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Deflation’s Worst Nightmare: A Short-Squeeze on the Dollar

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“Following every great bubble the senior currency eventually became ‘chronically’ strong relative to most asset classes, including commodities, and other currencies for most of the time.”

Bob Hoye, chief strategist of Institutional Advisors

***

With the U.S. dollar in the throes of a rally that has been rampaging since June, it’s time to revisit an idea that I first wrote about nearly twenty years ago – that a short-squeeze on the dollar could eventually cause a meltdown of the global financial system. Although doomsdayers have put forth many theories about how economic Armageddon might play out, it was always a given that the dollar would be at the very center of the crisis. The reason for this is that there are vastly more dollars in play globally than the central banks, even acting in concert, could hope to manage when the day of reckoning arrives, as it most surely will. There are perhaps a quadrillion digital dollars swirling in the financial ether right now, most of them created not by the central banks, but by modern-day alchemists who have transformed the very flotsam of the securities world – Bolivian reverse floaters, non-performing receivables of all kinds, rehypothecated brokerage accounts and such — into seven- and eight-figure bonuses for every partner on Wall Street. Each and every one of those dollars represents both an asset and a liability on the macro ledger, and although they would cancel each other out at some level, it can hardly be assumed that this would occur in an orderly way, if at all, in the event of a financial panic.

That the preponderance of those quadrillion dollars are being used to sustain an epic financial Ponzi scheme is inarguable, since the output of real goods and services in this world amounts to no more than around $80 trillion. The huge excess of funny money is tied mainly to debt instruments with life spans measured not in months or years, but in days or weeks. At present, the market for these instruments continues to function smoothly. This is mainly because a U.S. stock market trading at record highs has provided a psychological barrier against fear. However, if some unforeseeable event were to disrupt normal loan settlements, short-term borrowers unable to roll their debts would be pressed hard to settle up in cash. Given the sums involved, this would be like trying to evacuate Manhattan via the Holland Tunnel in an hour. As a result, the banking system would lock up overnight, triggering branch closures that could last for weeks or longer. The Fed would be powerless to act, since the fragile trust that currently allows the banksters’ to ply their Ponzi scheme will have been irretrievably lost. Cash would be in ruinously short supply, credit cards would no longer be accepted by anyone, and the economic world would be pushed into a state of barter. For anyone holding actual currency, fives, tens and twenties would be the coin of the realm, since that’s the only kind of money sellers of food, gas and emergency supplies would recognize at that point.

“Are You Nuts?”

When I ran this scenario past a few international finance professors some years ago, they acted like I was nuts. Even the authors of The Incredible Eurodollar, the book that had led me to believe that a short-squeeze on the dollar was possible, averred only that the theory sounded “interesting.” From a deflationist perspective, however, a panic-driven scramble for dollars seems not merely plausible, but likely.

For readers unfamiliar with the concept of a short squeeze, a brief explanation is in order. A short squeeze can occur when it comes time to repay a loan in some good or medium of value that has been overborrowed. If, in the interim, the supply of the good or medium has been reduced or curtailed for some reason, the borrower might have to pay up for it to acquire it for delivery.  This happens all the time in the stock market.  Speculators bet against companies by shorting a company’s shares in expectation of replacing them at a lower cost. They have effectively sold shares that exist only in virtual form outside of the float, and if there’s a dividend to be paid, the short seller must pay it out-of-pocket.  If the stock price falls, the short sale will be profitable; but if the price rises, short sellers will be on the hook to deliver at the original price. A contractual seller of nearly any item could conceivably be caught in such a bind. Consider the builder who promises in writing to complete a home for $1.25 million that includes copper roofing and gutters. If the price of copper were to rise by a significant amount, the extra cost to the builder might wipe out his profit or even produce a loss.

Subprimes Are Back!

To put this in the context of the dollar, all who owe have effectively taken short positions against the dollar. As such, they are implicitly rooting for inflation, since it will allow them to retire the debt in cheapened dollars. That’s a very big bet in the aggregate, since it encompasses all mortgage debt. Unfortunately, the opposite holds true for borrowers right now.  Deflation has begun to overwhelm the expansionary goals of monetary easing, particularly in Europe.  Meanwhile, the dollar is becoming dearer by the day despite the Fed’s best efforts to keep it in plentiful supply.  And although inflation is obviously rampant in the stock market, it no longer obtains in the housing sector.  Nor will it return any time soon, judging from the Fed’s wantonly desperate attempt to power real estate inflation with a new gusher of subprime loans and 3% downpayments from those who could not otherwise afford homes.

So far, the rise in the dollar seems benign, even if it has begun to negatively impact overseas earnings of U.S. multinationals.  But if the dollar continues to move higher, you can be certain this will unsettle the arrangements that have swelled the derivatives bubble to its current size.  More to the point, a steepening or even parabolic rise in the dollar would begin to suck money out of all investments and into the presumptive safety of Treasury paper.  Thus would the world’s investment capital come to reside in securities yielding 2.5% (and falling), sending all other classes of investable assets into a tailspin. That would be debt deflation at its worst and most unstoppable. With real estate prices falling more steeply than during the financial crash of 2007-08, even 3% mortgages would become a crushing burden on homeowners.

