Gyroscopic Investing

moda0306 wrote: I think there were some extreme economic mismanagement factors that had a lot to do with the hyperinflation.  Not monetarily related.

There's no doubt that Zimbabwe is the poster-child for economic mismanagement.  How else can you go from being Africa's bread-basket to not being able to feed your own populace?  But hyperinflation is everywhere and always a monetary phenomenon.

Pkg Man,

Let me pick your brain a bit on that assertion... lets say war breaks out in the middle east and the price of gas triples and causes a domino effect of inflation.

How is that a monetary phenomenon?

moda0306 wrote: Pkg Man,

Let me pick your brain a bit on that assertion... lets say war breaks out in the middle east and the price of gas triples and causes a domino effect of inflation.

How is that a monetary phenomenon?

That's not really inlfation.  That's the price of gas going up for a reason. 

It would only cause the domino effect of inflation if we printed money and gave it to people so that they could afford to purchase gas (which would cause the price to further rise).

Right?

The gas price increasing example would trigger a recession, as people have the same amount of money but it suddenly buys a smaller basket of goods because a larger proportion is going to buy gas.  This would continue until someone was able to deliver more gas to the market in a way that would drive gas prices back down.

I think it's right that it's loose monetary policy in the face of such an event that actually starts the troubling cycle of inflation that later becomes hard to stop (even after the cheaper suplies of gas begin making their way into the market).

In Zimbabwe, due to a numer of factors, including capital flight and a thief running the country, I believe they thought that they could make up for the shortage of products in the country by making money more widely available.  This, of course, didn't cause there to be any more products in the country, so the prices on the existing products continued to rise as the supply of money chasing the products rose.

I'm interested in PkgMan's thoughts on this topic.

MediumTex wrote: I saw them about two years later on the Master of Puppets tour and that was really an amazing show.  I was the right age and they were at the right stage of their musical career.  It was perfect.  I don't remember what I paid for that ticket.  I saw them a few times after that but it was never anything like that Master of Puppets show.

Consider me very very jealous.

Best Metallica album ever.

You won't catch me at a Jonas Brothers concert, but I did attend a Lady Gaga concert not so long ago (Monster Ball tour).

moda0306 wrote: Pkg Man,

Let me pick your brain a bit on that assertion... lets say war breaks out in the middle east and the price of gas triples and causes a domino effect of inflation.

How is that a monetary phenomenon?

Adam and MT have already addressed this, but let me go back to what the definition of inflation is.  It is the rate of change in the general price level, or as I said earlier, a continual change in the price level itself.  This is a fundamentally different concept from a one-time change in the price level or a change in relative prices.  

A tripling of gas prices due to mid-east chaos would cause a one-time increase in the price level.  Even though the price of other items that use energy would also go up, once the tripling of gas prices had been incorporated into the prices of all other items, the price level would be set at a new higher level.  It would not cause the price level to continue to rise year after year.

The other effect of a rise in energy prices is a change in relative prices.  For example, assume that right now the price of one iTunes album is $8 and gas is $4. The relative price of gas to iTunes is

   ($4 gallon of gas / $8 iTunes) = 0.5  

So the relative price of gas in terms of iTunes is 0.5, i.e., it takes two gallons of gas to buy one album, or equivalently, it takes one-half iTunes albums to buy one gallon of gas.

Now let's assume chaos spreads and oil prices rise, which triples the price of gas to $12 per gallon.  The new relative price of of gas is

   ($12 / $8) = 1.5.  

So now it requires only 2/3rds of a gallon of gas to buy an iTunes download, or one and a half iTunes albums to buy a gallon of gas.  In relative terms the price of gas has become more expensive.

Recall the definition of inflation, which is a continual rise in the general price level.  The general price level is the price of all items, so inflation refers to an increase in the price of everything.  In the example above only the price of gas increased, not the price of iTunes.  In pure terms no inflation has occurred, only a change in relative prices and a one-time change in the overall price level.

