Inflation v. Deflation

By Colin Twiggs
March 26, 2009 5:30 a.m. ET (8:30 p:m AET)

These extracts from my trading diary are for educational purposes and should not be interpreted as investment or trading advice. Full terms and conditions can be found at Terms of Use.

There are two competing views of global markets. One is driven by the rapid contraction of the money supply following collapse of the debt bubble. This points to a protracted deflationary spiral, with falling prices fuelled by debtors attempting to reduce their exposure by selling off assets. The outcome would be high unemployment, low commodity prices, low stock prices and a low gold price.

The second scenario is where the Fed and other central banks expand the money supply, fuelling inflation. Purchasing bonds to expand the monetary supply may be easy, but as the Japanese discovered, this does not necessarily translate into rising prices — bank credit continued to contract throughout the 1990s.

Monetary Base

We have already witnessed a rapid rise in the US monetary base, caused by the Fed's actions to shore up the financial sector. But the surplus has not succeeded in expanding bank lending, most of it finding its way back to the Fed, deposited as excess reserves. Banks are trapped by their inability to find sound customers who want to borrow: the private sector are selling off assets and reducing debt.

Will the Fed succeed where the Bank of Japan failed — and persuade the private sector to borrow to acquire new assets? The bond market is betting they will fail, with TIPS and treasury yields declining in anticipation of low inflation.

Gold buyers, however, are betting they will succeed and inflation will rise. Though silver appears to be taking the opposite view.

Despite recent signs that the Fed is prepared to inflate, the deflationary spiral will be difficult to break. Expect deflation for a year if not longer, followed by inflation if the Fed succeeds in its attempts to raise bank lending. This is likely to be a protracted recession.

Self-Defeating Behavior

It is interesting to observe most governments attempting to shore up falling asset prices — to protect banks from complete collapse. But their efforts may succeed in prolonging the recession. Low asset and commodity prices are the catalyst that spurs private business and individuals to start borrowing again. At some point the opportunities presented become to good for them to pass up. If prices are prevented from falling, the market stagnates as there is insufficient incentive to take on the additional risk.

When it comes to a trade-off between saving the banks or prolonging the recession, my bet is that the Fed will follow the BoJ and save the banks.

Read More....
Euro	Japanese Yen	Australian Dollar

The difficulty lies not so much in developing new ideas as in escaping from old ones.

Rand

“Inflation is not caused by the actions of private citizens, but by government: by an artificial expansion of the money supply required to support deficit spending. No private embezzlers or bank robbers in history have ever plundered people’s savings on a scale comparable to the plunder perpetrated by the fiscal policies of statist governments.”

--Ayn Rand

Thomas Sowell
      

Jewish World Review Dec. 16, 2008 19 Kislev 5769
This holiday season, give the gift of wisdom
By Thomas Sowell

http://www.JewishWorldReview.com | Good books are especially good to give as
gifts to the proverbial "man who has everything" because he (or she) may not
have heard of a new book that fits their interests.

Good new books are one of the few good things about this past year. Here are
some books that could make fine gifts, obtainable painlessly without battling
crowds at the mall— or even in the bookstores, if you order on-line.

The most outstanding political book of 2008 has been by Jonah Goldberg. It
shoots to pieces the prevailing ideas of who is on "the left" and who is on "the
right."

It can become especially relevant in the coming year, if the new administration
goes further with the government interventions in the economy begun by the
outgoing administration— the kind of economic policies that were at the heart of
fascism.

Fans of economist and JWR columnist Walter Williams will welcome a new
collection of his columns in a book titled "Liberty versus the Tyranny of
Socialism." Spiced with imaginative examples of economic principles in everyday
life, it is vintage Williams.
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      Washington consider "must-reading". HUNDREDS of columnists and cartoonists
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      here.

It's not all economics, either. Professor Williams' columns are also on
education, law, politics and other subjects, all done in his own inimitable
style.

Another economist and columnist, Robert J. Samuelson of Newsweek, also published
a new book this year— one focused on a topic that is likely to be of growing
interest and growing concern in the years ahead. Its title is "The Great
Inflation and Its Aftermath."

It is an account of how the American economy went from price stability in the
1950s to the beginning of inflation in the 1960s, reaching dangerous levels of
inflation in the 1970s, with inflation then being brought under control with a
lot of tough decisions and painful consequences in the 1980s.

This is the kind of book that may be more fully appreciated by an economist but
it is written in plain English, with no graphs or jargon, so it should be
interesting to a lot of people who are not economists.

