Posts Tagged ‘Inflation’
Dean Baker makes a catch that nearly every mainstream outlet declines to report: jobless claims are up more than 31,000 from last week. In other news, the Federal Reserve, whose stated job it is to keep unemployment “low” (usually defined as 4.0%) is failing miserably at its job. What’s worse, it seems to consider employment a secondary concern, particularly if this Times article is any indication.
I hasten to remind my readers that by law, the Fed is required to do all it can to keep unemployment as near to 4% or below. Its unseemly focus on “bank stability” and “inflation” are illegal. Maybe someone should inform Mr. Bernanke.
The Times has a pretty good rundown on Wall Street’s complicity in Greece’s current budget woes. The European Union has rather strict rules on the size of the deficit its member countries are allowed to have; but Greece, it turns out, has been under-reporting its deficit for nearly a decade. I wonder where they learned to cook their books?
The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.
It had worked before. In 2001, just after Greece was admitted to Europe’s monetary union, Goldman helped the government quietly borrow billions, people familiar with the transaction said. That deal, hidden from public view because it was treated as a currency trade rather than a loan, helped Athens to meet Europe’s deficit rules while continuing to spend beyond its means.
We’re going to hear a lot in the coming weeks about Greece’s irresponsibility and how Wall Street callously enabled them like a heroin dealer that profits from a junkie’s weakness. And while these accusations are no doubt true, they miss the real point of the Greek debt story, which has to do with the paradox on which the European Union is founded. In fact, a crisis like this was bound to happen. Greece’s and Wall Street’s malfeasance are inexcusable, and certainly no one should try to absolve them from blame on this, but we have to ask ourselves: how long did Europe expect this partnership to last?
At the heart of the EU’s troubles lie the fundamental disparities between its member economies. Germany, as we all know, is an economic powerhouse, and produces the lion’s share of the EU’s GDP. France does well for itself, as do Austria, Sweden, Switzerland and a host of other countries. But the countries that aren’t doing so well: Greece, yes, but also Italy, Portugal, Ireland, and Spain are all in a difficult and ultimately insoluble position.
Their economic fortunes entwined with that of the rest of Europe, they find themselves under enormous pressure to report spectacular economic growth. If unable to do so, their troubles extend to the other member countries, and, most importantly, cast aspersions upon the value of their shared currency – the Euro. So the incentive to fudge the numbers is tremendous.
The paradox of “Eurozone” (zone of countries that use the Euro) directly stems from this. Put simply, no country can leave the Eurozone after it joins, and at the same time, every Eurozone member has to post annual growth without fail. The Greek situation is a perfect illustration of this, but the point is that it could have happened (in fact, probably will happen) to several EU countries. Greece just happened to be the scapegoat because it had the biggest debt.
This handy chart from Der Spiegel should nicely demonstrate this point.
Even Germany and France, the so-called “EU powerhouses”, are technically breaking their own debt rules. But why doesn’t Greece just divest itself from the Euro, say it was too hasty in joining, and maybe re-apply for admission in a few years once it gets its economy under control? Well, it could do this – and likely would, if France and Germany had their say – but such a move would precipitate a run on Greece’s banks, sink its economy, and leave it a European pariah for at least a generation. Think about it: if you had a bank account in a Greek bank in Euros, and the Greek Premier announces one day that your account will be transformed into Greek Drachmas on such-and-such a date, what would you do? Obviously you would liquidate your holdings and invest in some more stable Eurozone country. Germany, perhaps?
But at the same time, Greece’s economic situation is causing near-panic among investors and ravaging the Euro. The Euro’s value has dropped more than 9% in just two months. And therein lies the paradox. By staying in the Eurozone, Greece threatens the whole enterprise. By leaving, it dooms itself to economic collapse.
A recent interview with the EU Central Bank chief economist Jurgen Stark displays the confusion now embroiling the EU. It’s clear that no one knows what to do about this. For the time being, I suppose, Germany or France will have to pony up the cash to bail Greece out, but this does nothing but delay the central problem described above.
This is serious. The Asia Times reports today that China is ready to start selling off its US Treasury Notes, ostensibly as a “punishment” for the recent US sales of arms to Taiwan. I and others previously warned about what would happen if China decided to let go of its dollar holdings – the gist is that China is the only thing standing between the US and catastrophic inflation. Previously these fears were pooh-poohed by establishment figures with the familiar arguments: “China needs us more than we need them”, “Who will China sell its surpluses to?” I even heard someone say, “Without us, the Chinese will be cavemen”. Well, it looks like China might have found itself a new trading partner, if this Asia Times article is any indication:
Dollar-denominated risk assets, including asset-backed securities and corporates, are no longer wanted at the State Administration of Foreign Exchange (SAFE), nor at China’s large commercial banks. The Chinese government has ordered its reserve managers to divest itself of riskier securities and hold only Treasuries and US agency debt with an implicit or explicit government guarantee. This already has been communicated to American securities dealers, according to market participants with direct knowledge of the events.
