Inflation is a tax which is imposed without representation and which nobody has to vote for. And of course, it is a marvelous tax from the point of view of a congressman trying to meet the demands of his constituent for more spending
The art of economics consists in looking not merely at the immediate hut at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups—Henry Hazlitt
Friday, November 01, 2013
Video: Milton Friedman on Why Inflation is a disease for a society
Friday, October 08, 2010
Commodity Inflation
The mainstream says there is LITTLE inflation to worry about.
However, evidence seems to go against this view.
Aside from the vibrant actions in the emerging market’s financial asset markets, where we seem to be witnessing ‘asset inflation’, we also seem to be seeing a broadening of rising price level activities in the commodity spectrum.
Below are nice charts from Bespoke Invest.
The Bespoke team comments
Most but not all have been on strong runs higher lately. In the charts, the green shading represents between two standard deviations above and below the 50-day moving average. Moves above or below the green zone are considered overbought or oversold. As shown, the two most widely followed commodities -- oil and gold -- are both trading outside of their trading ranges into extreme overbought territory. Silver, platinum, and copper are all at overbought levels as well. Wheat has pulled back to the bottom of its trading range recently, while coffee and orange juice have been heading lower as well. Corn pulled back from overbought territory a couple weeks ago, but it has bounced back some. Finally, natural gas remains in an epic downtrend.
These are symptoms of the relative effects of inflation.
Like in the domestic stock market, the rising tide tends to lift all boats but not simultaneously and not in the same degree. But overall, the general price level increments higher overtime as real purchasing power of currencies fall.
Well, even the US Treasury Inflated Protected Securities (TIPS) seem to be manifesting the same progressing expectations of inflation.
Bottom line: We seem to be experiencing the spreading effects of inflation.
Monday, April 26, 2010
Mainstream’s Three “Wise” Monkey Solution To Social Problems
Say what you want
Say what you will
'Cos I find you think what makes it easier
And lies spread on lies
We don't care
Belief is our relief
We don't care
-Roland Orzabal, Tears For Fears, Ideas As Opiates
For the mainstream, our social problems can be simplified into three “wise monkey” solutions:
First, speak no evil-throw money at every problem.
Everyone desires a free lunch. Almost everybody believes that they deserve a special place in this world. Since society’s interests are divergent, such sense of entitlement should come at the expense of someone else. It’s usually dignified and justified with the word “right”. One man’s effort is another man’s privilege.
For them, scarcity of resources can only solved by forcible redistribution. It doesn’t really matter if there are limitations to the scale of taxation. It also doesn’t matter if redistribution reduces the incentives to produce and trade. It doesn’t matter if “picking winners” takes away resources meant for productive activities which have been meant to enhance livelihood. The only thing significant is to be at the receiving end. And it’s hardly ever been asked “when is enough, enough”?
Heck, it would even be politically incorrect to argue for prudence. ‘Moral’ justifications demand for immediate gratification. It’s almost always about NOW. Forget the future.
That’s why the intellectual classes long came up with varied theories in support of these political demands.
Importantly that’s why the political classes are enamoured with these concepts. Redistribution enhances only their power, esteem and control over the others. And that’s why “inflation” has long been a part of human nature, since the introduction of government.
For as long as the system is tolerant of such nebulous tradeoff, trouble can be kept at bay, ergo speak no evil.
The other way to see it is that while everyone wants to rule the world, in reality this isn’t feasible. It’s a mass delusion. The universal law of scarcity always prevails. By force of nature, artificially induced imbalances are resolved eventually.
Second, see no evil-elect or put in place a virtuous leader.
The popular redress to most social problems has been premised mostly on hope, cosmetically embellished by “specific” ennobling goals.
In times of frustrations, the next alternative has been to look for a saviour.
Yet hope is mostly anchored on symbolism. And these are what elections are mostly all about. Even if one’s vote doesn’t truly count, everybody believes they do. Elections are reduced to the polemic of self-import.
Hardly has the directions of policies been the context of any meaningful discussion. People’s arguments will always be simplified to what seems “moral” in the popular sense. Yet, a vote on a person to office is a carte blanche vote on the ensuing policies. But it’s hardly about stakes involved and the prospective costs, but mostly about emotions and the feeling of being in the winning camp.
And since the world has been condensed into strictly a “moral” sphere, political leaders are most frequently deemed to have been transformed into demigods.
Once in power, people mistakenly believe that these entities have transcended the laws of scarcity. People have assumed that they possess the superlative knowledge that is needed to effect the exigent balance on a complex and continuously evolving society. These leaders are presumed to know of our needs, our values, our priorities and our preferences, which lay as basis of our actions in response to ever changing conditions.
Not of only of knowledge, but people also expect leaders and officials to dispense justice and equity according to our sense of definition. Many see these leaders as reflecting on their values. And that’s why many fall for the dichotomous trappings of the well meaning “motivations”. Yet, motivations barely distinguish the role of “means” and “ends”.
Essentially genuflecting on hope to see one’s moral desires as represented by politics can be construed as refusing to see evil for what it is.
And it’s only when the rubber meets the road, from which people come to realize that their expectations have misaligned with reality-and usually through deepening frustrations or in the aftermath of some horrifying outcome.
