patrick.net

deflation,

I am talking about about inflation as RAW PRINT on a small scale. Nobody takes on any interest, Fed just print the extra money by devaluing the USD. We pay nothing, we just pay in the way of spill-over inflation. Just imagine adding a 0 to everyone's asset and pay, and cost of goods. Debt is denominated in USD and it stays fixed, if I print an extra 0, done.

RAW PRINTING is the ONLY OPTION left at this point. Either we default within 12 months and face hyperinflation right away as USD ceases to exist in its current form, or we raw print in smaller scale first, then ramp up the scale later, hoping that nobody notices enough to start dumping USD asset in a big way.

Nothing else works at this point. We will be lucky that we stop at $1.3T deficit next year, given what Obama promises, we are looking at $3T. The current total holding of foreign interest in T is only $2.8T, and you ask them to double in one year? Domestic Americans don't have that kind of money, period, and even if you confiscate the net worth of the richest Americans, you can't even come up with $3T.

Paul: Iceland is an unusual case. Most of their food and other goods come from imports. Hence when the krona lost value, their citizens really got hammered. It would be hard to exactly replicate that situation in the U.S., as our food and much of our goods are produced by people compensated in our own currency.

"Ask the Icelanders!"

If we were anything like the Icelanders, the game would be over. If you looking for comparisons, try Japan but keep in mind that they were in better shape than we are when they first started tackling deflation (i.e. they were in a better position to resist it).

"Does anyone really believe that China will continue to buy US Treasuries at such a torrid pace given the resources needed to pacify the masses?"

And the alternative? Invest in their own dubious currency? The USD is more attractive right now. It will remain so for years to come.

Gold is an alternative, and I'm long but the USD is the better play right now.

China does NOT have the money to buy $1.3T, or even half of that. NO USD to buy, ok? Understand, it is not like China has the printing press, they can only print RMB, they cannot print USD.

China's total foreign reserve is shy of $2T, and they just announced an internal stimulus plan of $600B, leaving them less than $1.4T. You ask them to buy $1.3T on top of that $1.4T, where does the money come from???

Please understand, China has NO MORE USD to buy our $T even if they have to.

Those are interesting points to consider, are we like Iceland or are we like Japan. We are not like either of them, so our collapse will unfold differently.

"Deflation" has a point that we can be self sufficient for nearly everything we need except some "strategic" metals. (Yes we can be self sufficient in energy because we waste so much of it).

But Japan had a balance of payments surplus the whole time of its problems. We will have some real hardships to make that adjustment.

Since probably everyone will devalue their currency in a race to the bottom, there will be no currency to devalue against. Except maybe bullion. In that case it is just as probably inevitable that the world will go onto a new gold standard.

OO, either you're misunderstanding how the economy operates or I'm simply not grasping what you're proposing.

I assume we're speaking about the real world and not some hypothetical world where the laws of economics don't apply.

So you think we might have a $3T budget deficit next year? That's quite a deficit indeed. But let's deal with facts for a moment.

The Fed IS printing money at an unprecedented rate, right now, and have been for some time now, as shown here:

http://research.stlouisfed.org/fred2/series/BASE

I'm not quite sure what you mean by "printing extra money by devaluing the USD". And while I can imagine instantly

adding a zero to everything denominated in USD (from a purely hypothetical perspective), except for debt (whose

debt, I'm not quite sure as someone's debt is another's asset), I can't imagine how this would be done. While we're

pretending, why don't we just say we'll discover how to do cold fusion? Then we would be sitting pretty.

I think I've explained why I think inflating debt away is not an option in my last post. No reason to repeat.

You believe the end of the dollar will occur (either through default or hyerinflation) in 12 months, so what are you

doing about it? Long gold? Long commodities? Short UST bonds? Those strategies haven't played out well recently. Expect more of the same for some time. But don't fret, because your day will eventually come (assuming you don't go broke in the meantime:).

"China does NOT have the money to buy $1.3T"

There's that 1.3T again. Where do you get that number?

