Posts Tagged ‘hyper-inflation’

Bernanke ticking off another inflation trick- buying Treasury securities

Wednesday, December 3rd, 2008

Remember, back in Bernankeism and hyper-inflation, we had a list of Ben Bernanke’s ‘unconventional’ (read: crazy) schemes to fight deflation. One of the schemes was already implemented (see Bernanke ticking off another inflation trick- becoming a business lender). That’s one tick in the list. Another scheme in the list is

Purchase of long-term US Treasury bonds.

Today, we heard news that Ben Bernanke is suggesting just that. As reported in Bloomberg,

Bernanke yesterday said he may use less conventional policies, such as buying Treasury securities, to revive the economy, because his room to lower the main U.S. rate from the current 1 percent level is ?obviously limited.? Even so, reducing the rate is ?certainly feasible,? he said.

Watch this space.

Are government bailouts good for the economy?

Wednesday, October 1st, 2008

Back in June last year (2007), we wrote in Epic, unprecedented inflation that

Today, the world is experiencing an unparalleled inflation of asset prices. This is the first time ever that the world is experiencing asset price inflation in all asset classes (e.g. property, bonds, commodities, stocks and even art!) and in all major nations (e.g. US, China, Japan, Australia, UK, Russia, etc). We will repeat this point again: never before had such a universal scale of asset price inflation ever happened in the entire history of humanity! Today, even artwork is also in a ?bull? market (if you consider artwork as an asset class)!

The implication is, as Marc Faber opined, this synchronised inflation will eventually lead to a synchronised deflation i.e. price deflation for all asset class in all major nations. This is something that contrarians have been warning all along (see Spectre of deflation in January 2007).

This synchronised monetary inflation leads to a mighty economic boom that mainstream economists called (and cheered for) the “asset-driven” growth. But again, we were sceptical about this kind of boom. As we explained back in November 2006 in How will asset-driven ?growth? eventually harm the economy?,

Thus, when housing prices [asset price in general] increased due to the increase in ?demand? for housing, the common people are misled into thinking that the value of housing had increased as much as the increase in its prices. That collective error in judgement resulted in the economy misallocating scarce resources into housing sector?in the case of the US, a significant proportion of the jobs created during the asset-driven ?growth? was related (both directly and indirectly) to the housing boom. Since economic resources are always scarce, any misallocation of it implies an opportunity cost on the other sectors of the economy. The result is a structural damage to the economy that can only be corrected through a recession.

The dark side of this boom is the dangerous build up of debt and leverage in the global economy. As we explained in January 2007 at Myth of asset-driven growth,

As asset price growth outpaces income growth by an ever-increasing margin, increasing issue of credit (i.e. the flip side of taking up of debt) is required to bridge the gap between the asset price and income. What is most often overlooked is that the uptake of debt, which is required for asset-driven growth, has to be serviced. There are two kinds of debt?investment debt and consumption debt. Investment debts are being used for investments that will generally add value to the economy by increasing its productive capacity. Thus investment debts are self-servicing loans?they will generate the necessary economic returns to make repayments possible. The problem with asset-driven growth is that much of the debts are consumption debts. Since such debts are acquired for consumption, they do not add value to the economy because they do not increase its productive capacity. As such, asset-driven growth magnifies the consumption debts of the economy, which will have to be serviced in the future. By deferring the burden of debt servicing to the indefinite future, it can only mean that the nation?s wealth will shrink in the future. Hence, asset prices cannot rise in perpetuality. Eventually, the weight of future debt servicing burdens dooms the bubble to collapse under its own weight.

For those who are new to this publication, these explanations are from the classic business cycle theory of the Austrian School of economic thought. Followers of the Austrian School will look at today’s financial crisis with a yawn because it is obvious to those who understands the Austrian Business Cycle Theory. To understand this theory, we highly recommend our guide, What causes economic booms and busts?.

Currently, we are in the bust phase of the business cycle. In this phase, we will see a much needed painful restructuring of the economy as wasteful and unsustainable mal-investments of the prior boom time get liquidated. Real-life example of mal-investment liquidations can be seen in this news article, Frozen-out expats return to Australia for jobs,

A generation of young Australian expatriates are being forced home from New York and London due to the tightening job market in the finance industry.

Painful as it is, liquidation of mal-investments is a necessary evil so that the global economy can get back on its feet towards a sustainable growth path. The manifestation of this painful process is deflation. The magnitude of the coming deflation reflects the monstrosity of the prior unsustainable inflation. The fact that the media is now murmuring about the infamous “D” word (Depression) shows that the massive boom of the past few years is a cruel illusion that fooled many, including many of the mainstream economists and government.

But what are the governments around the world doing? They are fighting this necessary evil by stalling the inevitable liquidation of mal-investments by the free market with bail-outs and even more attempts at monetary inflation! This will delay the long-term recovery of the global economy. How can they solve the problem with more attempts at inflation when inflation is the cause of it in the first place?

Should they ever succeed in their attempts at inflation, the end result will be as we described in Supplying never-ending drugs till stagflation:

Students of the Austrian School of economic thought will understand that indiscriminate ?printing? of money (i.e. [inflation]) will worsen the plague of mal-investments and structural damage in the economy. Like drugs, the more you ?print? money, the less effective it will be in stimulating economic growth (see What causes economic booms and busts?). Eventually, it will come to a point that the economy will not respond positively any more no matter how much money is being ?printed.? That is the nightmare of stagflation (low or negative real growth with sky-rocketing price inflation- look at Zimbabwe).

