Deadly Embrace

In a computer system where multiple programs are running at the same time, updating shared data can be a serious problem. A program can lock a chunk of data while it is modifying it so that no other program can inadvertently update it at the same time, which would lead to bad data. But then the situation can arise where program A locks chunk 1 and then needs to lock chunk 2 to proceed, except that program B holds the lock on chunk 2 and needs chunk 1 to proceed. Clearly neither A nor B can proceed. This situation is called a deadly embrace.

The escalating sanctions remind me of this. Both sides are trying to hurt the other but it seems that there is no way that either side can emerge victorious. Mutually Assured Destruction (MAD) may be achievable without any nuclear missiles leaving their silos.

Typically in a computer system the supervisory software will step in and pick a winner, forcing the other program to start over. Unfortunately there doesn’t seem to be a candidate for that task in the geopolitical system.

Supply shock from China?

I’m concerned that China is losing its battle against Covid. The Chinese vaccine is clearly ineffective and the government is relying on aggressive lockdowns to contain the spread of the virus. So far without much success. What if it does not gain traction? More plants and ports will be shut down. The supply of a myriad of everyday items “made in China” will dwindle and shelves here will empty. But worse than that, China cannot feed itself. We do know that China has more than half of the world inventories of grains and beans, but how long will those last, assuming they can even be distributed? The Chinese people will conclude that the Communist Party has lost the “mandate of Heaven.” The Chinese government will panic and try to distract the populace from its incompetence by…. ?

The Top Of The Cycle

Jeremy Grantham is the expert on bubbles. This interview was a month ago, but is still extremely relevant. I recommend reading the whole transcript.

Jeremy Grantham (02:15):
I wouldn’t say necessarily, that we’re at the peak, I think it’s clear that we’re deep into bubble territory. Bubbles are characterized typically at the end of a long bull market by a period where they accelerate, and they start to rise at two or three times the average speed of the bull market, which they did last year, of course. And the Russell 2000 actually went up an amazing 50% in three months, ending in early February this year, which compares very favorably to the 50% rally in ’99 of the super tech bubble. And the NASDAQ went up 50% in six months. So, this was bigger and better.

Jeremy Grantham (03:01):
And, of course, they’re always extremely overpriced by average historical standards. And this one, there are a few people who would still argue that 2000 was higher, but most of the data suggest that this is the new American record or highest-priced stocks in history. And then, there’s the most important thing of all, which is crazy behavior, the kind of meme stock, high participation by individuals, which has kind of tripled in 18 months to an abnormally high level, enormous trading volume in penny stocks, enormous trading volume in options, and huge margin levels, peak borrowing of all kinds.

Jeremy Grantham (35:21):
No, I am not. I am leaving currency worries to other people. I have enough to worry about. With every real asset category, badly overpriced, that is quite enough for me to worry about. And history is quite complicated enough anyway without attempting to think about every aspect of the system. So, I will leave that to that. What is slightly unusual about this bubble on a global basis is that, yes, real estate has bubbled everywhere and often worse than in the US. Yes, commodities are everywhere. Yes, bonds are everywhere overpriced and interest rates are negligible everywhere.

Delta Demon

The writers who opine about these things claim that the selling in the last couple of days is due to fears of new lockdowns as a result of the spread of the Delta variant.

Perhaps this is so, and perhaps there will be new lockdowns. But the lockdowns will be to exert political power only, because the data show that there is nothing to fear – except political arrogance and megalomania.  Yes, the Delta variant is more infectious and has led to an increases in cases. However, the case rates have not caused an increase in hospitalizations or deaths. This is the normal course of evolution of viruses, where they become more infectious but less dangerous. Pay no attention to governors drunk with power or to Dr. Fauci, “I am the science”, political science that is, who should long ago have been removed from office pending an investigation into his role in the funding of the research that led to the escape of the virus from the Wuhan lab.

Mixed Signals

Time to say Hmmm… Bonds aren’t worried about inflation, yields are falling. 5 year breakevens are falling. The US dollar is rising. ECRI’s FIG (Future Inflation Gauge) fell last month. All these are indicators that tend to say the inflation panic is overdone.

But the pumping from the Fed and the Feds continues. Reported price inflation is no laughing matter. But maybe that Fed is right, it is transitory. Lacy Hunt believes so.

Anyway, I’m standing aside on the inflation trade.

Welcome To Stagflation

This morning’s jobs report, considered surprising and disappointing by the media and economists, showed only a very modest growth in employment. I would have thought that it was obvious that paying people not to work would result in people not working, and if that conclusion eluded economists the widespread reports of labor shortages would have inspired some curiosity as to the true state of affairs. But no, the models were consulted and they said “big number coming.”

But the main question is what conclusion the Fed will draw, and more particularly what, if anything, they will do in response. I see two choices – nothing, or an increase in money printing. Both choices are disastrous, just that the second one brings disaster sooner. The choice of doing less is forbidden, because it would cast a deep shadow on the Fed’s belief in its own infallibility.

