Tuesday, March 24, 2009

Mainstream economists shocked! - The flywheel of monetary inflation begins to spin up price inflation

The English language is a beautiful free flowing thing and the meanings of words within it are constantly changing. For instance, here is the old generally accepted meaning of the word 'inflation':


A general increase in the money supply - sometimes known as monetary inflation.
But here is the new generally accepted meaning:


A general increase in the price level - sometimes known as price inflation.
Obviously, as an Austrian, along with all the other Austrians, including most notably Peter Schiff, I believe that INFLATION should still be defined in the old way (monetary inflation) rather than in the new way (price inflation), which the government-loving Keynesians and Monetarists inflicted upon us.

However, accepting that word usage does change over time, which one of the two definitions is driving the other one? Well, the first one of course.

Yes, there are other forces acting on price inflation, as well as monetary inflation. However, in the end the flywheel of monetary inflation will always trump these other forces, which are usually self-eliminating, except perhaps the improvement of technology and entrepreneurial methods over time found within capitalist economies.

You might want to think of it this way. Monetary inflation is the male partner leading a dance, while price inflation is his female partner spinning around him. She may speed up, she may slow down, seemingly independent of her man, but overall she will tend to be where he leads her.

So what are these other forces affecting price inflation? Well, Jim Rogers would describe them as deleveraging. As we enter an economic shock wave, many investors and businesses are hit and either need to sell everything they have to cover short positions and margin calls, or sell inventory to clear debt. This creates a downward pressure on prices, hence prices fall, which can temporarily even offset the opposite force of massive monetary inflation. We can even move briefly into a period of price deflation, as the man goes one way, and his lady shoots back past him.

But it would appear, though nothing is ever certain in this predictive business, that the forces of deleveraging have reached their maximum. The Bank of England can no longer cut interest rates, therefore the monthly mortgage payments of most people on tracker mortgages can go no lower. The once powerful forces of deleveraging will also be fading away, in their own self-limiting processes.

The shorts must eventually get covered, the margin calls must eventually be filled, and the businesses must either close down or survive at a new lower price level. How long before we reach that fully deleveraged point?

Once we do hit it, this will leave monetary inflation as the only significant force driving price inflation. The male lead will then get his formerly free-floating partner firmly by the waist, and then start moving her across the dance floor in the direction of his choosing.

But how soon is soon? It's hard to say. The deleveraging and price slashing process may continue for a little longer to keep fighting the forces of monetary inflation, but deleveraging is self-limiting. Eventually, everyone is deleveraged.

However monetary inflation has nothing to hold it back except the whim of politicians. Having successfully escaped from the bondage of gold, in 1971, all the world's governments can print as much money as they want. It used to be that the only way to increase the money supply was to mine more gold. This was hazardous, difficult, time-consuming, and expensive. Therefore the money supply only grew slowly, whereas the increases in technology brought about by entrepreneurial capitalism offset this so much that prices gradually dropped over time, even though the money supply was constantly increasing.

Now all politicians have to do is take a column of zeroes in a specially guarded computer within the heart of the Bank of England, 0000000000000, and change the first of those zeroes to a one, to give us: 1000000000000. Thus, we have just created £1 trillion pounds out of thin air. Actually, what they done in the last four months is create the following amounts of money from thin air, each month:


This gives us a total of:



£126.3 billion pounds

Or an average of:

£31.6 billion pounds a month

It's amazing what computers can do for you. As the Bank of England has announced that it will create approximately £75 billion new pounds, out of thin air, over three months, in the additional process of quantitative easing, let's add £25 billion to that calculated figure, to arrive at how much they are going to be increasing the money supply, per month, over the next few months:

£56.6 billion pounds month (or approximately £942 pounds per person, per month)

As unemployment has 'officially' gone over 2 million, in this country, for the first time since 1997, Gordon Brown will be becoming increasingly desperate to reflate his bubble, to fool enough of the people over the next year or so that the problems are over. I think that figure of £942 pounds will actually be a conservative one. I reckon by the time he is through, it will be more like £3,000 pounds per person, per month. As we have gone exactly nowhere in 12 years of Zanu Labour, in terms of unemployment, and have also been sleepwalked into a depression, he will start taking enormous gambles, in the steps of his mentor Robert Mugabe, and pray that the Keynesian economists advising him know what they're talking about.

Even if he 'restricts' himself to just a grand a month, per person, he is playing a very dangerous game. If he times it exactly right, it could even 'work', at least from the viewpoint of maintaining personal power. He could balance the forces of deleveraging and monetary inflation just enough to fool this country into believing that the worst is over. He will then hold a snap election to take advantage of that happy feeling, before the underlying monetary inflation really begins to destroy this mirage, and all of that new credit feeds through the price system to push up real prices rather than imagined feelings of wealth.

This is what the useless blue socialists in the Tory Party must be terrified of; that Gordon gets his timing exactly right, and that he gets enough of what he wants in the forthcoming G20 conference to pull this timing rabbit out of the hat. Hence, their stupid pronouncements recently on increasing taxes and spending in the teeth of a depression.

But have no fear. The great 'Price Inflation' is coming. With M4 at 18.8% before they even began quantitative easing, what Brown is deliberately stoking up is the mother of all price inflations.