Bernankeism and hyper-inflation

Wednesday, September 24th, 2008

Today, we will shed another light for our readers in this highly polarising inflation/deflation debate. Since this debate is highly divisive and polarising, there is little wonder that many of our readers are very confused. This article can be seen as a continuation of:

We will assume that you have read and understood the content of these articles. Also, the source of today’s article comes from here at one of Marc Faber’s Gloom, Boom, Doom reports. That article was “originally given as a talk at the Burton S. Blumert conference on Gold, Freedom, and Peace, a benefit for” Lew Rockwell is the former congressional chief of staff to Ron Paul and founder and president of the Ludwig von Mises Institute (an institute of the Austrian School of economic thought).

First, as we quoted Ben Bernanke in Peering into the soul of Ben Bernanke,

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.

This speech gave Ben Bernake the nickname of “Helicopter Ben.” He is a student of the Great Depression and is convinced that deflation must be prevented at all cost. Particularly, he is obsessed with something known as the “zero bound problem.” Japan is a case in point for this zero bound problem. As we all know, Japan infamously cut its interest rates to zero in the 1990s and yet, still failed to win the war against deflation. As we explained before in What makes monetary policy ?loose? or ?tight??,

… remember that the central bank cannot control the demand for money and credit. It can supply whatever amount of them that it wants, but it cannot force business and people to desire them. Put it simply, you can lead a horse to the water, but you cannot force it to drink.

When deflation forces interest rates to be zero, that is the point when monetary policy becomes totally impotent in inflating. Therefore, Bernanke will want to avoid this zero-bound problem by making darn sure that inflation will happen.

But the question is how? The case of Japan showed that it is impossible. In that sense, the deflation argument is right. In the current credit crisis in the US, it is impossible to win the war against deflation.

Well, it is impossible unless unconventional means are used. The word “conventional measures” appeared prominently in much of the Fed’s discussion. According to Bernankeism, when the

… powers of a central bank are limited to “conventional measures,” the central bank may not be able to prevent deflation, nor to fight it once it has taken hold. In the Fed’s view, Japan tried conventional inflation measures to their utmost.

What are the unconventional measures that Bernanke advocated? If you read the Fed’s papers and speeches, you will find a series of “increasingly exotic plans,” from the “merely unsound to the bizarre and terrifying.” For your information, these are not something we invented from our imaginations- they are available in the public domain at the Fed’s web site. The list of references can be found here. Below are the unconventional measures:

  1. Expand the menu of assets that the Fed could purchase through its open-market operations. This measure is already implemented- see New tricks required to bail out financial system.
  2. Purchase of long-term US Treasury bonds.
  3. Writing interest rate option contracts.
  4. Purchase foreign exchange reserves in order to devalue the US dollar.
  5. Loan money into existence, accepting as collateral almost any private-sector asset whatever.

So far, the above measures depend on the willingness of borrowers to borrow the cheap money that the Fed prints. What if the private sector refuses to borrow? Well, no worries! The Fed will print and distribute the money (note: this quote is straight from the Fed’s mouth):

One tool commonly attributed to the Federal Reserve, at least in theory if not by the Federal Reserve Act, is that of conducting ?money rains?.

Money rains are a clean way to study theoretically the effects of increases in the supply of money. In practice, it seems a bit difficult to envision how the Federal Reserve could literally implement a money rain ? that is, give money away either through directly disbursing currency to the public or by disbursing it through the banking system. The political difficulties that are likely to arise from the Federal Reserve determining the distribution of this new wealth would be daunting.

Now, what if the Fed prints and distributes but the people are unwilling to spend? Well, the “next weapon in their arsenal is to make money pay a negative rate of interest.” While that sounds difficult, the Fed has actually written a paper to explain how they are going to do that:

The strategy for eliminating the zero bound, therefore, is to make money pay a negative nominal interest rate, by imposing some type of ?carry tax? on currency and deposits

The technological difficulty lies mainly in imposing such a tax on currency. In the 1930s, Irving Fisher of Yale University, one of the greatest [sic] American economists, proposed such a system, in which currency had to be periodically ?stamped?, for a fee, in order to retain its status as legal tender. The stamp fee could be calibrated to generate any negative nominal interest rate that the central bank desired.

What if this still fails to inflate? There is another weapon- the direct monetisation of goods and services (note: this quote is straight from the Fed’s mouth):

Why not have the Fed just conduct an open market purchase of real goods and services? Even more so than exchange rate intervention, this strategy would represent a direct stimulus to aggregate demand.

These unconventional measures are “absurd, bizarre, and preposterous monetary crank schemes ever proposed by anyone calling themselves an economist.” Some of them are even downright illegal! But is illegality an obstacle? As we said before in Recipe for hyperinflation,

Therefore, watch what the US government is doing with the monetary ?rules? in its attempt to fight deflation.

Now, as you are reading this, you may find it incredulous to see these crazy ideas mentioned by Ben Bernanke and his accomplices. Are we making them up? No, you can download this article here and check out the list of references at page 11. They are all straight from Ben Bernanke/Fed’s mouth (or pen).

The question is, are they really crazy enough to do it?