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ETFsRule (99.94)

Response to rfaramir & David in Qatar (ignore this if you don't like boring posts about inflation)

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May 11, 2011 – Comments (28)

Over here in comment #54, David in Qatar wrote:

"http://en.wikipedia.org/wiki/Hyperinflation#Examples_of_hyperinflation

Plenty of modern countries and democracies have suffered from hyperinflation or mass-inflation."

This is true. However, those countries were, in fact, "printing money" at alarming rates. The situation in the United States is completely different, and we certainly are not faced with a risk of hyperinflation, for reasons that should become clear from my response to rfaramir.

In comment #39 of that same blog, rfaramir wrote:

"It's not their being 'spent' that makes the excess reserves a threat. It is their being lent out. They will be lent in a fractional reserve fashion, meaning that each dollar in reserve will be the basis of about 9 more dollars in new deposit accounts created by loans capitalized by that reserve dollar.It is only the fact that the Fed is actually paying banks interest on their reserves at the Fed together with their fear of loaning money in the current climate that keeps those dollars in excess reserves. They are a nuclear warhead ready to go off at the first sign of a real recovery (nowhere in sight at the moment).

Speaking of end game scenarios, Chris Barker's $2000/oz price for gold is not a "terminal" price because a realistic price for gold when the dollar goes "terminal" cannot be stated. A) It's probably at least $40,000/oz by today's money supply measurements..."

First, it's true that excess reserves are very high right now, at a little over $1.4 trillion. It's also true that via fractional reserve banking, this could potentially result in the creation of an additional $12.6 trillion to the money supply. Of course, for this money to be created, the banks would need to loan it to someone. So my first question is, who would they loan this $12.6 trillion to?

For rfaramir's doomsday scenario to come true, we would need to see a quick turnaround in the housing market.

Based off these recent stats (which are probably too generous to begin with), I'll make some very rough and very generous estimates of home sales going forward:

Existing home sales: 6,000,000 per year at $200,000 per house = $1.2 trillion/year

Housing starts: 1,000,000 per year at $250,000 per house = $0.25 trillion/year

Total: $1.45 trillion/year

Even in this overly-optimistic scenario, it would still take: $12.6 / $1.45 = 8.7 years to loan out $12.6 trillion.

This would increase the M2 money supply from $9 trillion to $21.6 trillion over 8.7 years, a total increase of 140%. Annualized, this represents an increase to the money supply of 11% per year. This would cause high inflation, but it's still nowhere near the level of monetary creation that we saw in David's examples of hyperinflationary countries.

And again, these are "worst-case" estimates, which don't account for the obvious fact that the Fed can slow down lending by raising their rates and/or increasing their reserve requirements. Plus there is the fact that housing prices are still dropping, and housing starts are not exactly looking very strong right now.

Borrowings from the Fed are basically zero at the moment, so we still have quite a long way to go before we reach $12.6 trillion. If we can't get anyone to borrow money, even with a Fed rate of 0.1%, why would we expect lending to suddenly take off at unprecedented levels?

Can't we all just agree to worry about real problems (like unemployment) instead of imaginary problems (ie: hyperinflation)?

28 Comments – Post Your Own

#1) On May 11, 2011 at 7:55 PM, ChrisGraley (29.67) wrote:

On what planet is the US not printing money at an alarming rate?

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#2) On May 11, 2011 at 8:10 PM, TMFAleph1 (94.91) wrote:

Very nice post, ETFsRule.

Alex Dumortier

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#3) On May 11, 2011 at 8:15 PM, mtf00l (44.70) wrote:

Wouldn't have missed it for anything...

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#4) On May 11, 2011 at 8:33 PM, whereaminow (21.10) wrote:

In your scenario, when housing turns around, the $1.4 trillion (plus interest) will get lent out.

And this does not alarm you in the least?  Don't just limit it to hyperinflation. What about mass inflation (10-40% per annum), would that not be devastating?

Who pays interest on excess reserves? This is not alarming?

Could we have any other scenario where the money is lent out without a housing recovery?  

Is there any (price) inflation right now?