OO,

What you are missing (and most inflationists are guilty of this) is that thanks to fractional reserve lending, our 'money' supply is really a debt supply. And we've already had as much debt inflation as our economy can withstand.

You may have heard of the credit bubble? Or the housing bubble at least; do you think all those speculators paid with cash?

The 'printing' you are referring to is a desperate attempt by the Fed to keep the banks solvent in the wake of historic debt defaults; which are only getting worse over time. Debt destruction = money destruction. Or, as its more commonly known, deflation.

OO says: China does NOT have the money to buy $1.3T, or even half of that. NO USD to buy, ok? Understand, it is not like China has the printing press, they can only print RMB, they cannot print USD.

China’s total foreign reserve is shy of $2T, and they just announced an internal stimulus plan of $600B, leaving them less than $1.4T. You ask them to buy $1.3T on top of that $1.4T, where does the money come from???

First you say that China can't print USD, and then you say that we have to deduct their internal stimulus package from their USD reserves. So which is it? Their internal stimulus will be in RMB, not USD. That comes off their printing press, not their forex reserves.

I think this point has been beaten into the ground, but China cannot stop buying U.S. dollars and U.S. Treasuries. They have to create a trade imbalance to continue their growth, which requires a solid supply of our currency so they can continue pegging as they like. We don't take RMB, so they only way they can make that market is to buy dollars and T-bills.

Also, the T-bills they already hold generate payments, and that money must be re-invested. Until China starts buying goods from us in huge amounts, they will continue to accumulate dollars and dollar-denominated securities.

I do think that at some point the deflation here will stop. The banks will acquire enough dollars and T-bills in exchange for rotten assets to deleverage sufficiently. As long as they can mark-to-model (now supported by law), the reality of their worthless paper is suspended indefinitely. But when the banks are finally sated, I fear that there might be a huge reflex action where suddenly lending becomes attractive again, and all that 1% money rushes into the stock market, commodities and whatever new ponzi scheme we invent for 2010-2020.

If we get into that situation, that's when interest rates will shoot sky-high. I plan to convert my cash and commodities holdings into long term T-bills and retire to Iceland.

:o

Brand,

if we are in deflation, how do we send USD to China so that they can buy our Treasury?

If we do not reflate the economy, who is going to buy any China-made products? The chain of recycle can only be maintained by inflation, not deflation. We must buy more and more China-made goods (in value) so that they can have more and more money to buy our $T so that we can fund our bigger and bigger deficit.

Our money supply does NOT need to be debt if the Fed just RAW PRINTS, and it will. It just gives everybody extra money without any strings, which is the most effective way to set off inflation.

Where do you think the Fed comes up with the $600B to buy the mortgage bond to cause the bond rate to go down on Tuesday? The Fed's balance sheet only has $450B Treasury left and the rest is all junk, so how do they come up with $600B to buy?

Deflationists fail to see that there is one powerful tool that can change the rules of the game drastically, RAW PRINT. If the government just gives everyone $1M, with no strings attached, and it doesn't even take out any loans, how will that not set off a hyperinflation? Now, scale that back, assume the government starts with $1K a head first, then ramps up as situation gets worse.

Our FY2009 budget starts off with $500B deficit. In the last 3 days, we committed another $800B on top of the $500B making our total FY2009 deficit to be $1.3T.

China will have to use their foreign reserve to solve its own internal problem because its internal fiscal budget just went negative. People keep talking about China buying our T, but how much can they buy? If there are nobody buying our T, if we don't raw print, then we will have to default, no other alternatives.

The end is deflation, but we will go through a hyperinflation to get to deflation, and if we are lucky, we will get to deflation through very high inflation. When government raw prints, it is not creating debt, it is creating money, money out of thin air with no debt no collateral no nothing attached, just money, as simple as that. The Fed has already started raw printing.

It is very easy for us to add a 0 to everything. Probably not a 0, but bring up the price of everything 3-4x.

We just talk to our biggest creditors China and Japan, and say, look, we can never repay you given our exchange rate as it is. We will just default and you will get nothing.