Hardly has it been comprehended that politics and bureaucratic activities are merely HUMAN activities.
That leaders and officials are subject to the very same foibles as anyone else. That these people see things and act according to the incentives brought about by their interpretation of events, their existing limited and ‘biased’ knowledge and are swayed by influences brought about by cognitive biases, networks, familiarity, assessment of prevailing conditions, information relayed by the underlings, varying degree of stakes of involved and et. al.
Importantly like everyone else, their actions skewed based on personal values. So when a political or bureaucratic leader forces upon their sense of moral vision to a constituency and which has not well received, the result in some cases has been political upheavals.
Yet in spite of the repeated errors, people never learn from George Santayana’s admonition that those who ignore the past are condemned to repeat it.
The third intuitive recourse to any social problems is to hear no evil by enacting new rules/laws.
Like any “throw the money” and “virtuous leader” syndromes, rules are little seen for its costs but nevertheless oftenly envisaged as preferred nostrums to existing problems as identified from the biased viewpoint of the observer/s.
Causal factors are hardly considered in the appraisal of the existing problems. What seems more important is to automatically blame market forces and unduly impose proscriptions. Never mind if the past ills have been caused by the same underlying dynamic-previous interventionism.
The act of simply “doing something” is meant to be perceptibly seen by the voting public for political purposes (extension of career by vote or by appointment). Thus the “hear no evil” therapy, which is merely adding rules for extant fallibilities, are simply props for more of the same malaise.
Many rules, regulations, edicts or laws are imposed upon the “populist demand of the moment”, without the realization that rules, which tend to realign people’s behaviour, can cause huge unintended consequences and likewise entails costs of enforcement. Hence when new rules create distortions in the political economic order, the instinctive response is to have more of rules or regulations.
Importantly, popular clamor for new rules/laws hardly differentiates “rule of laws” against “rule of men”.
Rule of Law are in effect, the guiding principles or the laws that had been a legacy from our forefathers, as the great Friedrich August von Hayek wrote, ``Political wisdom, dearly bought by the bitter experience of generations, is often lost through the gradual change in the meaning of the words which express its maxims[1]”. (underscore mine)
This means because these laws have been constant, are anticipated by all and easily observed or practiced, they become part of our heritage. Again we quote the Mr. Hayek, ``Stripped of all technicalities, this means that government in all its actions is bound by rules fixed and announced beforehand.[2]”
In stateless Somalia, customary laws serve as default laws after her government had been eviscerated,
Benjamin Powell writes[3], ``Somali law is based on custom interpreted and enforced by decentralized clan networks. The Somali customary law, Xeer, has existed since pre-colonial times and continued to operate under colonial rule. The Somali nation-state tried to replace the Xeer with government legislation and enforcement. However, in rural areas and border regions where the Somali government lacked firm control, people continued to apply the common law. When the Somali state collapsed, much of the population returned to their traditional legal system... But Somalia does demonstrate that a reasonable level of law and order can be provided by nonstate customary legal systems and that such systems are capable of providing some basis for economic development. This is particularly true when the alternative is not a limited government but instead a particularly brutal and repressive government such as Somalia had and is likely to have again if a government is reestablished.” [bold highlights mine]
That’s simply proof that “rule of laws” exists even outside of the realm of governments, which also goes to show that society can exist stateless. None of this is meant to say that we should be stateless, but the point is rule of law is what organizes society.
Importantly, “rules of law” have been passed through the ages as a means to protect the citizens from the abuses of the authority, again Mr. Hayek[4],
``The main point is that, in the use of its coercive powers, the discretion of the authorities should be so strictly bound by laws laid down beforehand that the individual can foresee with fair certainty how these powers will be used in particular instances; and that the laws themselves are truly general and create no privileges for class or person because they are made in view of their long-run effects and therefore in necessary ignorance of who will be the particular individuals who will be benefited or harmed by them. That the law should be an instrument to be used by the individuals for their ends and not an instrument used upon the people by the legislators is the ultimate meaning of the Rule of Law.” (emphasis added)
In short, the fundamental characteristics of respected and effective laws are those that to limited, steady or constant, designed for the benefit of everyone and importantly a law that is clearly enforceable.
Of course this doesn’t overrule the occasional use of arbitrary laws, but nevertheless arbitrary rules should compliment and NOT displace the essence of the “rule of law”.
Mr. Hayek quotes David Hume[5], ``No government, at that time, appeared in the world, nor is perhaps found in the records of any history, which subsisted without a mixture of some arbitrary authority, committed to some magistrate; and it might reasonably, beforehand, appear doubtful whether human society could ever arrive at that state of perfection, as to support itself with no other control, than the general and rigid maxims of law and equity.”
In essence, in contrast to mainstream thinking, the rule of law and not simply arbitrary regulations, serves as the central element to well functioning societies.
Former President Ronald Reagan nicely captures part of our “Three Wise Monkey” solution as seen by the mainstream, “The government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it”, from which I would add, “if subsidies are not enough, elect one who makes sure it would”.
