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The Deflationary Shock

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February 22, 2011 – Comments (23)

The Pragmatic Capitalist has a very good comment on David Rosenberg's market letter this morning. I agree with practically everything in this post.

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http://pragcap.com/the-deflationary-shock
THE DEFLATIONARY SHOCK….
22 February 2011 by Cullen Roche


David Rosenberg makes some interesting comments in his morning note regarding the price action in US Treasuries.  He cites the rally as a sign that the world is concerned about the deflationary shocks from rising oil prices:

    “It is also interesting to see how government bond markets are reacting to the oil price surge — by rallying, not selling off. In other words, bond market investors are treating this latest series of events overseas as a deflationary shock.”

I think Rosey has this one spot on.  The risk of rising oil is not a hyperinflationary spiral, but rather a deflationary spiral.  Oil price increases are cost push inflation of the worst kind and for a country still mired in a balance sheet recession that means spending gets diverted which only gives the appearance of inflation in (highly visible) gas prices while creating deflationary trends in most (less visible) other assets (have a look at today’s Case Shiller housing report for instance).

The environment is not really so different from what we were experiencing in 2008.  What we have in the USA is an underlying balance sheet recession being papered over by government deficit spending and very easy monetary policy.  The math behind our economic plight is quite simple.  Since we are running a -3% current account deficit the government must spend to the tune of 3% of GDP if the private sector desires to save.  And that’s exactly what is occurring.  In fact, the 10% deficit is allowing the private sector to save quite a bit (roughly 7%). Make no mistake, the deficit spending of the last 2 years is what has generated recovery.  This is far from organic growth, but as we learned in Japan and during the Great Depression, the alternative is to risk something worse.  Unfortunately, our implementation of the recovery plan has been mangled at several steps along the way so it is primarily Wall Street that has benefited while Main Street continues to suffer.   I attribute this lopsided recovery in large part to the actions of the Fed.

The Fed’s dual mandate has them tinkering in the markets far more than they should and the repercussions are disastrous psychological impacts.  They manipulate rates, bailout the banks, and generally implement policy that is based around creating a healthy banking system.  After all, that’s really all their tool set can do anyhow.  Not surprisingly, their policies over the last 20 years have helped in significantly financializing the US economy.  The results of that world speak for themselves.

Today, in a misguided attempt to create a “wealth effect” via equities it appears as though Ben Bernanke has helped to generate a speculative boom in many commodities.  This is not the direct cause of the unrest abroad, but it’s certainly not helping.  But perhaps more importantly, the environment that Ben Bernanke is creating (commodity bubbles) actually increases the risk that we will relapse into a deflationary spiral (the very thing he is attempting to combat).  After all, if the global economy slows once again it is highly likely that we will see price action that was very similar to 2008 – a flight to safety in US Treasuries, USD, commodities get crushed and equities sell-off.  Today’s action is a small example of that sort of fear trade.  And make no mistake – this is not hyperinflationary price action.  This is deflationary price action.

For now it still appears as though the US economy is strong enough to generate low single digit inflation, however, if the commodity bubble were to worsen or oil prices were to cause a global recession (this looks increasingly likely as we head into summer) we are likely to find ourselves revisiting our deflationary discussions as opposed to fears over hyperinflation.   This is not the 70′s and it is most certainly not Zimbabwe or the Weimar Republic.  This is still an environment more akin to Japan and the 30′s.

23 Comments – Post Your Own

#1) On February 22, 2011 at 3:32 PM, ChrisGraley (29.65) wrote:

coming to a theater near you....

QE16

Bernanke's revenge.

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#2) On February 22, 2011 at 3:57 PM, binve (< 20) wrote:

ChrisGraley ,

>>coming to a theater near you....QE16 Bernanke's revenge.

You have to pay for the whole seat, but you'll only need the edge!!

:).

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#3) On February 22, 2011 at 8:45 PM, mhy729 (29.90) wrote:

lol...somebody should make a spoof trailer.  xtranormal wouldn't quite cut it b/c you need that guy that always does the movie trailers (sadly Don LaFontaine passed away in 2008).

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#4) On February 22, 2011 at 8:58 PM, APJ4RealHoldings (36.26) wrote:

exactly

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#5) On February 23, 2011 at 7:49 AM, ath002 (< 20) wrote:

Hi Binve,

 Thanks for the post. I want to ask you please, if you do believe that this deflationary period might come to pass, how would that affect silver and gold?