It is obvious that it is very difficult to distinguish between changes in relative prices, one time changes in the price level, and real inflation.  This makes it hard to measure inflation.  MT said earlier that our measure of inflation is a guesstimate, and he is correct.  I personally think that the BLS does as good a job as can be done, but it is still a guesstimate.

To follow up on my post above about gas prices, inflation and recessions, I think it is interesting to note that more or less every recession in the U.S. since the early 1970s was preceded by an oil price spike.  In other words, it looks like the process I describe in the post above is the way it has actually played out.

The interesting thing about where we are in the world today with respect to energy is that we are in all likelihood past the peak of global world production (i.e., past "peak oil" production).  One of the things that peak oil theory promises is that once you are past the peak you won't necessarily experience shortages (because demand may also decline as other energy sources come into play), but you WILL experience much greater price volatility (since world oil supplies will be so much tighter relative to demand than they have been historically).  This price volatility has the potential to create much more frequent recessions, if we accept the premise that oil price spikes have a tendency to throw modern economies into recession.

What is fascinating about what we are living through right now is that we are sort of on the other side of the last recession that was preceded by an oil price spike (i.e., the one that started in 2007), and we find ourselves with another oil price spike on our hands ($90 a barrel oil is VERY expensive from a historical perspective).  If this oil price spike doesn't trigger a new recession it will be the first time in our lifetimes that this cause and effect relationship has broken down.  This is an issue that no one is talking about (i.e., a new recession being triggered by rising oil prices), but I think it is probably one of the most important macroeconomic issues out there right now.  In a sense, the whole cluster of economic effects proposed by the peak oil theory is being tested right in front of us.

As a sidenote, if you ever hear anyone comparing current or future oil shortages to the 1970s, remind them that the 1970s oil shortages were politically induced, while current and future oil shortages (as reflected in higher oil prices) will in all likelihood be geologically induced.  Humans can resolve a politically induced shortage, but Mother Nature is a much tougher negotiating partner.

As usual MT makes some very good points.

James Hamilton, a quite famous economist, discusses peak oil from time to time.  You can read his comments here
http://www.econbrowser.com/archives/energy/index.html

Hamilton believes that rising oil prices was one of the things that tipped the US into recession.

I lived through the effects of a shortage and rationing a couple of years ago.  A pipeline that supplies Georgia with most of its gas broke and supply was lower than demand.  The Governor at the time made it clear that "price gougers" would be prosecuted.  As a result lines quickly developed for what gas was available.  So the prices stayed the same, about $3 per gallon, but you had to drive all over town to find gas and then wait in line once you found a station that had supplies, hoping they wouldn't run out before your turn.  Politicians of all stripes often forget that the fundamental role of prices is to ration scarce goods.

It's interesting that no matter how many times it is tried and fails, people never seem to learn that price controls always lead to shortages.

It's so obvious, and yet the politicians just can't seem to resist.

When I hear about the "gougers" in a situation where supplies of something are tight, I always think about the Wall Street guys who talk about "accumulating" stocks, but "hoarding" gold.

As Sailor told Peanut in Wild at Heart, "there are more than a few bad ideas out there."

Pkg Man wrote:
...let me go back to what the definition of inflation is.  It is the rate of change in the general price level, or as I said earlier, a continual change in the price level itself. 

What would your response be to those who argue that price changes are merely a symptom of inflation, not inflation itself?  These people usually define inflation as "an overall increase in the supply of money and credit."

I'm going to guess that you'll say that the above definition is overly simplistic in that it is increasingly difficult to define money and credit in our debt based economy...

Thanks for the responses, by the way.  You guys are very smart on this stuff.  Learning a lot.


Adam

Adam1226 wrote:

Pkg Man wrote:
...let me go back to what the definition of inflation is.  It is the rate of change in the general price level, or as I said earlier, a continual change in the price level itself. 

What would your response be to those who argue that price changes are merely a symptom of inflation, not inflation itself?  These people usually define inflation as "an overall increase in the supply of money and credit."