[1] Hayek, Friedrich August von, Decline of the Rule of Law, Part 1, The Freeman April 20, 1953
[2] Hayek, Friedrich August von, Decline of the Rule of Law, Part 1, The Freeman April 20, 1953
[3] Powell, Benjamin; Somalia: Failed State, Economic Success? The Freeman
[4] Hayek, Friedrich August von, The Road To Serfdom
[5] Hume, David; The history of England, from the invasion of Julius Caesar to the revolution, we earlier quoted this see Graphic: Origin of The Rule of Law
Sunday, April 04, 2010
Commodities And Bonds Point To A Return Of Inflation
The above charts from stockcharts.com reveals of near simultaneous breakouts of key commodities, in particular, Oil (WTI), Gasoline (GASO) and copper, while the industrial metal group (DJUSIM) is at the resistance levels.
Given the mainstream definition, where growth is associated with "inflation" [relative to the output gap], this perspective interprets the rise of commodity prices sensitive to the economy's growth as alluding to "recovery". As earlier commented, instead we think these are signs of a transitional formative bubble.
We'd have to admit that not every commodities has been on the run; and this has been evident in agriculture (DBA-Powershares DB Multi-sector commodity trust agriculture fund), particularly among grains, and in natural gas (NATGAS). The latter saw a recent spike, but remains on a medium term downtrend.
Albeit the performance of the Agriculture sector remains mixed to lower, with only the Livestock index (DJALI) seemingly at the outperform phase.
Meanwhile, the CRB index (CRB) remains at a trading range, despite the run in the metals and energy, to reflect on this balance.
Nevertheless, commodities do not usually move in concert. The only exception is during the 2008-2009.
As Howard Simons points out in Minyanville, (bold highlights mine)
``Note the large jump in late 2008 and early 2009; that wasn't convergence during a bull market in commodities, that was the period when all commodities along with all stocks, all real estate, all corporate bonds, and a handful of markets none of us knew could roll over and die all rolled over and died together in the financial market musical tribute to mass cyanide poisoning, Jonestown Is Your Town.
``Prior to that episode, the one-year rolling correlation of returns for these indices had never exceeded 0.51 and had, in fact, been negative. We're in the process now of moving back toward randomness."
My inference is that the difference then was that global equity markets were headed lower and much of the residual money from previous looseness found its way to commodities, which made a belated peak, even as the world economy had been contracting and money had been tightening. Perhaps this led to the anomaly of intra commodity convergence.
Meanwhile the Lehman episode, which resulted to a global banking gridlock, was the proverbial nail to coffin that brought almost all assets to its knees (except for bonds and the US dollar).
With the Bernanke Put clearly in place, which assures a continued flow of liquidity underpinned by the implied gargantuan support for her banking system, the reversion to randomness only suggest that inflation has yet to turn widespread.
This only supports our view that we are in the benign stage or in the "sweetspot" of inflation [see previous explanations in Philippine Markets And Elections: What People Do Against What People Say and Does Falling Gold Prices Put An End To The Global Liquidity Story?]
Finally, the actions in the equity, commodity and bond markets seem to be reinforcing the same story, a return of inflation.
Long term bonds as seen in the 30 year (TYX) and the 10 year yields (UST10Y) are seen inching higher.
Though the short term vis-a-vis the long term yields (UST10Y:$UST1 year-10 year versus 1 year and TNX:UST1Y 30 year versus 1 year) remain steep, they appear to have reached its zenith.
And competition to acquire materials for long term projects seem to be forcing up short term yields relative to long term yields [see Is The Recovery In Global Manufacturing A Symptom Of The Next Boom Bust Cycle?]
Yet the long end is looking at higher rates most possibly from inflation. As Morgan Stanley's Richard Berner and David Greenlaw recently wrote,
``In our view, heavy Treasury coupon issuance will combine with a revival in private credit demands to lift real yields. Moreover, uncertainty about inflation and the fiscal outlook will boost bond risk premiums."
Deflation, where?
Tuesday, January 05, 2010
In 2009, Stocks Over Bonds Means Inflation Over Deflation
According to Bloomberg,
``U.S. stocks beat 30-year Treasury bonds by a record 36 percentage points in 2009 as investors bet on a recovering economy and the government sold a record $2.11 trillion in debt.
``The CHART OF THE DAY shows the performance of 30-year bonds versus the Standard & Poor’s 500 Index since 1978, according to data compiled by Bloomberg and Bank of America Merrill Lynch. Last year, the debt lost about 13 percent, while the benchmark index for U.S. stocks surged 23 percent. Gold futures added 24 percent in New York.
``Stocks trailed bonds in 2008 as the worst financial crisis since the Great Depression drove investors to the relative safety of Treasuries. They switched places in 2009 as the yearlong contraction in U.S. gross domestic product ended and President Barack Obama raised money to fund economic stimulus programs."
Yet this serves as an example where a misread would have been devastating to the real returns of a portfolio.
We should see the same dynamics for the 2010.
Sunday, January 03, 2010
Prices, Statistics and Lies
The table shows that prices don't move up or down uniformly and are relative (some prices move more than the others).
Over the decade, most of the prices of goods or services had been higher although some were lower.
