Courtesy of Mish.
Sisyphean Fed Struggle
Earlier today in The Trouble with Porosity and Prosperity Bill Gross mentioned the possibility of deflation in the US and spoke of the Fed's Sisyphean struggle to create inflation.
Before the advent of central banks in the early 20th century, prices were just as likely to go up as down. The world of the 1930s and the more recent lost decades of Japan give testament. Prices change – and while they usually go up these days, sometimes they do not. We are at such a moment of uncertainty.
That one or the other should be favored, is a fascinating debate. Currently, almost all central bankers have a targeted level of inflation that approaches 2%. Some even argue for higher levels now that deflationary demons approach in peripheral Euroland. They argue that the 2% level is sort of like a firebreak. Once inflation approaches zero, goes their theory, the deflationary firestorm is difficult to stop. With interest rates at zero and quantitative easing approaching potential political maximums, there is little water left to pour on the flames. Best then to keep inflation at a reasonable 2% so that the zero hour never comes. They have a point, but then how to explain to the average 30-year-old citizen that if so, his/her retirement dollar will only be worth half as much come 65, and if inflation averages 3%, it will only be worth a third. Actually, a 30-year-old citizen of the 1970s (yours truly), has experienced a 75% depreciation of his purchasing power.
Jim Grant, one of the most gifted financial historians of our day, has long argued that economies did just fine during bouts of deflation in the 18th and 19th centuries – in fact, in many cases, they did better. America in the 1880s was a period of good deflation with output rising by 2% to 3% from 1873 to 1893.
But Grant must know, I suspect, that our modern finance based economy is not your 19th century Oldsmobile, if there had been one. Stopping the printing press sounds like a great solution to the depreciation of our purchasing power but today’s printing is simply something that the global finance based economy cannot live without.
Why not? Simple math, I suppose. Our 2014 U.S. Oldsmobile requires 4% nominal growth just to keep it running, and Euroland economies need at least 3%. Having created outstanding official and shadow banking credit of nearly $100 trillion with an average imbedded interest rate of 4% to 5%, the Fed presses must crank out new credit (nominal growth) of approximately the same 4% to 5% just to pay the interest rate tab. That of course wasn’t the case in Grant’s 19th century version – there was very little debt to service. But now at 500% to 600% of GDP (shadow debt included), it’s a Sisyphean struggle just to stay above water. Inflation, in other words – or in simple math – is required to pay for prior inflation. Deflation is no longer acceptable.
Such is the dilemma facing central bankers (and supposedly fiscal authorities) in 2014 and beyond: How to create inflation. They’ve made a damn fine attempt at it – have they not? Four trillion dollars in the U.S., two trillion U.S. dollar equivalents in Japan, and a trillion U.S. dollars coming from the ECB’s Draghi in the eurozone. Not working like it used to, the trillions seem to seep through the sandy loam of investment and innovation straight into the cement mixer of the marketplace. Prices go up, but not the right prices. Alibaba’s stock goes from $68 on opening day to $92 in the first minute, but wages simply sit there for years on end. One economy (the financial one) thrives while the other economy (the real one) withers.
The real economy needs money printing, yes, but money spending more so, and that must come from the fiscal side – from the dreaded government side – where deficits are anathema and balanced budgets are increasingly in vogue. Until then, Grant’s deflation remains a growing possibility – not the kind that creates prosperity but the kind that’s the trouble for prosperity.
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Faber on Gross' Deflation Theory and Japan's Bond Ponzi Scheme
In a Bloomberg TV interview, Trish Regan asked Marc Faber about Gross' deflation theory. Faber also discussed Japan's latest QE endeavor.
Faber stated: Japan is Engaged in a Ponzi Scheme. Click on link to watch video.
Transcript
TRISH REGAN: Hello, Marc. Always good to see you. What do you think here about what Bill Gross is saying? Do you think in fact deflation is a real possibility.
MARC FABER: Well, I think the concept of inflation and deflation is frequently misunderstood because in some sectors of the economy you can have inflation and in some sectors deflation. But if the investment implication of Bill Gross is that – and he’s a friend of mine. I have high regard for him. If the implication is that one should be long US treasuries, to some extent I agree. The return on 10-year notes will be miserable, 2.35 percent for the next 10 years if you hold them to maturity in each of the next 10 years.
However, if you compare that to French government bonds yielding today 1.21 percent, I think that’s quite a good deal, or Japanese bonds, a country that is engaged in a Ponzi scheme, bankrupt, they have government bond yields yielding 0.43 percent.
