Tuesday, September 21, 2010

More on the Hyperinflation Debate

If you are not aware, this week the United States is pumping a massive amount of money into the markets (POMO) in an attempt to stimulate inflation. This is the number one reason why Gold/Silver have been taking off in value lately.

The Bank of International Settlements (BIS) has come out with a report comparing Japan with the United States as both embark on the same solution to the economic crisis (QE).

As Zero Hedge notes, the report show us that "Japan, even during its two-decade long deflationary process is far better equipped to handle the economic collapse that is unravelling for an entire generation of Japanese consumers. Which is why the Fed is now actively pumping $5 billion in the market every other day to stimulate inflation, and the stock market, as this is now the Keynesian system's Maginot line. The Fed can not allow mass perception of the the double dip to become entrenched as that would be the proverbial game over. What has worked in Japan for 20 years will fail miserably when applied in the US, simply because US consumers are in a far, far worse shape than their Japanese counterparts."

Coincidentally our friend, Gonzalo Lira has also come out with a post examining the Japan/US comparison. I'll summarize it here but I know some of you will want to read the full post so I invite you to click the link and go to Lira's blog.

Japan went through an equities and real estate boom during the 1980’s — a boom that was really a bubble. And like all bubbles, it eventually burst in 1990. Since then, Japan has been lost and the Japanese government has spent a fabulous amount of money for domestic stimulus that hasn’t helped at all. Japan is in full-on deflation—in every sense of the word.

Now a lot of people believe America is set to begin its own version of Japan’s Lost Decades and Lira argues it will be something completely different.

Lira notes the rationale for a similar path is simple and superficially persuasive:
  • Just like Japan in 1990, the United States went through a bubble in equities and real estate, which eventually popped in 2007–‘08. Since then — just like Japan — the U.S. has been experiencing deflation. Just like Japan, the U.S. now has zombie banks, the so-called “Too Big To Fail”. Just like the Japanese government, the U.S. government is spending - spending - spending, so as to prop up aggregate demand. The Federal Reserve — just like the Bank of Japan — is issuing enormous sums of money in order to prop up aggregate asset price levels — the Fed’s policies are so reminiscent of the BoJ’s money printing that Bernanke & Co. have borrowed the term outright: Quantitative easing.

    Everything screams Just Like Japan—right? So according to the “Japan Is Us” camp, 2010 through at least 2015 will be just like Japan between 1990 and 2010: Sluggish growth, stagnation — and most important of all, deflation, deflation, deflation.

    But there is one key difference that the Japan Is Us crowd conveniently ignore. They ignore it out of blindness, or incompetence, or—occasionally—out of malice. They ignore this key issue like the elephant in the room that’s gone and got drunk, and is now making a fool of himself: Balance of payments. Balance of payments (BOP) is the measure of a country’s total exchange with the rest of the world.

Lira notes that this 'current account' is the key metric, it's all about the trade surplus or deficit.

The U.S. current account has been negative for a long, long time (since 1973). Japan, on the other hand, has a current account surplus.

To finance this massive current account deficit, the U.S. has sold assets to the rest of the world, which are Treasury bonds. And as everyone knows, Treasuries might be called “assets” by the sophisticates, but they are really nothing more complicated than a loan. In other words, Americans and their government have gone into massive debt with the rest of the world, in order to finance all this spending.

Japan, meanwhile, has been carrying a current account surplus. Therefore, the Japanese government has been borrowing money not from overseas, but from its own citizen’s savings. All of the Japanese government’s stimulus spending has been paid for by the Japanese people.

This is the main difference between the United States and Japan and Lira argues it should be obvious — and ominous — what this difference means.

  • The U.S.— unlike Japan—cannot pay back its loans: Because the United States is broke. The Federal government is running deficits of around 10% of GDP. America as a whole has racked up $7.5 trillion in current account deficits over the last 25 years — over 50% of total GDP — with no end in sight.

    So the United States — unlike Japan — has been spending what it does not have. The U.S. — unlike Japan — depends on the rest of the world to lend it money to continue on this spending spree. Americans — unlike Japan — do not produce enough to self-finance its government’s stimulus programs.

    Therefore — unlike Japan — the United States will eventually be unable to pay the Treasury bonds it has issued. Therefore... there will be a collapse in the Treasury bond market (triggering) a panic in Treasuries (that) will mean a run up of commodities — which will bring about the death of the dollar, and hyperinflation in America.