Against this outcome, we can only pray that the dollar stops rising.  However, on the basis of the foregoing we already know why this is occurring, and so we shouldn’t get our hopes too high. In the meantime, the old adage applies:  He who panics first panics best. That means leaping into long-term Treasurys right now with abandon, before most investors begin to figure out that the already impressive bull market in U.S. debt has been merely a warm-up. For a detailed commentary on this that appeared on Rick’s Picks a month ago, click here: Inflation, Deflation and Our Very Confident Bet in T-Bonds.

Please do not ask trading questions!

  • Other Paul November 16, 2014, 8:11 pm

    With all the thoughtful comments, above, I’ve only seen Mava, thank you, draw the conclusion that I hope would be addressed, that is, the federal government can expand its give-away programs to people-people and corporate-people, ala a million dollars in every pot, except in the greedy .1% ers’ $1, 000 pots.

    I understand Rick’s points about the increasing ineffectiveness of expanding GDP per dollar of addition debt. Since when, lately, has the Gov’t been concerned about inefficiency?

    If you give individuals the money to pay off their mortgages, there won’t be a mortgage crisis. The homeowner is happy (as Rick noted, above), and the lender is happy.

    I never thought that the government and central banks could save the financial world in 2008-2009. They did it with, relative to the GDP, a minor increase in their balance sheets. Why can’t they save the world again? Yes, the percentage increases in the balance sheets look dramatic, but a doubling or tripling from here doesn’t compare to the US or world GDP.

    Rick, thanks for the forum.

    • Rick Ackerman November 16, 2014, 8:55 pm

      The Fed is carrying more than $4 trillion of sludge on its balance sheet. Everyone — I’m talking especially about economists, bankers and the lazy, miserably ignorant hacks who cover the news — acts as though this little problem is somehow separate from the banking system itself. It is not. Our banks and the Fed are one and the same — are not merely joined at the hip, but share the same brain, nervous systems and organs. To speak of the Fed as ‘warehousing’ the entire banking system’s troublesome paper is almost as stupid as some of the things Greenspan used to say (i.e., that inflated home values constitute ‘wealth’, and that the U.S. supposedly was enjoying an investment boom when household savings growth was in fact negative.)

      Regarding your use of the word ‘efficiency,’ it’s not as though the problem has been stabilized, or that GDP growth per dollar of debt added is not getting worse. To paraphrase Herb Stein (Ben’s father, an economist who worked for Nixon and Ford), If something can’t go on forever, it won’t.

  • mario November 15, 2014, 12:48 pm

    Well worth noting:

    “According to data compiled by Goldman Sachs, most American workers earn below $20 per hour. Goldman Sachs economists David Mericle and Chris Mischaikow crunched Labor Department data that is used to generate the monthly jobs report that the market closely watches, in particular from the survey of employers.

    The chart, shown above, shows that 19% of workers make less than $12.50 per hour, 32% of workers make between $12.50 and $20 per hour, 30% make between $20 and $30 an hour, 14% make between $30 and $45 per hour, and 5% make over $45 an hour.”

    So, 51% of workers make $8 to $20/hr while and 44% of workers make $20-$45 while 5% make over $45/hr.

    So, 44% of 120 million employed in the U.S. is around 50 million folks earning $20-$45/hr.

    Converting to households, assuming 1.5 per household that’s 33 million households earning $3200 to $7000/month and 50 million households earning $1200 to $3200/month.

    I would suggest those 44% earning $20-$45/hr plus the 5% earning over $45/hr helps explain why the economy is not completely falling apart, that’s a pretty large swath of people doing well.

    Cheers, Mario

    • Andy Gutterman November 15, 2014, 2:47 pm

      Mario,

      What you just proved was that my ratio was too generous.

      81% make less than $30/hr. $30/hr. is ~$60K per year. $60K for a family of four isn’t very much, and they aren’t likely to be doing very well.

      The economy is being held up by fewer and fewer people, at some unknown number it reaches a tipping point and crashes from lack of demand for anything but essential goods and services.

      The rich cannot support the economy forever.

      Andy

      • mario November 16, 2014, 12:44 pm

        Hi Andy, all good my friend. However I’m going to disagree with you that a family on $60k is struggling. If they are, I won’t hesitate to suggest its their own fault, though I must note that they have been brainwashed by the society in which they live to be idiots when it comes to managing their household budget and choosing how to spend their money. A wise family of four could easily live a comfortable budget and sock away $500/month if they just paid attention to how to make that possible in a reasonable way. I won’t accept someone telling me its not “doable” when said family, using one example, typically has a $450 BMW leasing payment, etc…that’s them being pure idiots.