Prices reflect an amalgam of factors: government policies, supply demand or market dynamics, productivity, globalization, innovation, competition, demographics, cultural and others.
Would it not be a puzzle as to how these widely variant figures can be cobbled or aggregated as simplified statistical measures that are deemed by the officialdom and the public as accurately representing "inflation"?
Nevertheless these are the same tools used by central planners to determine and effect political and economic policies. No wonder the laws of unintended consequences exist.
As Mark Twain once observed, "There are three kinds of lies: lies, damned lies and statistics."
Friday, January 01, 2010
Mint.com: World's Most Expensive Cities
Budgeting – Mint.com
This from mint.com (bold emphasis mine)
``Which are the world’s most expensive cities? The cities included on this interactive map are from a 2009 study by the UBS, which tracked the ups and downs of various places in the wake of the financial crisis. Many cities have changed ranks, with some cities become more, and others becoming less expensive. Currency devaluations played a a major role in the change of rankings, specifically in regards to emerging market cities. High inflation rates also were a factor, especially in areas such as Caracas, Venezuela (30% per year, for the last three years) When a cursor is placed over each highlighted city, an information window will pop up, showing whether it has become more or less expensive to live in this city than it was last year, as well as last year’s rankings for that city."
My assumption is that the UBS calculations had been based on local currency terms, since inflation would imply the cheapening of the currency relative to foreign exchange, particularly the US dollar. As the above example, Caracas, Venezuela takes a leap to the 12th most expensive from the 40th spot last 2008.
Thursday, November 05, 2009
Jim Rogers Versus Nouriel Roubini On Gold, Commodities And Emerging Market Bubble
Mr. Nouriel Roubini, whose shot to fame and stardom came after accurately predicting last year's crisis and has been media's du jour favorite gloom spinmeister or otherwise known as "Dr. Doom", recently predicted that every assets, including commodities and emerging markets stocks are in a bubble!
Mr. Roubini's captivating 'one size fits all' theory for this forecast is based on the US dollar as the "mother" of all carry trade.
In a recent column at the Financial Times Mr. Roubini wrote, ``Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions."
Hence he predicts a massive recovery of the US dollar, as every asset class anchored to the carry trade collapses.
It would seem that the 2008 financial crash functions as Mr. Roubini's operating paragon from which this call has been predicated (Anchoring bias?).
Bloomberg recently interviewed commodity king Jim Rogers, who dismissed Mr. Roubini's prediction.
According to Bloomberg,
``Many commodities are still down from record highs and equity markets aren’t on the brink of collapse, Rogers, chairman of Singapore-based Rogers Holdings, said in an interview on Bloomberg Television today. The price of gold will double to at least $2,000 an ounce in the next decade, he said.
“What bubble?” Rogers said, when asked if he agreed with Roubini’s view. “It’s clear Mr. Roubini hasn’t done his homework, yet again.”
``Rogers countered Roubini’s arguments by saying that Chinese stocks and sugar, silver, coffee and cotton have all dropped from their historical highs by at least 50 percent.
One must note that the above charts exhibits nominal and not inflation adjusted prices.
Again from Bloomberg, ``When asked if gains made this year pointed to a bubble, he said: “It’s not a bubble if something is up 100 percent this year, but down 70 percent from its high. That’s not a bubble, that’s a good year. That’s a great year. Maybe it’s too high for this year, but that’s not a bubble.”
``“I suspect it’s going to go over $2000 some time in the bull market, but depending on what happens in the world it could go much, much higher,” Rogers said. “The old high, back in 1980 adjusted for inflation, would be over $2000 now, just to get back to the old high. So we’ll certainly get there some time in the next decade.”
``“I don’t know any emerging market stock markets that are so high I’d call them a bubble,” Rogers said. “They’re certainly all up a lot, maybe they’re too high, but being too high is not a bubble for anyone who knows financial markets.”...
``In contrast to Roubini, Rogers said the only bubble he sees in the Western world now is in U.S. bonds."
You can watch the video of Jim Roger's interview here
Meanwhile Mr. Roubini countered Mr. Rogers' objection by saying that gold at $2,000 is "utter nonsense".
According to Bloomberg, ``There is no inflation or “near-depression” to drive gold prices that high, Roubini said today at the Inside Commodities Conference in New York. If a severe depression came to pass, with investors buying canned goods and hiding out in log cabins, “maybe you want some gold in that scenario,” Roubini said.
``“Maybe it will reach $1,100 or so but $1,500 or $2,000 is nonsense,” Roubini said. Gold rose to a record $1,098.50 today in New York on speculation that central banks and investors will purchase the metal to hedge against a declining dollar...
``“It is very hard to justify oil going from $30 to above $80 based only on the fundamentals of supply and demand,” Roubini said. Prices are “in part” a bubble, Roubini said.
``Roubini predicted in 2006 the financial crisis that spurred more than $1.6 trillion of credit losses and asset writedowns at global financial companies".
As you would note, media highlights on Mr. Roubini's favorable call but ignores his glitches and miscalls.
