Posts Tagged ‘stagflation’

Anyone has any stories to share about hyperinflation?

Thursday, December 4th, 2008

Back in Zimbabwe?s central banker in praise of Fed, one of our readers, Temjin asked,

Lol Praised by Zim?s RB, such a honor. But is Gono really really serious about his monetary policy will work in the very end?

We scanned through the Reserve Bank of Zimbabwe’s First Quarter Monetary Policy Statement for 2008 and saw this:

Our economy is and has been in trouble for over ten years and our extraordinary interventions by whatever name have helped to keep the wheels of this economy moving.

Of course, in the short-term such interventions are without doubt inflationary but in the medium to long-term they trigger and propel economic growth and development that everyone craves for.

It is amazing to see how low the depth of human delusion can go. The disturbing thing is that the US is treading the very same path that Zimbabwe took years ago. As Marc Faber said here,

… central banks have become asylums for economists that have turned insane. And in their insanity, they became money printers. And so you have to be your own central bank. You cannot trust the central banks of our governments anymore…

As we said before in Supplying never-ending drugs till stagflation,

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 anymore 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).

Finally, Temjin asked,

Ed, can you paint us a scenario on the final ?breakdown? of a hyperinflation? What will happen afterward? Out of paper/ink to print? 😀 People resort to violence/anarchy? Full acceptance of bartering?

For this, we will do something different today- we will turn to you, our readers to share your stories about hyperinflation at our forum. Your stories can be first-hand or second-hand. If not, you can also share stories that you learn from TV, movies, books, newspapers and magazines, etc (e.g. what is happening in Zimbabwe today). We believe that stories are more effective than dry economic theories at helping all of us to understand the true meaning of hyperinflation.

We remembered that one of our readers, Sergey Stadnik, had a story at Harmful effects of inflation:

I lived in Russia during the hyperinflation of late 80s-early90s. It was exactly as you say: people and businesses were not interested in producing goods. The only path to success was speculating.

Perhaps you have more stories to share? Or you have questions about hyperinflation? Our forum is open for questions and sharing here.

Fading glory of the financial services and ‘wealth’ management industry

Sunday, November 2nd, 2008

October has just passed and it will go down in history as one of the worst months in stock market history. Even many veteran traders have not seen anything that bad before. As Marc Faber said in a recent Lateline interview (on 13 October 2008),

As of last week, world stock markets became oversold. Statistically probably the most oversold condition in the last 50 years or so.

One good gauge of fear in the stock market is the Volatility Index (VIX) indicator. As you can see from the chart below, the VIX spiked to its record high level (since 1990) at above 80 in October.

VIX indicator since 1990

Consequently, such intense level of fear had provoked the government into making up policies as they go and then tweaking away the side effects as an after-thought. For example, when the government gave unlimited guarantee to bank deposits, fearful money began to defect away from investment funds into banks. As these funds reacted by freezing redemptions from investors, prompting a crisis on their investment business. Some of these investment managers then pleaded with the government to guarantee their investment funds. We could sense the underlying sarcasm of the government officials as they replied by ‘taunting’ these investment funds to become banks if they want to fall under the protective umbrella of the government.

The global financial market had never been subjected to so much fear for a very long time. The sheer terror of a global financial meltdown had provoked knee-jerk reactions from governments, regulators, central banks, investors, traders and the humble savers. Beneath the raging waters of fear, panic, reactions and counter-reactions, the many decisions made on the spur of the moment by governments, regulators, and central banks will be judged by history to be turning points. These decisions will have many long-term side effects that are not immediately apparent. At this point in time, although there are signs that the panic is starting to melt away and calm gradually returning to the market, the lingering smell of mass ‘wealth’ destruction will still remain for a considerable period of time.

As we mull through the long-term ramifications, our thoughts are drawn to the future of the investment and financial service industry. The first effect we can think of is the loss of trust and confidence on the idea of ‘wealth’ management. Much of the panic selling in October was contributed by investors redeeming their money from managed funds and stuffing them towards the proverbial cash under the mattress (i.e. treasury bonds, guaranteed bank deposits and even gold). The number one priority was not return on their money. Rather, it was return of their money.