David in Qatar

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#5) On May 11, 2011 at 9:06 PM, ETFsRule (99.94) wrote:

"In your scenario, when housing turns around, the $1.4 trillion (plus interest) will get lent out.

And this does not alarm you in the least?  Don't just limit it to hyperinflation. What about mass inflation (10-40% per annum), would that not be devastating?"

Please explain how you're coming up with a figure of 10-40% inflation.

I came up with a worst-case scenario of 11%, and honestly, that number is unrealistically high.

"Who pays interest on excess reserves? This is not alarming?"

We do. And no, it's not particularly alarming because it's such a small amount of money compared to the size of our economy.

"Could we have any other scenario where the money is lent out without a housing recovery?"

Not really, unless you had something in mind? Commercial real estate will probably move in sync with housing, and auto loans are pretty insignificant.

"Is there any (price) inflation right now?"

There's a little bit, but I think we'd be a lot better off with higher inflation.

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#6) On May 11, 2011 at 9:30 PM, dbjella (< 20) wrote:

There's a little bit, but I think we'd be a lot better off with higher inflation.

Personally, I wish we would have deflation.  My wage is stuck, gas is at $3.99 and bacon, my fav, is at $4.25/lbs.  The stuff I consume is going up.  I don't know what hyperinflation is, but I don't like this inflation at all.

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#7) On May 11, 2011 at 10:20 PM, whereaminow (21.10) wrote:

ETFs,

I understand that you are not concerned. I am. In my posts, I don't try to scare people. I present the information that I think is relevant. Then I present my conclusion. They are free to agree or disagree.  There are many things about America that bother me and I don't pull any punches when I think someone in power is stupid and/or evil.  But no one has to believe what I say.

I know that you think higher inflation is good. I don't.  Those are separate arguments. I agree that housing is not recovering. I've been telling my fiancee for three years that her houses will not see their value come back like the MSM kept telling her.  (This is why she listens to me now, and not the news.)  I don't think housing has to recover for the dollar to continue losing value.  The dollar has continued to be very weak throughout this incredible housing decline.

I can't argue methodology with you. I am merely stating a range that is generally accepted to be mass inflation.  I can't make a specific price inflation prediction. It would be a fatal conceit.

1. Price inflation depends upon the shopping basket of the individual, and no two individuals have the same spending patterns.

2. Monetary value is subjective. The dollar hasn't weakened by 50% against other trading partners over the last 25 years because an equation was satisfied. It loses its value because it is not demanded.  All economic value extends from the human mind. 

But let's take the 11% scenario. 11% for how long? For 1 month or 10 years?  11% as they stand right now, with no further expansion of the money supply?  Is this the last time The Bernank has to fire up the press? 

I look at the trend. It's the trend that bothers me, not the point-in-time.  I don't expect to wake up tomorrow and see that America is suffering 20% price inflation.  But the trend indicates that Americans will at some point.

David in Qatar

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#8) On May 11, 2011 at 10:29 PM, whereaminow (21.10) wrote:

Also, ETFs, for me, there are few things more interesting than talking monetary policy. What a freaking nerd I have become rofl?!

But hey, I think you find it as interesting as I do, so even though we may never agree, at least it's fun to discuss.

David in Qatar

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#9) On May 12, 2011 at 8:41 AM, ETFsRule (99.94) wrote:

TMFBullnBear & mtf00l: Thanks for the support.

David: I'm the same way. I need a nerd-outlet... and since I can't play poker or fantasy football right now, this is the best thing left. Maybe it's time for me to buy some new video games...

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#10) On May 12, 2011 at 9:38 AM, buffalonate (94.16) wrote:

In the last 7 months we have added about 1.3 million jobs.  I believe that qualifies as a real recovery.  Walmart says inflation is around 5%.  They are so large that I would believe them over any survey.

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#11) On May 12, 2011 at 12:57 PM, smartmuffin (< 20) wrote:

Not to be the self-obsessed guy or anything, but unemployment isn't a "real problem" for me as I am gainfully and steadily employed.  Furthermore, I'm not certain employment numbers are a legitimate concern of the government in any case, but that's a different matter.

