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EJ
03-12-07, 06:37 PM
http://www.itulip.com/images/ackerman.gifRick's Deflation Schtick - March 12, 2007

Rick Ackerman today posted here (http://news.goldseek.com/RickAckerman/1173709353.php) part of an email exchange he and I had over the weekend. Rick, bless his stubborn soul, is for some reason still trying to talk me out of Ka-Poom Theory, which I developed in 1999, and which already happened once since then, and which made me money by leading me to buy a bunch of precious metals in 2001 at the time I posted this one and only article I'd ever written on gold (http://www.itulip.com/gold.htm) up to that point–not coincidentally, near the exact bottom of a 20 year bear market in gold. Ka-Poom Theory cycles are a fact, and profitable to trade, so I'm not sure why Rick keeps talking as if the Ka-Poom Theory debate is between "inflationists" and "deflationists," framed as a purely philosophical argument of the "number of angels dancing on the head of a pin" variety.


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Too much ideology and not enough science. By any standard definition of economic terms, a hyper-inflation is a debt deflation. Rick does not accept this from me so I guess he needs to sit in on an macro econ class at his local college. In any case, I have never said I expect a hyper-inflation–he must be confusing me with someone else–but have written many pieces over the years about the possibility of a major inflation. A major inflation also destroys debt, as do debt defaults, and is therefor also a form of debt deflation.

We will edit and post the entertaining discussion Rick and I had a few weeks back, after we post the Dr. Hudson interview. (Rick wins the Most Amusing Line prize when he says, by way of explaining why his theory of debt deflation can't account for $200 oil, "I'm a demagogue!"*

In our "discussion," I make these points in summary:

Central bankers have learned how to deal with debt defaults

Doctors no longer slap leaches on us when we have the flu or drill holes in our heads when we have headaches. At least mine doesn't. (Maybe Rick's does, which if a fact would provide a simple answer to the question of how he arrived at his conclusions about deflation.) In the same vein, so to speak, central bankers no longer sit around waiting for a nation's banking system to collapse and take the economy down in a run-away process of falling all-goods prices and debt defaults. That's what they did in the 1930s, what the Japanese almost did in the 1990s, and what the U.S. most certainly did not do in the early 2000s–the Fed printed like crazy after the stock market crashed in 2000, as predicted by Ka-Poom, and we experienced in consequence a big run-up in precious metals prices, which we did predict, and a massive real estate bubble, which we did not. One of these bubble cycles, perhaps the next, the reflation process may go haywire, resulting in a major inflation. This inflation may occur by accident, or be accepted as an optimum policy choice under the circumstances which prevail at the time.

The U.S. will not experience a hyper-inflation

Every piece I have written, including Ka-Poom Theory going back to 1999, models a major inflation, but not technically a hyper-inflation. Price Waterhouse and Coopers & Lybrand defines a hyper-inflation as 100% in one year.

December 2005 - Inflation is Dead! Long Live Inflation (http://www.itulip.com/forums/showthread.php?t=326)
April 2006 - Can the U.S. have a "Peso Problem"? (http://www.itulip.com/faceofinflation.htm)
September 2006 - No Deflation! First Disinflation, then Lots of Inflation (http://www.itulip.com/forums/showthread.php?t=417)
September 2006 - Ka-Poom is a Rhyme not a Repeat of History (http://www.itulip.com/forums/showthread.php?t=428)

These articles model an inflation of approximately 100% over a period of four to six years, not one.

The reason I do not believe we will have a hyper-inflation is that the U.S. does not now, nor is likely to have in the near future, the pre-conditions for a hyper-inflation. This point is lost even among some very bright guys in the industry.

