A Couple of Gems
on January 4th, 2009 at 10:38 am
One blog participant brought a post by George Monbiot to my attention. I frequently comment that the financial regime initiated after WWII omitted key ideas that Keynes proposed–in particular, a new currency for international trade and controls on the behaviour of surplus nations as well as those running deficits. Monbiot provides the historic detail of these proposals and their defeat. It is well worth a read.
A link to my site from another blog alerted me to another post, from the opposite end of the spectrum, which is a cert for my “Brickbats” page–both for its content and its timing. On January 19, 2007, Gerard Baker of The Times editorialised that “Historians will marvel at the stability of our era“. An excerpt for you:
“Economists are debating the causes of the Great Moderation enthusiastically and, unusually, they are in broad agreement. Good policy has played a part: central banks have got much better at timing interest rate moves to smoothe out the curves of economic progress. But the really important reason tells us much more about the best way to manage economies.
It is the liberation of markets and the opening-up of choice that lie at the root of the transformation. The deregulation of financial markets over the Anglo-Saxon world in the 1980s had a damping effect on the fluctuations of the business cycle. These changes gave consumers a vast range of financial instruments (credit cards, home equity loans) that enabled them to match their spending with changes in their incomes over long periods.
In the City of London and New York, the creation of the secondary mortgage market, cushioned banks from the effect of a sharp downturn in their core business. The globalisation of finance meant that downturns in one market could be offset by strength overseas. The economies that took the most aggressive measures to free their markets reaped the biggest rewards.”
Yeah, right. In this context, I can’t help quoting myself from 1995, in the conclusion to my paper on modelling Minsky’s Financial Instability Hypothesis for the Journal of Post Keynesian Economics:
“From the perspective of economic theory and policy, [Minsky's] vision of a capitalist economy with finance requires us to go beyond that habit of mind which Keynes described so well, the excessive reliance on the (stable) recent past as a guide to the future. The chaotic dynamics explored in this paper should warn us against accepting a period of relative tranquility in a capitalist economy as anything other than a lull before the storm.”
PS Paul Amery provided a link to a paper by Bernanke on “The Great Moderation” too, but it was not the correct link. Here it is–written in 2004 so it’s not as outrageously badly timed as Baker’s blather. But I wonder how often Ben goes to bed wondering “How on earth did it all come to this?”
Hi Prudent,
Welcome back.
I guess your argument is that as treasuries sell off from their bubble. A flood of money will flow back into markets leading to rallies across the board. Simple.
What about the following “spanners in the works”
1. Losses have been so great that investors are very afraid to go in hard. The psychology has turned bearish.
2. The deleveraging from losses, forced sales and liquidations have resulted in much more credit destruction that the FED has been able to create.
3. Because consumers are becoming increasingly bearish, demand is falling leading to profit destruction. This is leading to higher unemployment and further demand destruction. A downward spiral.
4. The Banking system in the Western world has terminal levels of risk. The bail outs by many Western Governments may fail this year and the resulting runs on the banks will destroy even more credit. Fear and risk aversion is ruling.
5. During the 1930 interest rates bounced along the bottom for over 10 years and there was no hyperinflation. In Japan rates have been near zero for over 10 years and they have had no hyperinflation.
Why are you so convinced that this looks like 1970 and not 1930? Have you considered that massive levels of debt/GDP in most western countries might change the story from 1970 to 1930? Does the crippling levels of debt change your views?
And finally have you seen any evidence of inflation yet? Anywhere? At this stage I only see signs of deflation.
Hello prudent.
There are enormous differences between 1970 and now. Firstly the mountains of debt now (2009) held by the Anglo countries, this is mentioned over and over again by Steve and posters on this blog.
The other major difference is that in 1970 these current debtor nations were not mendicant. We possessed the leading edge technology, the “means of production”. The US was landing people on the moon Australia was third or fourth country to launch a satellite. Australia was more than 60% self sufficient in technology and manufacturing. Australia ran current account surplusses, our net debt was of manageable proportions. Then came neo-classical economics which was given the motherhood names of “economic rationalism” and “globalisation” whilst in reality, it is about as rational as Russian roulette.
