Oct 232012
 October 23, 2012  Posted by at 9:38 pm Finance

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Japan is not a good example of how deflation typically plays out. As Ilargi points out, they were an exporting powerhouse exporting into the biggest consumption boom the world has ever seen. They also had a very large pile of money to burn through building their four lane highways from nowhere to nowhere, since they were the world's largest creditor when their bubble burst in 1989. This is clearly not our situation.

No one will be exporting their way out of a global economic depression. In contrast, exporters are going to feel the pain big time as their markets dry up. We can expect trade wars and protectionism to abound. Take note Germany, Scandinavia, Australia, New Zealand etc etc.

We have had the inflation, only instead of a currency hyperinflation, we experienced a 30 year credit hyper-expansion. Either one amounts to an expansion of money plus credit compared to available goods and services, and is therefore inflation. Credit is equivalent to money on the way up, but not on the way down. Credit loses 'moneyness' and credit instruments are massively devalued in a great deleveraging. This is deflation by definition and it is already underway. Debt monetization is nothing in comparison with the scale of the excess claims to underlying real wealth that stand to be eliminated.

I agree that the currency of a deflating nation strengthens. This is exactly why we have been writing about the value of the US dollar increasing, which it has done. The bottom came in a long time ago, and despite the set backs that are an integral part of a fractal market, the trend is up, and will be for some time. That's not to say it will be for the long term – far from it in fact – but for now that is the case. We have made it clear that cash is a short term bet (of the order of a few years), and that the longer term strategy is to move into hard goods at the point when one can reasonably afford to do so with no debt.

Some could do so now, while others would have to wait for prices to fall, as they inevitably do in a deflation, but not immediately. Price movements follow changes in the money supply. We have been in a counter-trend reflation since 2009, and prices have risen as a result. They may continue to do so for a while after the reflation is clearly over, but then the trend will reverse.

Prices will fall, but purchasing power will fall faster, meaning that prices will rise in real terms for most people. Those who have preserved capital as liquidity will find their purchasing power enormously increased, but most others will lose purchasing power because they will have no access to credit, highly unfavourable employment circumstances, rising property taxes and very little actual money.

The fiat currency regime will eventually descend into chaos as beggar-thy-neighbour devaluations become the norm, but not everyone can devalue at will or at once. The market will decide relative values for the next while.

Money will go from where the fear is to where the fear is not. It will be leaving the European periphery, and increasingly the entire eurozone, and flooding into currencies like the USD, the Swiss franc, the Swedish krona, and temporarily the British pound. It doesn't matter if the US is downgraded. Market participants will ignore the ratings agencies and vote with their feet on a kneejerk flight to safety.

You might think that the US indicators are much closer to the hyperinflation set-up than to deflation. I would disagree of course, for reasons Ilargi has explained (plummeting velocity of money for instance). I would also point out that people extrapolate the trend of the last three years forward, but fail to anticipate trend changes. We are in one. Many markets have topped already (gold, silver, commodities, oil etc), and the rolling top of the last year or so is about to claim the American stock market as well.

The rollover in the markets will drag the real economy down with it, with a time lag, since the time constant for changes in the real economy is much longer than for the financial world where value is virtual. We are headed into the teeth of the Greatest Depression, or at least the most significant one since the fourteenth century.

Hyperinflation is simply not on the cards any time soon. The depression will proceed for many years before that becomes a serious risk, unless you live in the European periphery that is, where currency reissue is a very real risk in the relatively short term.

In those currencies, loss of faith in New Drachmas, New Pesetas or New Lira is very likely, and the periphery countries will be cut off from international debt financing, with hyperinflationary results. That is not the situation in the US at all, and won't be for quite a long time. Eventually, when international debt financing is dead and buried, then printing will be a risk and a loss of faith in the erstwhile reserve currency could be expected.

In the meantime, debts defaults are going to skyrocket, each one doing its bit to destroy the value of credit instruments, and subtract from the effective money supply. This is already underway, and the great asset grab has begun as a result. Witness the asset stripping of Greece for instance.

In Europe, endless bailouts of sovereigns and the well-connected are doing nothing to increase the money supply or the velocity of money. In contrast, the ineffectuality of governments is doing nothing more than feeding the cycle of fear by demonstrating their impotence time after time. They are trying to overcome contraction, but are fighting an irresistible headwind. It is not going to work. Europe is already in contraction, and as fear will be increasingly in the ascendancy, that will only get worse.

