Tuesday, December 29, 2009

Inflation vs. Prices

KCB wrote: "My question is: since the U.S. dollar is now a fiat currency, how can the supply remain low in the face of strong demand? If there's strong demand for a currency, doesn't that imply willingness on the part of those who demand the currency to borrow it? Wouldn't that set up an inflationary scenario?"

It's amazing how many people are convinced that our currency is issued by U.S. government fiat. It's not.

The US$ is issued ONLY by private individuals who hold private equity shares in the private Federal Reserve Bank, and the private banks that lend with leverage on top of their reserves. Think of the Fed as a hedge fund for the world's wealthiest villains. They need the hedge to protect themselves against the greed of one another--much like the mob doesn't keep guns to hedge against police action (they can buy the law), rather,to protect themselves from one another.

To answer your question, it isn't that dollar "demand" is strong relative to the boom years of 1998/1999 or 2005/6, it's not. It is that there are few dollars to be found, so surviving dollars gain buying power.

The Fed is not our banking system. The Fed is a predator in our banking system. They have purchased a government blessing to flood our banking system with reserves whenever they wish to do so, AND when our private banking system is willing and able to arbitrage a low Fed wholesale price of funny-money into additional retail loans with leverage. When that happens, the Fed has a massive inflationary influence, if and when, our banks can reasonably mark up that cash. Obviously, with a 0.04% retail rate for same-term cash, banks are cut off from wholesale Fed counterfeiting--oops, I mean--from profitable Fed "lending."

Right now, the Fed is draining cash harder than they ever have before, by keeping the Fed short term cash price sky high at 0.25%--today it's about 700% higher than the market rate of 0.04%. This is an unmistakable sign that the Fed is trying to seize banks for profit. Suffocating banks under crushing reserve interest rates is not inflationary.

Another perceptual problem arises because some people think inflation means prices. Current price levels have nothing to do with inflation, but for a macro, market-based, cause-effect relationship. "Price" is the toll a trade exacts on the buyer, not a number on a board. Physically trading things, things displayed on stock exchange (the word "exchange" is used for a reason) tickers scrolling at the speed of light, actually takes a pretty long time. Only after the dust has time to settle, and people reconsider how much of something they are willing to give up for something else, is the price, or the toll in goods and services surrendered, truly adjusted at the market or macro level. That's what price means.

Inflation refers to a rise in the dollar supply, not the price level of goods/services when banks print dollars (notice I did not say "the government prints") to arbitrage the difference between their reserve cost and the short term market price of cash. When I use the term inflation or deflation, I'm not talking about prices, because prices in a vacuum have nothing to do with inflation or deflation. Today is a perfect example. Lets take the Dow:

The Dow is down about 40% from highs, -20% from Y2K, and -80% from Y2K when adjusted for buying power (as priced in commodities). This is the macro result of deflation. The best measure is that of long term buying power. The price of the Dow, or the toll exacted in goods and services surrendered, is down 80%. That is the profit one would have made, had they converted Dow shares into other things in 2000 (then bought them back today--which would be a dumb move at the present time).

But, the Dow was up yesterday, so people tend to think there was inflation yesterday. There wasn't, because prices can be set by any number of individuals operating within a greater market. If two people trade a share of the Dow for 50,000, that is the price for that day, but 50K is not a true market price, because two people do not = the market. Institutional sellers cannot fetch that price for their shares, because the one guy dumb enough to pay too much cannot absorb their volume of transactions. Much like the current 10.5K is not the true market price of the Dow, because of the anemic number of transactions we see trading today at that price--not enough dummies.

With near-zero trades, it is possible that the Dow could go to 100K tomorrow. And with absolute certainty, it will return to market value when high volume trading returns. High volume exited stage-left at 6.5K.

Of course, that was a different Dow 30 than we have today--but I think that having to change the Dow 30 is worse than being able to leave it alone, so the true market price is even lower.


