In his column in the Wall Street Journal Joseph C. Sternberg points to some indicators I hadn’t thought of before that there may be some trouble on the horizon:
Insight emerges from a browse through Adam Fergusson’s 1975 history of Germany’s hyperinflation, “When Money Dies.†The run-up in consumer prices was only part of the way the monetary excesses of the early 1920s destroyed German society. Other evils abounded.
Middle-class investors found the value of and income from their capital wrecked by a phenomenal bid-up in prices for financial assets, whose nominal gains masked inflation-adjusted plunges. Financial disorder stoked growing unease bordering on panic on the part of a bourgeoisie that had relied on its capital investments to fuel German economic growth and also to fund its consumption.
A consequence of chaotic financial markets was a new boom in speculation. The economic miseries of the era were not uniformly distributed, and the divergence between new classes of haves and have-nots stoked political and personal resentments alongside rampant corruption. Does any of this sound familiar?
In other ways too, faint but eerie echoes of the Weimar era are starting to sound. A curious phenomenon of that time was the emergence of Notgeld, or emergency money, printed by local governments or larger corporations to facilitate commerce amid the collapse of national money. Is bitcoin the Notgeld of our day? Elon Musk might think so, given Tesla’s recent $1.5 billion bet on the alternative currency and his tweet contending: “Bitcoin is almost as bs as fiat money.â€
Taking a broader view, Western democracies have not for at least 15 years acted like societies where economic conditions are benign, despite all the data professional economists cite to the contrary. We are witnessing vicious political polarization, rapidly deteriorating social trust, a breakdown in economic relations between the generations—even peasants’ revolts as varied as Brexit and GameStop.
Going back at least to the 14th century, such events most often have occurred in an environment where malfunctioning price signals (read: inflation) make it impossible for a society to allocate its resources with any rationality or fairness.
As I’ve been saying for some time, my concern for the foreseeable future isn’t ordinary inflation (interpreted as increases in consumer prices). That inflation is mild and will probably remain so. My concern has been for a catastrophic loss of confidence in the currency.
The actions of the Congress, the White House, and the federal reserve for the last half dozen years have been far from Keynesian. What Keynes wrote was that a gap between aggregate product and potential aggregate product could be made up for with government spending. Basically, the government’s extending credit to itself and pouring the created money into the economy can make up for that production gap. If money greater than the production gap were deployed, it should show up somewhere in the form of inflation.
The sums being disbursed now exceed anybody’s calculations of the production gap. Something has to give.
“What Keynes wrote was that a gap between aggregate product and potential aggregate product could be made up for with government spending.”
The rub is that “potential” can be anything one can imagine. And people can imagine a lot.
Even people predisposed to endorse anything the administration might come up with, e.g. Lawrence Summers, think what they’re doing is wrong.
“It feels so right, so right
How can it be wrong?”
-Elvis
I’m reminded of your post from 10 years ago on hyperinflation.
http://theglitteringeye.com/reading-up-on-hyperinflation/
To my mind, the key point is “In most cases they have been the result of other exogenous events such as ceding of monetary sovereignty, war, rampant corruption or regime change…”.
There’s an argument to be made whether the pandemic is such an exogenous event — but if it recedes through vaccines or acceptance, then confidence would be going up vs going down.
On the other hand, some inflation is baked into the cake for this year.
(1) Fossil fuel prices will be up significantly YOY starting in March, considering the last price last year fell to zero.
(2) Cryptocurrency mania has diverted a significant amount of semiconductor production into mining. Considering semiconductors are in everything, the shortages are going to disrupt and raise the price of cars, consumer electronics, appliances, etc. It has the potential to create a feedback loop because the disruptions/price rises are going to drive up the attraction and price of cryptocurrencies.
Cryptocurrency mining is presently responsible for about 17TWH of power consumption annually. That’s a third of total U. S. coal-fired power production.
… a catastrophic loss of confidence in the currency.
A better way of phrasing it might be: “a catastrophic loss of confidence in the future productive capacity.”
Since money is created through lending, a currency crisis is a debt obligation crisis, and the destruction of the existing production capacity will likely start the crisis, because debt obligations are based upon future production capacity.
The government is fueling a private debt bubble, and if this debt cannot be serviced, the bubble will collapse. This collapse will cascade to include much of what was created by the bubble, including existing and future productive capacity.
So many intertwined concepts, so little time.
“Middle-class investors found the value of and income from their capital wrecked by a phenomenal bid-up in prices for financial assets, whose nominal gains masked inflation-adjusted plunges.”
Sort of. A tale of two classes: Risk intolerant investors, especially retirees, have watched the Fed destroy the income generating capacity of their fixed income financial capital. Some commentators and Fed officials deny this, saying low real rates are market driven. However, when you are buying Treasuries by the wheelbarrow, its obvious. Fixed income investors therefore must consume their capital to retain purchasing power, partially (at least one time) offset by the inverse nature of yield and bond prices. But god save them when inflation hits. Short durations people. Short durations. Don’t be a lender.