It is not clear whether China’s motive is simple risk aversion in the wake of a sharp widening of corporate and mortgage spreads during the past two weeks, or whether there also is a political dimension. With the expected termination of the Federal Reserve’s special facility to purchase mortgage-backed securities next month, some asset-backed spreads already have blown out, and the Chinese institutions may simply be trying to get out of the way of a widening. There is some speculation that China’s action has to do with the recent deterioration of US-Chinese relations over arm sales to Taiwan and other issues. That would be an unusual action for the Chinese to take–Beijing does not mix investment and strategic policy–and would be hard to substantiate in any event.
Where do you think we’re getting the money to prosecute these $5,000 per second conflicts in the Middle East? Where did the money for our $2,500,000,000,000 (and counting) bank bailouts come from? China. They make our money real. Without their manufacturing powerhouse backing us up, our dollars are worthless. What, you think the world is going to value our “service economy” at $13,000,000,000,000 per annum if that money weren’t backed by Chinese promises? Not likely. And now those promises are now increasingly under threat.
Zero Hedge gives us yet more evidence that the Dow is overvalued: industry insiders are selling stock 82 times faster than they’re buying it.
In the most recent data set, $11.6 million in stock was purchased by insiders, while a whopping $957 million was sold. And somehow pundits are still spinning this mass orchestrated sell into the bid by those in the know as a bull market.
For significant holders of stock, now might be the time to unload.
Motley Fool gives us an excellent rundown of the arguments in favor of Dollar hyperinflation next decade.
Give it a read, and get ready to start papering your walls with Ben Franklin’s handsome likeness!
I just spoke with a relatively high-ranking investment banker who said he was “extremely worried” about dollar inflation. He said double-digit inflation within the next five years was a “certainty”, and mentioned some compelling reasons as to why it hasn’t happened yet.
First, the role of China in purchasing our debt cannot be overstated. They are the lifeblood of our liquidity. The dollars they pump into the Treasury have had a huge effect in keeping US interest rates low.
Also, my friend pointed to the Federal Reserve’s prime lending rate, which has been kept artificially at zero percent for almost a year now. This essentially amounts to free money to whosoever wishes for it. Needless to say the lending rate cannot be kept at zero indefinitely, and when it rises, my friend said he expects inflation to shoot upward as well.
His advice? Invest in gold.
Earlier I suggested that the Fed’s decision to drastically increase the money supply would debase the dollar, and ultimately render it worthless. When considered along with our debt to China, the monetary “magic” the Fed has just engaged makes fears of inflation, even of a prolonged inflationary cycle, rather justified. And yet the people who forge our financial policy, the businessmen of Citigroup, AIG, Goldman, et al. will not even entertain the notion of such an event. The link above outlines the major arguments they use to convince themselves of the impossibility that the dollar should significantly inflate. They are compelling, no doubt, but ultimately fallacious. Though they make liberal use of popular economic misconceptions (then again, so do most squealers of hyperinflation), their arguments do not stand to reasonable scrutiny.
The first and most powerful argument put forth by the anti-inflationists (most powerful because for the moment it happens to be true), is that we are nowhere near an inflationary cycle – in fact, prices are in a free-fall: what we are experiencing right now is deflation, on a large scale. In one sense such claims are undoubtedly correct – the whole reason for this crisis was the rapid, irrevocable deflation of securitized assets. Bundles of loans including sub-prime and prime mortgages, credit cards, student loans, car loans, etc. which in June 2008 were worth, say, $100,000, found themselves trading for pennies by November. Thus our banks saw their entire profits for the last decade totally cleared from their books. They panicked, and held a gun to our tax-paying heads, threatening economic devastation if they did not get the cash infusions needed to become profitable once again. Since securitized assets were our banks’ prized possessions, their losses compelled the financial sector to hoard whatever cash they had left on hand. Thus the mantra repeated by the Treasury Department that the economy’s major problem is that “our banks won’t lend”. Lower credit implies lower industrial output, so commodities began to deflate in price as well. By this argument, whatever currency the Obama Administration happened to print is insignificant compared to the wealth that had just been “destroyed”, and inflation should present no worry whatsoever. The numbers analysts generally float are $ 4 Trillion in “destroyed wealth” vs. $2 Trillion in printed money. The created funds don’t cover the destroyed funds, so we shall deflate if we don’t create more.