Earlier this year Mr. Roubini predicted stagdeflation, a continuing rout in asset markets including oil. According to Bloomberg (Jan 20th), ``Nouriel Roubini, the New York University professor who predicted last year’s economic and stock market meltdowns, said oil prices will trade between $30 and $40 a barrel this year.
“I see oil remaining throughout 2009 in the range of $30 to $40” a barrel, Roubini said in Dubai today."
In an earlier post we noted how Mr. Roubini hit only one out of several calls,see earlier post Wall St. Cheat Sheet: Nouriel Roubini Unmasked; Lessons, yet managed to harvest media's attention.
Going back to Mr. Roubini's theme of the US Dollar Carry. Here is why we are in the camp of Jim Rogers.
1. Past Performance don't guarantee future results.
Last year's carry trade paradigm had been based on financial institutions, such as the shadow banking system, and foreign banks (as Iceland and parts of Europe) which leveraged on the currency arbitrage.
Today, hardly the same parties or sector appear to be engaged in the said arbitrage activities considering their debilitated conditions.
Next, it isn't the carry trade that brought down the house in 2008, it was the US housing bubble. The carry trade only exacerbated on the downturn.
2. Barking At the Wrong Tree.
It isn't just private sector speculation as Mr. Roubini sees it, but governments' "speculating" as well.
The recent sale of half of IMF's gold stash to India (Bloomberg) came as surprise to the market whom expected China to do the bidding.
To add China has been engaged in a buying spree of commodity assets globally as seen by the World Bank table above.
In short, the governments of emerging markets have in themselves been "speculating".
Of course we'd like to add that these speculative activities isn't myopically based on "animal spirits", because there are underlying geopolitical and monetary dimensions in these.
3. US dollar carry isn't likely to be a major factor.
Given the massive deficits and the monetary inflation engaged by the US, it would be naive or blind allegiance on the side of professional investors to discard the risks of higher interest rates by taking large positions for such arbitrage.
4. Money is neutral.
Mainstream always view money as a seeming constant where additional inputs of money are deemed as not to have an impact on the supply and demand balances. This is evident on Mr. Roubini remarks "very hard to justify oil going from $30 to above $80 based only on the fundamentals of supply and demand"
Mr. Roubini underestimates the impact of the global reflation efforts by collective governments on global economies. Moreover, Mr. Roubini reflects on the mainstream view which have been moored upon the US as still the key engine of global growth.
Yet apparently Mr. Roubini sees today's higher commodity prices as having little impact on inflation, he says, there ``is no inflation or “near-depression” to drive gold prices that high"
On the other hand, Bespoke Invest sees inflation on the horizon, ``Over the last ten years, trends in the CS have often preceded moves in the CPI. So when the net reading in the CS rises, increases in the CPI are typically not far off. Therefore, given that the net number of commodities rising in price is currently at +10 from a low of -15 in February, don't be surprised if upcoming inflation reports come in on the high side of expectations."
5. Wrong Models/Apples And Oranges
Gold isn't likely to rise during a deflationary depression (a view which Mr. Roubini leans on).
To argue for gold's strength on a Great Depression paragon misses the point that the US dollar then operated under a quasi gold standard. Thereby the rush to the US dollar equaled the rush to gold. That would be comparing apples to oranges today.
Gold doesn't serve as a medium of exchange for the consuming public today, but is still used as reserves by central banks. So gold's strength will be magnified by an inflationary depression and not during deflation.
In contrast to Jim Rogers who says Mr Roubini hasn't done his homework, Mr. Roubini's call would seem like an attention generating act.
An oversimplified theme which connects to the prevailing bias, appeals to the public. Publicity matters more than the content.
Sunday, October 25, 2009
The Evils Of Devaluation
``The much talked about advantages which devaluation secures in foreign trade and tourism, are entirely due to the fact that the adjustment of domestic prices and wage rates to the state of affairs created by devaluation requires some time. As long as this adjustment process is not yet completed, exporting is encouraged and importing is discouraged. However, this merely means that in this interval the citizens of the devaluating country are getting less for what they are selling abroad and paying more for what they are buying abroad; concomitantly they must restrict their consumption. This effect may appear as a boon in the opinion of those for whom the balance of trade is the yardstick of a nation's welfare.”-Ludwig von Mises, The Objectives of Currency Devaluation, Human Action, Chapter 31
Policies can be said to be socially beneficial if gains exceed the costs.
By such measure we can say that devaluation, as seen by some as a necessary evil, is nothing but an illusion.
How? Because devaluation:
1. Undermines the role of the US dollar as international currency reserve.
The role of the US dollar as the world’s currency reserve is to provide the medium of exchange function not only for national use but for the global economy. This means that the main channel of providing liquidity for international exchange is to have strong (overvalued) currency that imports more than it exports. By expanding current account deficits, the US finances global transactions mostly invoiced in US dollars.
However once the US dollar reaches a point where deficits would be vented on the currency, the role of the US dollar as the sole international currency reserve may be in danger.
The global central bank holdings of US dollar have reportedly been down to about 62% from over 70% during the past years. Moreover, as discussed in What Global Financial Markets Seem To Be Telling Us, the clamor to replace the US dollar standard has been getting strident.
