Need a little guidance

[clacy]

I have been considering replacing VTI with XLE for the stock portion.  I believe energy companies will correlate very well with prosperity and also add some extra inflation protection.

[AgAuMoney]

I think it is sensible to at least entertain the possibility that we could be following Japan into a state of zero interest rate/ zero inflation/ zero growth economic stasis.

If so, the stock portion of my portfolio will carry the day as it is primarily composed of U.S. large caps with a majority of their revenues from outside the U.S. including large exposure to developing markets.

However our demographics will not support the Japan model as it has occurred there.  I consider it a low-probability event for the U.S.  Never the less, I believe I am prepared for that eventuality without sacrificing what I consider the more likely outcomes.

[AgAuMoney]

Taking that to greater extremes, can you really see largescale deflation occurring for a prolonged period of time?

Nope.

Should cash become significantly more valuable (read more scarce) the economic disaster for the U.S. debt will destroy the U.S. government.  They won't let that happen.  They have to have inflation and as Bernanke has made abundantly clear, the tools exist to create it and were not exercised in the 1930's as they should have been.

There is a reason why fiat money systems have always ended in inflation.

[stone]

Is it fair to say that Japan did try to create inflation and failed? I'm not advocating making the PP more extreme towards deflation. I'm just saying don't toss away the deflation protection. Japanese stocks also were focussed on exports and that didn't prevent Japanese stocks bombing and staying down. If the whole world is putting all their wages into propping up a growing burden of global zombie banks and so people have less and less money to spend; then global debt deflation might actually happen
You can create as much money as you want but if Goldman Sachs et al  efficiently skim it straight off and put that money straight back to work skimming off more you won't get inflation. Even if the children of the bank partners spray a lot of champagne around they will have a hard job to get champagne driven inflation through the whole economy.

[MachineGhost]

You can create as much money as you want but if Goldman Sachs et al  efficiently skim it straight off and put that money straight back to work skimming off more you won't get inflation. Even if the children of the bank partners spray a lot of champagne around they will have a hard job to get champagne driven inflation through the whole economy.

We need a new term.  Let's call it "zombieflation".

[AgAuMoney]

Is it fair to say that Japan did try to create inflation and failed?

Not according to Bernanke.

Policy options exist that could greatly reduce these losses. Why isn’t more happening? To this outsider, at least, Japanese monetary policy seems paralyzed, with a paralysis that is largely self-induced. Most striking is the apparent unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work.

That was in 2000.  He spent about 15 years criticizing BoJ for being to passive.  And so far he has done just about the same as did the BoJ.  Bernanke has yet to pull out the big guns.  According to Krugman it is because Professor Bernanke talked big, but Fed Chair Bernanke is just as afraid to try something that may not work as was/is the BoJ.

However the BoJ policy seems to be changing.  Last Feb they announced asset purchases (ala the Federal Reserve) with a stated objective to create 1% inflation.  We'll see how it goes.

I don't think BoJ or most Japanese really cared about the deflation over the past 20+ years.  Why?  To my mind the key difference Japan vs. U.S. is the surpluses Japan had both as a sovereign power and in general for the population.  Savers can afford and in fact benefit from deflation.  Contrast with the U.S. debt.  Debtors are absolutely crippled by deflation as money becomes more and more scarce (valuable) and it gets harder and harder to scrape together enough to make the payments.

[AgAuMoney]

Japanese stocks also were focussed on exports and that didn't prevent Japanese stocks bombing and staying down.

That is correct.  However it is not relevant.

Exports suffer in deflation because your money becomes more expensive, exports become more expensive, and sales drop.

The stocks I hold which I expect to provide some deflation protection are not significant exporters.  They manufacture outside the U.S. and employ people outside the U.S. and earn large profits outside the U.S.  This protects them from U.S. deflation in a way exports never could.