"The Great Inflation and Its Aftermath" also has that most uncommon
characteristic, common sense.

Not all the books recommended this year were published this year. "Greatness" by
Steven F. Hayward is an unusual book published in 2005. In its 170 pages of
text, it deftly compares Winston Churchill and Ronald Reagan as leaders,
revealing a truly remarkable range of similarities between these two men from
radically different social backgrounds.

Written at a popular level in an engaging style, "Greatness" is also a book from
which scholars can learn— except for those who think they already know it all.

A very different book is a little book of whimsical cartoons titled "Furry
Logic" by Jane Seabrook. It is good for a few moments of real pleasure and cheer
during the holiday season, perhaps especially good for people recovering in
hospitals or at home, but enjoyable by people of all ages and circumstances.

Books about the past can be relevant to the future, especially when the same
kinds of policies reappear under new names. It is good to have an understanding
of why these policies did not work when they were tried before, as a sneak
preview of what to expect from such policies the second time around.

Since so many of the approaches that Barack Obama has advocated under the mantra
of "change" are things already tried out during the 1930s by Franklin D.
Roosevelt, a devastating and very readable book titled "FDR's Folly" by Jim
Powell spells out just exactly what happened in the American economy when such
policies were put into effect.

My own new book this year is "Economic Facts and Fallacies." While I cannot
pretend to give an unbiased evaluation of it, I can point out that it received a
prize at an international gathering in Zurich and has already been translated in
Spain.

Since fallacies flourish during election years, you may already have heard quite
a few of these fallacies this year. "Economic Facts and Fallacies" can help
prepare you for what is likely to happen when those fallacies are turned into
policies in the new administration next year.

You often hear about the "$10 trillion national debt". This is a phenomenal sum, to be sure. But it doesn't even come close to what our REAL obligations are.

The "national debt" conveniently leaves out the government's obligations for Social Security, Medicaid and Medicare and similar obligations. Add these figures to the mix and the U.S. is in the hole by about $70 TRILLION!

And this is just the projected SHORTFALL. That puts a different spin on things, now doesn't it?

These obligations are impossible to meet through taxation. And they will never be met by cuts in government spending (the entire government would have to be practically eliminated... which doesn't sound like a bad idea!)

This leaves only two basic options...

Either the U.S. government eventually defaults on foreign loans and obligations to retirees

Or we hyper-inflate the currency and pay back previous obligations with fresh new money created from thin air

Which route do you think politicians will choose? They have already chosen, and the process is now underway.

Is your retirement protected? Are you prepared for the inflation that is inevitable?

Layers Of Complexity

By Colin Twiggs
November 29, 1:00 a.m. ET (4:00 p.m. AET)

These extracts from my trading diary are for educational purposes and should not be interpreted as investment or trading advice. Full terms and conditions can be found at Terms of Use.

What do a nuclear power plant, an aircraft, a ship at sea, and financial markets have in common? They are all complex systems with layers of safety measures intended to protect the system from catastrophic failure. Richard Bookstaber, a Wall Street risk management specialist, points out that the very safety measures that are intended to protect the system add to the complexity and make unforeseen failures more likely.

There is another common feature: all the above systems are tightly coupled. Failure of one component or safety measure can impact on other components or measures in an unforeseen manner — with catastrophic results. This is where complexity bedevils the process, hiding points of failure from sight until the system is out of control.

A simple example is the fuel gauge on an aircraft. A much-needed safety measure, the gauge warns the pilot when his fuel is running low. But if the pilot comes to rely on the fuel gauge to tell whether his tanks are full at take-off, a faulty gauge could lead to disaster. The safety measure, the fuel gauge, adds a layer of complexity that may hide a half-empty fuel tank until the pilot is over the Atlantic. Multiply this simple example by thousands of times and you will have an idea of the complexity of any of the above systems.

USS Forrestal

The deck of an aircraft carrier at launch time is a highly complex system with tightly coupled events. Aircraft are raised from the hangar below on giant lifts, to the flight deck where they are fueled and armed before being launched from a steam-powered catapult. Witnessing such an event gives an insight into the months of drills and planned safety measures that enable the carrier to function as a well-organized system. There are few gridlocks and arguments about procedure. Everyone knows their job. Layers of safety measures are in place to prevent failure of one component in the system from impacting (domino-like) on others in the process.