  1. With the treasury selling bonds to JPM and GS and the FED printing currency to buy these bonds a few days later, and then GS and JPM taking these new dollars and buying equities then returning them as collaterol to the FED in various accounts, is this not inflationary as monetizing debt? Sorry for the long sentence, typing on my phone.

  2. When you say that the DOW can print at 50,000k and that has nothing to do with inflation, should i continue to buy equities then? There is plenty of volume for the common man to get in and out of the market at any price. With prices for goods and services declining, which you see but I don't really, in Chicago at least, and the stock market rocking because yields are so low, then it would be best to keep making money being long stocks and thus having more cash for the deflationary crash in real goods and services. Since the two are not linked paper stocks should continue higher, even if volume is lower. I would love to see a 100k on the DOW and lower prices around me, I would be a multi-millionaire sitting on a hoard of cash. The problem is that we would all be multi millionaires, as the government is trying to make us all rich. I just don't understand the real world aspects of some of your philosophies. You often speak of currency as being starved but walking outside and you will see that this is not the case, there is plenty of cash to spend on everything. The banks don't need cash and the people have plenty of cash. Christmas bonuses this year were some of the best ever. The car dealerships outside of Chicago say that the 4th quarter was the best they have had in years, they can't keep cars on the lot. Jobs are also returning and pay is higher. I have 2 family members that have taken new jobs, starting next week. They did not lose their previous jobs but were lured away by more money from other companies, because business is picking up faster than anyone could have expected. So again, what are the real world implications of further deflation, if we see it. So far, deflation has been great for the common man, if in fact deflation is what we have in the last 6 months. You like to say the market is down 20% or 40%, but you just pick the time frame that suits you. Go back a bit further and the market is up a lot. As long as deflation keeps bring us higher wealth, than i am all for higher stock prices and lower retail prices. WIN WIN

  3. If your phone can see comments, it's better than mine. :)

    The answer is that the cash supply is primarily created by commercial bank loans, not the Fed. The Fed can create conditions favorable (or like today: unfavorable) to bank lending from simple arbitrage--borrowing cheap cash from the Fed to lend at a higher same-term interest rate.

    Complicating this, our safest banks lend with massive speculative leverage (and why not? they THOUGHT the FDIC could erase their losses) of around 10:1. Our weakest banks used to lend with a whipping 40:1 leverage, though most have scaled back due to a lack of high risk borrowers (they're broke).

    So when the Fed tries to strangle highly leveraged banks (which is all of them) with rates higher than the short term market rate (essentially 0% today, or even negative at time, it creates a deflationary bust.

    That lack of borrowers, world-wide, relative to the boom years is the source of deflation.

    If I drain an Olympic-size pool of paper cash with a sewer pipe, while I flaunt my altruistic addition of cash through a dripping garden hose, the net effect is not inflationary.

  4. "When you say that the DOW can print at 50,000k and that has nothing to do with inflation, should i continue to buy equities then? There is plenty of volume for the common man to get in and out of the market at any price."

    Sure, if you want to watch your trade drop when volume returns.

    Ask yourself the question this way:

    Should you buy one house when all the homes in your neighborhood are priced at $X and nothing is moving? Anyone can buy just one.

    What if another home of say, 10,000 on the market sells for 2X? Should you pay that price, too?

    What happens to your investment after the other 9,998 sellers finally feel enough pressure to lower their asking price to the true market price of .3X and 9,000 houses move quickly?

    Do you put your 1 house up for 3X and pray for a 300% return? Good luck.

  5. "As long as deflation keeps bring us higher wealth, than i am all for higher stock prices and lower retail prices. WIN WIN"

    Higher prices means less wealth. Fed counterfeiting, just like all counterfeiting, drives prices higher because they introduce paper to steal your wealth.

    Result--everything is less affordable.

    If they only counterfeited cash for profit, we might live with the Fed siphoning off all new production for themselves.

    Unfortunately for both the Fed and us, all crime rings ultimately spin out of control and burn themselves to the ground, because perpetrators of crime are just plain stupid. If they weren't, they'd be able to win in the free market.