    But even if you don’t subscribe to my hyperinflationary scenario — even if you think I’m full of shit on this issue (and plenty of sensible people think I’m full of it to the brim) — it’s obvious that Japan is not like the United States—it’s obvious to anyone who looks at the situation evenhandedly: The contrast in the two countries’ balance of payments is enough to show definitively and unequivocally that they are not the same.

    The source of the two countries’ funding is key: One produces its own stimulus from its current account surplus, while the other borrows it from abroad, adding more debt on top of its already existing debt. Therefore, one country’s spending and stimulus programs — Japan’s — are sustainable, while the other’s — America’s — is not. Which means that the mechanisms for this fiscal debt—sovereign bonds—are rock solid in Japan, but lethal in America.

Lira argues that you are seeing a promotion of the 'Japan Is Us' point of view and that is leading money managers to do the hard sell and lead their clients into Treasury bonds — because if you were in Japan in 1990, their sovereign bonds turned out to be the smartest investments in the long run.

But the U.S. is not Japan and US Treasuries have been under performing.

Lira suggests

  • "That’s why so many people keep insisting that Japan Is Us! - Japan Is Us! - Japan Is Us! They are selling their clients on something, or else trying to explain away their underperformance, by sheer force of personality — while ignoring the blindingly obvious fact that the U.S. is not Japan.

Which, of course, brings Lira to his foil in this debate, Mish Shedlock:

  • One prominent blogger in particular has been going insane, insisting day after day that Japan Is Us, to the point of psychosis — evidence to the contrary be damned. Every day, this blogger — Michael “Mish” Shedlock — bangs on the same old tired drum. Mr. Shedlock is affiliated with Sitka Pacific, whose performance leaves something to be desired. There are, apparently, a number of Sitka Pacific clients quite nervous about the direction of their investments. So it is reasonable to question whether Mr. Shedlock is ranting and raving how the U.S. is following the deflationary spiral that Japan did because he genuinely believes what he is saying, or because he is trying to convince someone — maybe his clients, maybe himself — of something that he knows in his bones might not be true.

    What is true is that anyone who has made bets that Japan Is Us will soon find out if they were wise bets, or foolish ones. The Treasury bubble is soon to burst — so we’ll know the fate of the American economy soon enough.

Back to you, Mish Shedlock.


Video clip on Bubbles

I promised a colleague I would repost these video clips from Chris Martenson on asset bubbles, the pattern they follow and past historical bubbles. It comes in two parts...

And finally, for what it's worth...


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  1. Elvis

    Lira is an imbecile and is completely insane. The United States is NOT broke. His theory that there will be sudden hyperinflation brought on by a single event is nonsence. Thats not to say we will never be in hyperinlfation. We may well find ourselves in that position if the U. S. Treasury keeps borrowing money at the current rate. As far as the U. S. being broke - we're not there yet. As long as the world considers us a safe haven for their money by putting it into U.S. treasures will will not be broke - we'll continue to have an unlimited credit card that never has to be paid until the world decides we're no longer the safe haven. That could be years or never.


  2. Arguing about hyperinflation is like arguing about an asteroid hit. Yes it is possible, but is quite remote. The mechanism through which hyperinflation will be bootstrapped, as described by Lira is unclear and quite arbitrary at best. He might as well have chosen a story about how above mentioned asteroid reaches the earth's atmosphere and explodes in megatons of freshly printed greenbacks raining on the world for one month. That would have been more believable. Even then it is reasonable to think, that fed/gov't would do everything in their power to remove the excess - up to and including the arrest of any-one possessing the alien papers.


  3. I find this quite fascinating. I'm not bought into the hyper-inflation argument, but at the same time, I've wondered for some time about the eventual outcome of the huge ongoing, and seemingly growing over time, US current account deficit. Do you really think in a floating exchange rate environment, that it's likely for a collapse, versus some kind of repricing? Potentially a material change to the ER, but not devastation as would be implied by hyper inflation?

    Separately, this one struck me this week. While US manufacturing as measured by dollars is bigger than every to my knowledge, it still amazes me how much we import. On the news this week,they reported the last US incandescent light bulb factory closing..Yes that's right, the country that invented light bulbs doesn't make them any more..There are CFL's but the same news story pointed out they're generally made in asia with limited US production.