[sjn]

The Automatic Earth

Our friend Stoneleigh, over at TAE wrote in rebuttal to Chris Martenson who himself recently posted a rebuttal to the deflationist position so strongly advocated by TAE: Commodities Look Set to Rocket Higher

Since TAE apparently refuses to let me comment, I'll start a discussion here with my rebuttal

As usual, I find myself in agreement with Stoneleigh on the details and importance of systemic feedback mechanisms, but do not reach the same conclusion of the case made for the "Deflation Thesis". As much as I enjoy reading their blog, I am always left with the impression that the only percieved possible outcome is the predetermined inevitable deflationary crash, and all evidence is presented as proof.

You might wonder how I can agree with with the arguments without accepting the conclusion? Firstly, I actually take issue with the idea of "a conclusion", there will come a time when the final quantum wave function collapses for humanity, but until then, while there is still uncertainty and people running around, I suspect there to continue to be a complex dynamical response within the ecological-system we reduce to financial-econonomics. As "financial-economics" as we consider it today is a reduction of the true system, a human political fiction externalising inconvienient variables and feedbacks which fail to recognsile into our simplified mental framework, the entire ediface can change or cease to exist as ever more is externalised and becomes detached from reality.

Secondly, I remember posting there a long time ago (2008) stating QE would happen, and that central bankers would do all in their power to fight what they understand to be the delfation scenario as laid out on these pages, even to the detrement of their soverign credit rating. It was dismissed as so much nonsense, nothing would be done which would so risk damage to the underlying safety in and reserve currency status of the US Treasuries and the US dollar. Of course much has happened since, and I'm still of the opinion the goose will be slain before hope is given up on infinite golden eggs.

Thirdly, IMO, the big picture issue is one of systemic net energy starvation, financial bubbles/busts (or deviations from reality within the financial-economic system) happen when the human imposed model fails to map the ecological system it attempts to simulate, resources are misallocated and the natural environment destroyed.

Fourthly, credit was created when the prevailing psychology was one of growth, infinite expansion, indeed strucurally the financial system is dependent on credit, interest, and ever more human appropriation of the natural world. Credit isn't the driver, it's the mechanism of translating or leveraging existing human capital and available energy into realising or liquidating natural capital and resources. It's that process which drives expansion and gives the apparent validity to the economic system as a whole. The decline in credit is arguably a psychological response to the unconscious congnition that the returns of capital investment no longer give added value, externalities are getting too significant to ignore. Past depressionary crises periods occured where the contemporay financial-economic system failed to sufficiently model the real human ecomomy, but there was still plenty of scope to manage our way out by refining he model to pump profit by redirecting loss into ecological sinks. The model itself evolved over time to enhance growth while figuratively and in some cases literally burying the costs.

So, that all said, I do not see this as simply a credit unwind or deflationary period, but as a phase of increasing instability and volatility as the financial system is overwelmed by externalities it has no control over and no ability to price. The eventual outcome of which will be the current system replaced with something else, knowing us, something equally as flawed, but until then I predict increasing chaos until the range of probabilites resolves into a possible configuration supported by reality, a new quantum state.

[eastbay]

Servicing the ever-growing sovereign debts is impossible in this recessionary/deflationary environment therefore, particularly with the economic slowdown, deflation will not be permitted.

In the US, expect the Federal Reserve to take firm steps to debase the dollar by increasing money supply. Deflation would be fiscally catastrophic for the US national budget and is unthinkable. It simply can't be allowed.

[Cog]

However deflation and default, both at a personal and federal level, is precisely the fix that is needed.

[evilgenius]

It's also the fix you are going to get. Just like at the beginning of the Great Depression 'common sense' is set to take the world the wrong way. Mankind's innate conservatism will not allow him to see what he is about to do to himself.

[The Practician]

Servicing the ever-growing sovereign debts is impossible in this recessionary/deflationary environment therefore, particularly with the economic slowdown, deflation will not be permitted.

In the US, expect the Federal Reserve to take firm steps to debase the dollar by increasing money supply. Deflation would be fiscally catastrophic for the US national budget and is unthinkable. It simply can't be allowed.

Servicing the ever-growing sovereign debts is impossible in this recessionary/deflationary environment therefore, particularly with the economic slowdown, deflation will not be permitted.

In the US, expect the Federal Reserve to take firm steps to debase the dollar by increasing money supply. Deflation would be fiscally catastrophic for the US national budget and is unthinkable. It simply can't be allowed.