 Hyperinflation; however, would be devastating for pretty much everybody.  It is also a problem that governments (or the reserve banks they create) explicitly create, and are certainly responsible for fixing.

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#12) On May 12, 2011 at 1:54 PM, Rehydrogenated (32.12) wrote:

Annualized, this represents an increase to the money supply of 11% per year. This would cause high inflation

I know there is no direct connection between money supply and inflation, but are you saying we can expect something like (just totally making this up) 8% inflation for the next 8-9 years minimum? 

I think David is right 8%+whatever else gets added over the next 8-9 is concerning...So like 12% inflation for a decade or so? It's not hyperinflation, but it is a long period of abnormally high inflation.

Either of you care to make up some more realistic numbers than the ones i just pulled out of the air?

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#13) On May 12, 2011 at 2:00 PM, Rehydrogenated (32.12) wrote:

Also, I am very interested in inflation as the government estimates it...

Do you have a prediction of what the wage inflation (ECI-Employment Cost Index) will be? 

Most of the contracts I manage are adjusted based on the ECI.

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#14) On May 12, 2011 at 3:53 PM, silverminer (31.04) wrote:

Although I've found myself too busy to stay actively involved, I've really been enjoying the ongoing dialogue, and particularly the way in which disparate perspectives have been coming together lately -- for the most part, anyway -- in a spirit of constructive exchange. This is precisely what makes The Motley Fool the greatest investment community in the world, and why I'm proud to call myself a Fool.

 

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#15) On May 12, 2011 at 4:13 PM, ETFsRule (99.94) wrote:

"Either of you care to make up some more realistic numbers than the ones i just pulled out of the air?"

I would predict the usual number: 3%. The Fed has gotten pretty good at inflation targetting over the past 25 years...  so, for the most part I think they'll be able to keep it near 3%.

The 11% number was just a worst-case scenario and doesn't account for any inflation-fighting measures that the Fed could take. I just wanted to show that the Fed's excess reserves are not enough to cause hyperinflation.

I don't know much about the ECI, but it would probably be about the same.

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#16) On May 12, 2011 at 6:24 PM, rfaramir (29.27) wrote:

Looks like Shadowstats is saying the real inflation number is already 8 to 10% (http://www.shadowstats.com/alternate_data/inflation-charts). I think the Fed has no hope of keeping it at 3%.

Lending out current excess reserves to only the housing market would yield 11% (extra) inflation for the next 8 years, all by itself? This is very worrisome. Not that the housing market will come back that nicely (for existing home owners, bad for home buyers), but that's just one small segment of the economy. Commercial real estate, commodity speculation (where do you think the manipulation comes from?), carry trade, there's lots of places for cheaply borrowed dollars to bid prices up in the economy.

 

Rehydrogenated: "I know there is no direct connection between money supply and inflation." It's not that you know so little, it's that so much of what you know is just not so! (Reagan paraphrase)

Unless by "direct" you mean something way more strict, there is definitely a connection between the money supply and inflation. An increase in the money supply is the old-style dictionary definition of inflation. Generally rising prices is the direct result of inflating the money supply, and therefore a rough proxy (a red flag, if you like) for the state of the money supply. Nowadays, we just say, "inflation," meaning rising prices, and don't even think of the inflating money supply causing it. The Federal Reserve (and the fed spenders) are very pleased at this NewSpeak.

 

ETFsRule: "Maybe it's time for me to buy some new video games..."

Or rediscovering some old ones. Civ I and III, Lords of the Realm II, Railroad Tycoon III, and Escape Velocity: Nova all keep me coming back to them every once in a while. Some of them require me to boot up my old 1997 Power Mac G3...

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#17) On May 12, 2011 at 8:01 PM, whereaminow (21.10) wrote:

ETFs,

What if we end up with 3% price inflation, but we were so productive as a nation that prices should have fallen 7%? (A 7% increase in value adding production is not that hard to imagine, particularly in the information age.)