It is now only a matter of timing as to when this monster will finally rear its destructive head. Gordon is hoping that it will be just after he wins the next snap election.

But then, the economists who are advising on this skulduggery have been surprised how quickly price inflation is catching up with monetary inflation, so expect him to be wrong once again, on a matter of national importance.

When the IMF start selling their gold, temporarily pushing the gold price down a few dollars, then buy it. If the Austrians are right, then you do not want to be left holding paper currency when the great 'Price Inflation' finally hits these shores.

You want to be left holding something which has value in and of itself, whether this is gold, silver, or any other hard asset.

Or do you trust your government to do its best for you, rather than its constituent members doing their best for themselves?


not an economist said...

Thanks for that. A really clear explanation of the reasons why price inflation may soon suddenly kick in. Suddenly made this aspect of the Austrian argument a lot clearer to me. Apart from when you delved into Jim Roger speak and started referencing "Shorts" and "Margins" that is: that still confuses the hell out of me but thats cos I am thick I guess.

Jack Maturin said...

It's easy to get confused. I'll try a bit of Japanese poetry and try to explain shorts in thirty syllables (or maybe a few more).

If I think Vodafone shares are going to go from $70 to $40, I can sell these shares, even though I don't have them. I'm bearish on Vodafone.

Let's say I want to sell a hundred of them. Naked shorts are too tricky, so we'll do a 'proper' short. I borrow 100 shares from a broker (how he gets them is just too complicated - often from his other clients), and sell these shares for $70*100, even though I don't own them. I receive $7000. I pay the broker a fee, let's say $10.

That leaves me with $6990.

My guess direction was right. The shares collapse in value, down to $50. They haven't gone all the way down to $40 yet, in the crash I expected, but I've made enough cash to be happy. I'm also very nervous of a rally.

The broker may also want his shares back (because they really belong to somebody else who wants to sell them at $50, before they collapse any further).

So I go onto the market with my $6990 and buy back 100 Vodafone shares. Every ten that I buy back pushes up the price by $1, because I am increasing demand for Vodafone shares.

Therefore, I pay the following amounts to get back the 100 shares I need to give to the broker:

10 * $50
10 * $51
10 * $52
10 * $53
10 * $54
10 * $55
10 * $56
10 * $57
10 * $58
10 * $59

That's a grand total of $5450. I take that from my banked amount of $6990, to leave a big fat profit of $1540 dollars.

I have 'covered' my shorts, got myself out of the market, and made a nice healthy sum.

Let's say the bears dominate the market, and they all try to get out together, to cash in. This will be a countervailing trend against the general trend of a collapse in Vodafone shares.

The bears/shorts will all try to get out, and in doing so, push up Vodafone share prices.

Once they are all out (once the deleveraging is over) the Vodafone shares do what the fundamentals really want them to do, and collapse down way past $40, my original bet, but all the way down to $10, despite having had this mysterious rally at $50.

As the short, you might think I am unhappy about this. Did I get out too early? No. You got out. You made a profit. End of story. Nobody ever knows where the bottoms and the tops are, unless you're into Elliot Waves, but again, that's FAR too complicated! ;-)

So in the recent crash, a lot of bears will have been covering their shorts and getting out, thereby providing all of these false rallies.

Once they're all out (as they may be, now, except for the really wild hedge funds), then the real fundamentals kick in.

In this case, the Great Crash goes on.

Margin calls are often mixed in with this, but I'll keep the case simple.

Another example. Vodafone is at $70 and you think it's going to $90. You buy 100 Vodafone shares, but you don't part with the full $7000 to buy them, you only pay a margin to your broker of 10%. So you pay $700 dollars (this is usually done with derivatives, but I'll make it equity for simplicity).

Next day, Vodafone collapses down to $50. This means that on paper you've lost $2000. The broker calls you up and demands the $2000, to cover his position of having loaned you $6300 to buy the original shares.

You must meet this margin call. The only way you can do this is by selling 40 of your Vodafone shares @ $50 each. You hand the money to the broker, who you now still owe $4300.

This pushes down the price of Vodafone shares.

The next day the price drops down to $30 dollars, and you decide to get out of the market.

You sell your remaining Vodafone shares for 60*$30, for $1800. You hand this to your broker. You also hand over another $2500 to pay off your original loan of $6300.

So you're out of the market, but you've lost $3200, which includes the initial $700 margin account, plus the $2500 you paid up at the end, to settle your account.

Your forced actions to sell, have contributed to the fall in the price of Vodafone shares, as you deleveraged.

Next day, once all the margined bulls are out of the market, the price rises to its 'natural' fundamental value of $50.

You though, are still happy. You got out with your trousers on. If the price had dropped to $5, your trousers would have been on fire.

Both covering shorts and meeting margins lead to what Peter Schiff calls 'head-fake' rallies, and mask fundamental positions, particularly when the movements and positions are very large in comparison to the size of the market.

Welcome to the wacky world of being a trader.

Der SchiffMeister reckons there has been a headfake move on the dollar, and that it is now ripe for a collapse, according to the fundamentals.

I think he is right.

But nobody KNOWS about these things for certain. And market sentiment can cover up an awful lot of fundamental effects for an awfully long time, especially once you throw in the spanner of government interference for the benefit of individuals in government.

Being able to tax and change laws, is a heady mix which few individuals fail to bend to their personal advantage.