  6. FDR: you didn't exactly answer my question.

    The question is: what prevents the USD from becoming a legacy currency?

    Your answer to that in the past is "strong demand". But as I said, if the demand is strong then people will be willing to borrow the currency. True, the demand may not be as high as it was during the boom years, but comparisons against the high are as meaningless as comparisons against the low.

    You can't say that it's strong demand, because if demand for a currency is strong then people will be willing to borrow it. Again, they might not be willing to borrow it at rates equivalent to the peak of the cycle but they'll be willing to borrow nonetheless -- enough that banks would be able to lend at interest rates high enough to make it worth their while. Enough that currency hyperdeflation isn't in the cards.

    Of course, that assumes that the central bank -- the Fed -- is willing to print currency at an interest rate low enough that the difference between the interest rate it charges and the interest rate the bank would charge is high enough to make it worth the bank's while. So what you say about the currency being both in high demand and being in a hyperdeflationary trend can only be true if the Fed steadfastly refuses to print at interest rates palatable to the banks.

    If loans to individuals and businesses are going out the door at, say, 4%, it's difficult to see how a Fed rate of 0.25% can be considered "too high". You comment that the Fed rate is many times higher than the "going market rate", but a "going market rate" is entirely meaningless if the banks can't actually get currency at the "going market rate". All that matters is whether or not potential borrowers are willing to borrow at rates high enough to satisfy the banks.

    But here's the kicker, something that wasn't really true during the Great Depression: the Fed, as a central bank, has competition! If businesses (big ones, in particular) can't get loans from banks that issue U.S. dollars because the Fed won't lend at reasonable rates, they can get loans from banks that issue, say, Euros!

    For what you say to work, all the central banks need to be pulling off the same scam at exactly the same time.

    So the question is: are they?

    And getting back to my original question: even if they are, what keeps the USD afloat if people can't get their hands on them?

    Keep in mind that today, the U.S. is a very weak producer. That is a very, very different situation from what we had during the Great Depression. It means that businesses by and large simply don't have to trade in U.S. dollars if they don't have to. And if they can't get their hands on them, they won't -- they'll trade in some other currency.

    So what keeps the USD relevant in the face of all that? What keeps it from becoming a legacy currency?

  7. I think the point is as simple as this:

    During the boom years, banks created dollars with 40:1 leverage. Now they can't, because few people want to borrow/leverage themselves into a depression.

    It isn't demand for dollars that has been shooting the value of the dollar higher for almost 2 years, it is the fact above: lower dollar production from banks that all fit into one of three categories:

    Going, going, gone.

  8. FDR: Thank you very much for all of your views, you have opened my eyes on a few things that I knew little about.

    I am a voracious reader, and load up a wish list on Amazon for books at Christmas. Two of these were "The Creature from Jekyll Island" (I live in Atlanta...., so I'm a little bummed), Creature scared me. Another was "Conquer the Crash," after that, I am now deeply concerned.

    Can you please offer any other books or resouces that may further enlighten me.

    Thank you again.

    PS. I also read (I read a great deal....) "When All Hell Breaks Loose, stuff you need to survive when disaster strikes," which is also very good. I'm somewhat of an outdoorsman and tend to go on walkabout every so often to just clear my head. Very entertaining read as well.

  9. kcb:
    "So what keeps the USD relevant in the face of all that? What keeps it from becoming a legacy currency?"

    the game starts by having the USD as the world's reserve currency. After some time other currencies become "stronger" at least they are advertised that way. The strategy is to accumulate as many USDs as possible at a low price.

    In 08/09 we see a preview of how the game will play out(the $ shot straight up) All of these USDs purchases will finally pay off. The players natives coins will lose value, and they will be able to change the valuable USDs for their coin reaping tremendous gains.

    As long as we are using our current system the $ will not become a legacy currency. The French and the English fought for control of the current system. We know the English won. There was a man that wanted to challenge the system and he was defeated by the allies.

    No one has risen yet to change this system. Someone will rise eventually and succeed until then $ is the reserve currency.

    This is my opinion.


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