Alternatively, you guys and the Europeans help beat my exchange rate down another 80% over the next 5 years, I will pay you back the nominal amount, and you can still get 20% of your money. And I will start to raw print since you won't be buying my T any more but you cannot dump, because if you dump, you get nothing.

That will easily boost the nominal price of USD-denominated asset.

I don't do margins, futures, so it will be really hard to bankrupt me. For gold, I have now completely swapped out of my paper positions, and I only hold physical outside of the US, I have 0 ounce in this country.

I won't short US T, because raw printing can go on for a while without much of an effect. But I am accumulating more energy, which I think is oversold.

Saw this on CR today:

The last thing anyone needs to worry about is fall in Chinese demand for US treasuries.
...
The World Bank forecasts that China’s current account surplus will RISE not fall in 2009, going from an estimated $385 billion to $425 billion. How is that possible if real imports are forecast to grow faster than real exports? Easy – the terms of trade moved in China’s favor. The price of the raw materials China imports will fall faster than the value of China’s exports. China’s oil and iron bill will fall dramatically.

http://calculatedrisk.blogspot.com/2008/11/everything-you-wanted-to-know-about.html

Kind of blows OO's argument out of the water.

OO,

We already had inflation, a deflationary collapse and are experiencing
reflation now. The inflation was the credit bubble.

You will be proven correct if the Fed just prints money and mails it to people as a stimulus check. However, I do not think anyone either in our government or the Fed is dumb enough to go that route.

A better compromise would be to allow small, low-interest loans directly to consumers to pay off high interest personal debt. Or get first-time buyers into foreclosed homes.

It's not a bad idea to hold gold. It has done well historically even during deflationary periods and will certainly do much better once inflation kicks in.

Energy might see more down side and will have a long way to go before a meaningful rally I believe.

We haven't seen the end of the deflationary collapse. Not even close. There's still alotta deleveraging going on.

Yeah, gold has held up remarkably well, as Peter Schiff recently opined.

Good to see one of his investments didn't go down the toilet!

I agree re: deleveraging. We still have all the alt-a, neg-am and prime loans to work through. Subprime was the literal tip of the iceberg.

Wu Hu Imrich is not Bing Bing Broke?

"Paul: Iceland is an unusual case. Most of their food and other goods come from imports. Hence when the krona lost value, their citizens really got hammered. It would be hard to exactly replicate that situation in the U.S., as our food and much of our goods are produced by people compensated in our own currency."

Right; they are unusual in that they import food and other goods like the USA is unusually as we import most energy and manufactured goods. Oh wait, that sounds very similar dont you think??

Aside from electronics, our manufacturing imports are less than people seem to think. And we import most of our oil, which is not the same as importing most of our energy. Our power plants will continue to operate without foreign oil (although at reduced capacity); people can survive if they have to carpool.

We would not starve, freeze or go naked without foreign trade. You can argue that the USA and Iceland are similar in that they both have imports, but the magnitude of those imports and the severity of their absence make that a poor comparison.

Brand,

That's and excellent point. When it comes down to brass tacks, what matters is being able to provide your poplace food, water, shelter and basic goods/services.

So everyone has to suck it up and go on a consumption diet for a few years. Would do us all a spot of good, in my opinion.

kewp: I'm oversimplifying, of course, but I also agree that a little "consumption diet" would do America a lot of good. Why does the rest of the world focus on producing consumer goods and services to sell to America? Largely because we have the natural and agricultural resources that they lack. Nobody in their right mind would stop trading oil, electronics or services in exchange for beef, grain, timber and metal. We have what the rest of the world needs; they have what we want (but can mostly live without).

Iceland is a frightening example of an unsustainable economy. Their population has grown to the point where it cannot be fed via fishing or subsistence farming. They depend on the U.S. and the European mainland for food, and derive a significant chunk of their GDP from tourism (and unfortunately in recent years, from banking and finance). Iceland woke up one morning to realize that they needed the rest of the world a lot more than the rest of the world needed them. When you're running out of food and you need an IMF loan to get food cargo moving off European docks, that is a profoundly terrifying moment for a population.

