Sunday, June 28, 2009

If Borrowers Ruled

I've made the point before that hyperinflation favors those in debt, and deflation benefits the lenders. Furthermore, I've stated that at the end of the day America is a democracy, but at the beginning of the day it is a plutocracy where political favors are lobbied by wealthy interests. Finally, I argue that hyperinflation versus deflation following a credit bubble is a function of monetary policy; deflation will happen with a hands-off approach, hyperinflation happens when money is printed and distributed without recourse.

Which all adds up to a safe feeling in my mind that the correction of the housing bubble, and all other bubbles blown of late, will be deflationary, and cash will increase in purchasing power and value as time passes. So long as the government can use tax money and treasury bonds to support inflated asset prices, it will continue to do so, but when that reaches its endpoint, the correction will be deflationary.

For every dollar of debt somebody owes, there is a quiet entity expecting to be paid back with interest, not to mention strong currency. Anyone who has treasury bonds or sizable holdings of bonds of any kind will have lobbying efforts intent on keeping the dollar strong. (Keep in mind, with a 10% fractional reserve policy, 90% of the money out there is debt.)

Now if politicians obliged themselves only to the voting public, it would be a different story. With most Americans having more debt than savings, they would benefit from strong inflation assuming incomes rose to match it. Employment was strong during the hyperinflation of the Wiemar Republic, although workers were paid with Monopoly money so their wages were really much less than in times of stable currency.

So hyperinflation had two benefits: it forgave debt, and unemployment was very low. Both of these are very democratic and enticing to anyone who can't find a job. Retirees who lived on fixed government pensions were left to starve, and anyone with cash holdings either moved it to assets or lost everything.

In Germany and Austria in the early 20's, the labor unions had particularly strong political status, and they favored free and easy money for reasons mentioned above. More so, we saw these countries strangled by war reparations. In this climate, we have a situation where hyperinflationary policies became politically possible. But given the general suffering and economic chaos that resulted, in hindsight it would still be inadvisable.

We are far from those conditions here. Hyperinflation is as easy as turning on the printing press. But politically, it is impossible.

Friday, June 26, 2009

Flight to Cash?

The U.S. savings rate hit a 15-year high, just under 7%, today. Despite all the financial shenanigans, we see a slight trend of people going back to cash. As always, this sort of thing is concerning to the contrarian investor. But the last time people moved into cash, back in September, the dollar had a nice run that lasted until March and the onset of quantitative easing.

It's been a tepid rebound we've had since March. If it were in line with past dead cat bounces, eyeballing the DJIA over the decades, such a faux-recovery spike could have easily reached 10,000 and maybe even 12,000 before the true decline to fundamentals began. So it's hard to draw conclusions about the last three months. Either we are waiting for the real rebound, or this was it and its weakness underscores the strong deflationary pressures at work.

Thursday, June 25, 2009

FOMC Outlines Quantitative Easing

Concluding their meeting yesterday, the Fed held interest rates at near 0%. This was expected and no surprise to anybody.

They reiterated their plan to continue what quantitative easing is currently underway, but did not add to it, citing some signs of a turnaround in the recession.

Here are the numbers: for this year they plan to buy $300B of Treasury Bonds, $1.25T of agency mortgage-backed securities, and $200B of "agency debt." I don't know what agency debt is, but I'm guessing both that and the mortgage-backed securities have very little market value so this amounts to a $1.5T infusion of cash into the economy, which can't be good if you have a savings account. The government is probably good for the treasury bonds, so the purchase of them with printed currency amounts to a $300B increase in money supply that will remit over the course of the bond.

More information about the mortgage-backed securities and agency debt is needed before any firm conclusions can be reached. Does the money for their purchase originate with printed currency or Treasury Bonds? And what recourse is there for the defaults? These will need to be known to determine how inflationary this policy will be.

And, although $1.5T is a lot of money ($10,875 T*Bux), the total money supply of dollars is somewhere around $10T, around 90% of it is debt, and that is all under heavy deflationary pressure at the current time.

Tuesday, June 23, 2009

Hyperinflation Survival Guide

Here's a few more thoughts from reading When Money Dies (UPDATE 5/20/10: sorry, online text has been removed by publisher's request, and it is quite pricey on Amazon).

There were some who prospered during the collapses of currency in Austria, Hungary, and Germany following WWI. There are also areas of need that were particularly hard hit, which caused much suffering in these countries. If you truly believe hyperinflation is about to happen in America, here are some preparations you can make, and some hot career moves.

When currency collapses in value, it is mainly consumable goods that will be scarce. Everybody will be hoarding them. Durable goods will be in plentiful supply, since people will be trading those for consumables—by which I mean food and fuel. The bomb shelter types will be in good shape for hyperinflation. I'd recommend keeping bags of flour, grains, and canned food, enough to last for a year, until the new currency is well established.

In case you forgot anything, have plenty of cigars and cigarettes on hand. In war, prisons, and hyperinflation, tobacco has always served as makeshift money when there is no other. Being durable, portable, divisible, and having intrinsic value—it fulfills pretty well the criteria for natural currency. Bummer about the huge tobacco tax—come to think of it, does the government know something we don't?

Farmers did okay during the Weimar collapse, mainly though the trade of durable goods for food. Either make friends with a farmer, or learn to become one. At least that way you won't starve. At the very least take up gardening if you anticipate hyperinflation. In Austria, in the early 20's, a farmer could trade a few bags of apples for a piano.