The only possible outcome I can see for this scenario I can imagine is stagflation, which I think of as deflation that has deluded its self into thinking its inflation. The "Credit" created by the printing of billions of dollars is never going to find it's way any farther than the stock market.


I favor the TAE deflation argument over inflation/stagflation. Methinks the fed does not have as much control over the perceived value of money as it likes to pretend it does, and that when the credit tap to the "real" economy is shut off, cash will be king in the real economy, no matter what sort of delusional shennanigans are going on in the markets. What happens from there? What happens when the markets figure out that nobody out here has the money to pay the ridiculous prices for commodities that have been bid up with the feds monopoly money?

The bottom line: Purchasing power of the 99% is going to be reduced. What more do you really need to know?

[evilgenius]

I like Stoneleigh's take on how money is valued. I have always said that the value of money depends upon the faith of the people. She doesn't put it that way, but that is essentially what she is saying, time lag and all.

This crisis resulted when the investment side of money, where derivatives go to breed, became untethered from the wage side of money, where the money that derivatives come from is born (through things like mortgages), back in 2008. There is still too much money in investment and way too little in wages. Those bailouts everybody hates to admit saved us then made certain of that. They weren't structured to address the issues that caused the crisis. They were structured to keep things together until with the space of time more and better could be done. Well, that time has gone by and still there hasn't been one person brave enough or smart enough to figure this out.

What Stoneleigh is saying is that while investment will likely collapse, wages will likely collapse at a greater rate. The ratio will not hold. Wages will suffer in the change more than investment. What this means is that if you have cash don't get duped into putting it into anything, not stocks and especially not commodities. Personally, I would amend that to, except for investment in the factors of production. I would, but there is a great chance that the rate of decline will make it wiser to simply keep track of where those are and buy later, when the timing is right.

The political will simply does not exist for any movement to shore up the money supply any further. In the absence of that will there remains only free fall when corporate earnings begin to come in lower than the trend and even more people lose their jobs. The US is about to discover what would have happened in the 30's if they had not elected Roosevelt (a man who would not give in to political expediency when it came to this). Perhaps their only saving grace is that Europe is too, only more so.

[sjn]

The political will simply does not exist for any movement to shore up the money supply any further. In the absence of that will there remains only free fall when corporate earnings begin to come in lower than the trend and even more people lose their jobs. The US is about to discover what would have happened in the 30's if they had not elected Roosevelt (a man who would not give in to political expediency when it came to this). Perhaps their only saving grace is that Europe is too, only more so.

Here in the UK, along with the new QE due in November, the latest plan is for the Treasury to directly purchase corporate bonds with money raised by selling gilts, obviously a good opportunity for corporations with access to the bond markets to make some free money, no sign of any failure of will to undermine the currency here. Interestingly, the linked news article and the government announcement claimed there will be no increase in debt (due to the new "assets"), while at the same time they propose buying high risk junk bonds with the proceeds from selling AAA rated bonds, right... Bizarrely, the UK still has its AAA credit rating!

[dolanbaker]

What's a AAA worth these days, as a comparative to others It's OK but to say any state is in good shape would be a joke.

It's a bit like rating the cars in a backstreet garage that specialises in cheap cars, the AAA rated ones are the ones that don't blow out black smoke when started!

[sjn]

What Stoneleigh is saying is that while investment will likely collapse, wages will likely collapse at a greater rate. The ratio will not hold. Wages will suffer in the change more than investment. What this means is that if you have cash don't get duped into putting it into anything, not stocks and especially not commodities. Personally, I would amend that to, except for investment in the factors of production. I would, but there is a great chance that the rate of decline will make it wiser to simply keep track of where those are and buy later, when the timing is right.

If the ratio doesn't hold, people just become poorer on average. That says nothing about a deflationary collapse per se. Deflationary collapse means the financial system no longer operates, that is cash has no value, the "system" no longer exists. This isn't hyperbole, financial markets freeze during significant deflationary episodes, cash flow ceases, during, and in the aftermath of a deflationary collapse there's no way to use the cash, there's nothing to buy and no mechanism to do so. As eastbay points out, the effect on the US Government would be complete insolvency, and automatic default, so much for the full faith and credit of the US Government! Are you going to purchase a tanker of crude with a handful of un-backed fiat money? Would you sell it to somebody who tried? By the way, good luck maintaining your property rights on the means of production without State enforcement!

[sjn]

What's a AAA worth these days, as a comparative to others It's OK but to say any state is in good shape would be a joke.