Unfortunately, the complexity of the system increases the likelihood of unforeseen events. The USS Forrestal is a classic example. Operating in the Gulf of Tonkin during the Vietnam war, the carrier experienced a massive fire on its flight deck, claiming the lives of 134 crewmen and injuring 161 others. The worst fire in post WWII US naval history. In a surprising twist of fate, one of the few who witnessed the disaster and escape unscathed was a young navy pilot, LCDR John McCain.

Post-fire investigations revealed an unlikely sequence of events precipitated by reliance on some of the very safety measures intended to prevent such an occurrence. An electrical surge, when switching from standby to internal power, triggered a 5-inch rocket mounted in a pod under the wing of an F4 Phantom jet being prepared for take-off. The rockets were not supposed to be armed until later in the launch sequence. Large red tags added to the electrical safety pins to make them more visible, however, had caused the pin to become dislodged in high winds on the carrier deck. That in itself could not have caused the disaster. There was a backup safety measure requiring that the "pigtail" electrical connection to the rocket pod only be connected when the jet was mounted on the catapult, ready for launch. But launch delays caused by faulty connections had caused the weapons safety board to agree that "pigtails" be connected earlier, while the aircraft were queued on the flight deck. They were unaware of the potential danger from an electrical surge on transfer to internal power — because safety procedures had until then masked this potential threat.

A third safety measure, preventing rockets from detonating at close range, also failed to avert the disaster. The rocket struck the fuel tank on one of two Skyhawks being fueled on the opposite side of the flight deck, one of which was piloted by LCDR McCain. It failed to detonate, as designed, but punctured the fuel tank igniting the contents. McCain and several other pilots managed to scramble from their cockpits and jump to safety.

Fire crews, on standby for just such an occurrence, moved to extinguish the blaze before it could spread. But events had conspired against them. Two 1000-pound bombs had been dislodged from the Skyhawk and lay on the burning deck. The crew were trained for just such an eventuality and knew that the ordnance was designed to withstand intense heat for at least 2.5 minutes, giving them sufficient time to quell the blaze. This is where their luck ran out. Due to the particularly heavy bombing campaign the Navy was running short of ordnance and had switched to Korean War vintage bombs that lacked the same heat resistant poperties. One of the bombs detonated, wiping out the fire crews and killing one of the pilots. This set off a further chaotic chain of fires and detonations which caused the massive loss of life and nearly sank the ship.

Financial Markets

"What does this have to do with financial markets?" you may ask. Bookstaber, in his book A Demon Of Our Own Design, illustrates how complex trading strategies employed by banks and broker dealers, hedged using non-standard financial derivatives traded in over-the-counter markets, can have unforeseen consequences similar to disasters in other complex, tightly-coupled systems. An institution's need to liquidate its position in one financial instrument may impact not only on that market, but on other financial instruments as well. Attempts to extricate from complex trading positions can cause liquidity to dry up, resulting in a price fall sufficient to provoke further assets sales — in order to meet capital or liquidity requirements. Setting off a downward spiral. Counterparties aware of the institution's position may withdraw, not only from the market for particular instrument, but from other markets where the institution has known exposure. Either to take advantage of resultant lower prices or through fear of a downward spiral. This merely reinforces the liquidity squeeze.

Bookstaber's solution is simple. You cannot make complex systems safe by increased regulation or additional safety measures. These merely elevate the risk of unforeseen events. The only way to make complex systems safe is by simplifying them. In financial markets that means standardizing derivative products and trading them through a formal exchange. It also means restricting leverage in order to limit the impact of individual failure on the whole market. In addition, we can simplify the structure of complex institutions and require stronger capital-asset ratios to protect against failure. I also see no reason why standards should not be higher for large institutions in the too-big-to-fail category.

The Economy

The global economy is probably the most complex of all systems. It is also highly coupled, with failures in one area impacting in unforeseen ways on other areas. Adding safeguards and increasing regulation will not protect us from failure. It merely increases the complexity, making failure more likely. The only viable solution is to remove complexity by standardizing and simplifying processes. And minimizing interference with natural market forces.

The science of economic engineering is highly overrated. If similar safety standards were applied to other complex systems such as aircraft design, engineers would not even bother to fit landing gear. Because every engineered take-off inevitably leads to a crash.

Gold

Spot gold retraced to test the new support level at $800. Respect would signal a rally to the upper border of the descending broadening wedge formation, while failure would indicate another test of $700. The primary trend is down, and breakout below 700 would offer a target of $550, the June 2006 low.

