``We're going to have a currency crisis, probably this fall or the fall of 2010. It's been building up for a long time. We've had a huge rally in the dollar, and artificial rally in the dollar, so it's time for a currency crisis.”-Jim Rogers Bloomberg
Nobel Laureate Dr. Paul Krugman recently wrote in his widely read column at the New York Times to dismiss of the risks of inflation. He suggested that what has been happening in the marketplace isn’t about inflation, but an attempt by the opposition to dislodge present policies,
``But it’s hard to escape the sense that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy. And their goal seems to be to bully the Obama administration into abandoning those rescue efforts.” (bold emphasis mine)
Dr. Krugman’s basis for debunking inflation has been 1) most recent data on consumer index and importantly 2) banks haven’t been lending enough since bank reserves remain bloated. Apparently, the popular economist believes that what happens today should be construed as tomorrow’s events.
Yet, Dr. Krugman’s prescription is for the Obama administration to continue with its inflationary path. In other words, the mainstream’s ideology has been epitomized by Dr. Krugman.
And this is the same ideology, which for us has been heightening the risks of intractable inflation, despite the supposed “omniscience” of the Nobel awardee.
As we argued last week in $200 Per Barrel Oil, Here We Come!, inflationary policies will largely cause a spike in oil prices in combination with oil’s structural fundamental imbalances.
Unfortunately Dr. Krugman, who believes in the almighty power of governments as solution to everything, has a skewed understanding of inflation; inflation has been always a political process. Since government actions, such as spending, lending, guaranteeing, protecting, subsidizing etc…, are not determined by the marketplace or by fundamental economic laws of demand and supply, as they are arbitrarily decided upon by policymakers and regulators, then such actions are reckoned as political in nature. Hence, inflation fear mongering isn’t political, Dr. Krugman gets it the other way around, but the use of mandated coercive powers to implement redistributive process is.
Monetary Forces Strengthens Decoupling
Mainstream experts, like Dr. Krugman, have been lost with the sudden rise of stock markets and in the commodity markets as the actions marketplace appears to have been detached from the developments in the real economy. This is because Dr. Krugman has been predicting of a deflationary depression and even wrote a book about it. Lately, Dr. Krugman conceded that “We have averted utter catastrophe.”
As we mentioned in our mid week article, see Monetary Forces Appear To Be Gaining An Upper Hand, these experts have been “rationalizing” on market actions to either affirm or dispute market accounts depending on their inherent biases.
For the bulls, the recent market activities account for as some form of triumph by government policy efforts to resuscitate the global economy or the much ballyhooed “greenshoots”.
For the bears, the widening disconnect with the real economy seems like a surefire indicator of a maturing bear market rally which will ultimately end in tears.
For us, while some signs of economic recovery have indeed been taking place in response to the “shock” (or our Posttraumatic Stress Disorder-PTSD) arising from the near meltdown of the US banking system, due to an institutional bank run which took place late last year, recent developments or market outperformance have been symptomatic of monetary forces asserting dominance over both the marketplace and the economic sphere.
We also beg to differ from the mainstream opinion that the present rising markets is about expanding global risk appetite.
Instead, we see the risk profile as shifting substantially to weigh against US markets more than Emerging Markets or Asia.
Aside from the Bond markets or stock markets (see Figure 4), we note that from the economic growth perspective to policy trajectories (Asia has been adopting policies directed at integration amidst this crisis) to prospective business conditions signs have evinced of “decoupling”.
And we are entirely agree with the observation that the ongoing dynamics has been a “shift from the Core to the Periphery”, as analyst Doug Noland in his Credit Bubble Bulletin predicts, ``A robust Core to Periphery Dynamic and the re-emergence of dollar vulnerability are a potent combination. U.S. markets to this point remain sanguine with the prospect of an expanding Federal Reserve balance sheet rectifying any spike in interest rates. But currency markets are no doubt increasingly fixated on our propensity to monetize our massive debt. At some point, increasingly unwieldy flows out of our currency may force the Fed’s hand. The scenario where the Fed is forced to choose between loose monetary policy and currency crisis could be a potential big negative surprise for U.S. markets.” (bold highlight mine)
In short, since the survival of the present paper money system is mainly a measure of confidence or trust in the system, policies that work to undermine these framework risks the extreme ends of either a hyperinflation or deflation.