        Cheers, Mario

  • mario November 14, 2014, 3:23 am

    However it may be indirectly tied to the current topic, headed up gang on next week when the mainland China exchange becomes linked to the HK exchange and open to the direct trading. Our interest should be what moves the institutional investors have put in place in anticipation and will do in coming weeks with their money. I have no idea how much of an outflow from the U.S. Indexes might occur, bit it’s a very big , high implication deal moving forward. Present Obama’s been here up in Beijing these days at the APEC and seems everyone is playing nice. That bilateral relationship is far more important than any other.

    Cheers, Mario

  • Andy Gutterman November 13, 2014, 3:57 pm

    Rick writes:

    Deflation will most likely be catalyzed by one or more of the following: 1) a geopolitical shock; 2) a bear market in stocks; 3) a small drop in home prices.

    There is a fourth, stealth cause for deflation that very few are aware of:

    The increasing inability of the consumer to be able to consume, caused by too much debt and therefore debt service and incomes that do not keep up with hidden inflation. If you have a family to feed and the box of cereal costs the same but has a couple of ounces less then the cost went up. I just read somewhere about diaper deflation. Same price but fewer diapers in the pack. All these changes put the squeeze on consumers.

    Add in the lousy job market, with most jobs created being either part time or low wage and that just exacerbates the problem.

    So what all this adds up to is a creeping inability to maintain spending across the economy. The same thing happened in the 20’s as money moved from the lower and middle classes to the upper class.

    Andy

    • Oregon November 13, 2014, 6:29 pm

      That is a higher price per diaper. How is that deflation?

      &&&&&&

      Any new father can answer that one, Oregon. Diapers that formerly were rated “14-20 pounds” are now designed to hold only 12 pounds of poop, maximum. The price is the same, though. RA

      • Andy Gutterman November 14, 2014, 2:55 pm

        Deflation in the number of diapers per package, for the same price or a touch less. Puts the squeeze on the consumer even more.

        We have a 60/40 economy. 60% are almost or on the margin, just able to make ends meet, while the other 40% cannot seem to understand the plight of the 60%. The 60% number is growing. At some point it gets large enough to cause the economy to go into runaway contraction.

        That’s when deflation will really take hold.

        But even when it does I doubt you will see it in falling prices since so much of what we consume is processed material. You can’t compare today to 80 years ago, its a completely different economy. We will get deflation in the price of assets and debt contraction on a grand scale. Anyone dependent on commodity prices will get hit, much like the oil companies today.

        Andy

      • Oregon November 15, 2014, 7:31 pm

        So less diapers per dollar is deflation, and more oil per dollar is also deflation.

        Probably just a coincidence, talking about diapers, cause I think you’re full of s**t.

      • Oregon November 15, 2014, 7:40 pm

        “Any new father can answer that one, Oregon. Diapers that formerly were rated “14-20 pounds” are now designed to hold only 12 pounds of poop, maximum. The price is the same, though.” RA

        RA, I feel like an idiot. Had I known that diapers could hold 14-20 lbs. I would have left my kids in them a couple days longer. Buying 1/6 of the diapers for two kids could have saved me alot of money.

        &&&&&&

        Many new dads rely too much on that “12 pounds” claim on the label, Oregon. My own kids’ diapers seemed pretty well saturated when only 4-6 pounds of poop had accumulated in them. There should be a law that forces Proctor & Gamble and their ilk to label diapers so that dads don’t get inflated ideas about a diaper’s limits. And frankly, I cannot believe that diapers labeled for “18-22 pounds” could possible hold that much.
        RA

  • Dwain Dibley November 13, 2014, 12:19 am

    There’s one key element you’re overlooking, credit, even when issued by the Fed, is not ‘Dollars’, that’s why they use the term ‘Denominated In’. Credit has no legal status as a currency at all. When the ‘dollar’ blows up, all that credit is going to POOF! out of existence and all anyone is going to be left with is the debt, with no medium to pay it.

    $1.24-Trillion in circulation around the globe, that’s all the ‘Dollars’ there are, all the rest is credit, a vacuous promise to pay.

    • Rick Ackerman November 15, 2014, 10:10 pm

      That’s why I always tell gold hoarders to hoard a shoebox full of ones, fives, tens and twenties while they’re at it, Dwain.

    • mario November 16, 2014, 12:37 pm

      Dwain, pray tell how the heck and why would the dollar “blow up”…its a mostly absurd idea relative to other currencies and commerce taking place around the world.

      Cheers, Mario

  • sutton November 11, 2014, 10:14 pm

    Cnbc’s website has a story on the popularity of trading 20 minute options. While I’m completely ignorant of such a product it sounds like something that appears at a top.

    &&&&&

    High-frequency traders are effectively already trading nanosecond options, since they have the ability to enter or retract bids and offers ahead of orders speeding at the velocity of light through the pipeline. But yes, it describes a dynamic that would only obtain in markets that have become overtraded nearly to death.
    RA

  • Traveler November 11, 2014, 8:52 pm

    Inflation, sure. Hyperinflation, no that is not going to happen. Not as long as there is a big market from anyone for US bonds. For while the big bondholders may not mind mild inflation since the money is created, not actually their money, they will not stand still for hyperinflation as that would make their bonds worthless.

