Sunday, Nov 22, 2009

World braced for inflation ignoring the only similarly interventionist precedent, Japan

Hugh Hendry via Market Oracle: United States Economy At Zero Hour To Service Debt Mountain

A long letter but well worth the read. China building massive industrial capacity for what? Interest rates have to stay low, if they go up the world's economy is toast. Inflation? look at Japan:
"Japan has championed both Friedman and Keynes. They have built bridges to nowhere and dropped Yen notes from helicopters for twenty years and still they have nothing to show for it. Clearly the additional return from Yen debt in Japan is close to zero and it exposes the nightmare of interventionists everywhere: it may just be that there are no policy remedies for a debt deflation."

Posted by mountain goat @ 10:53 PM (1535 views)
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17 Comments

1. devo said...

investor-centric article

old school

get with it man

Sunday, November 22, 2009 10:58PM Report Comment
 

2. mountain goat said...

get with it man

don't ask no questions

climb on the inflation bandwagon

the herd is always right

Sunday, November 22, 2009 11:21PM Report Comment
 

3. devo said...

the herd is always right

ah, we agree !

but which way will the herd turn ?

there's the rub !

Sunday, November 22, 2009 11:28PM Report Comment
 

4. Crunchy said...

Excuse me, the herd was for deflation. I have always said HYPERinflation. Some things are more obvious to some than they are to others. The painful thing this time is that interest rates will rise and wages will freeze, this along with possible import/export problems will make things really nasty methinks.

Money expansion without inflation is not possible, a done deal then.

Sunday, November 22, 2009 11:33PM Report Comment
 

5. general congreve said...

We will get inflation some way or another. If the governments left well alone we'd get deflation and people like we would be dancing on the ceiling and snapping up 40k flats. But they are trying to avoid this at all costs as it will make huge western govt.debts even more unserviceable (not to mention the private debts of their voting public), hence frantic untested attempts like QE to avoid deflation. They cannot afford to pull the plug, so the deficit spending will continue.

Japan was an export-led economy, with a trade surplus and it's deficit funded by the savings of it's own citizens during a period of unparalleled global economic growth, so it has been able to borrow and spend huge amounts to try and fight (ineffectively) deflation without the threat of a bond strike by an overseas creditor or the need to print fake money (yet).

The situation is different for the US/UK. Firstly half the world is now trying to sell record amounts of debt in a declining world economy, but they can't manage to sell it all, hence QE, which undermines the value of the currency involved and makes the value of bonds in that currency increasingly questionable to the investor as QE progresses. Seeing as the US/UK's debt is owed to other countries like China, then at some point these international creditors will cut and run if the situation doesn't change and there will be a run on bonds/gilts (unless they're as f*cking stupid as the people who run things in the West).

The result of such a run will be total economic collapse for the countries whose bonds will end up being worth little more than toilet paper. This will lead to the threat of widespread civil disorder as western spending commitments can no longer be met, or a massive increase in interest rates to attract funding back into bonds, which will just serve to cripple the economy, thereby lowering tax receipts (there is no way out). However, the governments will try to soften the blow by more printing to keep the ball rolling and public expenditure commitments fulfilled. This will devalue the currencies concerned and lead to inflation, but this may be considered the lesser evil over the longer run than an immediate halt to spending.

The end result will be the same, previously wealthy countries will end up relatively poor, but a managed decline in living standards through inflation will be easier for the public to swallow than total immediate economic collapse.

Basically, Japan could afford to try to pointlessly fight deflation for a long time. The US/UK can't afford to fight deflation so have resorted highly inflationary monetary policies to do so, which they are unlikely to be able to stop and therefore we'll ultimately get some degree of inflation.

Note to Devo - Buy gold ;)

Sunday, November 22, 2009 11:42PM Report Comment
 

6. mountain goat said...

GC - HH writes "I am now going to return to the torturous and binary debate concerning inflation." he has quite a lot of sensible stuff to say about how the gov bonds will be bought, just as Japan, locally. Americans are massively under-invested in Treasuries. When Uncle Sam runs into trouble raising funds don't you think he will make sure this is the only investment worth having?

However, where will the demand for all of this additional government debt come from? Let us review the Fed's Z1 numbers. The US has household wealth of some $67trn. Of that, $20trn is accounted for by real estate and is perhaps out of bounds for our purposes. But $8trn is held in the form of private pensions and insurance funds. And yet, remarkably, these institutions presently allocate just $630bn to Treasuries et al. Households have a further $22trn in time deposits and other financial assets. But again they own just $500bn of Treasuries, and commercial banks own a tiny $130bn or, 1% of their total asset base of $12trn.

Consider that in 1952, at the very end of the supernova bond bull market formed from the ashes of the Great Depression and the Liberty Bonds that financed the Second World War, US banks held 40% of their gross assets in Treasuries. That is a potential $5trn of demand from this one source alone, albeit spread out over a number of years. And again, the Japan experience lends support. Japanese financial institutions have quadrupled the percentage of their assets held in JGBs. Furthermore, their households have lifted their government bond weightings five-fold over the last ten years. Should the same pattern repeat itself stateside, American households would need to buy another $2.5trn, but again, over ten years.

And let us not forget that a trend of rising prices allied to the most basic human emotion of avarice encouraged commercial banks and other financial institutions to buy $3.2trn of questionable mortgage backed securities in 2004, $1.9trn in 2005, $2.2trn in 2006 and $2.1trn in 2007. So it is not inconceivable, at least in my mind, that financial institutions, and notable amongst them the nation's pension and endowment schemes, could be motivated by another basic human emotion, namely fear for their own survival, to snap up all these new government bonds. Perhaps in the end supply will create its own demand.