Another, mainstream deflationists continue to struggle with the fallacies of lack of aggregate demand, US centric global growth model, global surplus capacity, imbalances of current accounts and ‘velocity of money’ all of which are based on the assumption of the neutrality of money.
Debunking Mainstream Fallacies
Inflation doesn’t need demand. This mistakenly assumes that normalization of the credit process depends on the private sector as the sole pathway for inflation.
In the recent Zimbabwe or the 1920s Weimar Germany experience, their governments simply increased liabilities on an exponential scale and simultaneously spent them on the economy and the result was a hyperinflationary depression! No consumer spending required, it had all been government spending!
Today, governments not only in the US but all around the world have been frontloading fiscal expenditures or inflating altogether. Hence the inflationary transmission scheme can’t be compared to Japan in the 90s since this has been a global effort more than a stand alone stint!!!
In addition, as noted above, financing today has apparently taken place outside of the banking system, particularly on the capital markets. Example, financing for junk bonds in Europe has reportedly been brought back to life (Wall Street Journal)!
Thus, global government ‘stimulus’ spending, growth of financing obtained from global capital markets and a semblance of normalization of the banking system risks unleashing outsized or “substantial” inflation, if not the extreme-hyperinflation!
Remember Asia and the emerging markets have the capacity to undertake massive credit expansion since they are both systemically underleveraged relative to OECD economies and have a functional banking system largely unscathed by the recent crisis [see Will Deglobalization Lead To Decoupling?]. Moreover present government policies have likewise been geared towards attaining such goals.
The next problem would be if governments would be able to withdraw or reverse present policies at the right time if benign inflation turns savage!
Moreover, the collapse in global trade late last year was mainly read by the mainstream as a structural loss of the US driven global growth engine. Thereby, without the US consumers it is held, the world was bereft of a buyer for their products. This has been proven to be incorrect.
Apparently, the emergence of barter trades (post October collapse) suggested to us that demand wasn’t impaired but that the problem was in the gridlock in the US banking system which hampered trade financing [see What Posttraumatic Stress Disorder (PTSD) Have To Do With Today’s Financial Crisis].
And as the world has recovered from this shock, global trades have begun to show indications of significant improvements, and this partly includes the US.
So while it is true that we won’t see volume of trades in the magnitude of the peak of the bubble days and that it would take sometime for the world to adjust to new patterns, recent activities have only confirmed our suspicion that the world hasn’t been dependent solely on the US, as markets everywhere have depicted signs of “decoupling” or divergences.
And if the world isn’t US centric then the rest of the other fallacies which relies on the US as the center of power crumbles along with it, namely surplus capacity, velocity of money or current account imbalances.
Furthermore, since some public personalities such as Pimco’s Bill Gross or former US comptroller General David Walker have raised the likely prospects that the US could lose its AAA credit ratings based on present directions of government policies, some analysts have rushed into the defense stating that the US position is privileged since debt has been underwritten from its own currency and that the US has a larger taxing capacity.
We again beg to differ; if the US continues to debase its currency then it has effectively been implicitly repudiating its debt.
As Henry Hazlitt wrote in From Bretton Woods to Inflation, ``Devaluation is the modern euphemism for debasement of the coinage. It always means repudiation. It means that the promise to pay a certain definite weight of gold has been broken, and that the devaluing government, for its bonds or currency notes, will pay a smaller weight of gold.” Hence, the US risks jeopardizing on its hegemon as the world’s currency reserve standard as it breaks its promises to its creditors.