    Bondholders will also be okay with mild deflation. Only when deflation gets out of control will they get screwed. I didn’t say “if”, I said “when”. It is inevitable since deflation forces governments at all levels to confiscate a greater share of the economy to feed their pensions and power bases. Hence the ruinous deflationary spiral.

    Says here deflation, here we come. What’s unique about today is that *all* G20 economies and many more are affected. Very interesting times, indeed.

    &&&&&&

    A quadrillion-dollar bubble cannot be liquidated by mere inflation; only hyperinflation will do the job. Also, you seem to think that just because a particular economic outcome would be ruinous it can’t happen. History has demonstrated time and again that the opposite is true. RA

  • Stephen G November 11, 2014, 6:08 am

    Not sure if you’ve written much about the proliferation of currency agreements that China is pursuing. Last week it signed a deal with Canada for direct yuan-loonie exchange without converting to US dollars as an intermediary. It already has similar deals with Japan, EU, UK, Singapore, Australia, New Zealand, India, as well as its key ally Russia. The majority of these were signed just in the past 1-2 years.

    It isn’t just China either – India and Japan, for instance, have an agreement amongst themselves.

    The US financial media seem to have completely ignored completely the threat this presents to the USD by way of decreased international demand.

    &&&&&&&

    This trend will have no discernible impact on the dollar, since demand for dollars to pay for actual goods and services is insignificant compared to the demand for dollars to use for financial alchemy. Also, using currencies other than the dollar to pay for “stuff,” especially oil, is undesirable as far as the whole world is concerned. Who wants to pay for crude with hard(er) money or gold when crude can still be bought with dollars that are in nearly infinite supply? RA

    • Andy Gutterman November 12, 2014, 1:53 am

      I’ve yet to hear of a cogent argument for dollar replacement. What most people forget is other countries as well as our own want the reserve currency to be from a very stable economic environment. No country is more stable than the US.

      A reserve currency also has to have a gigantic trading market behind it with almost unlimited resources. The USA again.

      Last is trust. Would you want to trust your funds with Russia or China where the government is by dictatorship?

      Andy

    • mario November 12, 2014, 2:30 am

      Hi Stephen, agree with Rick. A more available RMB is not a particularly direct threat to USD strength and the ties between the U.S. and China economies are so complex now that there are other factors far more important. Any economic strength coming from China is a blessing to the rest of the world with the U.S. being first on that list. So then as expansion of the RMB trade outside of the mainland grows it furthers supports China’s economics which are supporting the U.S. economy which in turn is a very internationally diverse economy.

      Cheers, Mario

  • Scott November 11, 2014, 3:56 am

    This is a great conversation board…. Very thoughtful. But there will be NO DEFLATION until all other options are used. Govt will gladly take ALL our credit card and auto debt and means test it to annual income caps like they will be doing for student loans… Essentially granting the debt jubilee Professor Keen says is needed.

    What this country needs is usury laws back on the books.

    &&&&&

    Means-testing our credit cards? Even Obama himself might concede that would be a smidgen too socialist for his taste. Still, with the government judging and enabling my spending power, it might be a way to put the kabosh on my wife’s jones for shoes and handbags. RA

    • Jason S November 11, 2014, 6:28 am

      Means testing our consumer debt and/or mortgage debt is deflationary. That means that the lender takes the hit rather than the borrower. Debt being “forgiven” or delayed in its payment are both means of default and deflationary regardless of who eats the loss.

      • mava November 11, 2014, 9:36 am

        I think you’ve made a typo here, Jason S.

        Normally, in the US, a lender is always taking a hit. This is, again, a normal for US, inflationary environment.

        If deflation happens, then the borrower takes a hit.

        The whole reason for the inflation is to enable the borrower to screw the lender. Keep in mind who is the borrower in the US (the big brother). Little tiny insignificant entities such as people do screw the borrower only because they follow in the footsteps of a giant, it is incidental. And only in one plane – their little debt, such as their mortgages and credit cards, car loans and other junk. But they are all are the lenders to the us government, and they are continually getting screwed thanks to the policy of inflation.

      • Jason S November 11, 2014, 8:19 pm

        Mava, no typo. If there is means testing it indicates that the government steps into an existing credit contract and says, “if the borrower makes less than ‘X’ then they dont have to pay it back” or that the repayment provision is delayed or extended in order to help the borrower handle the debt load. In these instances it is the lender who is harmed by a loss rather than the borrower. Normally there would be consequences to the borrower in a default like loss of property, income tax inclusion of debt forgiven, increased future borrowing costs but with means testing this likely doesnt occur.

        As for deflation being under government control, it is not. Inflation is the construct, deflation is the natural order. It is much like the law of entropy, it is constant and consistent. Man is forever thwarted in the end trying to defy it. We believe we are gods and try to prove it by doing the impossible only to have a shocked look on our face when we fail. Then we begin blaming and then go back to trying the impossible.