Baltic Dry Index

The Baltic Dry Index reflects international trade, especially bulk commodity shipments of iron ore and coal. The index commenced another down-swing after a brief consolidation, warning that commodity exports from Australia, South Africa and Brazil, will continue to fall.

Interbank Lending

Yields on 3-month Treasury Bills are close to zero, signaling that uncertainty in financial markets remains high. Investors concerned about default risk prefer safety over yield.

USA

Dow Jones Industrial Average

The Dow rally appears to be running out of steam, though declining volume may be partly attributable to Thanksgiving weekend. Breakout above medium-term resistance at 9000 would signal another test of 10000. Reversal below 8000 is more likely, however, and would warn of another down-swing.

Long Term: The primary trend is down and penetration of the 2002 low of 7300 would offer a long-term target of 6000. This is calculated as 8000 - ( 10000 - 8000 ). Twiggs Money Flow (13-Week) shows a bullish divergence, but is yet to be confirmed by breakout from the downward trend channel. Recovery above 10000 is unlikely in the present climate.

You Cannot Get Even
By Hans F. Sennholz

Dr. Sennholz heads the Department of Economics at Grove City College and is a
noted writer and lecturer on monetary and economic affairs.

Government affects individual in­comes by virtually every decision it makes.
Agricultural programs, vet­erans' benefits, health and labor and welfare
expenditures, housing and community development, federal expenditures on
education, social insurance, medicare and medicaid programs, and last but not
least, numerous regulations and controls affect the economic conditions of every
citizen. In fact, modern gov­ernment has become a universal transfer agency that
utilizes the political process for distributing vast measures of economic income
and wealth. It preys on millions of victims in order to allocate valuable goods
and services to its beneficia­ries. With the latter, transfer pro­grams are so
popular that few public officials and politicians dare oppose them.

The motive powers that drive the transfer order are as varied as human design
itself. Surely, the true motives are often concealed, and a hollow pretext is
pompously placed in the front for show. And yet, man is more accountable for his
motives than for anything else. A good motive may exculpate a poor action, but a
bad motive vitiates even the finest action. Conscience is merely our own
judgment of the right and wrong of our action, and therefore can never be a safe
guide unless it is enlightened by a thorough understanding of the im­plications
and consequences of our actions. Without an enlightened conscience we may do
evil thor­oughly and heartily.

An important spring of action for the transfer society is the desire by most
people to get even in the redis­tribution struggle. "I have been vic­timized in
the past by taxation, in­flation, regulation, or other de­vices," so the
argument goes, "there­fore I am entitled to partake in this particular benefit."
Or the time se­quence may be reversed: "I'll be vic­timized later in life,"
pleads the col­lege student, "and therefore I want state aid and subsidy now."

This argument is probably the most powerful pacifier of conscience. It dulls our
perception and discern­ment of what is evil and makes us slow to shun it. After
all, we are merely getting back "what is right­fully our own." With a curious
twist of specious deduction the modern welfare state, which continually seizes
and redistributes private property by force, is defended by the friends of
individual liberty and pri­vate property. "Man is entitled to the fruits of his
labor," they argue, "we are merely getting back that which is rightfully and
morally our own." They borrow the arguments for the private property order to
sus­tain the political transfer order.

Surely getting back that which is rightfully and morally our own is a principle
that is rooted in our ina­lienable right to our lives. It is a property right
that springs from our human rights and from the right to life itself. It is the
right to restora­tion of the fruits of our efforts and labors of which we are
deprived by deceit, force, or any other immoral practice. It is a specific right
to re­covery or compensation from those who are wronging us or have injured us
in the past.

This right to restoration does not beget the right to commit the very immoral
act from which we seek restoration, to imitate others in act­ing immorally, or
to seek revenge against the trespassers or innocent bystanders. But this is
precisely what the "get-even" advisors urge us to do.

In an unfortunate automobile ac­cident we are hurt or injured, or our vehicle
may be damaged, because of the negligence of another driver. This gives us the
right to demand restoration and compensation from the guilty party. But it does
not give us the right to seize another car parked in the neighborhood, or
re­turn to the road and injure another driver. Or, our home is burglarized and
we suffer deplorable losses in personal wealth and memorabilia. This does not
bestow upon us the right to do likewise to others. But the "get-even" advocates
are draw­ing this very conclusion.

He who is desirous of "getting even" in the politics of redistribu­tion longs to
join the army of benefi­ciaries who are presently preying on their victims. They
would like to get their "money back" from whomever they can find and victimize
now.

