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Four Letters Re: Currency Inflation Expectations for the US
James:
The letter [from reader PNG] has severe mistakes and is fundamentally misleading
- your readers deserve even more refutation before anyone is lulled into a
false
sense
of
security. To quote: “Let's say the Treasury just invents another
two trillion dollars by printing currency and forgiving loans. Let's say
they
do that
every year
for the next five years. How much inflation would that create? The absolute
maximum inflation rate from this example is about 20%, because there's ten
trillion dollars in circulation already.”
- These numbers are incredibly
far off the mark. Actually M1 is the narrow definition of money - the core
money supply that the Fed controls. It
just spiked from ~ 850 billion to ~1,010 billion ($1.01 trillion) in one
month.
So he's off by a factor of 10 here. If the Fed printed (or created digitally)
the hypothetical two trillion $ this would triple the M1 money supply. Three
times as much money chasing goods would ignite hyperinflation very quickly…
- And
let's not forget about the multiplier effect of fractional reserve banking!
Even much smaller amounts of money creation are going to create serious
inflation because we live with the fundamentally dishonest and unstable fractional
reserve banking system. $10 deposited in a bank is used as “reserves” to
loan out more than $100. (Banks are only obligated to keep
less than 10% in reserves to pay depositors). Off by another factor of 10!
Two
trillion
in new
money becomes more than twenty trillion dollars in loans.
Quoting again: “But in practice, the additional money dilutes the much
larger pool of value represented by goods and services. This must be true
because the entire money supply isn't enough to buy everything that is for
sale.”
- Actually money has velocity - it is spent, or changes hands, several
times per year. The money supply multiplied by the velocity determines the
amount
of dollars bidding for the total supply of goods. E.g., $100 times a velocity,
or turnover, of 10 times a year = $1,000 spent in one year. This $1,000
bids for the supply of goods, NOT just the $100.
In the US (right now) velocity is moderate. In Zimbabwe it is incredibly
fast. So looking at just the supply of money is only half of the equation
when you
look at the $ bidding up prices for goods.
- There are lots of other mistakes
here, but one last note is in order “That kind of inflation is literally
unprecedented in otherwise functional economies” Crack open
an encyclopedia, and look under W, for Weimar Germany! And don't confuse
cause with effect
- economies become dysfunctional because of inflation - Argentina is a good
place
to start reading...
An aside - thanks to Dr. Gary North for making the link above freely available
on the public section of his web site. Sign up for his free Reality
Check newsletter if you’d like advance notice of economic trends
based on real numbers. (BTW, I have no relation to Gary North, other than gratitude
for giving me far more education than I paid for as a subscriber.) Yours truly,
- OSOM
Jim:
Here are
a couple of facts about inflation I'd like to share:
FACT: The US Federal Reserve is issuing loaned money at its discount window
at the rate of $100 Billion per day which is $36 Trillion, annualized. The
$100 billion daily
rate
is actually increasing each week. These quantities of money will never be paid
back because the national debt is 10T$ which it took 95 years to accumulate.
This is highly inflationary.
FACT: Every bank account has been guaranteed to $250,000 [more than twice
the old limit] with unlimited funds to back up FDIC insurance. This will be
highly
inflationary, if banks
fail. - J.K.
Jim:
Referring to the letter by PNG, “currency inflation expectations” and
your response. I would like to quibble a great deal with PNG, and a little
with you.
First, for reader PNG,
Week before last, the Fed increased the money supply
by nearly 23% in one week. They have been increasing the supply by huge amounts
weekly, but that
one took the cake. Disregarding Jim's accurate argument that there are other
things to inflation, (e.g. velocity of money) simply multiplying 22% times
52 weeks gives a minimum annual inflation number of 1144%. The way the Fed
has
been “printing” money since Aug 17 this year, triple digit inflation
is almost a given. (Not that the Fed can really “Print” money,
but it can sure “Create”.)
The government is constantly changing the way it calculates inflation. Now
they talk about “core” inflation, leaving out the “volatile” food
and energy, etc. costs. Since when do we not need food and energy to survive?
If one calculates inflation using exactly the same methods used during the
Clinton administration, (as they do over at the “shadow stats” web
site) you will note inflation is running well over 10% NOW, and it takes some
time
for newly “printed” money to work its way through the system to
become inflation.
And for you, Jim,
I certainly agree with your observations about debt and derivatives. The world
bank and others are coming up with estimates that the notional
amounts of derivatives run in the order of 1.31 Quadrillion dollars. No one
knows for sure. If any
one of the three counterparties to a derivative default, then the notional
amount owed becomes a real amount owed. To put that in perspective, the GNP of the entire world economy doesn’t run over $50 trillion.