[stone]

I guess every debtor is matched by a creditor throughout the world. Perhaps in Japan the debt is mostly between Japanese people and banks and government/central bank whilst much US debt is owed to foreigners. Japanese average Joes hold savings and Japanese banks desperately try and claw back money decade after decade to try and fill the hole from loans made to buy commercial property that is now worth 1% of the loans taken out to buy it.
Owing to foreigners would make US deflation more painful for the US as a whole BUT all political power in the US/UK/europe is with creditors. Global banks don't care about the American people and as far as I can see American voters seem to do whatever global banks ask them to do. In a free market, all the major banks would have gone the way of Lehmans and all the debt the banks owe (mostly to each other) would have gone the way of Lehman's corporate bonds (ie evaporated). The situation then would have been like the post WWII situation in Germany when the USA administering Germany declared that all debts (impossibly vast at the time) were voided but provided government protection to cash deposits. That set the scene for the "economic miracle". Getting out of the current hole that the global financial system has dug for itself would entail something along those lines today I guess. I can't imagine anyone with any influence today would allow that to happen.

[stone]

More generally do you agree that severe CPI type inflation needs the amount of money people spend on goods and services to be unmatched by supply of goods and services? To my mind that requires a constriction on supply. You have to have mass labour strikes, ineffective working practices, war time destruction, byzantine regulations or something like that. If there is a general strike across the USA and so all goods need to be imported and paid for in Chinese Yuan and Benanke prints USD for the USD to be exchanged for Yuan- Then I agree, Benanke will have got his inflation at will. That seems some way off to me so I think the 25% LTT is sensible.

[Pointedstick]

Perhaps in Japan the debt is mostly between Japanese people and banks and government/central bank whilst much US debt is owed to foreigners.

It's actually less than you might imagine:

[AgAuMoney]

More generally do you agree that severe CPI type inflation needs the amount of money people spend on goods and services to be unmatched by supply of goods and services? To my mind that requires a constriction on supply.

Not "unmatched" but "unmatched at today's prices" perhaps.

No constriction in supply necessary, just an increase in the velocity of money from either excess creation of money or lack of desire to hold money or perhaps other reasons.  Usually the constriction in supply doesn't seem to happen until people and companies are buying far in excess of current needs and production starts falling apart because of unavailability of inputs.

[stone]

AgAuMoney, I'm trying to get my head around how a severe inflation could occur in an economy that has excess capacity to provide goods and services available for sale in its own currency. Are you saying that people lose trust in the USD and so start hoarding real goods and bingeing on services? So people start panic buying tins of beans, automobiles and piano lessons until all that excess capacity is swamped? The problem with that idea in my mind is that all the excess USD from current money printing is with a small group of people. If someone is a billionaire isn't it very very hard to imagine them going on a shopping spree that causes CPI increases? Quite how much everyday goods and services are they going to splash out on?
Countries that have had hyperinflations (Serbia, Zimbabwe, Germany 1920s, Chile etc) needed foreign currency to buy essential goods/pay foreign currency debts and had a collapse in their ability to produce domestically. The USA is the worlds largest food exporter. You still have plenty of domestic industrial capacity. What is more, lots of foreign goods are available for sale in USD. US debts are all owed in USD. All those things could change but you seem to be saying that severe inflation is inevitable even if they don't?

[AgAuMoney]

AgAuMoney, I'm trying to get my head around how a severe inflation could occur in an economy that has excess capacity to provide goods and services available for sale in its own currency. Are you saying that people lose trust in the USD and so start hoarding real goods and bingeing on services?

Essentially.  I don't recall anything about 'services' but re. goods is how hyperinflation in Weimar, Argentina and Brazil all got started.  And it isn't just the consumer, it is also businesses hoarding their inputs.

Severe inflation is as much perception as anything else.  Once the perception sets in that holding the currency is a problem (not just the physical currency but also bank deposits, etc) it becomes self-reinforcing.

The same self-reinforcing pattern is also observed fairly regularly in spot shortages of various types.  In recent memory there have been hoarding-driven shortages of rice and toilet paper.  Reports of impeding storm (hurricane, tornado) cause a very short-term example of the same.