It's a bit like rating the cars in a backstreet garage that specialises in cheap cars, the AAA rated ones are the ones that don't blow out black smoke when started!

Ah, yes! Better than Ireland!

[sjn]

Some more on the UK National Debt

If all financial sector intervention is included (e.g. Royal Bank of Scotland, Lloyds) , the Net debt in July 2011 was £2266.3 billion (148.0 per cent of GDP). This is known as the unadjusted measure of public sector net debt.

The Public sector net borrowing PSNB (annual government borrowing) for 2010/11 was £143.2 billion or 11.7% of GDP.

This shouldn't come as a surprise here, we've discussed here before the structural issues the UK has with its dependence on the rapidly declining North Sea oil and gas production revenues, let alone the exposure to sovereign debt within the oversized financial sector.

All the focus on the Euro-zone is giving the UK a free ride for now, as far as the bond markets are concerned, the Government makes all the right noises regarding austerity keeping the IMF happy, and the sadly false perception that it's "OK comparable to others" still rules the day.

[evilgenius]

If the ratio doesn't hold, people just become poorer on average. That says nothing about a deflationary collapse per se. Deflationary collapse means the financial system no longer operates, that is cash has no value, the "system" no longer exists. This isn't hyperbole, financial markets freeze during significant deflationary episodes, cash flow ceases, during, and in the aftermath of a deflationary collapse there's no way to use the cash, there's nothing to buy and no mechanism to do so. As eastbay points out, the effect on the US Government would be complete insolvency, and automatic default, so much for the full faith and credit of the US Government! Are you going to purchase a tanker of crude with a handful of un-backed fiat money? Would you sell it to somebody who tried? By the way, good luck maintaining your property rights on the means of production without State enforcement!

What you are describing is more like what happens in hyperinflation, when the people lose all faith in a currency. Deflation should see an absolute rise in the value of a currency, relative to everything. What Stoneleigh is saying is that when that happens people's wages will be less too, lessened at a greater rate than the currency's rise would otherwise have apportioned to them. They should get rich, but they won't. She means massive job loss and massive wage restructuring. That's why if you have cash you should wait. That's also why I said I would be into the factors of production, whatever that is for a particular person's expertise. Because at least then a person has money coming in. It may not be much in comparison to today's standards, but it is an income stream. You certainly would not want to buy any commodity necessary for whatever form of production you are into now, but if say you make beer you could buy much of the stuff you would need to do so now.

[Revi]

I am afraid to do anything now. I'm not buying silver any more, because the price seems to hover around $30, and it could go down. I have decided that copper is a good buy now, and I am going to get a bunch of pennies from the bank and sort through to find the pre-1982s. I think it's something that is sure to work. I have a few rolls of pre-82 pennies already, and I'll get more now. I'm also going to concentrate on useful antiques. If they don't sell I can always use them. Stoneware jugs, cast iron fry pans, etc.

[prajeshbhat]

I believe hyperinflation is really possible.

The inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance-- John Maynard Keynes

It requires a billigerent government. There has to be a government hell bent on destroying the economy.
Without that it seems a deflation is in order. For the past half a century, the trend was vertical integration. Now we have banks that have 3 trillion dollars in assets. If one of them fails, 3 trillion dollars will be taken out of the market instantaneously. Probably the reason why governments are more than happy to bail them out.

[sjn]

So the BOE has decided to catch everybody out and restart QE earlier than expected. Maybe I've been understating my case...?

[sjn]

I am afraid to do anything now. I'm not buying silver any more, because the price seems to hover around $30, and it could go down. I have decided that copper is a good buy now, and I am going to get a bunch of pennies from the bank and sort through to find the pre-1982s. I think it's something that is sure to work. I have a few rolls of pre-82 pennies already, and I'll get more now. I'm also going to concentrate on useful antiques. If they don't sell I can always use them. Stoneware jugs, cast iron fry pans, etc.

I really don't think there's much risk in buying physical silver, unless someone steals it from you, it's quite safe from financial machinations no matter what happens to the paper price. I think you're on the right track though with buying useful items, personally (given my level of doomerosity) I'd probably invest in high quality high tech products which are likely to be difficult or impossible to manufacture in a collapse scenario. Quality tools, equipment etc.

[patience]

The 'flation debate still seems to suffer from unspoken, yet differing definitions. The Austrian economists define inflation as an increase in the money supply. Most people on the street see increased prices at retail level and call that inflation. The first can lead to the secocnd, but not necessarily and not immediately.

