiracies, because they are not the product of any conscious plan, but the way the situation unfolds tends to benefit those who are able to manipulate matters in the aftermath of the initial event.

[MediumTex]

Wonk and moda,

Okay, getting back to basics, if the decline in asset values since 2008 (primarily housing) is equal to $20 trillion or so, how does the Fed printing $2 trillion get us to macroeconomic inflation?  That feels like my firehose/tidal wave analogy.

RE inflating our way out of debt, take a look at this month's Contrary Investor commentary:

http://contraryinvestor.com/mo.htm

Wouldn't a spike in yields sink the whole government reflation project as increasing debt service costs outran the devaluation of the underlying debt?

[moda0306]

MT,

I'm not saying printing $2t is enough to get us out of a $20t deleveraging hole... I'm saying that the $2t isn't new debt.  One could argue that you'd have to accept higher rates on FUTURE debt, and therefore want to be careful what you print, but printing $ isn't debt as far as I can see.

This may sound ridiculous, but if the hole is $20 trillion (about $50,000 for every man/woman/child), if the fedtreasury sent each person that amount (from the printing press), who knows what inflation would look like, but the following would surely be the case:

1) A good chunk of it would go towards savings or to pay down debt, improving most peoples' balance sheets (a GOOD thing)
2) Some would be spent, on reasonable and unreasonable purchases alike, improving business
3) The dollar would be devalued (as would bonds), and interest rates would rise, CPI would increase, as would employment... at least temporarily.
4) Remaining debt at the government and private would be more easily serviced, as asset prices are up, and as the velocity of money is up again.

I'm not saying this is fair, moral, constitutional, environmentally sustainable, etc, but it's hardly a situation where there's a simple swapping one liability for another... at least as far as I can see it.

[Wonk]

MT,

I can't say $20T decline in asset values(mostly housing) is correct or not, but in one respect it doesn't matter.  Perhaps 30-40% of all houses don't have a mortgage.  What matters with respect to what we are talking about is the amount of bad paper that needs to be realized in some fashion or another. 

Under normal circumstances, as a mortgage goes bad, the debt would need to be written off--so credit in the consumer space gets destroyed and the bank takes the balance sheet hit.  In this case, a portion of that bad debt is being exchanged at par at The Fed.  That's inflationary because the paper isn't worth 100%.  Instead of destroying credit, The Fed is buying MBS to support the total credit market expansion.  If money & credit expand on a net basis beyond 2% annually, there will be no deflation.

RE: spike in yields.  In 2010, interest on the national debt was $164B.  Let's say it doubled.  Okay, say yields tripled.  Does anyone think the U.S. can't pony up another $328B?  Social Security alone was double that.  Charge it!  The 2011 deficit is projected to be about $1.8 "T."  Why?  Because people keep lending to us!  As much as I find him repulsive, in a crazy way, Krugman has a point.  Deficit spend $2T, $5T, $100T.  Who cares?  The answer is nobody until the eureka moment happens where enough people figure out you can't service the debt anymore. Then there's a mad dash to the door.  We're waiting on that eureka moment from Japanese bondholders.  The Japanese have clenched their fists tightly inside the monkey jar.  All that's needed now is for enough of the bond market to recognize it as such.

[MediumTex]

As much as I find him repulsive, in a crazy way, Krugman has a point.  Deficit spend $2T, $5T, $100T.  Who cares?  The answer is nobody until the eureka moment happens where enough people figure out you can't service the debt anymore. Then there's a mad dash to the door.  We're waiting on that eureka moment from Japanese bondholders.  The Japanese have clenched their fists tightly inside the monkey jar.  All that's needed now is for enough of the bond market to recognize it as such.

I don't disagree with the idea that we are really talking about a bunch of abstractions here--bookkeeping entries really.  What is the difference between a billion and a trillion to a guy making $10 per hour?  The only life they have is the narratives that we mold around them.  The fundamantal problems are, at this stage, largely theoretical.

What would be far worse would be if there wasn't enough food for everyone to eat (in our country anyway, I can't speak for the whole world), or enough infrastructure to facilitate economic activity, etc.

History teaches pretty clearly, though, that these abstract problems have a way of working themselves into the real world sooner or later, just as a mentally ill person can only remain mentally ill for so long before the dysfunction in his mind begins to manifest itself in his actions, at which point the dysfunction begins to spill over into the real world in chaotic and unpredictable ways.

The future ought to be exciting.  Happily, the PP provides about as good a measure of security against the range of future scenarios we may be facing as one could ever hope to find.

[AdamA]

I see a great deal of logic in the argument for deflation, but I can't reconcile it with the price if gold over the past decade.  Any explanations?

[moda0306]

Part of it is the fact that things had been going so well for almost 20 years at that point.  Disinflation, cheap gas, globalization, worldwide peace.  It seemed so self-sustaining to so many people that gold seemed almost obsolete as a store of value.

When the tech bubble burst, 9/11 happened, the Iraq & Afghanistan wars seemed unending and the middle east is now in disaray, Katrina, higher gas prices, maybe a peak oil curve hitting, private/public balance sheets totally out of wack... a lot less seems certain now than in 1999. It's not just a matter of CPI rising over a period of time, but (as MT puts) institutions that we normally take for granted starting to be questioned, and the very future of our society questioned.  When we start questioning things like the value of a big fancy home, an education at a private school, a nice sporty car, all the crap we buy, etc, not that many "assets" come out the other end of that thought process having a higher value than they did going into it.

Family, food, shelter, precious & rare items of some artistic or intrinsic value, a good bottle of wine, basic transportation, tools for survival... all those are examples of what DO come out of that collective thought process looking more valuable... though some seem odd, things like wine and precious commodities have shown tremendous resilience during hard times.  They say a wine cellar is as good as MRE's in a bartar economy.  Doesn't make sense to me, but neither does quantum physics.... I still know there are some pretty hard and fast rules that dictate how it works.

[Storm]

Thanks for the Contrary Investor article, MT, it was an enlightening read.  I had no idea so much of our US debt was short term.  I just naturally assumed that a good chunk of it was 10-30 year maturity and that "inflating our way out of it" was the master plan of the Fed.  I mean, we can joke about "the Bernank" all we want, but I believe there are some smart people within the Fed, so hopefully they have some kind of plan to wean us off the ventilator.