As we are the breadbasket of the world, there is less of a threat in the U.S. of a true catastrophic meltdown. For all its oil, Saudi Arabia can't grow grain in the desert. Japan can't supply beef for its relatively huge population (relative to arable land). China can't eat cheap plastic widgets; India can't eat call centers. If we froze all the docks in the whole world right at this moment and forced people to make due with only their own nation's resources, Americans would say, "Man, we're not getting anything cool for Christmas." Most of the third world would be dead by Christmas. Subtle but important difference...

Very true. Elimination or reduction of world trade would hurt our living standards a bit (maybe 10-15%), but that decline would be modest compared to the impact on other countries. China and Japan would be devastated.

"Yeah, gold has held up remarkably well, as Peter Schiff recently opined."

That is actually funny. Gold peaked at about $800 an ounce in 1980, and fell to a fraction of that price over the following 20 years. It has recently come back to the same price range ($819 today). Although on an inflation adjusted basis Gold is today worth only about one third of what is was worth in 1980. Not very stable in my book. Topsoil and horse manure have actually held their real value better than gold!

And nobody will steal your manure or topsoil. Just pile it up in the back yard. You don't even have to hide it.

After 20 years of actual losses - and lagging all other investment categories, and lagging inflation too (it actually fell in price during a decade of heavy inflation) - gold has had an decent partial recovery during the last few years.

Decades of significant pain for gold investors has finally ended. A terrible and volatile track record, actually. But people are attracted by shiny stuff. Like fish to a shiny lure.

I have never owned gold - and I never will.

Well said, Zephyr. I think it is highly worthwhile to note that gold itself is an investment vehicle with a perceived value that can vary considerably over time. A gold purchase is not necessarily a great inflation hedge, as that relies on people wanting gold more during inflation. This has a good historical correlation, but it's not a surefire hit, and gold is of limited utility in almost every other sense (fungibility, security, price predictability, etc.).

Gold is a dead asset. It produces nothing and does not grow or compound over time. Gold is simply a bet that everything else is going to become worthless or fall dramatically in value. In dangerous times, it can also be a bet that your wealth (or a considerable portion thereof) will need to be under your immediate control in a very portable form in the extremely near future... i.e. you are fleeing your homeland in mortal danger.

Since we live in a stable, powerful republic, I don't think that gold is an attractive investment choice. If times got really rough, then the attractive investment would be productive land and assets (note emphasis). People will still need to eat no matter what, and if nothing else you can always feed yourself and your family, and possibly barter for other goods and services. I would place my bet on Kraft mac & cheese, Proctor & Gamble toilet paper and Gillette razors (disclaimer: I own shares of PG, and have owned them since 2000). I am also considering bets in the less futuristic alternative energy companies, since many issues have been battered down and I think some offer intelligent solutions to our long term energy needs.

If this really were the end of the world financial system, the grass would still grow and the cows would still come home tomorrow.

:o

Gold is nice in jewelry - but not in an investment portfolio.

I must admit that I am biased by the last 30 years of history. Perhaps it is (or will be) different now.

The world is very sensitive to trade. And overall the people of the world have benefited greatly from increased trade. Wordwide real GDP per capita has increased by roughly 60% since 2002. Even though most of them still do not live nearly as well as we do it is amazing progress!

However, most people in the US have lost some ground in that time. Sharing can sometimes be painful.

But our minor loss has enabled many in the world to rise above malnutrition.

Yes. We are most likely doomed to collapse like the Easter Island example.

Let's see Gold was $20/ounce in 1934, apply the CPI inflator from 1934 to today:

http://www.westegg.com/inflation/

What cost $20 in 1934 would cost $306.73 in 2007.

But gold sold for $600/ounce in 2003! So you would have done much better than inflation holding fold for 63 years.

Gold was worth $35/ounce in 1971, when Nixon took us off the gold standard.