Like the victim of a burglary who becomes a burglar himself, they are searching
for other victims. But in contrast to the new burglar who may be aware of the
immorality of his actions, the "get-even" advocate openly defends his motives
while he is pursuing his political craft.

We cannot get even with those individuals who deprived us of our property in the
past. They may have long departed this life or may have fallen among the victims
them­selves. We cannot get even with them by enlisting in the standing army of
redistributors. We merely perpetuate the evil by joining their forces. So we
must stand immune to the temptations of evil, regardless of what others are
doing to us. The redistribution must stop with us.

The redistributive society has vic­timized many millions of people through
confiscatory taxation, infla­tion, and regulation. Government, acting as the
political agency for coercive transfer, seized income and wealth from the more
productive members and then redistributed the spoils to its beneficiaries.
Although many millions of victims and benefi­ciaries were involved, which often
obscures the morality of the issue, the forced transfer took place be­tween
certain individuals. It is true, the beneficiaries, who used political force to
obtain the benefits, cannot easily be recognized in the mass process of
transfer. But even if we could identify them, and establish a personal right to
restoration, our property has been consumed long ago. A vast army of
beneficiaries, together with their legions of gov­ernment officials and civil
servants, consumed or otherwise squandered our substance. There is nothing to
retrieve from the beneficiaries who probably are poorer than ever be­fore,
having grown weak and depen­dent on the transfer process.

When seen in this light, the get-even argument is nothing more than a
declaration of intention to join the redistribution forces. It may be born from
the primitive urge for revenge against government, state or soci­ety. But it is
individuals who form a government, make a state and con­stitute a society. By
taking revenge against some of them for the injuries suffered from the hands of
others, I am merely reinforcing the evil.

Revenge is a common passion that enslaves man's mind and clouds his vision. To
the savage it is a noble aspiration that makes him even with his enemies. In a
civilized soci­ety that is seeking peace and har­mony it is a destructive force
which law seeks to suppress. But when the law itself becomes an instrument of
transfer, the primitive urge for re­venge may burst forth as a demand for more
redistribution. It becomes a primary force that gives rise to new demands or, at
least, reinforces the popular demands for economic transfer. The common passion
for revenge, no matter how well con­cealed, undoubtedly is an important motive
power of social policy that leads a free society to its own de­struction.

No wealth in the world and no political distribution of this wealth can purchase
the peace and har­mony so essential to human exis­tence. Peace and harmony can
be found only in moral elevation that reaches into every aspect of human life. A
free society is the offspring of morality that guides the actions and policies
of its members. To effect a rebirth of such a society is to revive the moral
principles that gave it birth in the beginning. It is individ­ual rebirth and
rededication to the inexorable principles of morality that are the power and the
might. The example of great individuals is useful to lead us on the way, for
nothing is more contagious for greatness than the power of a great example.

To spearhead a rebirth of our free society let us rededicate ourselves to a new
covenant of redemption, which is a simple restatement of public morality. In the
setting of our age of economic redistribution and social conflict it may be
stated as follows:

 No matter how the transfer state may victimize me, I shall seek no transfer
payments, or accept any.
 I shall seek no government grants, loans or other redistributive favors, or
accept any.
 I shall seek no government orders on behalf of redistribution, or accept any.
 I shall seek no employment, or accept any, in the government ap­paratus of
redistribution.
 I shall seek no favors, or accept any, from the regulatory agencies of
government.
 I shall seek no protection from tariff barriers or any other institu­tional
restrictions of trade and commerce.
 I shall seek no services from, or lend support to collective institu­tions that
are creatures of redis­tribution.
 I shall seek no support from, or give support to associations that ad­vocate or
practice coercion and re­straint.

We do not know whether our great republic will survive this century. If it can
be saved, great men of convic­tion must lead the way—men who with religious
fervor and unbounded courage resist all transfer tempta­tions. The heroes of
liberty are no less remarkable for what they suffer than for what they achieve.

You Cannot Get Even| The Foundation for Economic Education: The Freeman, Ideas on Liberty
Foundation for Economic Education
30 South Broadway
Irvington-on-Hudson,
New York, 10533
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The Freeman: Ideas on Liberty - June 1978
Vol. 28 No.  6

©2007 Foundation for Economic Education. All Rights Reserved.
http://www.fee.org/publications/the-freeman/article.asp?aid=6015