PM's are viewed as defensive in inflationary periods, but what would they do in deflationary time as described above?

Thanks again for your thoughts,

L

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#6) On February 23, 2011 at 8:56 AM, binve (< 20) wrote:

mhy729 ,

that would be great :)

APJ4RealHoldings,

thanks

ath002,

No problem.

The problem is in the way the question is phrased. Many people assume that either inflation or deflation affects precious metals, and that's not it at all.

Consider in the 1980s, we had massive inflation. But Gold had already begun a major decline. Why? Because Volcker's policies had brought stability to the markets. Monetary policy was in a bad place, but he was starting to get things under control again (at least in comparison to the previous 10 years). Gold can fall in inflationary environments. It can also rise in inflationary environments. It can both rise and fall in deflationary environments as well.

I have rejected the 'Gold is an inflation hedge' argument for some time and that is reflected in my writings.

The reason why Gold will continue to do well is because of uncertainty. We see states calling for austerity because they are insolvent, we see policy makers in Washington clueless with how to deal with the situation, we see that when Washington does take action it is usually to affect Wall Streets best interests, etc.

I have demonstrated that QE is not inflationary. There are many things that people call inflationary that aren't. And many people are also discounting the deflatioary tendencies of consumers being in a balance sheet recession. There are a lot of deflationary headwinds. But, QE and other monetary polices of that nature causes instability. Not through money expansion, but by changing asset compositions and placing a psychological backstop: 'the Bernanke Put'. This is causing much more risk taking. This is highly unstable.

And so if Gold is a hedge against anything, it is against instability and against government decisions that are not in the interest of a smoothly functioning marketplace (policies that promote instability), regardless if the overall effect is inflationary or deflationary.

I am unconvinced that things have 'returned to normal', in either absolute or even relative terms. So I tend to think Gold will be in a bull market for some time. This doesn't mean the stock market will or has to crash either. I have shown through my long term Gold / SPX correlation charts that Gold and Equities are mostly negatively correlated, there are signficant periods of positive correlation.This is also why looking at Gold ratio charts is so informative. 

My thoughts at any rate :).

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#7) On February 23, 2011 at 10:33 AM, whereaminow (< 20) wrote:

Binve,

Can you explain to me what deflationary shock is? I've tried to find out but it just sounds like they changed the word crash into deflationary shock so they don't sound like bears.

David in Qatar

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#8) On February 23, 2011 at 10:44 AM, binve (< 20) wrote:

whereaminow ,

David, I hear what you are saying :)

But I think what Rosenberg is trying to get at with that term is: 'how do you interpret the response from an oil spike? Is it an inflationary shock or a deflationary shock?'.

The answer is, as always, complicated and timeframe dependent. But my take is that it is short term inflationary for energy-dependent prices (such as gasoline). But because consumers remain in a balance sheet recession, they will not absorb these price hikes and demand will fall. So in the current envrionment 'the cure for high commodity prices is high commodity prices', meaning that high food and energy prices will reinforce the longer and bigger term deflationary tendencies.

The demand side of most economic equations remains extremely weak right now.

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#9) On February 23, 2011 at 10:55 AM, whereaminow (< 20) wrote:

'the cure for high commodity prices is high commodity prices'

That appears to be another (weaker) way of saying "high prices are a signal to consumers to ration their consumption."

Anyway, I think I understand it now, but let me hear your response to this:

Since our underlying price trend is deflationary outside of food and energy (the important things), any bubbles that form in those sectors are even more dangerous since their inevitable bust will force down prices even more.

Is that what they're trying to say?

David in Qatar

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#10) On February 23, 2011 at 11:18 AM, binve (< 20) wrote:

whereaminow,

>>'the cure for high commodity prices is high commodity prices'.

That's actually Jim Roger's famous line, and I thought it was apporpriate to the dialogue

>>Since our underlying price trend is deflationary outside of food and energy (the important things), any bubbles that form in those sectors are even more dangerous since their inevitable bust will force down prices even more. Is that what they're trying to say?

I believe so. At any rate, from my point of view I think that is a very accurate statement.