Last week, a Latin American trade bloc of 9 members, the Bolivarian Alternative for the Americas (ALBA) declared that it would cease using the US dollar for regional commerce next year (Chosun English).
All these means that if the US continues to devalue its dollar, to point of losing its privileges from international seignorage [net revenue derived from issuing currency], or its international currency reserve status, this would translate to diminished access to global finance to fund domestic (trade or fiscal) deficits, reduced access to more goods and services worldwide, and a diluted leverage on the geopolitical sphere.
In short, the cost of devaluation greatly overwhelms the alleged benefits.
2. Overestimates the role of international trade as the share of the US economy.
One of the mainstream reductio ad absurdum is to overemphasize or, on the other hand understate, the role of global trade in the US economy, depending on the bias of the commentator.
For instance, some deflation proponents use 13% of import share to the US economy as rationale to downplay the transmission mechanism of global inflation to the US economy.
Using the data from wikipedia.com, we note that exports account for only 9% ($1.283 2008) of the US economy ($14.441 trillion 2008) while imports account for 15% ($2.115 trillion). The point is international trade accounts only one fourth of the US economy.
Yet common sense tells us that policies that allegedly promote 9% (exports) of the US economy at the expense of 91%, which is deemed by some as being net beneficial to the economy, is deceiving oneself or is consumed by political or economic ideological blindness, or is totally ignorant of the tradeoffs of the cost and benefits from said policies or is extending the intoxicating influence of political propaganda.
3. Creates Systemic Inflation Which Overwhelms Advantages From Currency Depreciation
When governments decide to devalue, it embarks on credit expansion or conduct fiscal spending or other monetary tools or a combination of these policies, in support of special interest groups, as in the case of the US, the banking system (for media, the exporters) for a specific goal (debt repudiation or promotion of exports/tourism).
This in essence would lead to a redirection of investments or a diversion of real resources from other activities.
If the currency depreciates as a result of the government actions but the impact of which does not reflect on domestic prices, then the interest groups supported by such policies or those that engage in foreign currency exchange or trade will likely incur large profits.
However, once prices adjust to manifest the impact of the currency depreciation on imports and to producer and consumer goods, then the short term advantage erodes.
According to Dr. Frank Shostak, ``the so-called improved competitiveness on account of currency depreciation means that the citizens of a country are now getting less real imports for a given amount of real exports. In short, while the country is getting rich in terms of foreign currency, it is getting poor in terms of real wealth, i.e., in terms of the goods and services required for maintaining peoples' life and well-beings. As time goes by however, the effects of loose monetary policy filters through a broad spectrum of prices of goods and services and ultimately undermine exporters profits. In short, a rise in prices puts to an end the illusory attempt to create economic prosperity out of thin air.” (bold emphasis added)
In short, the beneficial impact of devaluation to certain groups will likely be short term and will eventually be offset by inflation.
4. Neglects The Role of Division Of Labor In Terms Of Imports and Exports
Adding to the fallaciously oversimplistic methodology by which mainstream seem to look at the world as operating from a homogeneous form of capital, whose product is produced by a single type of labor and sold as one dimensional product to an indiscriminate market affected by the same degree of price sensitivity, they also seem to think that exports have little correlation to imports, whereby final product sold abroad are all locally designed or processed- raw material sourcing, assembly, manufacturing, packaging, testing and etc...
The mainstream forgets about re-exports or imports of semi assembled products, parts or components that make up another product to be re-exported.
Applied to Asia, global parts and component trades have increasingly made up manufacturing output (see figure 3)
To quote the ADB, ``In Integrating Asia, the share of parts and components trade (PCT) in manufacturing trade shot up from 24.3% in 1996 to 29.4% in 2006. That is a remarkable rise, not least since worldwide its share has scarcely increased, edging up from 19.6% to 20.2% over the same period.
``As a share of GDP, PCT is among the highest in the world in the ASEAN (especially in Malaysia, the Philippines, Singapore, and Thailand) and in Taipei,China, perhaps because the relatively small size of their economies makes specializing in small niches of comparative advantage particularly important. Broadly speaking, the success of these economies is based on policies that welcome foreign companies, encourage technological upgrading, and build strong connections with world markets, as well as on their proximity to Asian neighbors following similar strategies. PCT is particularly significant among ASEAN countries: it rose from an average of 35% of manufacturing trade in 1996 to 43% in 2006. The PCT share in the PRC nearly doubled over the same period, from 12.5% to 24.0%, while in India it remained at around 10.0%.” (bold emphasis mine)
In short, in a world where the integration of the global economy has been deepening to reflect on the specialization or division of labor, imports has significantly contributed to manufactured products which are eventually re-exported. Such trade specialization constitutes as the lengthening of the economic structure.
As an example, the ADB shows how Asia’s parts and component trade (PCT) for a hard disk drive, assembled in Thailand, is networked within Asia and partly outside the region. And that’s merely for a hard disk, which also is only a component for a computer set.
So currency prices haven’t been the only factor that shapes production, but importantly trade openness, comparative advantages, division of labor and variability of markets as the ADB points out.