A bailout of $700 billion is peeing in the ocean because there are a lot more
zeros in
a
quadrillion
than in a billion. A quadrillion is a million billions. Parts of this house
of cards are failing now, (your comment about Lehman’s explosion date
of Oct. 21 is spot on) and the numbers are so huge that undoubtedly one will
take down others in a row of dominoes effect. Lehman may be that first domino.
My quibble with you regards another possibility to inflation. In our fractional
reserve banking system, every dollar “printed” by the Fed is normally
multiplied by about 10 by the banking system (Theoretically it can be much
more than 10) So to inaccurately describe in economic terms, the dollar bills “printed” by
the Fed might be called M1. By the time that one M1 dollar makes its way through
the banking system an additional 9 have been created via loans for any purpose
to the average guy or company. That might be called M3. The commercial banks
get one dollar but loan out ten. And there is no way of telling whether what
you are spending is created by a commercial bank loan or was “printed” by
the Fed, and in practice, normally it doesn’t matter. There are, however
rules as to how much the banks can loan out based on reserves, which are normally
the capital and accumulated profit. (Equity)
However, in special circumstances such as we now face, it does matter
whether dollars are Fed created or commercial bank created. Normally, to make
as much
profit as possible, commercial banks will try to lend out every dollar they
can. In the current situation there are two things that stop the commercial
banks from lending. The first is they are scared silly, and rightly so. They
have gone from worrying about the return on money to worrying
about the return of money. No one can tell whether a bank is bankrupt or not,
because IF they
hold derivatives, those derivatives may suddenly become a giant liability.
As well, all the major companies used derivatives freely, and they are suspect
too. Ergo we have a credit crunch where the banks are afraid to lend, even
to each other. The fractional bank multiplier (one in, ten out) is not working,
contracting the M3, or money on the street. Very deflationary.
All these billions the banks are “writing off” come directly from
their equity, or reserves. Since they can only lend out a certain multiple
of their ‘reserves’, those reserves, or accumulated profit, are
dropping like a rock because of the writeoffs. They must contract their lending
to remain within the rules. So, it becomes an issue of the commercial banks
being neither willing, nor able to lend.
The government allows certain borrowings from the central bank to be counted
as reserves in time of turmoil, which hasn’t been a problem within the
life span of most alive today. During 2007, and prior, US bank reserves ran
in the order of $43 billion. The latest US figures I saw shows “non borrowed” reserves
at minus $403 billion. The rest is government loans “counted” as
reserves. Every bank in the US, and most of the rest of the world, is bankrupt.
Well, there will be one or two prudent exceptions, but they will also likely
be taken down too, if only because of the number of checks in circulation.
Suddenly those nine dollars of commercial bank created dollars are shrinking,
and they can shrink even faster than the government can print. All this is
highly deflationary, as the world found to its dismay in 1929. Why do you think
Paulson has opted to buy equity in banks with a significant part of his $700
billion? It pumps their reserves, so they have the ability to lend. No one
has mentioned how they can cause banks to have a willingness to lend.
My point is that so many assets are being destroyed, as they were in 1929,
that a deflationary scenario is entirely possible. And deflation is a much
meaner beast than inflation. I have previously forecast elsewhere an inflation
followed by deflation until it is all Fed created money. Then it is Zimbabwe[-like
situation for America], if the system holds together that long.
Like you, I much prefer a world of sleeping well at night, hot showers and
lights that turn on at the flick of a switch. - Allen
Mr. Rawles;
In response to he recent post where another reader thought that triple digit
inflation could only happen with $10 trillion per year increases in the money
supply I would
like to provide some further economic insight for your readers.
- Prices are
determined by supply and demand; therefore, a drop in demand for dollars
can have a far greater effect than a increase in supply. Many people
do not realize that in Germany the inflation rate was many times the rate
of the increase in the money supply.
- If the dollar loses its reserve currency
status (currently being discussed) then international demand could fall
off a cliff forcing half of the dollar supply
back to the United States (100% inflation).
- There is a time-lag for inflation.
In the early days people expect price stability and so inflation is much
lower in than the actual increase in supply. Over time
people expect more and more inflation until it spirals out of control.
It is a geometric function where most of the action takes place in a very
short period
of time. In other words, the huge increase in the money supply that resulted
in home prices going up has not yet fully been priced into other goods
and services.
- A decrease in production (due to recession) decreases the supply of goods
competing with existing money causing inflation.
- Ever dollar FDIC pays out
is inflationary; therefore, with the government backing almost everything
these days every deflationary "force" is
countered by inflationary government action. Ultimately, interest on the
national debt will exceed the ability to tax... this is the end game for
the dollar.
When
you factor in these things, triple digit inflation does not take much time
to get rolling. In fact, it can go from 10% (current) to 100% inflation in
just a few weeks. I hope this material is useful for your readers. - Dan
in Virginia