The government is running a deficit to try and spur 'aggregate demand'. It needs to run a deficit up to a point anyways because we have a trade deficit, and because the private sector wishes to save (and they should!!). But the government spends extremely 'sloppily' and the funds to not distribute through the economy efficiently. When speculator get their hands on the funds (though investment banks usually)  they bid up all sorts of things, including food / energy / speculative equities. So this part of the equation is where inflation comes in. Inflation doesn't come from QE or any of the Fed's OMO. All of those operations change asset compositions in the banking sector, but don't add net assets.

But then there is the other side of the equation, the demand side. And it is weak. The private sector remains in a balance sheet recession. I think private sector deleveraging is far from over. We started in 2000 at around $4 trillion in private sector debt, it peaked in 2007 around $13 trillion, and the last I saw it was still around $10 trillion. In this case, I think there will still be weak overall demand for many years.

So by the time the government spending gets to the consumer (after it has passed through the banks / hedge funds / speculators / businesses , etc.), they have several tough choices: first, do I have a job? for many, unfortunately the answer is no. next do my liabilities exceed my assets? unfortunatly for many the answer is yes? do I pay my mortgage? can I service all my debt? etc. In this case, food and energy, which are absolutely necessary, become managed. People will do with less or shift spending. We saw this happen in 2008, and if we get another commodites spike we will see it again. Because the consumer is hurting.

So even after all of that, consumers either default, or pay down debt, or save while spending less. These are all deflationary actions. And like we have talked about before, a little deflation is a good thing! There is nothing wrong, and in fact necessary for the long term, for citizens to save. To rebuild balance sheets. To regain some amount of pricing power

There will be many price increase that producers can't pass off to consumers in this environment, and that will be deflationary.

So the conclusion I come to when I consider the macro right now is that either hyperinflation or even massive inflation is not the most likely outcome for the next several years. I think it will be either midly inflationary or deflationary. The problem is, it will be very uneven. Core inflation will be mild, but food and energy will periodically spike and crash. I think this is a recipe for massive instability.

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#11) On February 23, 2011 at 12:40 PM, whereaminow (< 20) wrote:

binve,

Thanks for the response. We diverge a little bit, which is ok. Let me explain why I differ and agree:

The government is running a deficit to try and spur 'aggregate demand'. It needs to run a deficit up to a point anyways because we have a trade deficit, and because the private sector wishes to save (and they should!!). But the government spends extremely 'sloppily' and the funds to not distribute through the economy efficiently. When speculator get their hands on the funds (though investment banks usually)  they bid up all sorts of things, including food / energy / speculative equities. So this part of the equation is where inflation comes in. Inflation doesn't come from QE or any of the Fed's OMO. All of those operations change asset compositions in the banking sector, but don't add net assets.

It is fractional reserve banking that is inflationary. The Fed's role is to make fractional reserve banking easier, and thus, to set the conditions for inflation. QE sets up those conditions, so while it may not be inflationary when viewed independently (which is the MMT modus operandi), in the context of the role of the Federal Reserve in an economy dependent upon fractional reserve banking, QE sets up the conditions for greater inflation.

Government deficits are also inflationary. This detriment cancels out the gain in nominal savings caused by the deficit. So it's meaningless to say that government deficits equal private savings (I don't remember the exact term) or that if we increase deficits we increase private savings (and vice versa.)  So it's also of no practical use to say that the government should be running a deficit.

But then there is the other side of the equation, the demand side. And it is weak. The private sector remains in a balance sheet recession. I think private sector deleveraging is far from over. We started in 2000 at around $4 trillion in private sector debt, it peaked in 2007 around $13 trillion, and the last I saw it was still around $10 trillion. In this case, I think there will still be weak overall demand for many years.

Agreed. It's classic malinvestment caused by easy money.

So by the time the government spending gets to the consumer (after it has passed through the banks / hedge funds / speculators / businesses , etc.), they have several tough choices: first, do I have a job? for many, unfortunately the answer is no. next do my liabilities exceed my assets? unfortunatly for many the answer is yes? do I pay my mortgage? can I service all my debt? etc. In this case, food and energy, which are absolutely necessary, become managed. People will do with less or shift spending. We saw this happen in 2008, and if we get another commodites spike we will see it again. Because the consumer is hurting.

Agreed.