As for now Australia was, just before this collapse (early 2008), needing to borrow $AU1,000,000,000 per week to sustain it’s (net) non productive economy the US needed even more on a per capita basis. Australia is now about 95% dependent on other countries for our manufacturing and technological needs. The young people who may have been Engineers and Scientists took up (ne-classical dogma) economics, “management”(based on neo-classical dogma) and law. Inovation in these countries has been in financial derivites, CDOs, CDSs and corpoate manipulation to name just a few. This has turned these economies into giant Ponzi schemes. Regulators were even not able to identify a deliberate Ponzi scheme in the US (Madoff).
Yes in 1970 we were industrialised, if we honestly assesed our 2009 economies by 1970 standards we would probably have to say that they are now distively “third world”.
I am convinced there is a monster bond bubble dating back to the end of the 1980-s, when Alan Greenspan took over the federal reserve. I have been able to date that to track the movements of various stocks that will move with inflation, in comparison to long term interest rates. Under the Paul Volcker era those stocks moved flat! Under Greenspan, they have just moved worse and worse, each blast bigger than the last one, suggesting there is, and have been a huge inflation problem, with double digit inflation, almost every year back to 1988. I am convinced real estate in countries like Australia is going to stabilize without a crash, simply because real estate have been an inflation hedge more than a bubble. The bubble is probably in bonds. And the resource boom and inflation that will resume, will probably work as a pillow for real estate to land on in Australia. I suppose there will even be a new boom soon. Long term interest rates are so suppressed and have been it for so long it’s scary. You could blame it on Asian governments, but also the trend of globalisation that have enabled wild money printing since the fall of the berlin wall.. The chickens are coming home to roost, very soon. The money going into the black hole of globalisation, actually causing imported deflation, is very inflationary in the sense it adds pressure to the global resource usage, hollow out our own economies, and in a bond crash due to this hollowing, a thing that could happen is that we will pay a lot more for resources, while it’s cheaper for the new countries. Short term interest rates have also been very suppressed. It’s this effect that have caused all the bubbles, but the main bubble, behind it all are still intact. If there is 100 %, 200 % or 1000 %, or 10000 % debt to GDP simply does not matter in my opinion. The US must be viewed as a latin american country. In many ways the situation is much much worse than in the seventies, that’s why I think the inflationary blow off will be much worse. As the flight out of government bonds in hollowed out and non functional economies like the US and the UK, probably will lead to a dramatic raising of interest rates, or monetizing of debt, ending with Weimar hyperinflation. I think Obama will be able to create one boom, with lot of inflation, then Ben Bernanke will go, Larry Summers will come, and raise interest rates like crazy, unless bernanke already have wrecked it. The agreement among economists these days is scary. That just makes me sure on inflation.
If you trust me, then you put some money into fertilizer stocks:) This credit crisis in the middle of this rise of the new countries, and urbanization, will probably mean that harvests will suck in 2009, and add a great demand to fertilizer, farmland ,etc. It’s like the US was on top of the hill, but got lazy, stopped working, lived on credit, so on. Down in the hill you had china, starved, hungry, eye of the tiger, providing their savings for the US, to have their false sense of prosperity, slowly rising to the top. As this story goes, I think the story of currencies goes to.
Here the other day I bought a washing machine, 1400 RPM, Bosch, the price paid for this machine was an average days salary for someone living here. I think this is an unsustainable situation. I don’t see a trend of deflation bringing down the cost further.
Sorry if this post upsets a few people. This is not meant to be personal.
Prudent, You have been great in putting me in two minds and challenging my understanding. But I am becoming very sceptical.
This site is dedicated to Steve’s view on debt deflation based originally of Steve’s work building on Minsky’s theories.
But Prudent, you repeatedly ignore the effects of debt in your analysis. How can you read this site and ignore debt so blatantly?
Your notion that treasuries have been a growing bubble since the late 1980s fits perfectly with Minsky’s theory. That is, repeated smaller debt bubbles are choked off by smaller and smaller rises in interest rates. And that over time rates have to trend down because the debt burden becomes too large, until there is a final blow off (because the debt burden gets too high) and the system gets reset with much lower debt levels after the debt deflation runs its course.
Apologies to Minsky and Steve if I have dumbed down the theory too much.
