kidmercury

Over the past few months you may have heard the term "credit crunch." This means that banks have not been lending. As we discussed in our post on the story of money, all money originates out of debt: the more banks are lending, the more the money supply will grow; conversely, paying off debts means the money supply is contracting (aka deflation).

Deflation typically (but not always) corresponds to a strengthening currency and falling asset prices. Which is what we've seen over the past few months, as banks have not been lending and debtors have been selling assets to pay off debts.

Looks like things are changing now, though. Evidence:

1. TED spread is falling. TED spread is a proxy for the risk and fear in the banking market; the higher the TED spread, the more risk/fear there will be, and the less lending there will be. The TED spread reached record levels back in October, but is now at a more normal level.

2. MZM is expanding. Consistent with what we might expect with a declining TED spread, MZM -- a measure of the money supply -- has been rising.

Increasing money supply is characterized by a weaker currency. Often it corresponds to higher asset prices (and thus asset bubbles), although that is not always the case (when financial assets decline but consumer prices rise and the aggregate money supply rises as well, it is often referred to as stagflation).

Accordingly, the dollar gave back much of the gains it made over the past few months over the past few weeks. When the money supply is increasing -- aka inflation -- precious metals and foreign currencies are where it's at. Government bonds are the last place you want to be (whereas government bonds are a great place to be in deflation).

As I've said before (here and here), inflation is the larger economic story, in my opinion. With that said, I think we will continue to see falling financial asset prices, so I am really arguing for a period of deep stagflation. "Hyper-mega-stagflation," as Alex Jones has put it (see our song for Alex). Alex is often accused of exaggerating, though that scenario is looking more and more likely -- particularly if the TED spread continues to stay low and MZM continues to increase.

Jason Kolb

Interesting blog, thanks for the link love

When I first started investigating money and the economy I agreed with what you write here. I even wrote blog posts about it. I was wrong.

The thing you have to understand about currency is that it follows the law of supply and demand just like everything else.

We have two variables that go into the equation: how much is being created, and how much is being destroyed.

That's an incredibly difficult question to answer, but my research has led me to believe that far, far, FAR (far) more dollars are being destroyed than are being created. The Fed mathematically could not, possibly, print enough money to hyper-inflate. They would have to LITERALLY install printing presses in helicopters and print while flying over major metropolitan areas. They haven't done this, they aren't doing this, and they won't do this.

What you're seeing from them is pure social engineering.

As nonsensical as it seems, the dollar is going to keep going up.

We've had hyper-inflation over the past 10 years, and everybody missed it. It was right under our noses.

Now, that hyper-inflation bubble is bursting--as all bubbles must--a LOT of people are going to be taken by surprise.

kidmercury

hey jason,

thanks for the reply. my counter:

1. yes, i agree money is being destroyed. but is it being destroyed at a faster rate than it is being created? deflationists typically argue that because the economy is so crappy, no bank will lend, and no consumer will take on additional debt. this is the "peak credit" theory.

but is peak credit true? meaning will banks really refuse to lend and will consumers really refuse to borrow? the declining TED spread and the rise in MZM suggest this is not the case, and that lending is in fact occurring. verizon, for instance, was able to get a massive 17 billion dollar loan towards the end of 2008.

2. with treasury yields very, very low, alternative investments become more appealing. banks can sit on money or can buy treasuries with them, but if these rates are so low, they temptation to loan out in the market where they can get a better rate becomes more appealing. they can also speculate in the markets. many argue that that is irrational, though i argue negative yielding treasuries is also irrational.

3. bernanke's now famous speech in which he made a buffoon out of himself by saying he will avoid deflation at all costs because he can drop money out of a helicopter is worth noting. not because he is actually going to drop money out of a helicopter (or if he does, things are going to get worse than even i am expecting them to! ), but because he is clearly willing to resort to unorthodox practices to reflate the market. when many people say "this is just like japan, the bank of japan tried to inflate but couldn't because no lending/borrowing" they ignore that the bank of japan had some semblance of sanity and did not resort to unorthodox measures of inflation. for instance, paul krugman had encouraged bank of japan to fully monetize their budget deficit, which would have proven to be massively inflationary if the BOJ had done so (they did not). now in the US, we see the fed getting involved in all sorts of industries and buying up all sorts of assets. moreover, we have even seen the dumbocrats in congress try to force banks to lend.

4. obama's plan is to increase government spending while the tax base is contracting, meaning more deficit spending and a greater issuance of treasury bonds. but who is going to buy all these treasuries? especially when yields are so low? so that means rates go up to make treasuries more appealing or it means the debt is monetized, i.e. the fed buys it and just prints money. once there is enough debt monetization, there will be a run on the currency and the treasury market will collapse as it will be apparent that the debt can only be repaid if the currency is devalued. this is what happened in argentina in 2001. the way to stop this is to drastically reduce government spending (the ron paul revolution!). that doesnt seem to be happening any time soon.

5. in reality we are going to see characteristics of inflation and deflation. technically speaking inflation/deflation refer to the money supply, not to the price of anything, not even the price of the currency. by the technical definition we are under inflation as most money supply measures (m1, m2, mzm) have been increasing for the past couple months (hardcore deflationists like shedlock will argue those are all false definitions of money supply....i disagree, as do many economists. i prefer mzm as it is of most use for me in gauging the value of the dollar which as a currency trader is all i really care about). symptoms of deflation, though, include unemployment, falling asset prices. perhaps what we are really going to see is stagflation, though i tend to avoid that word because of a lack of a clear definition (rising money supply + contracting GDP as a possible definition?). alternatively i think we will see deflation if you price things in gold. from this perspective myself and other gold bugs view gold as the ultimate play here as it is a way to gain wealth.

6. i view argentina in 2001 and iceland in 2008 as predecessors to the US. in both instances deflation -- meaning a contraction of the money supply due to credit destruction -- occurred prior to massive inflation/currency devaluation.

7. i know most people don't like to think of conspiratorial evidence and view that as a weak cop out. however as this site clearly illustrates i am a new world order conspiracy factualist. this conspiracy requires dollar destruction so that a global financial order can be offered as the solution to this manufactured crisis, in much the same way the federal reserve was offered as the solution to the panic of 1907. i only mention this because ultimately much of our economic fate is dependent upon the psychology of central bankers and i view conspiracy stuff as insight in that matter and thus of importance. however i understand the unpopularity of it as well as proving it is a bit murky of a matter, much like trying to prove whether someone is sad or happy. you know it when you see it, but not really provable. so i won't mention it aside from as an extra point just tossed in there, the previous points are far more merit-worthy, in my opinion.

8. ultimately, though, brighter minds than mine have argued for inflation. this essay from murray rothbard is killer and argues against deflation/peak credit. peter schiff is my favorite (i even wrote a song about him), his site also offers lots of arguments and news for inflation.

phew, long post! i hope someone out there finds it interesting. anyway, inflation/deflation is one of my favorite discussion topics, and one of supreme importance in understanding the economy and preparing accordingly. so i encourage any and all to chime in with questions/comments/etc.