The second effect, of course, has been yield chase and the attendant bidding up of equity prices. That benefits a different person. Anyone blubbering about income inequality needs to look to Washington pols and the Fed first. Boiling in oil seems appropriate.
“A consequence of chaotic financial markets was a new boom in speculation.”
Like yield chase. Speculation is OK among the speculators, who provide liquidity. Not so much for investors, as the author notes in his last paragraph.
“The government is fueling a private debt bubble, and if this debt cannot be serviced, the bubble will collapse. This collapse will cascade to include much of what was created by the bubble, including existing and future productive capacity.”
Sort of. If debt financed assets or services are overproduced or overvalued because of a cheap money environment the effect of collapse of that environment will just be a reset to normal demand levels. eg Education loans have bloated the college system. Home prices have been inflated by cheap mortgages. Sectors like that could reprice in a rate rise. Is that bad? Other sectors would be unaffected, and no productive capacity destroyed. (The financial claims might get reshuffled, but the capacity would remain.) At its core its really more a resource allocation issue than just a destruction of valuable capacity issue. And over time that is definitely bad.
But then, we just installed in all three branches of government people hell bent on doing just that. Coal miners, welders, construction equipment operators etc all learning to code, build solar panels or become political science professors. Great. Yet to a person these pols will all claim to care about the people they are harming. You can’t fix stupid.
Geez. Where was all this concern about low rates when Trump was POTUS? Next, you will be complaining about debt and deficits.
Steve
I don’t know. Drew has been worried about low rates pretty persistently. I’m confident I could search through old comments here to demonstrate it.
Included in the concerns about persistent low interest rates are that
1. The elderly should be rebalancing their savings towards interest-bearing accounts. Ultra-low interest rates makes that difficult to stomach.
2. Other sorts of investors, e.g. pension funds, which should be balanced towards low yield but reliable investments are rebalancing towards higher risks to chase improved yields.
@Drew
My growing concern is a tipping point caused by the destruction of existing businesses. Future economic growth is built upon the present economic status, and if the future looks bleak enough, it will cascade through the economy.
From 2008 to 2019, most people believed that things were getting better and would get even better, and for the most part, they were justified.
As much as I dislike the financial industry, monetary system, and their interdependence, my actual concern is about capital (financial and physical), and the consequences of its large scale destruction.
@steve
@Drew (and his many aliases) has been railing against low interest rates for years.
Steve needs to traffic in garbage. When you can’t make an argument on the merits what’s left?
There are a couple good pieces at Zerohedge today. I agree with a lot; some not so much. Prominent is the notion that debt and equity pricing is so out of whack that the capital markets are a mess and resource allocation horribly disrupted. Thank the Fed. Is it a god complex, or accommodating Washington. I don’t know. Also in the articles is the notion Dave brought up, and that the debt game is increasingly ineffective and that the game of musical chairs does have an ending.
Dave – pension funds should have properly balanced portfolios if only on the merits of risk vs reliability. However, they also have to manage redemption requirements. Having to liquidate volatile assets at a disadvantageous time can hurt. Shorter: don’t ignore liquidity to chase yield. By the way, many pensions hedge those risks, the “financialization” so universally hated, but absolutely wise.
tasty – I lean more towards concerns about capital formation to finance future investment. Today’s factory may go through a right side balance sheet restructuring where the claims are re-juggled, but if the assets are useful they will remain intact. (as opposed to, say, a Big Education industry reliant on subsidy and generation of crap degrees by crap professors) The issue, as you say, is that if capital is wasted by poor policy driven misallocation then overall growth and wellbeing will be retarded over time. Also, I don’t rail against low rates, or high rates. I rail against non-market rates.
Separately – I think its only been Drew and Guarneri. Guarneri was driven by Dodd-Frank considerations, now past. Drew is actually real. Is, um, er, Tasty Bits an alias?
The Fed thinks that their charter is to run the economy. To that end they ignore their primary responsibility which is to regulate the banks. “Regulate” is from the Latin and means to direct using rules. Does the Fed impose rules on the banks? Do they enforce the rules set up by Congress and other regulatory agencies? I don’t see it.
“I don’t know. Drew has been worried about low rates pretty persistently. I’m confident I could search through old comments here to demonstrate it.”
But not while Trump was president. Silence during that period. When a Democrat held office he then expressed a lot of concerns about it. Note that he also has not complained about Debt while Trump was in office. I fully expect that to start again.
I think the arguments have some merits, but I am still not sure why we are favoring the older, investor class over everyone else. If we want to have interest rates lower it should as a policy choice for a good reason and not just to help a specific group of people.
Steve
Capital investment is necessary for wages to increase. Necessary but not sufficient. For example, a tighter labor market is also necessary.
Speculation, increasingly the rule of the day, doesn’t have the same effect. We want more investment and less speculation for a healthy economy and society.