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Over the
past few weeks, many people have asked me to comment on John Hussman's August
23, 2010 post Why Quantitative
Easing is Likely to Trigger a Collapse of the U.S. Dollar.
Most wanted to know how that article changed my view regarding deflation. It
didn't.
Several others went so far as to tell me that Hussman was calling for
hyperinflation. They were point blank wrong.
Here is the pertinent section from Hussman's September 6, 2010 post The Recognition Window.
A note on quantitative easing
One of the things I'm increasingly dismayed to learn is that no matter how
much detail, data, and qualification I might include in these commentaries,
my conclusions will often be summed up by writers or bloggers in a single
sentence that often bears no relation to my point. For instance, my view that
quantitative easing will trigger a "jump depreciation" in the
dollar has evidently placed me among analysts warning of hyperinflation and
Treasury default (a club whose card is nowhere in my wallet).
To clarify once again - I emphatically do not anticipate inflationary
pressures until the second half of this decade. As I've repeatedly
emphasized, the primary driver of inflation - historically and across
countries - has been growth in government spending for purposes that do not
expand the productive capacity of the economy.
Quantitative easing does not pressure the dollar by fueling inflation. It has
a much more subtle effect (but one that can be expected to be amplified if
fiscal policy is long-run inflationary as it is at present). Normally,
equilibrium in capital flows between countries is achieved through changes in
interest rates. As a result, countries with greater capital needs or higher
long-run inflation tendencies also have higher interest rates. If interest
rates can adjust, exchange rates don't have to. But notice what quantitative
easing does: by sitting on long-term bond yields (and creating a negative
real interest rate differential versus other countries), quantitative easing
prevents bond prices from acting as an adjustment factor, and forces the
burden of adjustment on the exchange rate.
While some observers have noted that the value of the Japanese yen did not
deteriorate dramatically over the full course of quantitative easing by the
Bank of Japan - from its beginning until it was finally wound down - this
argument misses the point. The exchange rate depreciation occurs as a jump
adjustment in order to set up a subsequent appreciation over time. That
gradual appreciation is needed to offset the lost interest difference caused
by the policy of zero interest rates.
In the
Octagon
Some of
the arguments that people have recently presented for hyperinflation are so
silly they are not worth discussing.
Yet, I have been drawn into discussing such arguments because of an
unfortunate off-the-cuff statement I made on a recent podcast, and because of
a misrepresentation of another statement I made in the same podcast.
Zero Hedge writes The Deflation vs Hyperinflation Debate On Steroids, Or Mish vs Gonzalo
Lira In The Octagon
A recent guest post by Gonzalo Lira on Zero Hedge,
providing a theoretical framework for the arrival of hyperinflation, went
viral, generating over 75k views and over 1,000 comments, further confirming that
the biggest and most confounding debate in all of finance is what will the
final outcome of the Fed's market manipulative actions be: deflation,
inflation or, and not really comparable, hyperinflation (which is a
distinctly different phenomenon from either of the above). The post
infuriated some hard core deflationists who continue to refuse to acknowledge
the possibility that in its attempt to inspire inflation at all costs, the
Fed may just push beyond the tipping point of monetary imprudence away from
mere target 2-3% inflation, and create an outright debasement of the world's
reserve currency.
One among these was none other than Mish himself, who a week ago recorded a
podcast on Global Edge with Eric Townsend and Michael Hampton (link here), in which his conclusion was that Hyperinflation
is the endgame, "so it is unlikely."
Hyperinflation
Ends The Game
Actually what I said is "Hyperinflation Ends The Game" NOT as Zero
Hedge stated "Hyperinflation is the endgame". The difference
between those phrases is enormous.
In the podcast I was asked about a guest post by Gonzalo Lira on Zero Hedge.
I had seen the article and I made an off-the-cuff statement that the post was
so silly it was not worth commenting not.
How Hyperinflation Starts According to Lira
Please consider the following snip as to how hyperinflation starts according
to Gonzalo Lira.
So this is how hyperinflation will happen:
One day—when nothing much is going on in the markets, but general
nervousness is running like a low-grade fever (as has been the case for a
while now)—there will be a commodities burp: A slight but sudden rise
in the price of a necessary commodity, such as oil.
This will jiggle Treasury yields, as asset managers will reduce their
Treasury allocations, and go into the pressured commodity, in order to catch
a profit. (Actually it won’t even be the asset managers—it will
be their programmed trades.) These asset managers will sell Treasuries
because, effectively, it’s become the principal asset they have to
sell.
It won’t be the volume of the sell-off that will pique Bernanke
and the drones at the Fed—it will be the timing. It’ll happen
right before a largish Treasury auction. So Bernanke and the Fed will buy
Treasuries, in an effort to counteract the sell-off and maintain low
yields—they want to maintain low yields in order to discourage
deflation. But they’ll also want to keep the Treasury cheaply funded.
QE-lite has already set the stage for direct Fed buys of Treasuries.
