Inflation

The wide ranging criticisms of the ECB's performance are bullshit. An inflation target necessarily implies restraining deflation.

There are several independent, but non-mutually exclusive causes of inflationary pressure. Academically, the two classical causes are termed demand-pull and cost-push. Additionally, one must consider the Milton Friedman fallacy that "inflation is always and everywhere a monetary phenomenon."

Demand pull inflation is always and everywhere a monetary phenomena. People can ask for all of the increases in wages they want... But in totality, if the central bank doesn't print enough money to keep up with economic growth, an employer's ability to increase wages will be constrained by their employee's ability to increase his productivity. There will simply not be enough money in the system to stimulate the economic growth needed to encourage an additional consumption of products.

This goes both ways. When Arthur Burns ran the Federal Reserve, he allowed Richard Nixon to bully him into printing money. The continuation of Johnson's "Great Society" push to appease the opposition to Vietnam through increased social spending coupled with the credit creation abetted by the Burns Fed. This double-whammy over-stimulated a strong economy already close to its natural limit of unemployment. The additional money in the system temporarily drove the unemployment rate below 4%. As people were driven off their couches by rising wages, so to were people driven to ask for higher wages to stay at their current jobs. With rising wages came higher expenses, and the demand-pull wage spiral took off.

This is not at all the case today. Europe is on the verge of a terrific period of stagnation and deflation. (inflation=up, deflation=down, dis-inflation=steady) We will see no economic growth, and no additional jobs in the periphery of the Eurozone until the artificially uncompetitive wages of the peripheral economies come back down. America is going to be relatively okay, but with lackadaisical wage growth, stagnant real-estate prices and impressively high unemployment for four years at a minimum.

The price mechanism is a powerful signal. Despite the extremely bearish situation in the world economy, the prices of many key commodities are at extreme levels. This tells us several things: Coffee and cocoa are expensive. Global income/consumption is rising.
Oil is expensive. We are running out of oil.
Coal is somewhat expensive. We will find more coal.
Wheat, soybeans, and corn are cheap. We have had three years of excellent harvests worldwide... we also have powerful subsidies in the U.S. for these crops.
The prices of many rare earth metals have been relatively unaffected by the panic of '08/'09. Global income and the consumption of advanced technological goods is rising and perhaps we are running low on these metals.

Get it? We will find more of the things we are short of globally, except the things we are running out of, namely oil. But on a macro scale, the developed countries are printing more money, and the developing countries are consuming more products. The deflationary impulse of the developed world is being countered by both the printing of money (Friedman inflation), the demand pull of economic growth in the developing world, and the cost push of the world transitioning from an oil based economy. Add in a few years of bad harvests and we will move beyond academic disputes over the nature of the Phillips curve (the reciprocal relationship between rate of inflation and and the rate of unemployment) into a general acceptance of Gregor Macdonald's concept of compartflation...

Basically we are talking really shitty stagflation in the developed world, with the slim possibility of outright deflation if we get a trade war, or a real war, or a European banking collapse, or a revolution in China... etc, etc. In either case, developed world real estate prices will not appreciate in nominal terms for 8 years at least. Stocks and and paper stores of value look terrible.

It is essential to recognize that the dichotomy between deflation and inflation is false. They can easily coexist as a growing differentiation between assets values intensifies along the classic lines of supply and demand. As we enter into a world where the values of the dollar and the euro depreciate together due to both the decreased demand for currency and the increased supply of money, we will see the price of many assets in high supply (real estate, stocks) stay stagnant. Thus the inflation of the money supply will cause a subtle but dramatic deflation in the price of over-abundant assets. However, as we run of of cheap energy the price of oil and coal will continue to inflate with drastic consequences for the world economy.

This will of course work itself out. Indeed, as these events come to pass, market prices are no more than the manifestation of this process of self renewal.

Stop freaking out, you know you're okay.

The Dow is going somewhere just south of 9000. The Euro is going to $1.15. Gold is eventually going to $2400, once the dollar turns around.

Will everyone please calm down? The markets are working.

The only present concern is the fact that everyone who can is bailing out of long-term European peripheral-economy debt by selling it to the European Central Bank. The amount the ECB is actually purchasing is the only relevant data point. If they are forced to purchase excessive amounts, they will not be able to sterilize their purchases, turning so called "credit easing" (I've also heard the nonsense term "qualitative easing" used) into "quantitative easing." In fact, the Federal Reserve fell into a liquidity trap when they attempted their form of "sterilized" quantitative easing, and were forced to print money to prop up the falling money supply.