Money Is Not Neutral
We also agree when experts tell us that the US will endure from significantly higher taxes in order to finance government redistribution programs when nearly two-thirds of the population is close to being bankrupt and that the remaining one third would suffer from a stifling burden of new taxes.
All these imply that the US won’t see any vigorous recovery soon and probably could experience intermittent bouts of economic recessions or weaknesses.
Yet this is also exactly why we should continue to expect accelerated inflation. The mainstream represented by Dr. Krugman, whom has been influential to the present administration, encourages its government to adopt a Dr. Gono “Zimbabwe solution” of money printing away from its miseries. This is because mainstream ideology thinks of money as neutral.
According to Ludwig von Mises in The Non-Neutrality of Money, ``The reasoning of modern marginal utility economics begins from the assumption of a state of pure barter. The mechanism of exchanging commodities and of market transactions is considered on the supposition that direct exchange alone prevails. The economists depict a purely hypothetical entity, a market without indirect exchange, without a medium of exchange, without money. There is no doubt that this method is the only possible one, that the elimination of money is necessary and that we cannot do without this concept of a market with direct exchange only. But we have to realize that it is a hypothetical concept which has no counterpart in reality. The actual market is necessarily a market of indirect exchange and money transactions.”
``From this assumption of a market without money, the fallacious idea of neutral money is derived. The economists were so fond of the tool which this hypothetical concept provided that they overestimated the extent of its applicability. They began to believe that all problems of catallactics could be analyzed by means of this fictitious concept. In accordance with this view, they considered that the main work of economic analysis was the study of direct exchange. After that all that was left was to introduce the monetary terms into the formulas obtained. But this was, in their eyes, a work of only secondary importance, because, as they were convinced, the introduction of monetary terms did not affect the substantial operation of the mechanism they had described. The functioning of the market mechanism as demonstrated by the concept of pure barter was not affected by monetary factors.”
In other words, mainstream economics have analyzed mainly from the context of pure barter trades, or if money is taken into account, they consider its function as medium of exchange only.
This view disregards or dismisses the other function of money as a store of value. Hence, the proclivity by the mainstream, like Dr. Krugman, to suggest of money printing as certified way to juice up an economy.
However for us, money isn’t neutral. It impacts prices relatively, and importantly functions as a store of value (backed by real savings) that has psychological underpinning based on expectations which is being transmitted on real time to the marketplace by virtue of price signal dynamics.
As Henry Hazlitt wrote in What You Should Know About Inflation, ``the value of money varies for basically the same reasons as the value of any commodity. Just as the value of a bushel of wheat depends not only on the total present supply of wheat but on the expected future supply and on the quality of the wheat, so the value of a dollar depends on a similar variety of considerations. The value of money, like the value of goods, is not determined by merely mechanical or physical relationships, but primarily by psychological factors which may often be complicated.”
Surging Food Prices As The Proverbial “Nail In The Coffin”
Well as the mainstream remains firmly in denial, the unfolding price surges continue across stock markets and the commodities sphere.
We will just wait until these significantly percolate into food prices from which should serve as the final “nail in the coffin” see figure 5.
In addition to the creeping food prices above, last week saw White Sugar rose to a 3 year high in London and soybeans notched its third weekly gain.
In other words, the broadening of gains seen in commodity prices has now filtered into food. This reinforces our view that monetary forces are becoming “sticky” and that the price inflation has been accelerating.
Since food prices are even more politically sensitive than oil or energy, rising prices will consequently mean a global public outcry that risks political destabilization in some parts of the world. Again this initially will be blamed on “speculators” than on governments, until inflation gets really out of whack.
We expect the 2007 episode to dwarf and function as a prologue to the forthcoming food crisis that could be expected to erupt in several parts of the world as discussed in Four Reasons Why ‘Fear’ In Gold Prices Is A Fallacy.
Finally, the growing incidence of public discontent on high food prices will eventually lead the mainstream ideologues and deflationists to capitulate.
But that would be a great time to talk about deflation.