The world didn’t end. So the Fed will feel confident as it moves
forward and nips this Treasury yield jiggle in the bud.
Debating
the Flat Earth Society
Supposedly ... A slight rise in oil will cause a "jiggle" in
treasury yields.
As a result of that jiggle "asset managers will sell Treasuries
because, effectively, it’s become the principal asset they have to
sell."
Really?
Since when are much despised treasuries the "principal asset"
of asset managers? And pray tell, why would the asset managers "have
to sell"?
Oil at $140 did not start a chain reaction before. Why would a "slight
but sudden rise" in commodity prices start such a chain reaction,
now?
I do not know how anyone could keep reading after those statements, but it
goes on and on, getting sillier and sillier about who has to sell what and
why, and in turn what the Fed's response will be.
One interesting aspect of Lira's post is that I agree with his definition of
hyperinflation: a complete loss of faith in currency. Yet, Lira never even
discusses how a selloff in treasuries causes a loss of faith in the dollar.
However, Lira does go on to say "....That’s why I think
there’ll be hyperinflation in America—that bubble’s soon to
pop. I’m guessing if it doesn’t happen this fall, it’ll
happen next fall, without question before the end of 2011. "
Commenting on the above is tantamount to debating the flat earth society. The
premise is so silly it's not worth discussing, yet here I am trapped into
discussion by a mischaracterization of my statement "Hyperinflation Ends
The Game".
How Does Hyperinflation Occur?
"FOFOA" hops into the hyperinflation debate with Just Another Hyperinflation Post - Part 1
First of all I would like to clear up probably the
most common misconception about hyperinflation. What most people believe is
that massive printing of base money (new cash) leads to hyperinflation. No,
it's the other way around. Hyperinflation leads to the massive printing of
base money (new cash).
Hyperinflation, in most people minds, conjures images of trillion dollar
Zimbabwe notes. But this image is simply the government's reflexive response
to the onset of hyperinflation, which is actually the loss of confidence in
the currency. First comes the loss of confidence (hyperinflation), then, and
only then, comes the massive printing to keep the government and its
obligations afloat.
Zimbabwe
vs. Weimar
In the case of Zimbabwe, a loss of faith in currency occurred before the
printing occurred. The Weimar Republic is a different story.
In Zimbabwe, the Mugabe government initiated a "land reform"
program intended to correct the inequitable land distribution created by
colonial rule. Ultimately, Mugabe's attempt to to bail out the poor at the
expense of the wealthy is what triggered capital flight and loss of faith of
the currency.
His reforms not only caused a flight of capital and human capital (the
wealthy), they also led to sanctions by the US and Europe. In response,
Mugabe turned on the printing presses but the loss of faith in the currency
had already occurred.
In Weimar Germany, printing for war reparations kicked off hyperinflation.
Wikipedia provides a good accounting in Inflation in the Weimar Republic.
It is sometimes argued that Germany had to inflate
its currency to pay the war reparations required under the Treaty of
Versailles, but this is misleading, because the treaty did not allow payment
in German currency. The German currency was relatively stable at about 60
Marks per US Dollar during the first half of 1921.[1]
But the "London ultimatum" in May 1921 demanded reparations in gold
or foreign currency to be paid in annual installments of 2,000,000,000 (2
billion) goldmarks plus 26 percent of the value of Germany's exports. The
first payment was paid when due in August 1921.[2] That was the beginning of
an increasingly rapid devaluation of the Mark which fell to less than one
third of a cent by November 1921 (approx. 330 Marks per US Dollar).
The total reparations demanded was 132,000,000,000 (132 billion) goldmarks
which was far more than the total German gold or foreign exchange. An attempt
was made by Germany to buy foreign exchange with Marks backed by treasury
bills and commercial debts, but that only increased the speed of devaluation.
The monetary policy at this time was highly influenced by the Chartalism, and
was notably criticized at the time from economists ranging from John Maynard
Keynes to Ludwig von Mises.[3]
Hyperinflation
is a Political Event
The commonality between Zimbabwe and Weimar is they are both political
events. In Zimbabwe a political event triggered capital flight, in Weimar a
political event started massive printing, triggering hyperinflation.
Interestingly, FOFOA's commentary seriously weakens the hyperinflation case
once one dives into the politics of the cause.
Can The Fed Cause Hyperinflation?
I do not think the Fed can cause hyperinflation and more importantly I am
sure they would not if they could. The
reason is "Hyperinflation Would End The Game"
·
Hyperinflation by definition would destroy the
currency and thus the banks
·
Hyperinflation would destroy the wealthy and all
their corporate bond holding
·
Hyperinflation
would destroy the Fed
·
Hyperinflation would destroy the wealthy political
class
That is what I meant by it would "end the game" and that is
why the banks, the Fed, the politicians, and the wealthy would not let "the
game" progress that far.
Fiat World Mathematical Model
The above addresses the question of "Would the Fed Cause
Hyperinflation?"