How would any of us know that we suffered 10% price inflation? 

I'm curious as to how you would determine that you suffered 10% price inflation (and hence, a 10% loss of wealth) under that scenario.

David in Qatar

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#18) On May 13, 2011 at 12:59 PM, ETFsRule (99.94) wrote:

rfaramir:

The Shadowstats inflation numbers are just "estimates", and frankly they are ridiculous estimates. Compare them to any independant studies of price indices and you'll see that the Shadowstats numbers are always much higher.

Shadowstats should be considered a political blog, because that's really all it is. It's not a source for reliable statistics.

whereaminow:

Everyone has different views, but I think the two of us agree that increasing the money supply causes inflation. But, this takes a couple of years, and inflation only rises after the newly-created money is actually spent. So, there is inflation, but at the same time people have more money in their pockets to buy stuff with.

Let's look at the total change in purchasing power of a country:

Scenario 1:

Net gain from increasing the money supply: +10%

Net loss from inflation: -10%

Net gain from productivity gains: +7%

Total: +7%

Scenario 2:

Net gain from increasing the money supply: 0%

Net loss from inflation: 0%

Net gain from productivity gains: +7%

Total: +7%

This is why I'm so unconcerned about the issue. Technically, scenario #1 will have higher price inflation, but it doesn't matter because it doesn't reduce the purchasing power of the country, or of the average person.

And I have yet to meet one of the hypothetical "savers" who is being crushed by inflation because their money is stuffed in a mattress somewhere. If these people do exist, they could just buy TIPS, or find some other way to beat inflation. It's really a non-issue.

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#19) On May 13, 2011 at 11:19 PM, whereaminow (21.10) wrote:

 So, there is inflation, but at the same time people have more money in their pockets to buy stuff with.

This does not follow from the Cantillon Effects of monetary expansion. Now, if there are other ideas about how money steps through the economy, I'd be interested to hear it.  I think the money neutrality theory (I believe originating from the monetarists) is incorrect.  In other words, I don't think money, once created, gets distributed evenly throughout the economy nearly instantaneously. That defies reason.  I believe that money steps through an economy from the initial spenders to the last spenders.

In light of the Cantillon Effect, people have less money to buy stuff.  The prices of the things they buy rise before their wages rise.  This is why labor wage gains always trail inflation.  I wrote about this in my basics of inflation post, that Keynes understood that there was a queue to get your hands on the newly created money, and that he was skeptical of organized labor's ability to keep moving up in the queue. Of course, he felt this was offset by the need to get people working in the first place during a recession.  This is obviously something I disagree with, but not directly related to this post.

So I feel confident that Keynes (as well as my boys at Mises) would disagree with your assertion.  If we are correct, then there will not be an even gain in wealth from inflation like your numbers show.

This is one of my main arguments against inflationary policy. It can and does stimulate certain sectors of the economy, but only in those sectors where the money is spent. What if it is exactly those sectors that need to readjust?  What if those lines of production are obselete or unable to compete with smarter, more efficient firms?   With inflationary monetary policy, they reward losers and punish savers (and labor, which they then try to even out by giving labor more political power.... one intervention creates another.)

Ok, I should stop here.

David in Qatar

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#20) On May 14, 2011 at 11:17 AM, ETFsRule (99.94) wrote:

"This does not follow from the Cantillon Effects of monetary expansion. Now, if there are other ideas about how money steps through the economy, I'd be interested to hear it."

I'm not sure what the mechanism of monetary creation looked like in Cantillon's day, but it was probably different from the way that money enters the economy today in America. Newly-created "money" enters the system via a loan to a homebuyer. Liquidity enters the system via the seller of the home, who presumably will spend his money on equities, living expenses, and other normal things that people spend money on. And, as I said earlier, it takes a little bit of  time for this monetary creation to cause an increase in inflation.

"The prices of the things they buy rise before their wages rise.  This is why labor wage gains always trail inflation."

That's quite an assertion. To my eyes, the data doesn't seem to support this idea. But if you've done extensive number-crunching to prove that this actually is the case, I'd like to see it.