      • mava November 12, 2014, 7:05 am

        Funny that we have such a different outlook.

      • mava November 12, 2014, 7:13 am

        The discussions on various board across the net on subject of deflation are the best time spent (for fun). They count pages and pages, and everyone means different thing when they say “deflation” or “inflation”, yet they argue as if their subjects could not even theoretically be in two separate places at the same time.

        &&&&&&

        For the record, when I talk about deflation I mean to imply a tightening of debt’s noose rather than the standard definition — i.e., a decrease in the money supply. An increase in the real burden of debt is what is going to do us in, and although the process is being held in check for now by the central banks, it cannot be stymied indefinitely. Deflation will most likely be catalyzed by one or more of the following: 1) a geopolitical shock; 2) a bear market in stocks; 3) a small drop in home prices. RA

  • Rick Ackerman November 11, 2014, 3:01 am

    Gentle Readers:

    If you’re going to weigh in, please do so with deference to that teensy mortgage problem. As far as I’m concerned there are only two pathways: 1) hyperinflate so that mortgages go away. That ain’t gonna happen; or 2) re-write mortgages so that, in the Second Great Depression, we all become, effectively, renters.

    I’ve written about #2 before, and it seems like the only possible outcome. Inflation it is not.

    • mario November 11, 2014, 5:03 am

      #2 seems the direction Rick… Let’s not fret too much about the idea of being a nation of renters… its the norm, for example, in Germany….Cheers, Mario

    • Carol November 11, 2014, 5:46 pm

      We are already a nation of renters. It’s just that people “believe” they own their homes. Stop paying the “real owner” the county their property taxes and see how fast they take “your” property. If they can take it and sell it, they must own it, right?

      &&&&&

      Spot-on, Carol. Nice to see you back. RA

  • mario November 11, 2014, 2:01 am

    A great thread on the USD here. It can be looked at strictly from a technical/banking/lending/money supply point of view, but what about the economic/market forces view. The entire core structure of how we do business across the globe, how we buy and sell services and products, what those products and services are, how they are distributed logistically is radically transforming in today’s modern global economy. There are so many elephants in the room that even the experts aren’t any more. New barriers are going up, yet old business barriers are toppling like the Berlin Wall on a global economic scale. Any attempt to analyze what is happening from a “U.S.” economy point of view is inherently myopic and narrow.

    When I tell you that one day 500,000,000 people with plenty of cash across the Pacific can’t purchase on amazon.com today but suddenly can tomorrow and forevermore, tell me what THAT does to the economy USD? I’ve got a dozen more scenarios like this happening as we speak, all on a scale of mega global impact. I’m trying very hard to wrap my head around it, create a cohesive picture and impact in the future even just ten to twenty years from now. The China Center, 190,000sq ft on five floors in the new World Trade Center just opened, creating hundreds of jobs.

    We need to figure it out, and in the end I don’t sense the combined forces are going to lead to a global Armageddon scenario. While there will be damage along the way, markets and societies respond to insanity, to change. Look at the rise of local pharmacy based lowcost medical clinics in pharmacies for example, in response to the tyranny of Obamacare in the U.S. Now a dollar buys more there, a good thing.

    What does a radical transformation of the global economy do to the USD, it aint just about the bankers.

    Cheers, Mario

  • mava November 10, 2014, 10:46 pm

    I was going to ask the question of what would stop the FED from printing any amount of dollars needed to cancel the debt that needs cancelling, or even simply credit those accounts that would need to be credited, thus short circuiting the bottleneck around the Holland Tunnel?

    But Other Paul had just asked that.

    • mava November 10, 2014, 10:56 pm

      I see that Jason S took a stab at the question. But, I don’t see the explanation of why wouldn’t the FED triple, quadruple, or multiply their efforts by ten of a hundred times?

      What, do you think that these honorable government shmucks will sit down and say: “Nah… let’s just have the deflation!”?

      The truth is, they will take it as high as necessary to counter the deflation (as defined here), and on the maximum printing inflection point we have the danger of igniting the hyperinflation, which is still way more preferable to the government than the dollar appreciating. There is nothing that can stop them to try to inflate even a million times more than necessary. They can and will overshoot. (Because they can).

      This is why, the only outcome is hyperinflation.

      • Jason S November 11, 2014, 2:32 am

        Mava,

        I will try and answer the question (I am not sure there is an answer as the Govt may try anything at some point to avoid the inevitable).