Americans and Brits will fall in love with their own currency and bonds again out of necessity, survival, as every other asset price falls and money in bankrupt bank earns you no interest. As he says everyone finds endless reasons why Japan was an exception. But actually they are the only example we have, ignore it at your peril. USA is still the biggest export nation by the way.

Monday, November 23, 2009 12:01AM Report Comment
 

7. general congreve said...

@5 - Selling govt. debt to your own taxpayers through direct bonds sales and pension funds, a fine piece of ponzi scheming if ever there was one. What HH is forgetting is that US/UK citizens can't afford to invest money in bonds, most can't even afford a pension thanks to crippling levels of personal debt. So if the US/UK govts think there own citizens will bail them out I think they're barking up the wrong tree.

Remember, Japan was a surplus economy and therefore it's citizens could afford to be stupid enough to indulge their govts. equally stupid fiscal policies - 300% of GDP debt now and counting I believe, it'll end in tears for them too.

Monday, November 23, 2009 12:54AM Report Comment
 

8. Scepticus said...

the japanese saving rate is now at 2%. The UK saving rate is now at 5%.

Monday, November 23, 2009 08:56AM Report Comment
 

9. hpwatcher said...

@general congreve

Very nicely put.

Though, the option seems to be chosing the lesser of two evils....high interest rates or economic collapse.

Monday, November 23, 2009 10:09AM Report Comment
 

10. hpwatcher said...

Money expansion without inflation is not possible, a done deal then.

We know that on here.....but how long before the politicians realise it, or have the guts to do something about it?

Or are they too obsessed with trying to create a socialist utopia, where everybody gets absolutely everything they want?

Monday, November 23, 2009 10:34AM Report Comment
 

11. mountain goat said...

Money expansion without inflation is not possible, a done deal then.

But that is the point, it isn't expanding it is collapsing in default. Half the Fed's "assets" $1 Trillion are mortgage backed securities. If marked to market what are those worth? When the hpc is over what will the houses be worth? How much credit card debt will default as people keep losing jobs, how many business' are going bust, debts unpaid. What happens to commodity prices when China realises it can't sell 50% of what it is producing?

So the money printing will work, economy will keep humming along? If that is the case then Friedman and Keynes are right; I would rather have a job and high prices than no job and deflation. Surely if you are so convinced about inflation you should be taking on debts and buying a house? Japan shows this won't work. We keep a sick economy burdened by high taxes, capital undermined by zero IR, the only safe financial products not at risk of default that will remain will be those backed by the biggest military stick the world has ever seen, US Treasuries.

Monday, November 23, 2009 11:02AM Report Comment
 

12. general congreve said...

@11 - It's true, we may not actually get inflation, the deflationary powers at work are exceptionally strong. However, the US/UK's govts. attempts to fight deflationary collapse through a managed inflationary policy will ultimately lead to bond strikes and a currency crisis. Biggest military stick or not, I'm buying gold, not US treasuries. Of course, if I wake up with an Apache Gunship outside my window one morning with it's guns trained on me then I might change my mind.

Monday, November 23, 2009 11:52AM Report Comment
 

13. hpwatcher said...

Surely if you are so convinced about inflation you should be taking on debts and buying a house?

Actually, I am looking at this.

Monday, November 23, 2009 11:53AM Report Comment
 

14. Crunchy said...

10. hpwatcher said...Or are they too obsessed with trying to create a socialist utopia, where everybody gets absolutely everything they want?

Keeping the host alive. It's the fractional reserve system that is on the ropes. Socialism is for the status quo, which is in it's last period.
This is why we are hearing about big global changes. A restructuring.

Monday, November 23, 2009 12:02PM Report Comment
 

15. bellwether said...

GC canI question the logic of your position?

First though I'd make the point that this is not really about deflation/inflation but about how we mask what has already happened. In handing almost all production over to what used to be thought of as the third world we have created increased demand on world resources which inevitably means we in the west have been getting poorer. This has been happening for the past 20/30 years and has now reached a critical point ie a point where it is becoming obvious. With limited resources I don't believe we can all get richer together. Credit expansion is limited because the resources that underlie the monetery system are limited.

Anyway if you see the inflationary forces as working because of a level of desperate determination I'd suggest that gold is the wrong investment because the determination will focus initially on supporting land prices and then on attacking things that undermine the value of currency ie gold. If govt is determined enought to print at all costs it will clearly be determined enough to confiscate.

I'd also be concerned that gold has been on a bull run for 10 years when other commodities haven't. Would gold investors just be better investing in companies that produce essentials? There is at least a rational floor under these, an income and less chance of govt intervention.

Monday, November 23, 2009 01:01PM Report Comment
 

16. hpwatcher said...

I'd also be concerned that gold has been on a bull run for 10 years when other commodities haven't

And the stock market?


I'd also be concerned that gold has been on a bull run for 10 years when other commodities haven't. Would gold investors just be better investing in companies that produce essentials? There is at least a rational floor under these, an income and less chance of govt intervention.

I simply don't accept the deflationist argument...it isn't possible in a fiat money system, where money can simply be created from nothing.

Monday, November 23, 2009 01:58PM Report Comment
 

17. Fallingbuzzard said...

You can create as much money as you want but you can't make it move. Isn't that what Japan found and still find?

Monday, December 7, 2009 10:04PM Report Comment
 

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