Here, globalization reveals that the division of labor and comparative advantage has been more than just “ideal” or “theoretical”. Instead, these economic forces depict of its pervasiveness in the global economic capital construct. They have even proven to be a more potent force than simply acquiring market share via currency price adjustments.
Talk about a genuine multiplier effect from free trade!
5. Overlooks On The Role of Societal Transition
One of the reasons why many support the government’s devaluation policies has been underpinned by concerns that US manufacturing output as a share of GDP has been declining.
The misimpression is that jobs have been exported out to third world countries.
Again, mainstream myopia which only looks at the surface sees jobs as one dimensional in nature. Their highly mechanistic viewpoint can’t seem to distinguish between low-scale low-value highly-commoditized jobs vis-Ã -vis high value specialized jobs or can’t seem to comprehend or digest the role of comparative advantage and specialization or division of labor in a world which practices globalization or freer trade.
The US supposedly is the premiere representative of the world’s democratic capitalism which implies that she has once been the world’s freest economy. Yet it is when an economy is economically free or open to trade that the advantages of comparative advantage and specialization can be seen and felt most.
For instance: in the 2008 capital goods accounted for the top US exports, according to US Department of Commerce, International Trade Administration, ``Capital goods represent the largest goods export category (end-use) for the U.S. with $469.5 billion worth of exports in 2008. The U.S. trade surplus in capital goods rose $12.8 billion to reach $15.7 billion in 2008, up from a surplus of $2.9 billion in 2007.”
On the other hand, top imports for 2008 crude oil, passenger cars, medicinal preparation, automotive accessories, other household goods, computer accessories, petroleum products, cotton apparel, telecom and video equipments (world’s richest countries). This means that aside from final consumption goods, the US imports parts and components for assembly or re-exports as well as raw materials.
The other way to look at this is that the US sells goods or services which reflect on its advance “technology age” state (capital goods) while buying input goods for reprocessing or commoditized goods for the end user.
Simply said, if the world has evolved from the agricultural era (agricultural economy) to the industrial era (manufacturing economy), then we are presently in a transition towards the information age or the post industrial society as identified by Alvin Toffler in his Third Wave Theory.
This means that the lengthening or expanding phase of an economy’s capital structure in an information age extrapolates to a bigger share of contribution from information and technology based goods and services relative to the overall economy.
As much as the share of output in agriculture shrank relative to the overall economy during the industrial era, today’s modern economy should see a smaller or declining contribution from the vestiges of the agricultural and the industrial output relative to economy.
Nevertheless, contrary to mainstream’s fanatical obduracy, US manufacturing in terms of productivity is at a record high (left window).
Moreover, while manufacturing jobs have been on a decline to reflect on productivity gains (right window), it is only during the last year’s recession where a drop of manufacturing output from record highs occurred. Still yet, all these, signify the advancement and not retrenchment of US manufacturing at the present state.
As University of Michigan’s Professor Mark Perry recently observed, ``More and more manufacturing output with fewer and fewer workers should be considered a positive trend for the U.S. economy, not a negative development. We should think of it the same way as the trend in farming over the last 150 years - we're much better off as a country, with a much higher standard of living, with 3% of Americans working on farms compared to 150 years ago when about 65% of Americans toiled on farms. If we can continue to produce more manufacturing output with fewer workers, we'll be better off as a country, not worse off.” (bold highlights mine)
So anyone who expects a return of the conditions of the industrial manufacturing age in today’s post industrial society simply suggest of the curtailment of progress or a throwback in time similar to Argentina in the 1930s or is against human progress.
And to adopt a protectionist economy combined with massive devaluation, which likewise signifies fear of competition, is a sure route towards decadence.
6. Promotes Capital Flight
Mainstream outlook seem to discern people as irresponsive to the incentives provided for by the governing circumstances. They haughtily presume of better intelligence than most of the society. While they could be somewhat correct, in terms of information (and not knowledge), we know that macro thinking is a poor substitute to the knowledge of F.A. Hayek’s “man-on-spot”.
This implies that when major policies which tend to have a momentous impact on society are undertaken, people consequently will respond in accordance to how such policies are transmitted into their respective fields or industries. In other words, in the marketplace a micro outlook is fundamentally superior than a presumptive model based macro analysis.
And devaluation policies would likely have an unintended effect: capital flight!
While there will be some sectors or interest groups that would benefit from a reconfiguration of investment flows, the alternative bet would be for capital to flow out of the country which have been engaged in policy devaluation and flow into assets of foreign currencies which have not or to real assets.
Economist David Malpass, a columnist at Forbes magazine, recently wrote an incisive article articulating how capital flight will subdue any tinge of benefits from devaluation.
Mr. Malpass wrote, ``Some weak-dollar advocates believe that American workers will eventually get cheap enough in foreign-currency terms to win manufacturing jobs back. In practice, however, capital outflows overwhelm the trade flows, causing more job losses than cheap real wages create. This was the lesson of the British malaise, the Carter malaise, the Mexican malaise of the 1990s, Yeltsin's Russian malaise through 1999 and the rest. No countries have devalued their way into prosperity, while many—Hong Kong, China, Australia today—have used stable money to invite capital and jobs. The more the dollar devalued against the yen in the 1970s and '80s, the more Japan gained share in valued-added manufacturing, using the capital from weak-currency countries to increase productivity. China is doing the same now. It watches in chagrin as the U.S. pleads with it to strengthen the yuan, adding productivity fast with the dollars rushing its way in search of currency stability” (bold emphasis mine)
Systemic inflation aggravated by capital flight is likely to overwhelm any purported gains from devaluation.