Adam

That is pretty much correct, with the caveat that an increase in the supply of money needs to exceed the demand of money in order for inflation to occur.  If the supply of money grows but at a slower rate than the economy, you could still have deflation.  Theoretically you could grow the money supply just fast enough so that real inflation is equal to zero.  In practice this is impossible for a multitude of reasons, probably the least of which is that it's impossible to perfectly measure inflation.

Adam,

I think that a good shorthand way of thinking about the inflation topic is to ask the following:

"Has the underlying quantity of goods and service increased or decreased?"

If there is the same amount of goods and services and more money chasing it, then you would expect to see inflation.

If there is a declining quantity of goods and services and the same amount of money chasing it, then you would expect to see inflation.

If there is an increasing quantity of goods and services and the same amount of money chasing it, then you would expect to see deflation.

This last point is not well understood by many people.  In the last 100 years world ecomic output has exploded.  If there had been a fixed amount of money in an environment of such dramatic economic expansion, there would have been intense price deflation (assuming that such economic expansion could have even occurred in the first place without an expanding money supply).  The implication of this economic expansion has been that it has historically been possible to steadily increase the money supply without triggering undesirable inflation (so long as money supply growth roughly tracked economic growth in general).

What we are seeing right now is, in my view, totally different from what most people are perceiving.  We are seeing the wholesale destruction of money in the form of debts being paid off or defaulted on and a relatively lower level of new borrowing occurring.  In other words, the supply of money (including credit) is going down.  The Fed is doing everything in its power to make it as easy as possible for those who want to borrow to borrow (providing liquidity to banks, keeping interest low, etc.), but at the end of the day if people are simply not interested in re-leveraging, then this entire experiment will fail and not only will there be no inflation, there will be strong deflationary forces, which tend to create unpleasant feedback loops, all of which were elegantly predicted and described by von Mises and other Austrian economists in their writings about the bust that much follow a credit-fueled boom.

The metaphor I like best is Ben Bernanke standing on the beach with a fire hose trying to neutralize an incoming tidal wave.  The tidal wave is deflation and the fire hose is loose monetary policy.  As Irving Fisher described in his writings about deflation, once the process of wealth destruction starts following the bursting of a credit bubble, the feedback loops are such that the central bank simply cannot print enough credit-based money to outrun the forces of asset deflation.

We have built a world that only a very few can actually afford to live in; we just haven't fully internalized this reality yet.  It is deflation that will drive this reality home, as people begin to discover what the real value of things are when the distorting effects of easy credit are removed from the picture and the multiple claims to the world's underlying assets begin to be sorted out (this view of things would be very bullish for gold).

The net effect of the processes described above is that the middle and working classes will become poorer in a "ratcheting down" process, while the richest 1% will continue to get richer as their errors are transferred from private to public balance sheets.  If one thinks of it in conspiracy terms, I would describe it as a "self-organizing" conspiracy of which no individual participant is actually aware.  It's sort of like Adam Smith's "invisible hand" attached to an epileptic kleptomaniac (how's THAT for a mental picture-- ).

MediumTex wrote:
We have built a world that only a very few can actually afford to live in; we just haven't fully internalized this reality yet.  It is deflation that will drive this reality home, as people begin to discover what the real value of things are when the distorting effects of easy credit are removed from the picture and the multiple claims to the world's underlying assets begin to be sorted out (this view of things would be very bullish for gold).

Nicely put, MT.  I've heard this argument several times, but never in a such concise manner.  Strikes me as true.

 
If one thinks of it in conspiracy terms, I would describe it as a "self-organizing" conspiracy of which no individual participant is actually aware.

Great point.  As compelling as some conspiracy theories can be, I always have to laugh.  There's simply no way that human beings could conciously organize in such a way as to make these theories true.  People do what they have incentive to do.

MediumTex wrote: What we are seeing right now is, in my view, totally different from what most people are perceiving.  We are seeing the wholesale destruction of money in the form of debts being paid off or defaulted on and a relatively lower level of new borrowing occurring.  In other words, the supply of money (including credit) is going down.  The Fed is doing everything in its power to make it as easy as possible for those who want to borrow to borrow (providing liquidity to banks, keeping interest low, etc.), but at the end of the day if people are simply not interested in re-leveraging, then this entire experiment will fail and not only will there be no inflation, there will be strong deflationary forces, which tend to create unpleasant feedback loops, all of which were elegantly predicted and described by von Mises and other Austrian economists in their writings about the bust that much follow a credit-fueled boom.