My concern now is that you are a “plant” or “creation” to juice up this site. Your opposition seems to polar for me. I love hearing from you, but I am starting to worry if you are real or created by one of Steve’s mates.
I think the answer lies in how we choose to view the US. Think that the US was a latin american country with debt issued in their local currency, the pesodollar. The bigger debt load, would actually inflationary, as it would be even more optimistic to think that you would get something back, other than the money you actually were paying in. At one point the whole illusion or ponzi scheme would start to break, and interest rates would start to move higher as people would demand more to hold these securities. However in this crisis interest rates on 10 year notes have went lower and lower, when they were around 3,5 % rumors started flowing that the fed were going to do quantitative easing. That have caused speculation causing rates to go even lower as speculators are betting on selling the notes to the fed at an even higher price in the future. There is no investment demand. It was when that point cross that the stock market started moving higher, even notes still were yielding less. In this great latin american debt bubble, I think that eventually treasuries will sell off, and that move will be inflationary. Imagine China selling all their treasuries at once? What would happen? Hyperinflation, instantly.
Prudentsaver,
your analysis is flawed.
There is no bond bubble.
When has there ever been a bubble in a market with massive risk aversion (fear)? A market that manifests a bubble is one which exhibits euphoria not fear!
If U.S. treasury paper is sold off, what stops the U.S. Fed. from purchasing these securities and at the same time steralising that money by selling off assets (assets accumulated from all of it’s alphabet soup credit lines that it has recently established) that are now on the asset side of it’s expanded balance sheet?
The U.S. Fed. has not performed a form of quantitative easing as implemented by Japan. The Bank of Japan grew the liability side of their balance sheet in flooding the financial system with liquidity, the U.S. is expanding the asset side of it’s balance sheet, in flooding the financial system with liquidity!
The shape of the yield curve tells me something very different, and it is by no means the shape of the yield curve of the 70′s.
The Chinese have no interest in selling off their holdings in U.S. treasuries, they are in fact adding to them, not divesting of them. They are certainly rebalancing their portfolio away from Agency paper, and guess what, they are purchasing more U.S. Treasuries. Whilst China has a current account surplus they will be purchasing U.S. Treasuries or maybe even U.S. assets which would also help.
Sorry prudentsaver, your analysis does not stack up to scrutiny
I disagree. The last months, there have been more and more talk about a bond bubble as people have moved into treasuries, driving down yields to super low levels. The same thing happened in 1998. That’s not the bubble, however, you could call it a mini bubble of fear super imposed on a long term bubble, right before the mini bubble sells off, all the money flow into something “hot”, and treasuries sell off with a pressure to raise interest rates. That is how things work in the practical world I think. And that’s how it happened in 1998 and 2003, no deflation, even that’s what people were calling for. The bubble is in the downwards trend of yields beginning already in the late eighties, that have been enabled through the channeling of Asian savings and other surpluses into the US. The thing in the last months is more like a spike, in this longer term bubble. There have been 2 spikes before, on in 1998, and another in 2003. The yield curve, right before the talk about quantitative easing when speculators jumped all over the long bonds and 10 year notes, was in fact very stimulating, similar to before any other expansion. And the odds for anything other than expansion was less than 0,5 %, as long as two months ago.
I think the Chinese could very well sell of their treasuries. They made a threat to sell them off before, when the US wanted to introduce taxes on Chinese products. If they do, I think that would make everyone else to do the same thing. That very thing would drive US debt into junk bond status, similar to what Roubini have been calling for before.
To the risk aversion. Yes, there have been lots of bubbles connected to fear. Look no further than the bubble in gold, lasting to 1980. A fear driven bubble. Oil and other commodities are also often driven by fear. But it’s only the mini bubble in treasuries, that are fear driven, not the long term treasury bubble, that’s fear driven. The longer term bubble is more driven by ignorance I think, and failure to see the US for what it is, due to old notions about the US. The transformation for the US from a prime, to a subprime borrower have happened so gradually, so have even the tampering with the statistics that were supposed to give a way of measuring inflation. I know what a hamburger is increasing in price at the local place I buy it. That’s like 12 % each year. That’s inflation. Some imported goods from china might decrease in price. That is NOT deflation. However, due to all the mass production, and increase in living standards in these new economies, oil and other commodities might go upwards. That’s inflation. It’s like every country in the west have been printing money like crazy, driving down imported prices, up commodities, local stuff like what you buy at a cafe, a hamburger store, real estate, gold, commodities, etc, and to me that is inflation, bigtime, no matter what the statistics and bean counters say about it.