So even after all of that, consumers either default, or pay down debt, or save while spending less. These are all deflationary actions. And like we have talked about before, a little deflation is a good thing! There is nothing wrong, and in fact necessary for the long term, for citizens to save. To rebuild balance sheets. To regain some amount of pricing power

Agree completely.

There will be many price increase that producers can't pass off to consumers in this environment, and that will be deflationary.

Or they'll go out of business. We could have a collapse of businesses in the intermediate goods and final goods sectors who can't pass these costs off.  That would reduce supply and cause prices to rise again.

So the conclusion I come to when I consider the macro right now is that either hyperinflation or even massive inflation is not the most likely outcome for the next several years. I think it will be either midly inflationary or deflationary. The problem is, it will be very uneven. Core inflation will be mild, but food and energy will periodically spike and crash. I think this is a recipe for massive instability.

I don't know. There is no such thing as a true price level. When I think about inflation, I try to imagine what would have happened had the Fed not stepped in to "save" us in the first place. Prices would probably be much lower than they are now. That's (monetary) inflation though not acknowledged by econometric (price) inflation.

On the subject of massive instability, that would be bad for the stock markets, which begs the question where to put the money? If we have massive instability, PM's still win. (I think.)

We are turning back the clock to the French pre-Revolution House of Bourbon (my next post). Inflationary finance, economic instability, massive regulations, militarism abroad and welfare at home. The result was "apres moi, le deluge." It took 200 years for the whole scheme to crumble. I think it'll happen faster this time.

David in Qatar

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#12) On February 23, 2011 at 12:54 PM, Valyooo (99.39) wrote:

Were things EVER normal in the market/world?

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#13) On February 23, 2011 at 1:58 PM, binve (< 20) wrote:

whereaminow ,

Thanks David

>>We diverge a little bit, which is ok.

Agreed! We won't necessarily agree on everything, but I appreciate the honest discussion!

>>It is fractional reserve banking that is inflationary. The Fed's role is to make fractional reserve banking easier, and thus, to set the conditions for inflation. QE sets up those conditions, so while it may not be inflationary when viewed independently (which is the MMT modus operandi), in the context of the role of the Federal Reserve in an economy dependent upon fractional reserve banking, QE sets up the conditions for greater inflation.

I don't agree with this, not completely. I used to. But I think this is partially incorrect because it is very supply side focused. I spent a lot of time coming to grips with the fact that I was misunderstaing. But my last big post on this was an honest effort from the ground up based on ideas from a number of different sources. And when I follow the logic, this is what it leads me to. Please read this post I wrote, I will excerpt from it (http://marketthoughtsandanalysis.blogspot.com/2011/02/one-of-smartest-comments-i-have-read.html)

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whether the bank holds reserves and Treasuries (which are the most liquid asset on the planet next to cash) or it holds just reserves, a swap between Treasuries and reserves is just an asset swap. Moving back and forth from one to the other is not inflationary and does not change net financial assets in the banking system. Therefore, absent any vertical money creation, at any point the amount of Treasuries held by banks + Bank Reserves is a fixed number. This means the banking system by itself cannot increase or decrease the amount of net reserves in the system. It can swap reserves for Treasuries, or vice versa. It can lend reserves amongst each other. But it cannot affect the net amount of bank reserves in existence.

All transactions within the banking system net to zero (for every asset on somebody's balance sheet, there is a corresponding liability on someone else's balance sheet. When a loan is created, a corresponding deposit is also created). This is why all transactions within the banking system are called 'horizontal'. This includes actions taken by the central bank. The Fed cannot arbitrarily print money and give to a bank [maybe it will be given that power in the future, but it does not have that power today. However you may rightly point out that the Fed bought essentially worthless MBS's at phoney market rates from banks. This is tantamount printing the money, buying worthless paper in exchange for new reserves, so that the bank now has reserves that it could buy Treasuries with and the Fed is stuck with worthless paper. So while the technicality of the asset swap was maintained, the Fed knowingly overpaid. I would argue that instances like these are inflationary if the Fed never tries to unload that paper.]. Whenever the Federal Reserve 'prints money', it is always buying something that exists already. So just like interbank transactions net zero, so do most central bank transactions [again, there are some exceptions to this rule, but OMO is the policy tool of choice and nearly all activity engaged by the CB is OMO. And the point being that OMO is an asset swap].