Hyperinflation

I just read this piece, which asserts that hyperinflation is not really a threat because monetary velocity is low. Since the gentleman calls his blog “realinvestmentadvice,” I should point out that my blog is not investment advice, it is just my thoughts on what is happening and is more of a personal diary than anything else.

He includes a quote from his show:

“Hyper-inflation comes from a complete loss of faith in a currency from the threat of losing a war (Weimer Republic), an economic collapse, or some other catastrophic event. The U.S., even with all of our economic ills and woes, is still the safest place, in terms of liquidity, depth, and strength, to store excess reserves. The near historic low yield on government treasuries tells the story here.” – Real Investment Show

The first few words are correct. It is not about the numbers, it is about sentiment. It is about fear. Generally, it is fear that the government is unwilling or unable to limit its spending. That is because it is only the government that can create money and credit unrestricted by the need for collateral or capacity to repay. The fear may arise from those items he lists, but not necessarily. Let me introduce a quote from Austrian economist Wolfgang von Mises:

The advocates of public control cannot do without inflation.They need it in order to finance their policy of reckless spending and of lavishly subsidizing and bribing the voters. — W. von Mises, The Theory of Money and Credit, 1912, p. 479

Huh. That was written more than a hundred years ago, but it hasn’t changed, has it?

With much arm-waving, he goes on to argue that not only is there no risk of hyperinflation, there is a significant risk of deflation. I would agree that if the government abandons its inflationary policies, then there is a risk of deflation.

But until then, let me start with the following price statistics, recent vs. a year ago:

Personal income: +13.1% (Jan 2021/Jan2020, FRED).

Food: Soybeans +59%, Corn +45%, Coffee +25%, Wheat +16%

Energy: Oil +16%

Materials: Lumber +115%, Copper +46%, Cotton +30%

Shelter: House Prices: +10%

According to the government, this yields a CPI that is only +1.45%. To which I can only reply, seriously? And of course this has yet to reflect any impact of Biden’s spending spree. For your first essay question, please assess the likelihood of the Biden or Harris administrations willingly limiting their spending.

The velocity of money is not directly measured but is derived from the monetary equation, PQ=MV. The general Price level (P), Quantity produced (Q) and the Money supply (M) are used to calculate Velocity of money (V) by V=PQ/M. So if P is understated, then so is V. Since I am pretty sure P is wildly understated, then clearly V is likely unreliable. According to FRED, the M2 money supply increased by 25.8% between Jan 2020 and Jan 2021.

We know from many previous examples that when people lose faith in the currency they don’t want to hold it because they believe that it is a depreciating asset. So they rush to spend any money they receive. V goes through the roof and you’re done. For your second essay question, please assess the likelihood of this happening given the spending plans of the Democrats. Extra credit will be given for support or refutation of the following quotations from two people who I consider to be geniuses.

Wolfgang von Mises:

Inflation has always been an important resource of policies of war and revolution and why we also find it in the service of socialism. — The Theory of Money and Credit,p. 255

Inflation is the fiscal complement of statism and arbitrary government. It is a cog in the complex of policies and institutions which gradually lead toward totalitarianism. — The Theory of Money and Credit,p. 468

Sir Winston Churchill:

“Socialism is the philosophy of failure, the creed of ignorance, and the gospel of envy.” —Perth, Scotland, 28 May 1948, in Churchill, Europe Unite: Speeches 1947 & 1948 (London: Cassell, 1950), 347.

“The inherent vice of capitalism is the unequal sharing of blessings. The inherent virtue of Socialism is the equal sharing of miseries.” —House of Commons, 22 October 1945.

And now for something completely different. Watch Jimmy knowing that in 2020 Federal government spending was 31% of GDP and total government spending was 44% of GDP. Jimmy, you have the mic:

CPI Indicates Financial Stability?

I just read an article that makes a compelling argument that the Fed has consistently used the CPI as the primary indicator of systemic financial stability.

SPACs are hot, the IPO market is hot, credit markets are hot, commodities are hot, the crypto markets are hot. Everything is hot – only the Consumer Price Index is cold. And that is all that matters for the Fed.

It is actually pretty scary, if true. And since the CPI is politically so visible, it may well be true. The reason it is scary is because the CPI is an artifact, designed and refined over the years to lowball actual inflation. And actual inflation is what blows bubbles and destroys currencies, economies, lives and livelihoods in the aftermath. And, apparently, consistently blindsides the Fed.

It is not complicated. Our economic system is based on using money – the dollar, in our case – as a means of making the exchanges of labor and goods which constitute the economy. And if the dollar becomes unreliable and no longer has a stable value, the whole thing goes pear-shaped, as the English would say. People resort to barter, other currencies and these days probably crypto (GLWT), none of which function as legal tender. It is like when you have a diesel engine runaway – the engine starts running on its lube oil, spins faster and faster and then all of a sudden explodes when the oil pressure fails.

Modern Monetary Theory

Investopedia on MMT

Modern Monetary Theory (MMT) is a heterodox macroeconomic framework that says monetarily sovereign countries like the U.S., U.K., Japan, and Canada, which spend, tax, and borrow in a fiat currency they fully control, are not operationally constrained by revenues when it comes to federal government spending.