I have not said the fed have yet done quantitative easing yet like japan, but they are saying they might do it. And that’s what have caused the low yields on the 10 year treasury bonds, as people as hoping to sell to the federal reserve at a higher price. But at what price? And what will happen to the dollar? If they even choose it as an alternative to raising rates, then I think, inflation is going to go crazy.
In most long bonds and notes that are not US, like the long gilt , you can clearly see that the downtrend started already in 1998. Since then, yields have been trending higher. It don’t show in the US bonds, and I think it’s due to the “happy and wasteful junk bond” buying of surplus countries. When will US government bonds reach junk bond status? When they do, this deflation discussion becomes rather useless, as it becomes more a question of quality instead of quantity of debt.
Let me correct myself, there have been 3 spikes before
Sorry, Let me correct myself, there have been 3 spikes before, this latest spike is the 4′th one. Yields have been trending up since 1998. Every time they sell off, things start to flow again and the music plays. And the surplus countries start buying bonds like crazy, if they did not, then the US would not be able to have such low interest rates, and the treasuries would just keep loosing altitude, until they dropped to the ground. In 1994 it was japan that saved the US. In 2000 it was china. Who it is going to be now?
http://www.investmenttools.com/futures/interest/long_gilt_bond.htm
Prudentsaver
One other point, if the Chinese stop buying US treasuries the US will not be able to import the Chinese cargo and the Chinese manufacturers will be in even more trouble.
I don’t think that is going to happen. It’s just a false notion, similar to a notion the US had during WW2 that ending the war would be bad for their economy, and that they would fall back into the depression. Rather, it would be good for China, as letting the US go, would suddenly increase their purchasing power, and put more food on their table, and at the same time get rid of any notion that the US is going to have deflation, and cause inflation in the west to shoot straight upwards.
I think there would be stagflation in the US, similar to when the yen rose in the seventies, simply because China is making “everything”, there is no way th US can stop buying Chinese goods, even of the price had increased between 2-6 times. It’s just crazy that I can buy a 12V laptop charger from China, including postage, have it shipped over the whole world with aircrafts, and pay less than 1/4 for the product including shipping than just sending the package back to where it came from.
It would still not pay off to make these things in the US, because of the costs of making manufacturing, plus salary costs. Some products made in China, like amplifiers for Hifi, costs 1/10 to 1/20 in china, of similar quality as US made equipment. The difference in price is crazy. China in terms of Hifi equipment is where Japan was in the early seventies, in that they are making large, bulky stuff, of high quality that are very, very cheap, compared to what you get in terms of commodities. After japan let their currency rise, from the early seventies, they went on from making bulky quality stuff to making light cheap stuff, because the yen got to strong for japans exporters to give buyers real value for money. As that transformation went on, korea became the new japan, just as China are the new japan or new korea. After China I think it will be vietnam, north korea, or some of the other asian countries on the rise. Japan have already been a net seller of treasuries since 2005. I don’t think it’s far fetched to see China stepping down to. I also think it’s possible to have an increasing trade inside asia, as I think many of the other asian currencies are supressed against the dollar, and is likely to rise together with the chinese renminbi if the dollar falls further out of fashion.
If you look at this graph again and remember that for deflation to become real, treasury bonds, and gilts must stay at this new level “that looks as a permanent new and high plateu” http://www.investmenttools.com/futures/interest/long_gilt_bond.htm
If you ask me, it looks as they are going to come down hard. Just as fast as they went up. A new president, is not going to keep those treasuries “up there in the sky”, unless they choose to print the money to buy treasuries, but then the dollar will take the hit, so against gold, treasuries will still suffer a loss.
Sorry prudentsaver,
still disagree.
Talk is cheap. Just because the herd says it’s a bubble doesn’t make it a bubble.