I started to listen an interview sent to me by a reader this weekend but stopped about two minutes into it when the interviewee stated that printing more money in 1930s was not an option for the Fed because that would have produced a hyper-inflation in the U.S. as had happened earlier in Weimar Germany. That's nonsense. Hyper-inflations occur when a nation a) has external debts and internal government entitlement obligations which together exceed the economy's national surplus and foreign and domestic borrowing capacity, that is, the means to pay the debts, and b) has suffered a complete loss of political control over major institutions of national government, so that all officials have left to deal with the debt deflation and currency depreciation crisis is the "print" button on the printing press, which, while solving short term nominal payroll and debt obligation problem makes all other economic matters worse.
"The Kapp Putsch (http://en.wikipedia.org/wiki/Weimar_Republic) took place on March 13, 1920, involving a group of Freikorps troops who gained control of Berlin and installed Wolfgang Kapp (a right-wing journalist) as chancellor. The national government fled to Stuttgart and called for a general strike. While Kapp's vacillating nature did not help matters, the strike crippled Germany's ravaged economy and the Kapp government collapsed after only four days on March 17."
Without both (a) and (b), you do not have the pre-conditions for hyper-inflation.

The U.S. was a net creditor in 1930s, its government payroll was miniscule relative to its economy even after the economy had contracted by 25%, and while there was political unrest there was no putsch in Washington–not even close. There was, therefor, no chance of a hyper-inflation in the U.S. in the 1930s.


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Today Government is the largest employer as a segment of the economy at 17% with 22,122,000 on the payroll (up from 3,988,000 in 1939), about the same as the Goods Producing sector. It is also one of the fastest growing, increasing by 18% in February, according to a report issued by the Labor Department last week. Only Booze, food, and hotels grew faster. Construction and mining fell off a cliff, of course, decreasing by 23% and 24% respectively, tech fell 14%, and demand for people selling mortgages to drug addicts and poor old ladies declined 9%

War and Inflation go together like rats and rat turds

The U.S. suffered a 35% inflation over the six years of the Vietnam War. The only reason we haven't already experienced an even more serious inflation due to the Iraq War, which has cost us much more in real dollars, is because of massive lending by Asia.


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But make no mistake. Today's massive foreign debts, taken on for non-productive purposes such as war, are tomorrow's high taxes, high inflation, or both.

Inflation is no more or less moral than deflation

As a side-effect of mixing economic theory and ideology, Rick has gotten this nutty idea stuck in that big brain of his that if there's a big inflation that all these carefree debtors, who've been living high off the hog, get off scott free while careful, gratification delaying savers get creamed. He seems to think a major inflation is unfair, nay, immoral! Tell that the citizens of the now defunct Soviet Union who were wiped out in the inflation that raged there from 1992 to 1996 (http://www.russiansabroad.com/russian_history_196.html):
"In 1992, the first year of economic reform, retail prices in Russia increased by 2,520 percent. A major cause of the increase was the decontrol of most prices in January 1992, a step that prompted an average price increase of 245 percent in that month alone. By 1993 the annual rate had declined to 840 percent, still a very high figure. In 1994 the inflation rate had improved to 224 percent.

"Trends in annual inflation rates mask variations in monthly rates, however. In 1994, for example, the Government managed to reduce monthly rates from 21 percent in January to 4 percent in August, but rates climbed once again, to 16.4 percent by December and 18 percent by January 1995. Instability in Russian monetary policy caused the variations. After tightening the flow of money early in 1994, the Government loosened its restrictions in response to demands for credits by agriculture, industries in the Far North, and some favored large enterprises. In 1995 the pattern was avoided more successfully by maintaining the tight monetary policy adopted early in the year and by passing a relatively stringent budget. Thus, the monthly inflation rate held virtually steady below 5 percent in the last quarter of the year. For the first half of 1996, the inflation rate was 16.5 percent. However, experts noted that control of inflation was aided substantially by the failure to pay wages to workers in state enterprises, a policy that kept prices low by depressing demand."
Annual inflation in Russia now, by the way, is around 15%.

If it's any consolation for Rick, a major inflation wipes out debtors' debts, but it wipes out what little savings debtors have, too, unless they've moved them–such as they are–overseas. That's what savers do just before a major inflation, in a "Poom" process that becomes self-reinforcing (as inflation expectations rise, capital flows out of the country, the currency slides, causing an increase in inflation expectations, and so on.) A saver who has his money overseas in bonds denominated in other currencies and in precious metals still has most of his savings. A debtor, by definition, doesn't have any savings to send overseas or store in PMs. So how does he make out better?