Currently, foreign flows into the US by both private and official sectors appear to be in a swan dive as the interest to own US securities have evaporated (see figure 6).
If capital flight from US residents and foreigners snowball into a tsunami, then the risks of exchange controls could be in the horizon.
This would be different from the recent capital controls imposed by Brazil, which uncannily slapped a 2% tax on foreign capital flows into fixed income and the stock market (Bloomberg). Such unorthodox move was meant to stem the tide of capital inflows where the Brazilian government deems the recent surge of the real and its stock market as indications of a seminal bubble.
Conventionally, capital controls are instituted to curb capital from stampeding out of a national economy or from the region.
Applied to the Asian financial crisis of 1997 which had been largely blamed by the domestic officialdom on speculative hedge funds, Joe Studwell in Asian Godfathers, Money and Power in Hong Kong and Southeast Asia argue that local tycoons were more culpable, ``An enquiry after the crisis found little evidence that hedge funds and other leverage investors played a significant role. There was widespread in the region of massive capital flight orchestrated by local tycoons; but Singaporean and Hong Kong banking secrecy is such that this is impossible to quantify.”
Exchange controls only serve to appropriate the properties of its constituents and of foreigners. By adopting a close door policy in finance and trade, the impact would be to dramatically increase the risk profile of a country. This should translate to a reduction of wealth via a markdown on assets as investors will pay less to own income flows or property or demand higher premium than where there is full convertibility of the currency.
The bottom line is present policies aimed at attenuating the US dollar risks not only capital flight from foreigners but also from local residents.
7. Raises The Risks Of Global Currency War
The perils of using models for prediction would be the assumption that conditions of the past have similar dynamics today. For instance, when Fed Chair Ben Bernanke used the Great Depression as paradigm for measuring the success of devaluation, he probably assumes that the US dollar today can devalue against other currencies without much resistance or would be cordially tolerated by other central bankers.
This would be highly presumptuous.
During the Great Depression, the US managed to devalue because it operated under a gold standard. President Franklin D. Roosevelt’s EO 6102 basically confiscated gold from every Americans in 1933 from which gold’s role as the public’s medium of exchange had been indefinitely suspended.
Since President Richard Nixon closed the Bretton Woods standard in 1971, otherwise known as the Nixon shock, the US dollar has assumed the role of gold as transaction currency for international exchange and as anchor reserve currency for global central banks.
Compared to gold based notes whose rate of issuance would depend on the rate of output from extracting gold from the ground, which is vastly limited due to the high cost and the attendant risks from mining, should the US decide to massively devalue, it could easily facilitate these using the Federal Reserve’s printing press or the technology enhanced digital press. Yet this would impact fundamentally all currencies, given its role as the world’s foreign reserve currency.
To consider according to wikipedia.org, 14 countries are unofficial users of the US dollar or has a dollarized economy. In addition, 23 countries are pegged to the US dollar. If the US dollar continues with its descent in response to the prevailing policy actions, then basically all 37 countries will be importing inflation from the US. Yet, their economies haven’t been afflicted by the same debt woes.
This may lead to a supply shock, where massive waves of money will be chasing after scarce supply of real goods or property.
Moreover, one can’t discount that the other central bankers may not be as cordial or as permissive as Ben Bernanke expects them to be and might attempt to counteract the US devaluation policies by arbitrarily conducting their own currency weakening process.
At the end of the day, if more and more government hops into the devaluation bandwagon then we could countenance a global currency war. And a global currency war risks a horrendous hyperinflation on a worldwide scale.
Ludwig von Mises has admonished us on the possibility of such risks, ``If one looks at devaluation not with the eyes of an apologist of government and union policies, but with the eyes of an economist, one must first of all stress the point that all its alleged blessings are temporary only. Moreover, they depend on the condition that only one country devalues while the other countries abstain from devaluing their own currencies. If the other countries devalue in the same proportion, no changes in foreign trade appear. If they devalue to a greater extent, all these transitory blessings, whatever they may be, favor them exclusively. A general acceptance of the principles of the flexible standard must therefore result in a race between the nations to outbid one another. At the end of this competition is the complete destruction of all nations' monetary systems.” (bold emphasis mine)
Devaluation is a risk endeavor which US policymakers appear likely to undertake (or in my view “gamble on”) in order to neutralize the impact from an unmanageable debt burden plaguing its system.
And this has been cheered upon by their exponents. Yet given the above, it would seem that policymakers and their cheerleaders don’t truly have the necessary understanding or comprehension of the risks involved or has vastly underestimated them.
Devaluation isn’t a necessary evil. Devaluation can take the form of the inflation demon, from which having emerged from the inferno, may wreak more systemic havoc than expected. After all, in the context of history, devaluations have been the seeds to the extinction of currencies. This time may not be different.