What cost $35 in 1971 would cost $177.35 in 2007.

Gold has beaten inflation over the short and long term, and is a good asset class to hold in addition to real estate, stocks and bonds.

I expect a competitive deflation over the next decade, where gold hold up well, but so well other real assets, like land, timber, copper and food.

Jimbo and Zephyr,

Aren't you both cherry picking your dates to calculate return on gold investments ? You both have a point. But, returns from peak to peak are never as bright as returns from trough to peak.

I am long gold - because I view it as a currency alternative. Not as an asset. There are very limited options available when all fiat currencies are bent on destroying themselves via over supply. Gold is one such option.

I am also curious. In Japan, has the price of food gone up over this "lost decade" ? What about energy ? Other commodities ? I mean as measured in yen. If anyone knows, please post the details.

Guys,

I don't think you should price the value of gold in dollars. You know some economists price it in barrels of oil or how many ounces to buy the DJIA.

I was pricing it in hours of labor worked for the median American based on census data to purchase on ounce, you can get the wage date from the US census website. Next make my own "deflator" for our declining standard of living by the gradual transition in our society from one-income household to two-income household, which I reckoned was about 1% decline per year (ie, each year the median us laborer ought to have to work 1% harder to buy that ounce of gold than the year before). It has been awhile since I looked at this regression, but I'd accumulate below about $750-ish or something like that, and liquidate above something like $990. So there was a selling opportunity that lasted a day or so for me but since I am one of the same working Americans in the formula I could not getaway from my job long enough to even know that it spiked about $1k for a day much less dig it up from my backyard, take it to the dealer and sell it.

Since the census data is an extreme laggard it could very well be that $750 is now the peak price if we have severe wage deflation.

As we are the breadbasket of the world, there is less of a threat in the U.S. of a true catastrophic meltdown. For all its oil, Saudi Arabia can’t grow grain in the desert. Japan can’t supply beef for its relatively huge population (relative to arable land). China can’t eat cheap plastic widgets; India can’t eat call centers. If we froze all the docks in the whole world right at this moment and forced people to make due with only their own nation’s resources, Americans would say, “Man, we’re not getting anything cool for Christmas.” Most of the third world would be dead by Christmas. Subtle but important difference…

That is a really brilliant piece of writing. And comforting as well!

Re: Gillette razors. Check this thing out: http://www.asseenontv.com/prod-pages/sab_ontv.html

I have one and it really friggin' works!

You can select periods where gold has done well. But for the long-term gold is an inferior investment. And short term it is a casino crap shoot.

It is also not a stable store of value. Quite the contrary. It is volatile and has had very long periods of substantial loss of real value. Yes, it does recover - but who wants a store of value that sometimes needs to be held for decades to recover? For safe preservation of value, I expect minimal loss of value. Gold fails that test.

"I expect a competitive deflation over the next decade, where gold hold up well, but so well other real assets, like land, timber, copper and food."

If gold and other assets and food hold up well it would not be deflation.

In a deflationary environment prices would decline as the fiat currency appreciated. Assets and commodoties would be very sensitive to this effect.

Stuck in moderation...

Maybe a slight wording change will free me:

You can select periods where gold has done well. But for the long-term gold is an inferior investment. And short term it is a casino gamble.

It is also not a stable store of value. Quite the contrary. It is volatile and has had very long periods of substantial loss of real value. Yes, it does recover - but who wants a store of value that sometimes needs to be held for decades to recover? For safe preservation of value, I expect minimal loss of value. Gold fails that test.

Well, except gold held up pretty well during the Great Depression; while oil was five cents a barrel.

I think the point is that during periods of high deflation; money (whether its gold or currency) is a constant while assets devalue against it.

If gold is your currency it will appreciate in a deflationary environment.

In fact, that is one of the major flaws of gold as a currency. It can induce or exacerbate deflationary panics when people run to gold.

We have had far fewer and less severe panics and economic downturns since the end of the gold standard.

During the depression the price of gold was fixed by the government.