The U.S. doesn't have a lot of savers, of course. It has a few, and–boy–they've saved a lot. So much, in fact, that they need their own scale; in the chart below, the saver's scale is on the left, the everyone else scale is on the right.


http://www.itulip.com/images/ahnw2004.jpg

We're working on an update to Ka-Poom Theory called "The Last Ka-Poom: When Reflation Fails," which is less like a World Wrestling Federation style match between "inflationists" versus "deflationists" than a careful examination of the prospect of a failure of monetary policy to achieve the objective of continued credit expansion without causing a decline in the value of the U.S. currency. A summary will be available to all, with details available to available to iTulip Select (http://www.itulip.com/forums/showthread.php?t=1032) subscribers.

* Wikipedia says: (http://en.wikipedia.org/wiki/Demagogy) "Demagogy (Demagoguery) (from Greek (http://en.wikipedia.org/wiki/Greek_language) demos, "people", and agogos, "leading") refers to a political strategy for obtaining and gaining political power (http://en.wikipedia.org/wiki/Political_power) by appealing to the popular prejudices (http://en.wikipedia.org/wiki/Prejudice), fears (http://en.wikipedia.org/wiki/Fear) and expectations (http://en.wikipedia.org/wiki/Expectation) of the public — typically via impassioned rhetoric (http://en.wikipedia.org/wiki/Rhetoric) and propaganda (http://en.wikipedia.org/wiki/Propaganda), and often using nationalistic (http://en.wikipedia.org/wiki/Nationalism) or populist (http://en.wikipedia.org/wiki/Populism) themes. The early 20th century American social critic and humorist H. L. Mencken (http://en.wikipedia.org/wiki/H._L._Mencken), known for his 'definitions' of terms, defined a demagogue as 'one who preaches doctrines he knows to be untrue to men he knows to be idiots.'"

I do not agree with Rick that he is a demagogue. A man dripping with leeches, holes drilled in his head, needs to be granted broad poetic license.

iTulip Select: The Inside Scoop (http://www.itulip.com/forums/showthread.php?t=1032).
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grapejelly
03-12-07, 07:12 PM
great article. I am eager to hear the discussion.

Steve Saville recently made an excellent point about inflation. He feels that the US government may have set up a major consumer goods inflation because of the senseless ethanol policies of the US government.

So much food in the US is based upon corn. You could draw the food pyramid and put corn at the base and be quite accurate.

So Steve said that chances are good that meat prices and food prices will rise rapidly due to high corn prices from the ethanol policy.

This is a very visible manifestation of dollar depreciation that will (finally?) make the enormous current inflationary policies evident even to Joe Six Pac and could cause damage to the Goldilocks perception.

jk
03-12-07, 08:15 PM
a good discussion, ej, but some quibbles:

First- I suggest that you and rick stop quibbling over whether inflating away debts should be counted as a kind of “debt deflation.” This is an argument about definitions, not concepts, and thus a distraction from thoughtful analysis.

Is that 275000 figure right for gov’t employemnt? Seems awfully small.
Where’s japan among holders of u.s debt?

Your preconditions for hyperinflation start with overwhelming debt and governmental obligations. why don’t we qualify with our enormous federal spending, our enormous federal debt and even more enormous unfunded entitlement obligations re social security and medicare? For now, the u.s. has the borrowing capacity, but if the u.s. has a significant recession with sharply decreased consumption, our foreign creditors will have little incentive to keep funding flowing our way. besides, even if they wanted to, where will they get enough [to make a dent] dollars to "invest" in u.s. debt securities?

You predict inflation of 15-25% but don’t give a quantitative reason for these numbers. why 100% in 4-6 years?






Steve Saville recently made an excellent point about inflation. He feels that the US government may have set up a major consumer goods inflation because of the senseless ethanol policies of the US government.

So much food in the US is based upon corn. You could draw the food pyramid and put corn at the base and be quite accurate.

So Steve said that chances are good that meat prices and food prices will rise rapidly due to high corn prices from the ethanol policy.