[stone]

AgAuMoney, in the UK we have had a couple of hoarding fiascos in the last decade or so due to fuel tanker driver strikes http://en.wikipedia.org/wiki/2012_Unite ... uel_crisis so I know what you mean. But to my mind that was entirely an example of supply constriction. Weimer was due to debts in a foreign currency being serviced (or attempted to being serviced) by printing German currency so that it could be dumped on the forex markets to try and get USD- and a general strike. Brazil and Argentina also involved forelorn attempts to meet foreign currency/pegged currency debts  didn't they? I know Brazil had the additional problem of indexation.
As I see it many housholds in the USA and UK have big debts and those debts need to be serviced with our currency. That is providing an ever present need for money. People are never going to want to frivolously dispose of money if they have a debt overhang Apple may hold vast amounts of USD. Lets imagine they get itchy feet. Apple isn't going to buy $100B of food and see it rot are they? There is commodity speculation these days aided by all the ZIRP "free money" but that causes price swings rather than persistant price increases from what I can see.
I totally agree with the general point that avoiding hyperinflation is by far the most important responsibility of monetary authorities. I just think that people need to focus attention more on foreign currency debt as a danger rather than on monetary base expansions. The USA is in the good position that it has no foreign currency debt. I also think people need to be aware that if catastrophic supply constrictions occur (such as due to war or natural disaster) then sometimes rationing of essential goods is the only way to prevent a spiral of hoarding and price chaos. I'm sure that if the UK hadn't had rationing post WWII, we would have had hyperinflation.

[Ad Orientem]

I'm sure that if the UK hadn't had rationing post WWII, we would have had hyperinflation.

If you didn't have rationing you would have lost the war. I don't like rationing and as a rule I think it's a bad idea. But there are exceptions to every rule.

[chrish]

Stone is referring to post war rationing I believe. Rationing in Britain didn't end until 1954!

http://en.wikipedia.org/wiki/Rationing_ ... er_the_war

[Ad Orientem]

Good catch. I didn't read it that carefully.

[Gosso]

AgAuMoney, in the UK we have had a couple of hoarding fiascos in the last decade or so due to fuel tanker driver strikes http://en.wikipedia.org/wiki/2012_Unite ... uel_crisis so I know what you mean. But to my mind that was entirely an example of supply constriction. Weimer was due to debts in a foreign currency being serviced (or attempted to being serviced) by printing German currency so that it could be dumped on the forex markets to try and get USD- and a general strike. Brazil and Argentina also involved forelorn attempts to meet foreign currency/pegged currency debts  didn't they? I know Brazil had the additional problem of indexation.
As I see it many housholds in the USA and UK have big debts and those debts need to be serviced with our currency. That is providing an ever present need for money. People are never going to want to frivolously dispose of money if they have a debt overhang Apple may hold vast amounts of USD. Lets imagine they get itchy feet. Apple isn't going to buy $100B of food and see it rot are they? There is commodity speculation these days aided by all the ZIRP "free money" but that causes price swings rather than persistant price increases from what I can see.
I totally agree with the general point that avoiding hyperinflation is by far the most important responsibility of monetary authorities. I just think that people need to focus attention more on foreign currency debt as a danger rather than on monetary base expansions. The USA is in the good position that it has no foreign currency debt. I also think people need to be aware that if catastrophic supply constrictions occur (such as due to war or natural disaster) then sometimes rationing of essential goods is the only way to prevent a spiral of hoarding and price chaos. I'm sure that if the UK hadn't had rationing post WWII, we would have had hyperinflation.

I always find this chart fascinating:


http://research.stlouisfed.org/fred2/gr ... GM2JPM189N

Japanese CPI is the red line, Japanese M2 is the blue line.  Both y-axes are logarithmic.

It seems clear to me that M2 had a profound effect on overall inflation in the Japanese economy.  If Japan had attempted to maintain a currency peg against the USD and increase M2 then, IMO, Japan would have seen inflation.  But for whatever reason the BOJ decided to slow the rate of monetization.  Although they have achieved their mandate of price stability and low unemployment, so maybe they're onto something.

[MachineGhost]

If you didn't have rationing you would have lost the war. I don't like rationing and as a rule I think it's a bad idea. But there are exceptions to every rule.

How did rationing work?  It just seems to me it would contrict the supply further.  Was the food free with the black market price hyperinflated?

[stone]

Gosso

It seems clear to me that M2 had a profound effect on overall inflation in the Japanese economy.  If Japan had attempted to maintain a currency peg against the USD and increase M2 then, IMO, Japan would have seen inflation.  But for whatever reason the BOJ decided to slow the rate of monetization.  Although they have achieved their mandate of price stability and low unemployment, so maybe they're onto something.