As I said, the US Fed has the option to buy these treasuries and steralise the money injected by their purchase, given all the assets they now have on their balance sheet, thus removing any inflationary effects. So how do you respond to this?
China is not going to decouple, that myth has been already been disproved. China does not have a sufficiently developed consumer based economy to do anything like replace the massive consumption engine of the US, it just isn’t going to happen, in the short term in any case. It will take decades for China to reach that eventual stage. China is export driven economy, period. With the external consumption that they relied on gone, China will see massive unemployment, as is already happening. The numbers bandit around for their fiscal stimulus is now questionable. So I don’t hold out for China doing anything other than going down the gurgler like all other economies.
The pegging of the yuan and their low wage policies has made this mercantile trading possible. Unless they pay high wages they will never create a consumer base to be able to give the Chinese govt. to not depend entirely on the export market.
If China expects the rest of the world to continue to consume their over production, when the current account deficit countries have now ceased, they will be left with massive inventory overhangs and will be in a worst position than the debtor countries.
Prudentsaver, track what the price of a hamburger is from now on, you will see disinflation.
prudentsaver,
on the point of quantitative easing, the US is already in the midst of using quantitative easing, with trillions of dollars on banks balance sheets doing nothing. In fact, most banks are holding these funds with the Feds. Reserve account, which is also paying them interest on these accounts. So none of this money is seeing the light of day. No increase in the velocity of money, no inflation.
Furthermore, as has been stated by Bullturnedbear, the debt destruction that is now occurring is far greater than the funds that these Banks are accumulating from the Fed. That is their balance sheets are getting worse not better. No bank is going to lend in this environment. So no credit, no money multiplier, no inflation.
It’s really quite simple– yes, no?
I think there is a flaw in your logic. What you are implying is that the US consumer, and the rest of the western hemisphere will stop consuming, even if china change the balance, by letting their currency appreciate, and the dollar fall. Instead, this move will move the yield curves in the western world, towards ultra stimulative levels and create a huge temptation to have a period of negative real interest rates in the west. And cause a new debt driven boom, with rising house prices, and even higher consumer prices, and higher gold price.
Towards you last post regarding the money multiplier, it’s correct for now, and as long as the notes stay at elevated “peak levels”. Whenever they have did that in the past, treasuries have fallen down from their peak very fast, and that have always been very inflationary. If things are indeed different this time, it means treasuries will stay elevated, with no buying from the fed, just market support. That basically means the US government can borrow and spend like drunken sailors to get themselves out of this crisis.
However, I don’t that’s the case. There is a limit for how much demand there is for treasuries. I think that Obama is going to find that limit pretty fast, and whenever that happens they will sell off, creating a new inflationary boom.
No I am not implying that.
China has no intention to appreciate their currency, to the contrary they have pegged it to the US dollar and will leave it that way. Just as an aside, there are a large no. of countries in Asia and the Middle East which have their currency pegged to the US dollar.
So if the U.S govt. attempts to create any inflation in the U.S. this will merely make all of the products produced in the U.S. dollar pegged countries even cheaper to the U.S. consumer, which will only further exacerbate the global trade imbalances, create greater deflationary forces in the western economies and create further difficulties in competing with these countries. That is, it would be far more difficult for the U.S. to be competitive, so greater difficulties creating employment in the U.S. and increasing their exports to get themselves out of the debt that they have dug themselves into.
The Chinese govt. will attempt to further support their export industry, given they have no other quick fix, however, this will not work given the rest of the world has already reduced it’s consumption and will continue to reduce it to repair their balance sheets.
An appreciation of the yuan, which won’t happen, is not going to cause the yield curves in western economies to ultra stimulative level. Why would it?
prudentsaver,
The peak levels reflect the environment. They are at peak levels for a reason, you do realise that?
If treasuries are sold off, the U.S. Fed. will merely buy them and steralise the money injected into the system with sale of assets they have on their balance sheet, given the Fed. is pretty much going to be owing much of the U.S. economy the way it is going.
With regards to limits, well, Obama may if necessary release some obama bonds (yen denominated US treasuries supported by the Bank of Japan), just like Carter (deutsch mark denominated US treasuries) did.