This is a very visible manifestation of dollar depreciation that will (finally?) make the enormous current inflationary policies evident even to Joe Six Pac and could cause damage to the Goldilocks perception.
happily, however, food isn't counted in "core" inflation. rents should be restrained by the the unoccupied houses and condos that are gradually coming onto the rental market. gasoline and heating oil might be high, but it's not "core," either. so bls inflation, or maybe we should just say bs inflation, will be restrained.

DemonD
03-13-07, 12:42 AM
Another piece of the puzzle falls in. Yeesh. And now to research international bond funds.

Spartacus
03-13-07, 02:03 AM
Surely not .... (???)

I'm under the impression that the Iraq war is a far smaller fraction of the economy than Vietnam was.

>> The U.S. suffered a 35% inflation over the six years of the Vietnam War. The only reason we haven't already experienced an even more serious inflation due to the Iraq War

AMaltsev
03-13-07, 02:17 AM
Interesting discussion. Rick says the U.S. consumer cannot be forced to borrow, and thus the deflation is inevitable. However, to me it seems that the U.S. government can borrow as much as it 'needs', and it can do it on behalf of the consumer. Whether you apply for this mortgage or not, at the year-end Pentagon will surely ask for more money... not to mention other Agencies with similar needs.
No, no - you're definitely going into inflation!

Annual inflation in Russia now, by the way, is around 15%.
This depends on your definition of inflation. "Official" one is slightly below 10% and falling, whereas M2 money supply grows by almost 50%(!) a year (RUR 8995,8 bln on 01.01.07, RUR 6045.6 bln on 01.01.06, according to http://www.cbr.ru), and "basket" of selected goods is allowed to grow by no more than 12% annually. Of course, growth of M2 expresses itself in the prices of stocks (70% more just in 2006), real estate (50-100% more), and many other things which do not belong to the "basket".
Looking into Russian M2 figures, it's hard to imagine how the USD/RUR ratio could drop further. It seems our central bank can print just so many rubles to cope with the incoming flood of dollars and thus keep the exchange rate intact.

And a bit of personal experience. On Jan 1, 1992 my mother asked me to go and buy some food. I went to a shop and could not believe my eyes: gone were the long cues and ever-present crowds. Empty, clean premises. No one rushed to buy, because... (and here I had to re-read and reconsider the price tags)... Because in just one day prices went up nearly eight-fold! Hard times began, and that day I was able to buy just bread, and bread alone. Ouch!

Spartacus
03-13-07, 03:13 AM
Depends on your definition of "forced" (I'm thinking especially of the new bankruptcy act, which may add a few twists to to the definition of forced).

Suppose your ARM rates reset upward and the government realizes there's a problem and starts offering new programs.

You can't meet the new payments of your ARM, but if you're about to lose a house with say $50k equity and this new government scheme offers to roll over the existing arm at 1% financing for 20 more years, zero down, no payments for a year, CASH OUT (added to the balance), even though you many not "want" to take it what choice do you have (what with the new bankruptcy act ).


the U.S. consumer cannot be forced to borrow, and thus the deflation is inevitable. However, to me it seems that the U.S. government can borrow as much as it 'needs', and it can do it on behalf of the consumer.

medved
03-13-07, 04:24 AM
Interesting discussion. Rick says the U.S. consumer cannot be forced to borrow, and thus the deflation is inevitable. However, to me it seems that the U.S. government can borrow as much as it 'needs', and it can do it on behalf of the consumer.

Absolutely. And this is the way they will solve the most urgent problem - collapse of the subprime lending sector. The gov't will borrow (print) money and channel it to the big banks to buy subprime lenders.

The same gov't money will be used later to support housing prices, until we have enough CPI inflation and wage increases to revive the RE market.

All this will coincide with $US devaluation controlled by CBs. Foreigners will agree to sacrifice some of their savings and global market share to stabilize the situation (a-la Plaza accord).

So, no need to worry about poor borrowers. It will be a minor inconvenience for them (until one of the coming Ka-Pooms gets out of control - but that's another story).

m.

