patrick.net

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.

If your currency is fully tied to gold, then your currncy supply can only increase with an increase in the supply of gold held by the government (or currency backer). So if the supply of gold does not increase then any increase in the size of the economy would be accompanied by deflation. Prices for everything would constantly decline. This would create an environment where doing nothing with your capital would pay better than investing in factories and infrastructure. The rich would hoard their appreciating gold. Unemployment would rise and productivity would decline. Living standards would decline signifcantly as the economy stagnated.

Zephyr,

Thanks for the info.

I was always pretty sure Peter Schiff and Ron Paul were barking up the wrong tree when it came to returning to the gold standard. However I never could figure out exactly *why*.

@kewp: It's a typical Velocity of Money problem. One common form is:

V = nQ / M

nQ ~= GDP, M = money supply

The left side of the equation seems to depend primarily on technology level of the civilization. i.e. you can't really accelerate the pace of transactions in a huge economy by telling people "book your transactions faster". At some point the money is just changing hands as fast as it possibly can. As Zephyr notes, the supply of gold is primarily related to your ability to mine it, so it expands slowly. If your economy is growing at a real pace, but M is constant, then the demand for money will increase dramatically. This is because number of transactions occurs at an approximately fixed speed (at a particular technological point in time), but as the economy grows you naturally need to cause more transactions, and this causes the demand for additional money.

Blammo, instant deflationary spiral. As the economy grows the demand for money is increasing, which increases they money's value, encouraging people to hoard it instead of spending it, which lowers supply, which increases its value, and so forth. Either growth will stall out--because literally not enough people will be able to complete transactions--or debts based on future exchange (like agricultural contracts) will soar in value relative to what the assets will actually fetch in the future, incentivizing deliberate contract default.

Oh man, Brand, Kewp and Zephr, sorry but your analysis and understanding of monetary theory and practice are so woefully wrong that I don't even know where to begin. So instead I'll just refer you and anyone else who is interested in learning about how economies truly work to www.mises.org.

In there you'll find why fiat currencies cannot work and why the gold standard (or some manner of constraint) must be brought back. You'll also learn why the supply of gold is not a problem, and why deflation is a corrective phase that is caused by inflation that is caused by fiat currencies and fractional reserve banking and the fed, all which must be eliminated.

If you're still in school and taking economics, then you might as well get a head start on what will invariably be the new economic model for the entire world in a couple of years when the prevailing Keynesian theory is totally discredited.

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

You mean like USD is doing right now?

"V = nQ / M nQ ~= GDP, M = money supply"

You remind me of this guy Randy (on this blog from a while back) who said we would/could never experience deflation here in the US. All he did was point to formulas from his college economic books based on a discredited and obsolete theory of economics.

Read about the Austrian theory of economics to understand why your analysis is ass-backwards.

TOB, I believe the issue at hand is the current administration's actions and letting the economy correct itself with minimal interference. So far they've done nothing but try to stall this process (mostly to no avail and to the taxpayer's detriment).

frank, I happen to think that Randy H. is a pretty smart guy. Perhaps you would care to provide some actual rebuttal of why you think Austrian theory is so far superior to Keynesian theory? I would recommend starting with why you believe that hard money does not result in deflation during periods of real growth (via productivity increases or improved labor supply).

I find it hard to believe that Randy said we couldn't experience deflation. Do you have a link? His own blog at Capitalism 2.0 has a very detailed explanation of why velocity of money and deleveraging must result in short-term deflation. Randy has repeatedly said that no credible military power has ever experienced hyperinflation, simply because it is easier to tell your creditors to take a hike, but I don't recall him ever commenting that we couldn't see deflation.

Frank, you said: "I believe the issue at hand is the current administration’s actions and letting the economy correct itself with minimal interference."

Minimal interference??? What rock have you been under? We are currently experiencing the biggest government intervention into the economy in history!

Fiat has a bias toward inflation, and deflation is very unlikely. However, if velocity slows sufficiently we can have deflation. But deflation is not likely to last long with fiat currency because the government can just print it's way out of a deflationary environment.

Frank said: "Oh man, Brand, Kewp and Zephr, sorry but your analysis and understanding of monetary theory and practice are so woefully wrong that I don’t even know where to begin."

Really? You can't think of anything? You offer no argument.
You just insult us - and don't bother with any facts.

You have no idea what we know or how experienced we might be in these matters.

And you have offered no information or arguments on the topic.
Do you have anything to offer? You have shown nothing so far.