There is also the reactions of central banks and governments to consider once something occurs in the economy. I don't for a second think that govt. will NOT react when, say, we find ourselves with great deflation from collapsing credit. The reaction is as predictable as sunrise and as wrong-headed as can be: Throw money at it and the problem will go away. THEN you get your "inflation".

Meanwhile, we have the two-headed monster of central bank intervention supporting banks that feeds money into commodities and causes them to rise in price, amidst a failing economy. Call that effect stagflation, if you will, or whatever, but at street level, it means more expensive food, fuel and other goods.

To compound the confusion, we have Congress ready to enact a bill to require China to let their currency float, beating the golden goose that has been eating our inflation for a long time. They tried protectionism in the '30's, with Smoot-Hawley. How'd that work out?

In a drastic move to devalue the gold-tied dollar of the 1930's, gold was "bought" (confiscated) at a lw price and then declared to be worth a lot more--once the government owned it all. With no gold backing now, that is not to be expected. Outright thievery, however, is the order of the day now, so I look for intrusions into the PM markets to go from the present (and past) manipulations to stealing the gold "profits by speculators", maybe by onerous taxation, or simple confiscation. A dying monster thrashes about, so stay out of the way of it.

[GoIllini]

Well, I think we're seeing the same dynamic as we saw in the '70s and '30s when the Philips curve moved in.

The interesting thing is that while the Austrian, Chicago, and Keynesian schools of economics debate this stuff, a biologist named Ehrlich actually gives us a good starting point:

Environmental Impact= Population x Affluence / Technology Constant.

Let's assume for a sec that there's hard geological and biological limits to the impact we can have on the environment. Call the environmental impact a constant instead.

Population x Affluence /(Technology Constant) = Environmental Constant.

Affluence = (Environmental Constant x Technology Constant)/Population

What happens if population increases too fast relative to resources? Affluence goes down; in other words, the Philips curve moves in as either resources get more expensive or we have fewer middle-class jobs relative to the population. That is, we get more inflation or unemployment, and the Federal Reserve gets to decide where we sit on that curve.

We got out of the 1870-1890 downleg by developing new sources of energy like oil and gas. We got out of it in the 40s by producing more oil. We got out of it in the early 80s by conserving. (US oil consumption per capita is still below its 1972 highs even today.)

We will probably get out of this one with shale gas and Athabasca, but I'd much rather see us get out of it using fusion or capturing the energy from the sun that doesn't hit earth every day.

[evilgenius]

If you rephrase that as not technological capability present in the overall society, but instead technological capability which the society is capable of implementing, then there is some evidence of it now. An article posted over at CNBC has this to say,
"Manufacturing is hurt by a dearth of skilled workers.

'What we have been saying for quite a while is that even though there is a high unemployment rate, it's very difficult to find skilled people,' said Jeff Owens, president of ATS, a manufacturing consulting services company.

A survey by ManpowerGroup found that a record 52 percent of U.S. employers have difficulty filling critical positions within their organizations — up from 14 percent in 2010." - my single quotes replace the article's double quotes for clarity.
http://www.cnbc.com/id/44888058
We had too many construction workers when housing ran up. The housing run up went on for so long that this imbalance became chronic. The skills those workers, mostly men, knew before they got into construction have been superseded in many cases by new generations of tech that those people either don't know yet or don't want to know yet. A lot of people have gone back to school since this started. Many of them have gotten out and yet this is still the result. What is going on? Are people too lazy? Are they getting worthless degrees? Is the higher education system too busy making money to be relevant to today's tech needs? Maybe this has to do with something Pops brought up about how mobility is practically null right now due to the underwater housing nature of this crisis?

[highlander]

We will probably get out of this one with shale gas and Athabasca, but I'd much rather see us get out of it using fusion or capturing the energy from the sun that doesn't hit earth every day.

The cost of energy from your hoped for escape from consequences of our lifestyle choices is way too high. I suppose we could build a nuke plant or 30 over the deposits to supply the energy needed to extract the oil to meet our transportation needs, but that seems quite unlikely.

We made good choices in the 70's that led to conservation, but we are getting away from them in our fascination with high tech gadgets. We have not made necessary improvements to the grid to support wind and solar, and we have a 60's mindset when it comes to horsepower in our vehicles.

While deflation is the right outcome, inflation is in the best interest of debtor nations. It has always been the path chosen. the end of that road has almost always been war. Fasten your seatbelts, it is about to get interesting.