Rajiv
03-13-07, 08:16 AM
On the Russian experience, <a href="http://cluborlov.blogspot.com/">Dmitry Orlov's</a> articles are quite enlightening. Among them

<a href="http://www.nukku.net/no/orlov.html">Post-Soviet Lessons for a Post-American Century</a>

<a href="http://energybulletin.net/23259.html">Closing the 'Collapse Gap': the USSR was better prepared for peak oil than the US</a>

and

<a href="http://survivingpeakoil.com/article.php?id=our_village">Our Village</a>

grapejelly
03-13-07, 08:40 AM
this is what deflation believers keep harping on -- "you can't force consumers to borrow if they don't want to." It is true that sentiment can turn so bad that people get beaten down and don't want to borrow or spend.

But of course there are so many ways to increase the stock of money that do not depend upon consumers or producers borrowing.

Recipe:
Start with bailouts of failing institutions. Add some tax rebates. Fold in some direct purchasing of bad loans. And now, using a helicoptor, add cash into the mix and keep adding until the mix is completely saturated...

EJ
03-13-07, 11:22 AM
this is what deflation believers keep harping on -- "you can't force consumers to borrow if they don't want to." It is true that sentiment can turn so bad that people get beaten down and don't want to borrow or spend.

But of course there are so many ways to increase the stock of money that do not depend upon consumers or producers borrowing.

Recipe:
Start with bailouts of failing institutions. Add some tax rebates. Fold in some direct purchasing of bad loans. And now, using a helicoptor, add cash into the mix and keep adding until the mix is completely saturated...
This is what many fail to understand. Yes, one way that money is created is when a consumer takes out a mortgage or a charges a meal to a credit card. Another way is when the government borrows. Consumers tend to reduce their spending at the bottom of a business cycle* to the point where the resulting aggregate drop in demand can become self-reinforcing as demand for goods falls, firms lay off employees, reducing aggregate income (or savings, if you're a Mises fan), which further reduces demand, eventually producing recession. The core of Keynes' theory is that the government can step in to become the consumer and employer of last resort, running deficits if necessary, to short-circuit this recession process. That's step one. Step two: once the economy gets going, the government spending can be cut, the fiscal budget brought back into the black.

The Fed and Congress were too late 1933 - 1937 with their Keynesian cures. The damage to the global economy and investor confidence was so severe that the domestic politics of many nations were a shambles and thus the geopolitical environment had deteriorated to the point that a coordinated global central bank recovery policy was unworkable. Instead Europe got the disaster of WWII and the U.S. got the giant public works project that was WWII from the American economic perspective, which was when the U.S. took on its role as the demand engine for the global economy, a role it has maintained ever since.

For the next global economic downturn, U.S. policy intentions are clear. Before and during the next recession, the U.S. government is likely to offer discount mortgages, purchase the bonds of distressed companies (e.g, GM), "diversify into risk assets" (read: buy stocks), etc. Foreign central banks will also print in their local currency in order to redistribute some of the pain of the dollar depreciation which will occur when the U.S. prints to buy U.S. assets.

Two main wild cards are:

1) Will all global central banks be as accommodating to the U.S. as they were 2001 - 2005? Japan has a new administration, the first post WWI generation Japanese government, elected on a platform of weening Japan off dependence on the U.S. for exports and on developing a domestic military–no need to pay the U.S. "protection money" in the form of U.S. Treasury purchases, plus they get the income from selling weapons. In any case, as the Japanese are developing closer political and economic ties with each other than either has with the U.S., whom will Japan need protection from? China has partnered with Iran, Russia, and Venezuela, and is building political good will (via infrastructure and other investment) in Africa, and South and Central America, in order to secure access to oil and other natural resources for its growing economy. Will the Russia/China-centric G10 block and its satellites (Iran, Venezuela, etc.) play the same game again if the U.S. bubble economy hiccups, importing inflation from the U.S. to the detriment of their local ecnomies?

2) The U.S. never implemented step two, once the U.S. economy got going again in the mid 2000s, government spending was not cut, the fiscal budget was not brought back into the black. What happens when the U.S. attempts to reflate when deficits are already high, 50% funded by foreign central bank borrowing, oil at $60+ versus $12, and unfunded entitlements are now $50 trillion versus $20 trillion as of 2000?