Of course that line of reasoning employs several fallacies, the most glaring of which I highlighted in quotation marks. Wall Street’s greatest sorrow over the last year has been what they termed “destruction of wealth”. They refer, in that buzzword euphemism, to the fact that AAA-rated pieces of paper once worth millions are now so worthless that only a child would want one (so that he may draw on the back). Banks that once thought themselves to be doing so well that they handed out million-dollar bonuses to the mail clerk, abruptly learned of their financial ruin one sad day in September. Their wealth had been “destroyed”, so to speak, by the vagaries of the market.
But did such “wealth” really exist in the first place? It is not a trivial question. A country who has had its factories bombed can rightfully declare that its wealth was “destroyed”. Once there was a factory churning out products, now it is a smoky ruin. But if a few friends and I decide at one point to treat Monopoly dollars as real cash for inter-group transactions, slave for it, fight for it, think ourselves rich for it, and then suddenly realize it’s only Monopoly money and worthless after all, was our perceived wealth “destroyed”? Wouldn’t it be more accurate to say that it never existed in the first place? This analysis is more plausible than it would first appear – since our departure from the gold standard, our fiat currency has essentially been Monopoly money agreed upon by all. Of course, the US purchased such unanimous agreement by military means.
The question becomes less academic and more concrete when considered in context of our Treasury’s commitment to the financial sector. It would be useful to summarize briefly what the Treasury Dept. and the Fed have done over the past year. The stated goal of their actions, in numerous speeches from President Obama, Treasury Sec. Geithner and Fed Chair Bernake, was to infuse enough Federal Dollars into the financial industry to make up for the losses they incurred via asset deflation and to “get our banks lending again”. To that end, the Federal Reserve has exerted all its twofold powers (controlling the interest rate and injecting cash into the economy) in an effort to make our banks appear profitable, when in fact they had just spent their money on imaginary assets. That was the ultimate goal of every bailout we have seen so far. Their worries assuaged, their books balanced, the financial sector should once again issue credit (“the lifeblood of our economy”, as President Obama said), greasing the wheels of commerce and setting the economy right in its ever-upward spiral.
So in short: The US Treasury is printing trillions dollars to distribute amongst the financial sector in order to make investments which they once thought valuable – but in reality turned out to be worthless – worth trillions once more. When a petty criminal turns worthless paper into dollars, most people call it counterfeiting, but a venerable establishment such as the United States Government deserves a more benign phrase – fine, call it a “bailout”. Spending of this sort is inflationary by its very nature: we are re-creating “destroyed wealth” that never existed in the first place. I have heard counter-arguments posit that securitized assets are surely worth something, even if the value is not so high as it reached at the height of the bubble. But such claims are beside the point. Our government is not trying to restore those assets to some reasoned “real” value – they are trying to restore them to the value they attained just before the crash: several orders of magnitude higher than the “real” value would be.
Then why no inflation already? The money has been printed, yet asset and commodities still deflate in dollar-terms. Here is where the second major fallacy of the anti-inflationists comes in. They either refuse to believe in or decline to mention the iron grip China has over our economic livelihood. China owns us, in every sense of the phrase. The dollar still trades at nominal value, still holds its place as the currency of global commerce solely by the good graces of its eastern benefactor. As the single largest holder of US Treasury assets, the world looks to China in order to gauge the US economy’s health. The moment they decide to divest from the US, it is reasonable to assume many other nations will also. That is when this round of Treasury printing will make its effects known. Our inflation rate is kept low and our dollar remains valuable only for China’s willingness and ability to absorb our debt. Once this is no longer true, we may as well start papering our walls with Benjamin Franklin’s handsome likeness.
The big question is “when”, and while I admit I have heard many self-proclaimed economists predict dollar hyperinflation within a year or two, I have not heard any reasonable explanation for why it should occur then, and not in ten years. The truth is that the timing depends entirely on China, whose motives are inscrutable. China owns $2 Trillion in US debt now and continues to buy it. I think the only true statement one can make about when China will decide to sink the US economy is that they will do so when the perceived benefit of such an action (priced in dollars) outweighs the value of their US assets.
International politics and global finance are largely a resource game. If China were of the opinion, for instance, that scuttling the US would gain them influence in resource-rich countries, and the value of said resources would be greater than $2 Trillion, then out those Treasury assets would go! One can think of a dozen similar scenarios. Though such a day may be hard to predict exactly, I don’t think there should be any doubt that one year hence or ten, it is coming.
One parting thought: Why is it that China agreed to finance our adventures in Iraq and Afghanistan? Did they somehow also think it would be a good idea? Or was it only a good idea for them?