Government obligations will be shed right, left and centre (by governments of the right, left and centre) because they will have no choice. Yes, this will lead to anarchical unrest, and yes, this will be met with a heavy-handed repressive response. Social polarization is very much on the cards – governments vs people, haves vs have-nots, natives vs immigrants, employers vs workers, unionized vs non-unionized, Us vs Them in general terms. This will not be pretty, to say the least. Just because it is a bad thing does not mean that it cannot happen, or that government, by their actions, can make any difference to the outcome.

Bailouts are never for the little guy. The creditors hold the political power and write the rules. They will not allow debtors off the hook. Instead of repayment in money, they will take people's freedom instead, making debt slavery much more real than it is today. Debts will not be forgiven, but sold on to more aggressive debt collectors. This is already happening in the US, where debt collection is becoming increasingly unconscionable.

Debts will only be effectively forgiven when people have nothing useful to repay, not even their labour. By then the middle classes will probably be living in latter day Hoovervilles, like the Villas Miserias populated by the formerly middle class Argentines.

Savers will have all the buying power, IF they have managed to get their savings away from dependence on the solvency of middle men. Otherwise they will likely disappear in a giant black hole of credit destruction, as yet more excess claims to underlying real wealth.


Home Forums Japan Is Not A Good Example Of How Deflation Typically Plays Out

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    Vic financial group collapses owing $660m

    Nervous investors, including farmers and workers in regional Victoria, will have to wait to find out what will happen to the hundreds of millions of dollars that are tied up in the company’s collapse.

    This is what TAE was talking about, but on a really large scale.



    Ever wonder what the reaction if those headlines should ever read “All Mutual Funds Halt Redemptions Until Further Notice,” meaning until all insiders have cleared their holdings? Or, “Money Market Mutual Funds Break the Buck. Redeemed at 50 cents on the Dollar.” Many don’t know how close to breaking of the buck we were in 09.

    Not to scare the horses here, but, the more I research this stuff, well,
    putting new line on the reels and sharpening the hooks! Might have to do a Sweeny Todd and open a barber shop, to keep the wife in pie material 😉


    professor –

    Not to scare the horses indeed.

    If things go really badly south (meaning, if major institutions whose short-term repo instruments fill the money market funds go BK the way Lehman did) the fifty cents on the buck event could happen.

    The funds are a bit smarter this time around – they’ve dropped euro banks from their dance cards, which I think will address the first wave of issues. But if I see tensions rising severely, you can bet my digital cash will run and hide in a short term treasury. Treasury Direct. Fewest middle men involved, and hopefully the last thing to get thrown under the bus. Its that or a demand deposit account.

    Note that buying a short term treasury and stuffing it in your brokerage account will avoid losses from your money market fund breaking the buck, but it will NOT address the problem of the broker going under. Case: MF Global bankruptcy, where MFG customers who had physical gold bars (paying storage fees, no less!) became general creditors in the bankruptcy losing the same 20-something percent off their account balances as everyone else. Best to have a sturdy broker who doesn’t play funny games with hypothecating customer assets.

    Note also the Treasury Direct purchase should probably occur a number of days prior to the emergency, or else the ACH transaction from your bank might not go through – or it might get reversed, etc. And some auctions only happen weekly, so…probably best not to cut things too fine.

    Probably best to have a plan in place, with all the abilities to transfer assets tested ahead of time, understanding the delays involved.

    Rules of Trading:
    Rule #1: don’t panic!
    Rule #2: when a panic is going to happen, make sure you panic first.


    Random chart I’m working on:

    This is a chart of finance-related headlines since late 2006, aggregated by nation, counted on a monthly basis. Its a pretty simple concept, but I think it is interesting to see how the newsflow moves from nation to nation. Is the rough number of finance-related headlines indicative of the level of crisis in the nation? Or just the amount of breathlessness the press brings to bear upon the issue?

    I don’t know. Its just data I collected. Submitted for…your enjoyment.

    Attached files


    Got it there, Dave.

    I’ve, sometime back, connected Mutual Fund accounts with FDIC bank accounts, and set up self directed IRA’s in SIPC brokerage accounts for misc. paper solids. The GNMA’s and TIP’s have been good these last few years, both .gov backed, but the sweet is about gone there. I mean, where to from zero? Damn, might as well stick it in the Bank of Atlas/Mason at these rates, yes? Especially considering what the “C” in the above “Insurance” institutions stands for!

    Pretty much collected everything forward I’m gonna need here these next few 5 or 6 years, so I’ll weather it. Been through worse.

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