The way that net reserves in the banking system change is through Congressional spending.

The Treasury is the only party that can create money 'vertically' within our banking system. Treasury spending is the only transaction in which there is no corresponding liability. I am not talking about Treasury bond issuance here. Like I said above, Treasury bonds 'fund' nothing. When the Congress wishes to spend, they authorize the projects and direct the Treasury to spend. When the Treasury spends, it simply spends. It doesn't wait for 'bond revenues', it doesn't wait for 'tax revenues'. Both of this concepts had applicability under a Gold Standard. They have absolutely no applicability in a fiat currency system.

When the Treasury spends, money is created out of nothing. There is no asset swap. The Treasury either credits private bank accounts directly or issues checks that transact through the banking system. The result is a net increase in reserves. When the Treasury taxes, the result is a net decrease in reserves. In no way do taxes 'fund' anything in a fiat currency system.

... [ However government spending *MUST* be in some proportion to private sector productive capacity otherwise inflation will ensue. There is no 'free lunch' here. But the point of this section is to discuss the specifics of monetary operations, which is highly relevant to this post ]
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The question comes down to, what is cause and what is effect?

Is expansion of the monetary base and an increase in reserves a cause that force parts of the private sector to take on more debt?  

Fractional reserve banking is a facilitator. The Fed can create the conditions under which debt expansion can take place, but they can't force people to borrow. Will low interest rates affect borrowing decisions? Yes, of course! But there comes a point where consumers don't want to borrow anymore, and changes to already low interest rates won't increase the propensity to take on more debt. Affecting the supply side of the equation (which is all the Fed can do) only effects monetary policy (the Feds desire for 'controlled inflation') when times are close to normal. And I don't think they are right now.

This is why I don't think the Feds actions right now are likely to lead to a massive new wave of borrowing.

>>Government deficits are also inflationary. This detriment cancels out the gain in nominal savings caused by the deficit. So it's meaningless to say that government deficits equal private savings (I don't remember the exact term) or that if we increase deficits we increase private savings (and vice versa.)  So it's also of no practical use to say that the government should be running a deficit.

I don't really agree with this one either. Again, I used to. But after much reading and thinking, I think that much of the discussion on government deficits and surpluses is wrong.

For a soceity whose governement is the soverign issuer of its currency, the only way for the private sector to net save is for the government to spend more than it taxes. I know this is highly controversial, but I also think it's true. The US Government spends money into existence. It goes through the banking system and winds up into businesses and consumers. Economic activity is generated by the transfer of money. Some of it is saved. But money must leave the private sector and be returned to the government through taxes. So when you think about how money is created (federal government spending) and how it is destroyed (federal government taxation), the only way for the private sector to net save is for the government to spend more than it taxes.

It all comes down to sectoral balances.

In our soceity we run a trade deficit. That means money 'leaves our borders' to other countries. That means that if the private sector desires to net save, the government must spend enough to cover the trade gap + whatever it taxes in order for money to 'accumulate' in the private sector.

Contrast that to Germany, which has a trade surplus. In this case, the government *can* run a surplus and the private sector can net save as long as the difference between government spending and taxation is smaller than the trade surplus.

I am not saying this is good, I am not saying this is bad. I am saying that in a fiat currency world these are the accounting identies that describe the reality of the economy.

My personal opinion is that government deficits should be smaller than they are now. Because the size of the deficit is trying to bridge the output gap that we had vs. 2007 levels where a vast majority of the economic activity was unproductive.

So in having a meaningful discussion on this, we must be cognizant of how money acutally moves through the system, and more importantly what economic activity is productive and sustainable. The problem is that congressional thinking over the last 20 years is that a healthy economy can be driven by monetary policy, and I think that is demonstrably false.

>>I don't know. There is no such thing as a true price level. When I think about inflation, I try to imagine what would have happened had the Fed not stepped in to "save" us in the first place. Prices would probably be much lower than they are now. That's (monetary) inflation though not acknowledged by econometric (price) inflation..

That's not really where I was going with that, but I can see how you interpreted it that way based on what I wrote.

I agree that the Fed's interference in the markets are distorting all kinds of pricing signals (such as their MBS purchases). While QE is not inflationary, it manipulates asset comoposition in the market, which creates instablities.