Which brings up hot careers: aside from farming, look into finances or the black market. Crazy profits are to be made there. While many starved and died of disease and exposure, others partied—and you want to be one of those. Wall Street types did well during the collapse of the Krone and the Mark, for the exact same reason they've done well in the past decade. When cash is devaluing, the stock market is hot. Foreign currency and stocks were the primary ways people preserved what wealth they had. Since financiers get a cut of these transactions, they will profit handsomely during the collapse of the dollar. They may be losing their jobs now, but they shouldn't get too cozy at their parent's house. They will be plenty busy when hyperinflation hits.

Now, when people are freezing and starving, they will gladly trade their most prized and valuable belongings for food and fuel. While the government tries and fails to ration everything, the international black market will be sizzling. Don't miss out!

If you follow these simple rules and quickly get your money into stocks and gold, there is plenty of fun to be had with hyperinflation. Any schadenfreude renters may now be feeling will pale in comparison to those prepared for the dollar's collapse. At the very least, it will be your chance to loose those 20 pounds you've been meaning to shed.

Sunday, June 21, 2009

The Distinction Between Deflationary and Hyperinflationary Policy

I've been reading When Money Dies: the Nightmare of the Weimar Collapse by Adam Fergusson. The book is so rare it costs several hundred dollars on Amazon, but fortunately it is free online. I'm still near the beginning but it is a thought provoking read.

What interests me in it is the distinction between deflationary and hyperinflationary outcomes of economic contractions. The more I read, the more I conclude the differences are disturbingly narrow, and if monetary policity shifts from one direction to the other it could easily go without notice to the public for awhile.

I hope both inflationists and deflationists can agree that either outcome will be a determination made by the regulators of fiscal policy—in the U.S. it would be the Fed and the Treasury Department. There is nothing inherent in economics that will naturally go in one direction or the other. Hyperinflation or deflation is a choice consciously made and acted upon by financial authorities.

In the event of recessions, governments try to stimulate the economy with loose monetary policy. In our case now, this has been going on without stop since the end of the internet bubble. It is still going on, first with a real estate bubble, then a second stock market and commodities bubble, and now with quantitative easing. Efforts at money creation have been taking place non-stop for a decade.

But all the money created by the government, so far, is in the form of credit, which is expected to be paid back. The act of paying back credit at the end of a bubble is deflationary. First, there will be less credit available in the coming years, and second what disposable income people now have will be mainly used to pay off debt. The overall result is money contraction and price deflation.

What happens in hyperinflation is that money is created and distributed without any need to pay it back. It is handed out as payment for government services or entitlements without any expectation it will be returned.

This difference turns out to be subtle. So far, all reported stimulus money is a government loan underwitten by the tax base. This fundamentally does not expand money supply. Any expansion is only temporary, so the ultimate outcome is deflation. Were such loans NOT to be underwritten by the tax base and could be defaulted on freely, hyperinflationary risks come into play.

When it comes to tight wages, unemployment, reduction of government services, widespread defaulting on credit, and tight lending standards—deflation is what we are seeing. Prices of everyday goods remain about the same but most investment classes remain down from 2008. All deflationary unwinds have exhibited rebounds like the one we are seeing now and if deflationary patterns hold then corrections to fundamentals will resume any day now.

My money remains in dollars, but at this point diversifying into gold and some competitively priced stocks would be a more sensible strategy than when this blog first began. Were I a more savy investor I would have jumped from dollars into stocks in March, but had I done that now I would be going back to cash.

Saturday, June 20, 2009


News of economic woes has fallen on California a lot lately, and given the budget crisis and a particularly bubbly real estate market and tech industry—it seems California will be leading the way down this economic sink hole.

For May, the jobless rate here cracked the 10% barrier, 11.5% actually. It leads the rest of the nation now at 9.4% and rising. Maybe there is some cause for optimism from the rebound of the stock market, but to my mind there are no real signs of improved employment opportunities and a lot of government jobs in jeopardy come July.

With the Alt-A resets only starting, and the middle- to upper-end housing market cracking at the seams, there is plenty of room still to fall, and years before a turnaround can be expected.

Monday, June 15, 2009

California Foreclosure Prevention Act

In one of those efforts that means well but in the coming months we will probably see a far worse backlash, today California added 90 days to the period between the first defaulted payment and repossession through foreclosure, unless the servicing bank has a program in place for loan modification.

As history is playing out, banks are much more resilient toward any sort of loan modification than I would have guessed, based on general business sense that lowered loan payments are better than no loans payments and trying to sell the house in a saturated market. But as it happened, all government efforts to assist the process have failed. The original Hope For Homeowners Act was a bust, which followed a similar Bush plan that was also a bust. In that we need this sort of legislation, the more recent Obama plan must be struggling.

Where the mortgage markets are already starting to freeze, despite the Fed's efforts at quantitative easing to keep money flowing, a move like this can't make banks more likely to originate loans.

Thursday, June 11, 2009

Sign of the Times

That resort, St. Regis in Dana Point, where AIG famously held a $440 thousand spa retreat for its executive to celebrate their newfound bailout money—that resort is in a foreclosure sale.

Ah, AIG. It hasn't made the news for awhile. I wonder how much of it there is left. Monetary policy has become so quiet lately.

Friday, June 5, 2009

ECB Pause

With the Fed and Bank of England ZIRP'd, the ECB holds at near-ZIRP of 1%, catching the social vibe that maybe the worst is behind us and things are about to turn around.

At home, the DJIA has been hovering at the upper 8000s. Unemployment is on a constant march upward, and at 9.4% for May it could well surpass 10% in a month or two. But it's no longer "unemployed"... it's "funemployed!" Recent successes of the DJIA and rising oil prices have reassured the more optimistic among us of good investment opportunities soon.

The debt unwind, and the consequent contraction of money supply, has plenty of room still to go. Quantitative easing can stall the process but does not affect fundamentals.