Our stand is that the trust and confidence on the idea of ‘wealth’ management through ‘investments’ in financial assets was a misplaced one. The whole idea of ‘investments’ was based on a massive bubble. As we said before at Have we escaped from the dangers of inflation? in February 2007,

Today, the global spigot of liquidity (see Liquidity?Global Markets Face `Severe Correction,? Faber Says on the concept of ?liquidity?) is wide open, spewing out huge amounts of money and money substitutes into the financial system.

With all these flood of fiat money inundating the global financial system, we look at all these skyrocketing financial asset prices with a yawn. Price bubbles of all sorts are found everywhere in the world?from Chinese stocks, junk bonds to private equity booms. Back here in Australia, it looks to us that nowadays, everyone is ?playing? the stock market, many using leverages like CFDs and margin lending. We hear stories of novices ?investors? opening a trading account to ?learn? how to trade. The logic is simple: central banks around the world are hard at work ?printing? money. These monies first go to the financial system, creating price bubbles. The bubbles then attract speculators, gamblers and punters into the asset markets the way bees get attracted to honey. Soon, word get round to the masses and they want a slice of the action too.

Over the years, central bankers are creating copious amount of money and credit out of thin air. The masses then take on the delusion that these fiat money are real wealth. As we asked before in The myth of financial asset ?investments? as savings,

Can the printing of money, which spawns the growth of an industry to shuffle it, cause a nation to be richer in the long run?

There were so much money and credit conjured from thin air that an entire industry (i.e. financial service and investment industry) has to be bloated beyond its fundamental use in order to shuffle them. As we said before in Connecting monetary inflation with speculation,

Thus, by further inflating the supply of money and credit in the financial system at such a time, there comes a situation whereby there are excess liquidity without adequate avenues for appropriate investments.

Thus, the global credit crisis is a return back to reality as the masses wake up their idea that all these ‘wealth’ are illusionary. As we quoted Ludwig von Mises at The myth of financial asset ?investments? as savings, real wealth is based on real capital formation. Shuffling money and competitive chasing after assets with fiat money do not make a nation any richer.

Alas, there are still many who still do not get it, even when the threat of a Great Depression II is gathering at the gates of the global economy. For example, in Australia, the Opposition Leader, Malcom Turnbull still speak of the ‘savings’ trapped in investment funds due to the Australian government’s unintended side-effect bank deposit guarantee. The fact that he is using the concepts of savings and investments interchangeably to refer to the same thing shows that he has no idea about what he is talking about.

Dear readers, to be a successful investor, you have to understand the difference between savings and investments. We urge you to read The myth of financial asset ?investments? as savings. The entire superannuation and wealth management industry is based on the myth that investments (especially ‘investments’ in financial assets) are savings. Consequently, the build-up of mal-investments that such a myth introduced brought about the financial crisis that we have today. Real investment brought about real capital formation, which is the cornerstone of real wealth in the future.

As far as we can see, the bull market (in real terms) on financial assets is over. What comes next is either deflation or stagflation. The implication is that peak glory (2001-2007) of the financial service and wealth management industry will be history.

Government’s contradictory messages

Wednesday, October 22nd, 2008

Back in Can China save Australia?, we mentioned about SBS’s Insight program, Greed. As we read the transcript of that program, we cannot help but realise that while the government officials are busy trying to deal with this crisis, they are sending out contradictory messages as a side effect.

For example, take a read at this:

JENNY BROCKIE:  But what sort of possibilities are we talking about here? I mean unemployment going up to 10%, 20% in the event of this taking hold in Australia? What could happen?

LINDSAY TANNER:  Definitely not. None of us can see into the future and the international crisis is obviously so unprecedented that it’s very hard to make predictions, but the fundamentals in Australia are very strong. We’re better off than virtually anybody else in the world to deal with these problems and we remain optimistic that we will be able to ride through this buffeting in reasonable shape.

On one hand, Lindsay Tanner ruled out the possibility of Australia’s unemployment going north of 10%. Yet, on the other hand, he said that no one knows the future and make predictions. If you notice, by saying “Definitely not,” he is already making a prediction!