>>On the subject of massive instability, that would be bad for the stock markets, which begs the question where to put the money? If we have massive instability, PM's still win. (I think.)

I agree. See my response above to ath002.

Great conversation. Thanks man!..

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#14) On February 23, 2011 at 2:25 PM, whereaminow (< 20) wrote:

binve,

I just want to focus on this statement, because it's the simplest right now.

For a soceity whose governement is the soverign issuer of its currency, the only way for the private sector to net save is for the government to spend more than it taxes. I know this is highly controversial, but I also think it's true.

My friend, that's not savings. Net financial assets are just that and nothing more.  Savings is the foregoing of consumption in order to produce or consume more in the future. It's an action.  And this action exists independent of government/central bank accounting.

If the government drastically reduced the deficit, people would still be saving. The nominal representation of their act of savings would shrink, but their increase or decrease in real wealth would be dependent upon how successful they were in foregoing cosumption and producing things of value. It has nothing to do with how much paper money is in the system.

David in Qatar

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#15) On February 23, 2011 at 3:23 PM, binve (< 20) wrote:

whereaminow,

I really don't have a disagreement with that. I think this is an excellent statement.

In fact, that is part of the issue. Productive econonmic activity does not necessarily equal consumption (sometimes it does and sometimes it doesn't). And so discussion of deficits and savings cannot be divorced from productive economic activity, which tends to foster savings.

Sometimes I spell that out, but sometimes I lump all of it together (I get sloppy, I admit).

However, I would like to make a slight clarification with this:

>>The nominal representation of their act of savings would shrink, but their increase or decrease in real wealth would be dependent upon how successful they were in foregoing cosumption and producing things of value.

I agree with this in how you stated it. However, I have seen a lot of commentary and calls for action that ignore the nuance in the statement and use it as a justification for austerity. Austerity which does not sacrifice consumption for the purpose of growing producitve enterprises, and basically just sacrficies blindly, will likely do more harm than good.

However, the implied opposition based on an equally blunt interpreation would be that since blind austerity is bad, blind consumption is good. Which is as equally erroneous. We as a soceity have to come more into balance (i.e. our consumption and our production must come closer together than where we are now).

So in the current environment, net savings in net financial assets (paper money) is probably necessary because consumers are still in a balance sheet recession. And all current debt is denominated in paper assets. Until this condition is cleared, I find it difficult to believe that there will be major long term sustainable economic growth. Once consumers deleverage (either by paying down debt or defaulting) can paper savings morph into real savings. By that I mean that once consumer don't have to worry about debt servicing (once it ceases to be the largest part of their balance sheet), they can invest in new businesses, existing businesses, their own education, etc. This is the type of real savings that will be the genesis for the next economic boom. I have no doubt it will happen, but that is what has to happen.

In the meantime, I hope bad decisions will not force us into blind austerity. But at the same time, I hope that fiscal policy (not monetary policy) will be put into place that can allow organic and sustainable ecnomic activity to take hold. We must not allow current government spending to make it seem like all the issues are fixed.

I hope that clarifies my position when reading my previous comments. Thanks!.

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#16) On February 23, 2011 at 4:10 PM, whereaminow (< 20) wrote:

binve,

Thanks for the folllowup. I think the semantic approaches of the various economic models we have studied (MMT, Austrian, Keynesian, Chicago to a lesser extent) and the differences in methodolgies makes it difficult to communicate our ideas to each other.

But hey, at least we're studying right? I'd prefer having to take the time to make a clarification or read your clarification than to be completely lost.

So in the current environment, net savings in net financial assets (paper money) is probably necessary because consumers are still in a balance sheet recession. And all current debt is denominated in paper assets.

Ok, I now understand why you feel this way, but I still don't understand how this makes the situation better.  I realize that you're not saying "just stimulate, stimulate, stimulate!"  But every idea I have come across to improve the asset side of the consumer balance sheet is the same ideas that got us into this mess. 

David in Qatar

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#17) On February 23, 2011 at 4:48 PM, binve (< 20) wrote:

whereaminow,

Indeed!

Ok, I now understand why you feel this way, but I still don't understand how this makes the situation better.  I realize that you're not saying "just stimulate, stimulate, stimulate!"  But every idea I have come across to improve the asset side of the consumer balance sheet is the same ideas that got us into this mess.