* I don't like the term "business cycle." Cycles are repeated events, and no to periods of business development are alike, so are not, strictly speaking, "cycles."

Rick Ackerman
03-13-07, 11:52 AM
Broderick Crawford's Willy Stark comes to mind when I hear the word demagogue. Me, I'm just the son of a Mississipppi sharecropper who still hasn't given up on the dream of owning a Lamborghini Murcielago and a hideaway on Boca Grande. I must apologize for the brevity of this post, and for my inability at the moment to dive headlong into the discussion, but I am currently quite busy making final preparations for a series of online seminars I'll be doing starting at month's end. Anyway, to dismiss all that has been said in this "Schtick" (sic) thread with an imperious wave of the hand, let me say only that $400 trillion derivatives bubbles do not end other than spectacularly. To insist that merely "serious" inflation will result is like predicting that Earth's collision with a giant asteroid would be felt as far away as Des Moines.
Carry on, gentlemen.<O:p</O:p

EJ
03-13-07, 12:38 PM
Broderick Crawford's Willy Stark comes to mind when I hear the word demagogue. Me, I'm just the son of a Mississipppi sharecropper who still hasn't given up on the dream of owning a Lamborghini Murcielago and a hideaway on Boca Grande. I must apologize for the brevity of this post, and for my inability at the moment to dive headlong into the discussion, but I am currently quite busy making final preparations for a series of online seminars I'll be doing starting at month's end. Anyway, to dismiss all that has been said in this "Schtick" (sic) thread with an imperious wave of the hand, let me say only that $400 trillion derivatives bubbles do not end other than spectacularly. To insist that merely "serious" inflation will result is like predicting that Earth's collision with a giant asteroid would be felt as far away as Des Moines.
Carry on, gentlemen.<o>:p</o>:p

Hi, Rick. Thanks for stopping in. Indeed, Willy was a kind of demagogue, and well intentioned, as are you. We look forward to your seminars, and hope sales help get you closer to that Lamborghini.

There are, BTW, two ways to spell shtick. The other is schtick. Both are correct, although shtick is closer to the Yiddish word shtik from which the English word is derived.

Spartacus
03-13-07, 08:07 PM
Ah, but remember that the major reason (later admitted by Poole, I believe) for slamming interest rates to 1% was the drop in automotive prices in late 2000.

Poole admitted this in a speech about "good data".

Now imagine what the FED reaction will be to actual housing price declines - not massive freebies and sweeteners, but actual declines.

Question for you USers - can you go back over your taxes and claim a house sale at a loss against prior capital gains from prior years?

Like say some people who paid several hundred thousand in capital gains in 1999 on Internet bubble stocks now sell their houses at a loss.

I'm just trying to envision how bad a hit this would be for governments, to not have new rising house price appraisal related taxes and to have to regurgitate some prior year capital gains taxes.


a good discussion, ej, but some quibbles:

First- I suggest that you and rick stop quibbling over whether inflating away debts should be counted as a kind of “debt deflation.” This is an argument about definitions, not concepts, and thus a distraction from thoughtful analysis.

Is that 275000 figure right for gov’t employemnt? Seems awfully small.
Where’s japan among holders of u.s debt?

Your preconditions for hyperinflation start with overwhelming debt and governmental obligations. why don’t we qualify with our enormous federal spending, our enormous federal debt and even more enormous unfunded entitlement obligations re social security and medicare? For now, the u.s. has the borrowing capacity, but if the u.s. has a significant recession with sharply decreased consumption, our foreign creditors will have little incentive to keep funding flowing our way. besides, even if they wanted to, where will they get enough [to make a dent] dollars to "invest" in u.s. debt securities?

You predict inflation of 15-25% but don’t give a quantitative reason for these numbers. why 100% in 4-6 years?





happily, however, food isn't counted in "core" inflation. rents should be restrained by the the unoccupied houses and condos that are gradually coming onto the rental market. gasoline and heating oil might be high, but it's not "core," either. so bls inflation, or maybe we should just say bs inflation, will be restrained.