Incidentally, in Jobless rate may double as China slows, JPMorgan Australia’s chief economist Stephen Walters said that

“We now expect the jobless rate to more than double to 9% in late 2010, from the current 4.3%,” Mr Walters said. “Softer growth in one of Australia’s leading export destinations means Australia’s export volumes will be lower, as will be the terms of trade.

“That said, on our forecasts, there will be 1 million unemployed Australians by the second half of 2010.”

The current way of measuring the employment rate includes those who are under-employed (see Nearly 600,000 Australians under-employed). When the economy slows down, it is those kinds of jobs that will be shed first, especially jobs in businesses that depend on discretionary spending (e.g. retailing). Therefore, a figure of 1 million unemployed people is not so unthinkable after all.

The next contradictory message from the government is on spending:

JENNY BROCKIE:   OK, there are quite a few things in what you’ve said that I’d like to pick you up on because we live in very contradictory times at the moment. You’re saying we should be thinking about thrift. You’ve just released a $10.4 billion package and you’re telling people to go out and spend. I mean, should Siobhan keep spending, keep getting into debt? What’s the message the Government is sending at the moment?

We believe that the government’s $10 billion stimulus package is a misguided Keynesian policy that will not solve the problem.

Firstly, as we said before in Will Australia?s own pump-priming work?, it is far too little to combat the deflationary force.

Secondly, even if it is big enough to induce the masses to spend, it is the wrong medicine. If such policies are carried out to the extreme, the outcome will be hyperinflation (see Bernankeism and hyper-inflation). As we explained in Supplying never-ending drugs till stagflation,

Students of the Austrian School of economic thought will understand that indiscriminate ?printing? of money 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 anymore no matter how much money is being ?printed.?

Without the liquidation of mal-investments and restoration of the structural imbalances that is brought about by deflation, applying bigger and bigger stimulus packages will only function in similar ways to drugs- more and more for less and less effect. The reason why Keynesian reflationary pump-priming worked during the Great Depression was that it was applied after the cleansing effects of the deflation had done its work. But today, in reaction to the financial crisis, governments all over the world are doing so before the purge of fire. As a result, the much-needed economic correction that the economy had to have will not happen.

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).

RBA’s interest rates dilemma

Wednesday, September 3rd, 2008

Yesterday was the first time in several years that the Reserve Bank of Australia (RBA) decided to cut interest rates. As you can read from the mainstream news media, this fall in interest rates is not necessarily good news. For example, Ross Gittins from the Sydney Morning Herald said in Yippee, the bad times are back,

YOU beauty. Interest rates have been cut and happy days are here again. For good measure, we’ve even got petrol prices coming down.

Sorry, don’t be too sure about that. The Reserve Bank has cut its official interest rate only because times are getting tougher.

But our loyal readers should already know about this fact long time ago. Back in July last year (2007), when the talk in the market was still about booming asset prices and inflation, we warned in Should you purchase first home whilst asset price inflation?,

… it is prudent to arrange their finances with the assumption that interest rates are going to be in an upward trend for at least in the medium term. Having said that, it is still possible for interest rates to be cut? when the economy is hit by a threat of recession or depression

While those heavy in debt would welcome RBA’s interest rate relief, there are still many unresolved complications. The most important thing to remember is that Australia’s price inflation problem is still not yet resolved. The RBA is forecasting rising price inflation till the end of the year at least. Normally, no central bank will cut interest rates in the face of rising prices. But this time, they have a bigger worry than rising prices- economic recession. In other words, Australia is facing stagflation (economic stagnation/downturn and rising prices) and the RBA is more worried about the ‘stag’ part of the stagflation. And they are betting that the ‘stag’ part will somehow resolve the ‘flation’ part.

But from what we can see, the RBA’s hands are tied. If they try to prevent the slowdown from turning into a rout by slashing interest rates aggressively, it is very likely that the Aussie dollar will continue its down trend. As we explained before in Falling currency and inflation,

A rapid depreciation of the Aussie dollar will result in rising price inflation for the same reasons stated above.

We do not envy the job of the RBA. It looks like Australia may be moving towards the same path as the US (see Supplying never-ending drugs till stagflation).