I am not saying it makes the situation 'better', I am saying it makes the situation less bad than the alternative. Here is why I say so:

If the government decides to stop spending (or spends less than it taxes), then the private sector by definition cannot net save FRNs. Consumers have little net savings (which is why they want to save right now).  But since you need FRNs to service your debt and to pay your taxes an ugly reality shows up: The only way to clear this reality is likely though defaults, probably a massive wave of uncontrolled defaults will be the upshot of a policy like that. It will be ugly, messy, can massive dislocations, hurt families that are already hurting. It would be chaos. And I think that would be a horrible path for our government too follow.

I agree, too much spending (that encourage consumption) got us into this mess, and more spending (that preserves the status quo) will not get us out. But I think there has to be a more orderly way to change private sector balance sheets than simply running a government surplus. We need to rectify our consumption / production imbalance, and we need policies that address that.

So given all of that, I am in favor of running a deficit to all the private sector to net save FRNs as long as policies are being put in place to generate sustainable economic growth. Right now, we don't even really need to increase spending. Tax code simplications and reductions would go a long way. Since taxes fund nothing (they are just a resource drain for fiat currency), shift taxes away from productive areas of the economy (small business, technology, manufacturing, etc.) and put them on unproductive areas (financials and consumer discretionary). In fact you could even leave net spending and net taxes the same if you used fiscal policy to target the tax side of the equation.

That is another problem. Ever since we adopted a fiat currency system, we have not come to the realization that taxes and federal governement bonds fund nothing. I know it is difficult for the mainstream to grasp. I labored under a false assumption for a long time. But once you realize that, you come to the determination that taxes (at the federal level, states are diffierent) are 'flexible'. And the way the federal taxe code is strucutured it encourages all kinds of non-productive activity and is an uncessary headwind to productive activity.

I would love to see discussion like this take place.

So in short, the status quo stinks. We have an opportunity as a nation to really understand our monetary system and to change our policies to reflect how the system actually operates (or to build a new system, if we choose). And so we can try to transition gracefully (allow the private sector to net save and pay down debt while we change spending/taxation to promote sustainable economic activity) or we can transition cold turkey (slash govenment spending which will cause the private sector to go into deficit and preciptate and wave of debt default). In etiher case, the future has to be different than it is today, becuase the current spending and economic policies are not solving any problems, and that's the part that is unsustainable..

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#18) On February 23, 2011 at 6:49 PM, ath002 (< 20) wrote:

Thanks for your thoughts Binve.

Also enjoyed your debate with David.

Goodnight,

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#19) On February 23, 2011 at 9:22 PM, mhy729 (29.90) wrote:

This was a great read.  Thanks for writing binve and David.

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#20) On February 24, 2011 at 1:51 AM, binve (< 20) wrote:

ath002 ,

Absolutely, glad you you enjoyed it.

mhy729 ,

Thanks man, no problem!..

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#21) On February 24, 2011 at 9:14 AM, russiangambit (29.33) wrote:

>  That is another problem. Ever since we adopted a fiat currency system, we have not come to the realization that taxes and federal governement bonds fund nothing. I know it is difficult for the mainstream to grasp. I labored under a false assumption for a long time. But once you realize that, you come to the determination that taxes (at the federal level, states are diffierent) are 'flexible'. And the way the federal taxe code is strucutured it encourages all kinds of non-productive activity and is an uncessary headwind to productive activity.

Yep, trying to explain this to anyone outside of the financial world is not only impossible you also aquire a "conspiracy theorist" status almost immidiately.

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#22) On February 24, 2011 at 9:39 AM, binve (< 20) wrote:

russiangambit ,

>>Yep, trying to explain this to anyone outside of the financial world is not only impossible you also aquire a "conspiracy theorist" status almost immidiately..

I hear you man :).

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#23) On February 26, 2011 at 6:57 AM, vincecate (< 20) wrote:

"I think the semantic approaches of the various economic models we have studied (MMT, Austrian, Keynesian, Chicago to a lesser extent) and the differences in methodolgies makes it difficult to communicate our ideas to each other."

 In an effort to help different groups understand each other I offer an explanation of MMT that Austrians will "get" and an explanation of hyperinflation in MMT terms:

http://pair.offshore.ai/38yearcycle/#chartalism

http://pair.offshore.ai/38yearcycle/#mmthyperinflation

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