"Could the Fed cause hyperinflation?" is a different question. I
have my doubts.
To understand how powerless the Fed is, one needs to understand the
difference between credit and money, how much the former dwarfs the latter,
and what the Fed's role is in getting banks to lend. I discussed those ideas
in Fiat World Mathematical Model.
Unlike Congress, the Fed has no power to give money away. Nor would they do
so if they could.
By the way, I did see Quantitative Easing, ZIRP, and various Keynesian
silliness in advance and stated they would not work.
October 30, 2008: ZIRP Coming To Fed?
ZIRP did not help Japan and it will not help US
banks either. In fact, the rate cuts appear to be counterproductive. However,
one cannot rule out the Fed cutting rates to 0% anyway. Bernanke is in
academic wonderland and appears to be hell bent on sticking with his models
regardless of how poorly those models perform in actual practice.
March 06,
2009: Groping In The Dark' With Quantitative Easing
Excuse me but has anyone looked at the success rate
of Bernanke's quick slash of interest rates from 5.25 to 0 and the fast
$trillions Congress, Paulson, Geithner and Obama have thrown down various
black holes?
Of course the Keynesian clowns will always come back with "It would have
worked if only we threw money away faster". They do every time. Krugman Still Wrong After All These Years is the
perfect example.
January
02, 2009: How "Something For Nothing" Ideas Become Policy
Bernanke Correctly Judged Nothing
Bernanke considers himself an expert on the great depression and on the
Japanese deflation as well. Trying to act quickly, Bernanke has come out
blazing with 8 new policy tools, including the TALF, TARP, PDCF, ABCPMMMF,
CPFF, TAF, and MMIFF to go on top of Open Market Operations, Discount Rate
setting, and setting reserve requirements.
The result so far is deflation. The result in Japan was deflation.
There is only one way to defeat deflation and that is to not let the
conditions that foster it to build up in the first place. What caused this
deflationary bust is the credit boom that preceded it. What caused the great
depression was the credit boom that preceded it. Hoover's policies and FDR's
policies made the great depression worse.
Bernanke's policies are going to make this depression worse. Yes, I used the
word depression. It may not be as big as the great depression, but the word
"recession" does not do justice to what we are in and what is
coming down the pike.
Contained Depression
I agree with Hussman that Quantitative Easing will not cause hyperinflation.
Nor will "jiggling" of treasury yields, nor would a "slight
but sudden blip" in commodity prices, nor would another $1 trillion
stimulus effort.
Kevin Feltes and Jerome Levy, economists for the Jerome Levy Forecasting
Center, have come to the same conclusion.
For an discussion of ideas from the Levy institute, please see "Contained Depression"
For Now, It's Deflation
For a full discussion of where we are today please see Are we "Trending Towards Deflation" or in It?
Unlike hyperinflation, deflation does not "end the game" (destroy
the currency). The Great Depression and Japan both provide proof enough.
Given that hyperinflation is a complete loss of faith in currency, tangible
goods, any tangible goods must by definition rise exponentially in such a
situation. Yet amazingly many hyperinflationists are bearish on housing.
Hyperinflation accompanied by a housing collapse is simply impossible - by
definition.
What Could Cause Hyperinflation?
As noted above, the Quantitative Easing will not cause hyperinflation.
Moreover, it is doubtful the Fed can cause it at all. The Fed cannot give
money away nor can the Fed force banks to lend or consumers to borrow. Those
who disagree must still address the difference between theory and practice.
Unlike the Fed, Congress could give money away.
I do not know if giving everyone in the US $60,000 would do it or not, but
announcing a plan to give everyone $60,000 a month indefinitely would sure do
it.
How likely is that?
The answer is 0%. Congress struggles right now extending unemployment
insurance. There is little political will for more stimulus. The next
Congress is a guaranteed bet to be more conservative.
To be sure, more stimulus and more Quantitative Easing are coming but the
latter does not matter and the former will be in insufficient quantity.
Theory vs. Practice
Please note that banks do not want hyperinflation or even massive inflation.
The reason is simple: Banks will not want to be paid back with cheaper
dollars, especially worthless dollars, and Congress is beholden to itself and
the banks.
Hyperinflation could theoretically come from massive sustained
political will to bail out the little guy at the expense of the banks, the
wealthy, and the political class. However, unlike Mugabe and Zimbabwe,
neither the banks nor the Fed nor the political class wants to bail out the
poor at the expense of the wealthy.
Indeed, Bernanke's, Paulson's, and Geithner's actions to date have done the
exact opposite!
We have bailed out the banks at the expense of the ordinary taxpayer (keeping
the little guy in debt).
This is what it comes down to: In theory, Congress can easily cause
hyperinflation. In practice, they won't, and neither will the Fed. As Yogi
Berra once quipped "In theory there is no difference between theory
and practice. In practice, there is."
Mish
GlobalEconomicAnalysis.blogspot.com
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Thoughts on the great
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