MT,

What happens when the banking and government sectors step in to expand when the consumer refuses?  If net money and credit expands in the face of consumer deleveraging--as we have been witnessing for the last year in M3+Z1--I would imagine your position would be that the net expansion would be unsustainable longer term.  Am I correct?  If I am, in your view what would be the catalyst for the contraction in credit in the banking and government sectors?  What are your thoughts on The Fed purchasing MBS's at par from the banking sector?  Do you see that as affecting the deflation/inflation equation?

Wonk wrote: MT,

What happens when the banking and government sectors step in to expand when the consumer refuses?

Isn't this just standard Keynesian recession medicine?  The problem is we have been doing Keynesian stimulus for the last 30 years, whether there was a recession or not, and it seems like we are nearing the point of diminishing returns on additional government borrowing.  Isn't the conventional wisdom that when debt hits 100% of GDP it stops having any (even theoretical) beneficial effects?

If net money and credit expands in the face of consumer deleveraging--as we have been witnessing for the last year in M3+Z1--I would imagine your position would be that the net expansion would be unsustainable longer term.  Am I correct?

How does velocity work in that equation?

If I am, in your view what would be the catalyst for the contraction in credit in the banking and government sectors?  What are your thoughts on The Fed purchasing MBS's at par from the banking sector?  Do you see that as affecting the deflation/inflation equation?

Returning to the idea of diminishing marginal returns on public debt beyond a certain point, it seems like that would basically be the snare. 

It also seems that if the Fed moves down the food chain more and more, paying par for crappier and crappier debt, that's just this same ongoing theme of moving private sector debt onto the public sector balance sheet.  I don't see how that could ever lead to anything good.

In general, I think the Fed's premise is that there is some action that governments or central banks can take that will subvert a natural process of healing that unfortunately takes a long time.  In the same way that taking steroids can make you stronger for a while, but at the expense of long term health, it seems like we are further damaging an already injured system by trying to hurry the process of repair rather than trusting the market to repair itself without all this distorting governmental interference.

To a degree, though, I feel sympathy for Bernanke and co.  I think that the deleveraging process following the bursting of a credit-driven bubble is like cancer that only presents when it is stage IV.  By the time the symptoms are there, the range of options is small.

One of my favorite comparisons is that we are in a "Weekend at Bernanke's" economy, where the economy is actually dead, but for various reasons we need to make it look like it is still alive (and even vibrant).  The problem is that this charade becomes harder and harder to pull off as decomposition begins to occur.  To me, examples of this decomposition can be seen in long term structural unemployment and insolvent state and local governments.

MediumTex wrote: Isn't this just standard Keynesian recession medicine?  The problem is we have been doing Keynesian stimulus for the last 30 years, whether there was a recession or not, and it seems like we are nearing the point of diminishing returns on additional government borrowing.  Isn't the conventional wisdom that when debt hits 100% of GDP it stops having any (even theoretical) beneficial effects?

I agree part of it is Keynesian medicine.  The other part is the expansion of the banking sector.  Whether or not that is sustainable is anyone's guess at the moment.

MediumTex wrote:
How does velocity work in that equation?

Let's say M2 velocity stays between 1.6-1.8; roughly where it was between 1960-1990.  Would that change your outlook?

MediumTex wrote: Returning to the idea of diminishing marginal returns on public debt beyond a certain point, it seems like that would basically be the snare. 

It also seems that if the Fed moves down the food chain more and more, paying par for crappier and crappier debt, that's just this same ongoing theme of moving private sector debt onto the public sector balance sheet.  I don't see how that could ever lead to anything good.