        To create money the Fed will buy government bonds or foreign currency from the open market (i.e. banks, brokerage houses, other governments, etc.) These assets then are on the books of the Fed (currently $4.3 trillion). Let’s say that the US Govt wanted to create $80 Trillion and deposit it into the accounts of Americans to shock our economy to life. First the Fed has to buy $80 trillion of bonds and foreign securities out of the market which would drive interest rates down to literally zero and prices would go sky high since everyone around the world holding US Govt bonds would hold out for outrageous prices knowing Uncle Sam had an $80 trillion checkbook. They would also buy foreign currencies and that would cause the dollar to devalue against whatever foreign currencies they were buying. Those foreign currencies would go much higher making their economies suffer overnight, likely throwing them into immediate recession or worse. Which Govts do we want to piss off that badly because it will likely start a shooting war?

        Now, the Fed injects all this money into the banking system and the Govt forces those banks to deposit the money via some formula into every American’s bank account or send them a check if they don’t have an account. Now America goes on a spending spree. Let’s say it takes us two years to spend this windfall money. Early on everything goes up, securities, tangible assets, employment etc. but it doesn’t take long for input prices to rise as well. This leads to horrible inflation. But once the money is spent there is no longer crazy demand for stuff, production drops, people are laid off and we hit a recession or worse. Because prices are sticky they stay high longer than they should, compounding the problems of dropping production and lay offs, increasing the loss of standard of living. People become complacent and demand more money from thin air, they don’t want to suffer the hangover.

        There is a limit to how much in securities and currency a Central Bank can hold on its balance sheet before other Central Banks, etc. lose faith in their ability to maintain order. We just don’t know what that is and it varies. This precludes war breaking out due to the manipulation as I stated earlier.

        Technically what we are experiencing is the after effects of creating about $5 trillion (not to mention the many more trillions that are in the shadow banking system that spawned from our fractional reserve system). This course of action breeds societal apathy and degeneration as more and more people are incentivized to not be productive. Why work when money falls from heaven?

    • Rick Ackerman November 11, 2014, 2:52 am

      Mortgage holders wouldn’t like that, Mava — but hey, if I got a check from the Guvvamint to pay off my mortgage in snide, I wouldn’t complain.

      • mava November 11, 2014, 9:21 am

        Jason S,

        You won’t believe how many points I agree with you on. It’s just somehow, when I read your post, I get that you say all this, basically predicting the inflation, and yet, somehow you think that the government will choose an even worse option, – the deflation.

        You describe how the dollar will get killed if the govt decides to print 80 trln. Correct. Somewhere between that and now (dollar grows), lies a happy point which they will attempt to hit. They always do.

        To think that they will chose tough love of deflation is to think that a drug user will decide to go thru horrible recovery rather than to continue shooting ever increasing doses.

        And, of course, as you note (no telling what the govt will do), they don’t have to buy anything to create the money. Who’s watching? No one. We are not even allowed to know (Patriot Act , etc.). They will simply print, and inject where necessary. Through same cia fronts as always.

        Also, appreciating currency does not have any impact on trade. It’s a Keynesian myth, because it plays perfectly with the alleged reason for constant inflation. Thanks to this myth, all states continually inflate, supposedly to reverse the harm the other states had done by inflating.

        BTW, Peter Schiff kind of explained the gist of this a little bit in his recent address to Swiss citizens on their upcoming referendum.

        RA,

        You won’t get any, as you are not systemic. But, like you, I would not reject it either, ha-ha. Only the big boys will keep getting it.

        I totally agree that what an economy needs is the deflation. But my point has always been that it will not be ever allowed to proceed, and we will always choose a sweet deadly pill of one more round of inflation instead, because we can. Until the day when the last round of QE has triggered a runaway hyperinflation and a complete collapse.

        For this drunkard cannot stop, – it’s a country not a person. There is no single will connected to that same person health and future. It’s a “society”, meaning that while our common future is being destroyed, the continuation of this destruction if even for one day at a cost of eternity, is always going to be beneficial to some.

        We are going to hit the wall full speed without ever applying the brakes of deflation, because this eventuality is governed by the economic law described as the “tragedy of the commons” (I absolutely hate commons, so I don’t find it tragic at all). If it was even possible to do the right thing and to allow the deflation, then we would not see the history chock full of failed nations. They all have done the exactly same thing for the same reason.

        &&&&&

        If it were a matter of not “letting” deflation happen, Japan and Europe would not be getting sucked into a black hole of deflation, as is the case. If any country, the U.S. included, wants to get serious about inflating, then let them declare a moratorium on income taxes for a year.
        RA

      • mario November 16, 2014, 12:35 pm

        On your comment about income taxes Rick,

        In fact since issuing $80 billion a month had become commonplace for the past several years…what if they did in fact announce an income tax reduction bonus plan for the country to the tune of $80 billion while also issuing another $80 billion…hell, what’s another $80 billion on top of the Trillion + they already issued… Am I being dumb here?

        Cheers, Mario

  • Jason S November 10, 2014, 10:39 pm

    It has been a long time since I looked at the Big Mac index and found this a little shocking as well. More from the standpoint that Singapore, Canada and Australia have higher per capita incomes than we do. You can also see that Norway almost doubles ours.

    http://www.economist.com/content/big-mac-index

  • Other Paul November 10, 2014, 6:26 pm

    Government leaders and Central Bankers took the course, Deflation 101, in 2008, and passed the course with flying colors, if asset prices, car sales and GDP growth are any indications since then.