If their hand is forced there is a real danger the Euro will hit parity to the dollar. (Or as my fiancee suggested, falls below parity... "It's only fair.") So far the adjustment is in line with events, and the re-balancing of the Euro is equating supply and demand of money and goods judiciously. But if parity happens, America and Europe will be in deep shit.

Moody Blues

Moody's downgraded Moody's Investment Services today, in response to Moody's receipt of a Wells notice from the S.E.C. which threatens to revoke its NRSRO status.

God I wish this were true. Who knows?... stranger things have happened.

Re: Letter to Trichet

Uh... so I guess he got the memo. I was thinking something more on the order of 2 trillion dollars, but $962 billion sounds reasonable. Glad I could be of service.

Letter to Trichet

At the risk of sounding brash, I believe that Jean-Claude Trichet made a major tactical error Thursday morning by muting calls for the ECB to initiate quantitative easing.

The argument against QE in Europe is that the ECB's actions would necessarily be political, possibly opening up the ECB to scrutiny and jeopardizing the central bank's independence. However, the exigencies of the crisis necessitate bold action and I am surprised that Trichet would allow himself to be caught flat footed on this issue. He was unique amongst central bank governors in the summer of 2007 when he (by fax from the beach) provided unlimited liquidity to the European banking system. This bold action ameliorated the onset of the panic of '07.

Trichet is attempting to restore normality to the markets by withdrawing this liquidity support. This is a mistake. Trichet should have said that the ECB was prepared to come into the market with overwhelming force to drive down the unproductive interest rates on European government debt. With the TED spread and the LIBOR-OIS spread approaching panic levels (in plain English, European banks are no longer lending to each other overnight) he should have reiterated his commitment to provide unlimited liquidity.

If he feels that the "traditional" QE is unpalatable or unworkable, he should initiate a political process by which German bunds (the yields on which are currently plunging do to "safe-haven" searching) are issued and the proceeds used to purchase the debt of weaker European countries (which are in danger of being priced out of the lending markets due to their surging yields.) If this were implemented on a significant scale, it could go a long way towards driving a convergence between bond yields on the debt of European countries.

This may be a good opportunity to raise a domestic issue I've been kicking about in the back of my mind. The political separation between the two control levers of the economy, Fiscal Policy (the Spending and Taxation decisions made by Congress) and Monetary Policy (the control of overnight interest rates by the central banks) is necessary but unworkable. If I were in charge, I would make a commitment to restrain overnight interest rates around 0% for three years. Any adjustment necessary to restrain inflation by choking economic activity should be made on a quarterly basis by manipulating the tax rate on corporations and individuals. This is of course politically impossible, however, it cuts to the heart of the biggest danger facing the economy today, the surging national deficit and the possibility, however remote of a U.S. sovereign default. By increasing taxes temporarily if necessary to restrain economic growth, the government would bide its time by funding the exploding national deficit. This would increase its ability to maneuver by stocking some dry powder in the case that additional Keynesian stimulus is required. Which it will be.

Dance Casa

Also, what the fuck happened at the art sales this week?!? Excuse me for swearing three times in three posts within this hour, (I'm sorry, I got bored and stopped paying attention for three weeks worth of trading days) but $25,842,500 for a 28 inch forearm/hand by Giacometti???

Felix Salmon had an excellent post a few weeks ago. He suggested that works of art produced in limited multiples had a higher value than a unique work of art. That the cache derived from the narrative surrounding the provenance of the sister pieces would speak to the sophistication of the new buyer... to brutally paraphrase his excellent article.

But the fact of the article was that a huge Giacometti had just sold for something like $50 million dollars.

So here we have: the beginnings of bond vigilantism in the European Debt markets, the beginnings of a"1930s U.S. depression style" overproduction thing happening in China, massive surpluses of oil and basic industrial commodities, shortages of rare earth metals and soft commodities (such as coffee, cocoa, orange juice), a severe long term shortage of oil, a short term shortage of coal, Japan done and borrowed twice its GDP, excellent harvests several-years-running depressing the prices of agricultural products, and a tiny fucking Giacometti selling for half the price a monumental sized Giacometti sculpture.

Again. What is going on???

Here's the deal. We are, luckily, not going to have a post-banking system collapse how the fuck do we pay the police if the ATMs don't work kind of situation. But things are very bad. Terrible in Europe. Terrible in New York. Terrible in China.

Less than perfect in L.A., Austin, Brazil... but go to any of these places if you need to. There is oddly enough work.

Thirty-Nine Percent

39% of investors in the iShares/FTSE Xinhau A50 China Index ETF have lent their shares to short sellers. In the words of the immortal Drake, "Who the fuck are y'all?"

Holy shit.

(Update 5/6/10) Yep...