The BOJ (or the Fed or the bank of england) has very very little power to control M2 particularly once interest rates are already at zero (high interest rates MAY lower M2). The central bank has absolute power over M0 and can set short term treasury interest rates. The BOJ has let short term rates fall to zero and bloated M0 up but private banks have not responded by increasing M2. Instead the ratio of base money to broad money shifted such that as M0 increases, M2 stays still. The same pushing on a string monetary policy has happened in the USA and UK since 2009.

The broad money M2 is more a response to inflation rather than a cause IMO. Banks create as much M2 as the economy can absorb.

[stone]

If you didn't have rationing you would have lost the war. I don't like rationing and as a rule I think it's a bad idea. But there are exceptions to every rule.

How did rationing work?  It just seems to me it would contrict the supply further.  Was the food free with the black market price hyperinflated?

I only know what my grandparents told me/ history lessons at school. Apparently people were given ration books of tokens and you were able to buy (with money) goods up to your ration. I've seen ration tokens my grandmother kept. It covered clothes, food, fuel etc. Supply at the time was constricted by people working to rebuild stuff/ not enough farm land etc . Remember the country had been bombed flat. The UK had been a food importer for many years. It wasn't as though farmers stopped producing because they couldn't sell all they could produce- there was more demand than could be met. Some stuff was sold on the black market- stuff such as hunted rabbits etc. I don't think that "hyperinflated". Hyperinflation requires desperation. Thanks to rationing no one was in desperation. I'm not saying rationing makes any sense when an economy is functioning properly. I'm just saying it is a necessary response when a catastrophe cuts off the supply of essentials. Interestingly the UK was at its healthiest when rationing was in place .

[AgAuMoney]

Weimer was due to debts in a foreign currency being serviced (or attempted to being serviced) by printing German currency so that it could be dumped on the forex markets

That's a common and likely incorrect perception.

debts need to be serviced with our currency. That is providing an ever present need for money. People are never going to want to frivolously dispose of money if they have a debt overhang

Are the debts fixed payment?  For example I would hold cash to pay my mortgage because the payment is fixed.  Credit card debt or variable rate loans will either be paid of or be ignored under hyperinflation because they become impossible to pay.  People won't "frivolously" dispose of money.  The attitude becomes "money is losing value so fast I have to buy something tangible while I still can."

  Apple may hold vast amounts of USD. Lets imagine they get itchy feet. Apple isn't going to buy $100B of food and see it rot are they?

Probably not, that would be idiotic.  But Apple may buy up 2x or 10x or more solder and plastic and screws and etc. other general inputs to avoid future shortages or price increases.

Some food companies also might buy up food supplies that are known to keep -- whole grain, bulk oils, etc.

Consumers in the past facing these situations have made similar decisions.  And sometimes companies and consumers are not smart, and do end up overbuying and things go to waste.  It happens in normal times, and it happens worse when panic fleeing the currency is underway.

[AgAuMoney]

If you didn't have rationing you would have lost the war. I don't like rationing and as a rule I think it's a bad idea. But there are exceptions to every rule.

How did rationing work?  It just seems to me it would contrict the supply further.  Was the food free with the black market price hyperinflated?

Not necessarily free, but usually available.  Usually you had a coupon book "ration coupons" and you could buy rationed goods for which you had coupons.  Any sales without the coupon were illegal, and shop keepers had to present coupons to replace inventory.

My father's family raised bees.  Sugar was rationed, but they had all the honey they wanted.  Unfortunately my grandmother was allergic to honey. (and bees!)  They used to trade their honey for sugar.  They also sold honey for people to use it as antifreeze in vehicle radiators because the commercial antifreeze was not available.

[stone]

AgAu money, although I sincerely hope that you are wrong about a hyperinflation being on the horizon as you describe, I'm not certain that you are wrong. I always intended to stick to a rule not to ever rebalance in the same direction more than once a year. If gold hits rebalance bands twice in the same direction in the same year, then your warnings will act to give me resolve to stick to that plan. I guess it is also sensible to take note of exchange rates not just between developed world currencies but also against developing world currencies.