    Here is the final exam’s question with suggested answer for the (near?) future Deflation 201’s course:

    Question: Deflation’s killing the economy–dollar’s rising, demand for Treasuries going through the roof, loan defaults ravaging lender’s balance sheets, non-1%ers suffering, etc. You are the economic guru for Uncle Sam and Ms. Yellen. What do you advise?

    Suggested Answer:

    Summary: Conjure, borrow, print, distribute dollars, as much as needed.

    1. You give the country’s spenders and borrowers digital dollars, and, to satisfy those old, hardcore, show-me-the-money, fuddy-duddy vendors, print paper dollars for the spenders to convert their vapor dollars into “real money.”

    2. To bless the populace with free money, issue Treasuries and have the Fed or US Treasury conjure up the digital bucks to buy Treasuries. USGov’t agencies distribute the money to “deserving” spenders and businesses based on economic justice principals.

    Voila–Prices rise, demand increases, private debts can be paid off (or the lender or businesses bailed out). Those pesky problems of dollar strength and deficiencies in Treasury debt availability? Solved!

    Epilogue: Global governments and central bankers have been there and done the solution to the Great Recession. The solution to the Great Depression II (or I, part 2?) will not be the meek government response of the early 1930s, gold confiscation (plenty of paper gold around now-a-days), and, God forbid, physical work programs like the WPA. It will be digital dollar production, direct deposit preferred, need not work to win.

    • Jason S November 10, 2014, 10:12 pm

      OP,

      Your options 1 and 2 have been what the US Govt. has been trying. Option 1 has been done in the form of extended unemployment benefits, food stamps, HARP program loan forgiveness, etc. yet velocity continued to decline. Option 2 has been done in the form of TARP and QE 1,2,3 &4 yet velocity continued to decline. We have been applying your epilogue’s point, “The solution to the Great Depression II (or I, part 2?) will not be the meek government response of the early 1930s, gold confiscation (plenty of paper gold around now-a-days), and, God forbid, physical work programs like the WPA. It will be digital dollar production, direct deposit preferred, need not work to win.” in ever increasing amounts for decades and now we are to the point where we are actually paying people more money to not work than what the job market is willing to pay them yet velocity continues to decline.

      The problem is that the debts of the 90% far exceed the assets of the 10%. In this environment the dollar’s appreciation will increase the deflationary pressure. That will benefit the upper 10% of the population but that growth cannot counter balance the deflationary pressure applied to the other 90%.

      The dollar appreciation could be the iceberg that sinks the Titanic. Since everyone is trying to devalue at the same time in order to support their debt burden the problem isn’t with the US’s ability to borrow or pay but with all of the emerging countries who have tied their currency to ours. They are already heavily indebted and as the dollar strengthens it forces them to borrow more to buy dollars in order to maintain their peg or run the risk of out of control inflation and the societal/political chaos that would bring.

      Take this statement from the latest Geneva Report, “The world has not yet begun to deleverage its crisis-linked borrowing. Global debt-to-GDP is breaking new highs in ways that hinder recovery in mature economies and threaten new crisis in emerging nations – especially China.”
      http://www.voxeu.org/article/geneva-report-global-deleveraging

      It looks like we may be accelerating to a global inflection ‘bang’ point postulated by Reinhart and Rogoff.

      &&&&&&

      Nice work, Jason. RA

      • Jason S November 10, 2014, 10:29 pm

        As an epilogue, read Manias, Panics and Crashes by the late, great Charles Kindleberger. He outlines how these types of monetary and financial actions have created debt fueled financial crises in the past. This time around it will be interesting to see if and who the lender of last resort will turn out to be.

      • mario November 11, 2014, 1:28 am

        My understanding Jason is that the IMF is next in line more broadly extending their Special Drawing Rights tool if and when needed…. What will that do to the rising dollar?

        Cheers, Mario

    • Rick Ackerman November 11, 2014, 2:42 am

      You haven’t cured the real estate problem, Paul, not by a longshot, and it would still be by far the biggest item on Joe Sixpack’s balance sheet. A temporary fix came in the form of a 3%+ re-fi cycle after the Great Financial Crash that provided a crucial boost to the consumer economy the last few years.

      But for reasons I tried to make clear in my commentary, there is no way the Masters of the Universe will be able to trigger off another re-fi cycle at 2%. The reason for this is chicken-or-egg: a housing inflation that ain’t gonna happen would be needed first to “top up” equity for such a binge. Instead, it would seem, all the Fed can muster, working in concert with Fannie and Freddie, is 30-year mortgages at 4% for buyers who can’t actually afford to own homes.