If the US will have to issue Obama bonds as I have mentioned here before, then inflation is going to be at very high levels, with gold well above 1500 dollars, with treasuries having sold off, like after 1977. it’s similar to 1975 now, but mix in Obama entering the picture 2 years before carter, and inflation might surge well before 2011. Those peak levels for treasuries are artificial, they are now, but if history is any guide it’s not going to last very long as a new president is not good for bonds
The similarity to japan is as follow:
Japans stock market in 1989 was at a level that at the time was 3,3 times as high as the US stock market now. Japan had a very undervalued currency and a prudent level of debt, being a net creditor. There was a global trend of falling commodity prices lasting to 1998, and a lack of willingness to act to correct deflation. The culture in Japan is similar to the Swiss in terms of the currency strength.
most inflation hedges now, especially stocks that hedge inflation is up 3-4 times since year 2000, in spite of the stock market being lower. Still treasuries are at an all time high. If you ask me it just don’t add up. And I think it’s the treasury market that’s wrong. I just can’t see stocks like ConocoPhillips falling towards 1998 levels of 19 dollars. That would give the oil company a yield of 8,6 and a P/E of 1,67, and a Price/book of 0,3.
If that happened, then treasuries would really confirm that they was in a genuine bull market. But this wide spread, suggest that it’s a suckers rally, and just a sharp peak, that will head down again fast. Maybe you think I’m crazy, but I don’t think that a trend with increasing commodity prices, can coexist, with a genuine trend of more expensive US government bonds. Paper is only good as long as it buys more and more hard assets. When that trend turns, bonds are in a bond market. Yes, if oil falls below 8 dollars, then it’s deflation. but even after dramatic falls, most commodities are still at levels that suggest that they need to fall more than 50 % more, to confirm any bull market in treasuries.
If the Chinese government suddenly decide that they for some reason choose to announce that they were loosing faith in the credit of the US, and would sell off their holdings of treasuries, it could cause a run on treasuries and even the dollar. How would that damage China? They have everything to gain on that.
What we have in my opinion is a correction in an inflation trend.
http://www.centralfund.com/images/Historical%20Gold%20Charts/Historical%20Gold%20Chart%201985%20to%20Dec%202008.gif
As this picture shows, I think it’s way to early to say we have deflation. You had corrections like that in the seventies. Until gold are below 250-300 dollars, we don’t have deflation. Gold needs to fall so low that, treasury bonds can buy more gold than they could in 1998. Otherwise, this deflation talk just does not add up. There is no way, that gold can increase from 250-820 dollars now, and treasuries really be worth more. If treasuries was worth more now, than in 98, they would buy more gold than they could then.
Here is some alternative outcomes of this mess.
One is a 1 termer for Obama, the two others are two termer’s.
1. The Carter scenario. Bonds sell off, there is a boom like the one from 2003, just more inflationary, due to higher spending, weaker dollar, and harder times for the US to finance their expansion. THis expansion will end in a hard tightening of interest rates, like in 1980-1981, and resemble Carters presidency.
2. The Reagan scenario. This is sort of a dual mixture of 1999, when bonds sold off, and in 1980, before the second dip in the double dip recession. This means, that bonds will sell off this year, bring sort of a double top or blow off in commodities, and force the fed to raise interest rates high again to kill commodities and gold, like they did with the dotcom bubble in 2000, Obama might support this. This will give the US economy severe destruction, and I think it’s a match with what Anna Swartz have been saying about this crisis as late as October. The destruction will sow the seed of a new boom starting in 2010 that will resemble 1982, giving Obama 2 periods. If the US economy don’t collapse from the rough treatment.
3. Roosevelt option,is the most boring one. The debt deflation scenario, with lame, boring booms, from fiscal stimulus, public spending packages, relatively low inflation unless we head towards WW3.
iconoclast, the Fed has not been sterilizing everything like they have in the past. China is conducting trials in doing international settlements in Yuan instead of the US dollar.
http://www.financialsense.com/editorials/williams_j/2008/0114.html
http://www.shanghaidaily.com/sp/article/2009/200901/20090107/article_387229.htm
-Ernie.
Ernie,
that’s my point against inflation that prudentsaver keeps on saying.
China is conducting trials within China’s borders not as a settlement currency on the world stage.