I believe in the non-neutrality of money. But, I disagree with the Austrian assumption that non-neutrality of money only affects the economy in negative ways.

To me, it seems that having an inflation rate around 3% is good for the economy. And, I still believe that deflation is inherently a bad thing - which is what we're seeing right now in the PIIGS countries, and still, in Japan - where real GDP growth continues to plummet.

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#21) On May 14, 2011 at 10:14 PM, whereaminow (21.10) wrote:

1st graph - Wages and inflation

I see the pattern you are looking at. From your graph, it appears that wages changes preceeded price changes in the 1970s. What does that one decade of correlation tell us in a graph covering 6 decades?  What can we determine to be absolutely certain from looking at that graph? Nothing.  It is interesting, however.

On the other hand, I have empirical data that shows the Cantillon Effect is correct. I've never seen a Treasury Department official in my neighborhood handing out crisp, freshly printed dollar bills nor have I ever heard of such a thing, have you?

Wages can rise for several reasons. First and foremost being an increase in productivity.  Second would be workers pushing for higher wages to keep up with a rise in the cost of living.   Third would be legislation, like minimum wage laws that increase the cost of production by increasing labor rates.  How does the graph explain each of these factors in relation their importance? 

If money is created solely through fractional reserve banking (a common practice), it does reach consumers more quickly. I'll grant that.  That still leaves the problem of fractional reserve banks being inherently insolvent and the primary cause of the business cycle.

2nd graph

There has never been any deflation in Japan.  It's a myth.

http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=JPNCPIALLMINMEI&s[1][transformation]=pch

Deflation is either a persistent drop in the general price level or a  severe contraction of the money supply. But it has to last more than one quarter to be called deflation.  Japan has never had that throughout the last two decades.

David in Qatar

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#22) On May 15, 2011 at 12:02 PM, ETFsRule (99.94) wrote:

David: The 70's were one example. But by zooming in on that same graph, we can see that in 2009 wages and prices both started to rise at the exact same time.

I think your point about Japan is nitpicking. Mainstream economists all agree that inflation under 1% is bad for the economy, and Japan supports that idea. If you really want to be technical about it, they did have deflation in 2008 Q4 and 2009 Q1.

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#23) On May 15, 2011 at 12:35 PM, ETFsRule (99.94) wrote:

I could also use this graph to show that Japan has had a "persistant drop in prices" over the past 13 years.

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#24) On May 16, 2011 at 12:00 AM, rfaramir (29.27) wrote:

Deflation (nowadays) hurts, but it is not a bad thing. It is like throwing up during a hangover or like cutting out gangrenous flesh to avoid death by blood poisoning. It is necessary pain due to unnecessary previous bad decisions. The blame should fall on the bad decisions, not the following red flags.

Gentle deflation during good times with a stable money are the feeling of getting richer through higher production while your income stays nominally the same. This is a definite good thing.

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#25) On May 16, 2011 at 8:11 AM, whereaminow (21.10) wrote:

ETFs,

It's getting nitty gritty now. That chart shows a drop from 103 to 100 over the course of 12 years.  That is so benign, one could actually argue that the BOJ created a stable price level.

I'm going have to let this conversation go, but I think we both have good points here.  

Unfortunately, I am swamped right now.  Stupid work and life getting the way of all my fun!

Take care dude. You are an interesting debater for sure.  We'll see you in the comments sections of OPB's (other people's blogs), where I tend to throw out less reasoned analysis haha, until I get time to write seriously again.

David in Qatar

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#26) On May 16, 2011 at 11:51 AM, ETFsRule (99.94) wrote:

Take it easy David.

This discussion actually gave me some ideas for a model to value the stock market using economic data, rather than just corporate financial data. This should keep me busy for a while...

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#27) On May 16, 2011 at 12:19 PM, TMFAleph1 (94.91) wrote:

@ETFsRule

I'd be curious to know more about your model, once you have put in some work on it...

Alex Dumortier

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#28) On May 16, 2011 at 9:26 PM, ETFsRule (99.94) wrote:

Alex: you got it man

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