  • Bob Hoye November 10, 2014, 4:46 pm

    Guys
    When the financial world, including desperate central bankers are geared for advancing prices, falling prices become a dangerous prospect. The way it seems to work is that leverage is employed against rising prices. Indeed it is rising prices that permit the credit expansion and then it is falling prices that force the credit contraction–making the debt very difficult to service. Particularly when it is due and payable in the senior currency and into the financial center. It used to be sterling and London. Now it is dollars and New York.

    The notion that soaring crude oil is a soaring tax on the consumer is a “crock”. The business cycle prevailed for a long time before petroleum became a commercial product. Commodities went up and down. For example one of the important ones has been copper. So was copper a tax on the consumer. No way, nor are crude oil prices.

  • Andy Gutterman November 10, 2014, 2:41 pm

    I thought your chart was interesting. You started the line from the secondary peak in ’06 rather than the primary peak on ’05.

    I redrew the line:

    http://www.booktrakker.com/Economy/RicksDollarChart.jpg

    What you get is a “perfect” backtest of the previous resistance, which now becomes support.

    So now the dollar is on its way into the stratosphere, with gold going in the opposite direction.

    Deflation in its purest sense. First gold, now oil, eventually debt. How it plays out is anybody’s guess, but I suspect its going to be a lot worse for China than it is for us.

    The US may actually benefit from all of this.

    Andy

    • Rick Ackerman November 10, 2014, 4:29 pm

      I’d considered the same trendline you’ve drawn but decided it was overkill. Also, the line I settled on picks up the third peak more precisely. Regardless, both say “Breakout!”

  • Bc November 10, 2014, 11:05 am

    Well the Ruble is falling like a stone. 11% in one week. The Yen is threatening to collapse for very good reasons. Europe looks to be breaking up starting in Spain. How strong will those new currencies be? Yuan? Please.
    A very strong dollar seems baked into the cake at this point. Very cogent analysis.
    Another debt deflation predictor is Steve Keen. He just points out that aggregate demand equals aggregate income plus the change in debt. If private debt shrinks aggregate demand tanks. When paying down debts begins in earnest to escape the pain of deflation aggregate demand shrinks. People forget that default is also a wicked form of retiring debt. Default also drives the change in debt negative and clobbers aggregate demand. Irving Fisher figured this out in the thirties but we have forgotten the lessons.

    • Andy Gutterman November 10, 2014, 3:39 pm

      Consumer debt, excluding mortgages, is at an all-time high. Mostly because of auto loans (many subprime) and student debt, plus the inevitable living off the CC because income isn’t enough.

      Deflation in the early stages is very beneficial to the economy, especially because it affects the largest component of all, energy. Like a tax cut.

      The real question is where is the income to support the debt?

      Why won’t Wile E. Coyote look down?

      Andy

      • Rick Ackerman November 10, 2014, 4:33 pm

        We don’t have the “good” deflation, which historically has been a benefit of technological advances. What we’ve got is outright bad deflation — the kind in which the real burden of debt is steadily increasing and savers get cheated out of decent returns.

  • SA1 November 10, 2014, 11:04 am

    “Following every great bubble the senior currency eventually became ‘chronically’ strong relative to most asset classes, including commodities, and other currencies for most of the time.”

    What the H#!! does that mean? I assume the USD is the senior currency referenced and so because of the (housing?) bubble is strong versus the other currencies and commodities? Is that supposed to be a bad thing? Why? All due respect to Bob Hoye, it is only remotely related to that bubble. But the USD will be the last currency standing.

    Cheaper commodities? Great. Cheaper gold? The better to buy my friend. Cheaper Euros, Yen, Aussies, Loonies? Thank you. I’m short those currencies.

    “…a short-squeeze on the dollar could eventually cause a meltdown of the global financial system “ Now that I can buy. I also wouldn’t be bothered too much by such an occurence. I am short, since Aug., every major foreign currency except the Peso, and that one is on my watch list.

    “The Fed would be powerless to act, since the fragile trust that currently allows the banksters’ to ply their Ponzi scheme will have been irretrievably lost.” YES! Thanks to the Republican takeover and control of the congress, the Fed (the democrat’s instrument for financial manipulation) will not be able to do QE 4 or anything similar to save Obama.

    Regarding the quadrillion dollar derivative debt hanging over our heads, I believe that I was the first to bring that up in the Rick’s Picks chat room a few years ago along with the repercussions and was laughed out of the room by Paul Coughlan and Andy Maguire. They probably picked the Miami Heat over my Spurs last year too.

    I have a mortgage that I incurred a few months ago. I do not consider it a short against the dollar because I am not betting on inflation to pay it off. As long as I am able to pay a PPI at 3.5%, I am in no jeopardy. Rates could go from ZIRP to 14% ( the rate I bought my first home at in 1974) and it shouldn’t affect me at all as far as my mortgage debt is concerned.

    • Rick Ackerman November 10, 2014, 4:40 pm

      Dale: Chop the value of your home by 70% and see how that new mortgage feels. Regarding the Republicans plans as regards QE, it doesn’t matter which party’s in power — the monetary perpetual motion machine, like the Mississippi, jes keeps rollin’ along.