In general, I think the Fed's premise is that there is some action that governments or central banks can take that will subvert a natural process of healing that unfortunately takes a long time.  In the same way that taking steroids can make you stronger for a while, but at the expense of long term health, it seems like we are further damaging an already injured system by trying to hurry the process of repair rather than trusting the market to repair itself without all this distorting governmental interference.

If--and that's a big if--The Fed is successful at a constant and somewhat stable rate of "M" and "Z" growth without a major crisis, I would think it will be the most amazing high-wire act of all.  I don't think it's fair to certain groups, but they are currently dancing on a razor's edge.  More monetizing and they risk losing confidence.  Less monetizing and they risk a deflationary collapse.

I believe the most likely scenario--today--is one that mimicks the 1970s stagflation.  The interesting twist is right now the inflation is overseas because of the balance of trade.  We don't see inflation here so we say it doesn't exist--but it does. 

I agree with your premise of a Japan-like scenario only if The Fed allows total money and credit to drop OR if money and credit stagnate and velocity drops precipitously.  Right now we don't have a clear crystal ball.  But I just don't see any circumstance where The Bernank will allow asset prices to drop and credit to be destroyed for a sustained period.  Volker yes, Bernank no.

Wonk,

What is it that gets people to start borrowing again in the first place if they can't even afford to service the debt they already have that funded past consumption?

That, to me, is the real question, because if people don't start borrowing, I don't see what the catalyst would be for inflation.

If people can somehow be convinced to start borrowing again, however, I can easily see inflation taking off.

RE the staglflation thesis, how does the fact that home values are still falling fit into that view of things?  What turns that around (especially if interest rates continue rising)?  Where does the housing demand come from if you have an entire generation downsizing into smaller homes and the demise of Fannie and Freddie is simultaneously making home financing harder to come by?

MediumTex wrote: Wonk,

What is it that gets people to start borrowing again in the first place if they can't even afford to service the debt they already have that funded past consumption?

Low interest rates and bailouts 

Adam1226 wrote:

MediumTex wrote: Wonk,

What is it that gets people to start borrowing again in the first place if they can't even afford to service the debt they already have that funded past consumption?

Low interest rates and bailouts 

Adam, if house prices are dropping, people are afraid of losing their job, and the fed can't generate expected inflation, it's tough to get people to borrow at even low rates because they are already balance-sheet restrained as it is. 

I know...I was just joking. 

MediumTex wrote: Wonk,

What is it that gets people to start borrowing again in the first place if they can't even afford to service the debt they already have that funded past consumption?

That, to me, is the real question, because if people don't start borrowing, I don't see what the catalyst would be for inflation.

If people can somehow be convinced to start borrowing again, however, I can easily see inflation taking off.

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.

Fearing trouble, the door busts open and in walks The Bernank.  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.  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.  Let's say he adds another $1000 of fresh cash to our room.  So we should have $2000 in cash to chase the same goods and services.  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.  Prices should rise, right?

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. 

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.

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.

MediumTex wrote: RE the staglflation thesis, how does the fact that home values are still falling fit into that view of things?  What turns that around (especially if interest rates continue rising)?  Where does the housing demand come from if you have an entire generation downsizing into smaller homes and the demise of Fannie and Freddie is simultaneously making home financing harder to come by?

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.

Somehow I am the deadbeat homeowner?

moda0306 wrote: Somehow I am the deadbeat homeowner?

Yeah, and Storm made that very ill-advised loan to you.  Very unwise.  Frankly, I expected better from you guys. 

I'm just glad Wonk didn't make me The Ben Bernank.

In all seriousness, I think it's a great analogy.  If I'm trying to predict the future (which is usually a foolish thing to try to do), I say China throws in the towel and allows their currency to appreciate.  The purchasing power of their citizens rises and that liquidity starts flowing back in from the next room over (or at least stops flowing into the next room.)  Inflation returns.

moda0306 wrote: Somehow I am the deadbeat homeowner?

Sorry moda, nothing personal.  I was in the midst of a thought and yours was the first name that popped into my head.  I'll be the deadbeat. 

Wonk,

I am digesting your analogy.  Will reply when processing is complete.