In other words, governments can spend whatever they want and just print money without collecting taxes.

Or, in still other words, “To infinity and beyond” — Buzz Lightyear

Well, governments have been spending whatever they want for quite some time without much theory behind it. However, they issued and sold debt securities to fund spending not covered by revenues. Then, in 2001, the Bank of Japan (BoJ) initiated a program called “Quantitative Easing” (QE), since adopted by other central banks around the world, including the Federal Reserve. QE is simply the purchase of debt or other securities in exchange for newly issued money in order to lower interest rates. Now the Fed purchases $120 billion worth every month. So MMT is in effect to the extent that Federal debt that is purchased by the Fed is effectively cancelled and replaced with money.

Stephanie Kelton, Joe Biden’s economist, MMT advocate and author of “The Deficit Myth” is correct in most of what she claims because it is simple accounting. Yes, GDP increases (although it should not – government “output” should be treated like business sales, and valued at the amount paid for it, i.e. tax revenue). Yes, household savings increase. But she ignores or avoids the most fundamental aspect of money, and that is value. Money has value when it represents an exchange, of labor for pay for example.

New credit, whether government or private, creates money. A signed promissory note creates money, for example a checking account deposit in the name of the borrower. Joe Biden just signed a $1.9 trillion promissory note on everyone’s behalf. But credit money includes no value – nothing was exchanged except a promise of future value, there is no supply of value to the economy – even though goods and services will likely be demanded in the present.

What creates inflation? Credit. “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” — Milton Friedman

While credit is necessary for the functioning of the economy, disproportionate expansion of credit, such as is caused by artificially low interest rates or government deficit spending, causes inflation. That is why we have seen obscene inflation since the founding of the Federal Reserve in 1913.

Ms Kelton uses the low interest rates of WWII as an example to support her theory, claiming that these demonstrate that the Fed can always suppress interest rates, while ignoring the fact that during WWII, the Office of Price Administration (OPA) used price controls and rationing to manage the value of the dollar. Between April 1942 and June 1946, the period of the most stringent federal controls on inflation, the annual rate of inflation was just 3.5 percent; the annual rate had been 10.3 percent in the six months before April 1942 and it soared to 28.0 percent in the six months after June 1946

I’ve discussed the 1970’s inflation crisis, largely associated with the Vietnam war, in a previous post. The nation spent more than $120 billion on the conflict in Vietnam from 1965-73; this massive spending led to widespread inflation, exacerbated by a worldwide oil crisis in 1973 and skyrocketing fuel prices. Well, $120 billion was massive then, now it is pocket change, it is the amount of debt the Fed monetizes every month.

While there is no OPA, we have had a form of rationing in effect for the last year with lockdowns, restrictions on travel, cancelled events, business bankruptcies and shutdowns, etc. As these restrictions come off, as they must now that vaccination is well underway, we will see how MMT holds up. We may get a hint tomorrow as to the Fed’s willingness to cooperate. Will the Fed monetize Biden’s $1.9T note, thereby essentially committing to purchase the whole supply of Treasury and agency debt going forward, implementing full MMT? As I understand it, budget reconciliation is done and dusted until September at the earliest, so a tax increase would require Senate Republicans to agree. Unlikely. So if the Fed is not the buyer, then who and at what price? The banks’ balance sheets are full, will the Fed waive the limit?

In 1913, when the Fed began, prices were only about 20 percent higher than in 1775 and around 40 percent lower than in 1813, during the War of 1812. The Fed has enabled government deficits to ruin the value of the dollar. The government’s inflation calculator says the 1913 dollar is worth about $26 today. Comparing average annual income in 1912 to 2019’s median gives $52. But obviously there have been quality-of-life improvements so the best value is somewhere in between. Speaking of which, after the death of Julius Caesar, the annual pay of a legionary in the Roman Army was set at 225 silver denarii. Using today’s price of silver, that’s about $750. Compares to about $20K for a private in the US Army, but today’s soldier lives a lot better!

What Now?

The 10-year Treasury note closed at 1.2% on Friday as its gradual rate increase continues amid signs and portents of coming inflation. The CPI is restrained by its 40% weighting to rents, which are under pressure for various reasons, mostly due to the Wuhan virus. Over the last 10-months the price of oil has recovered from a virus-related collapse in April of 2020 to over $58 for a barrel of West Texas Intermediate (WTI) crude.  The UN Food and Agriculture Organization’s food price index is at its highest level since July 2014.  Private sector hourly wages are up 4.2% over the last 12 months (Jan/Jan, FRED). These are important prices and the PCE price index, the Fed’s preferred measure, should do a better job of reflecting their impact.

Chair Powell has made it clear that he has abandoned the Fed’s mandate on stable prices and will be looking solely at full employment. December’s core PCE index showed an 0.3% rise while the core CPI was unchanged. We get January’s report on the 26th. of this month and I expect the PCEI to further pull away from the CPI. Given that the last batch of $600 “stimmies” was distributed in January, we can expect an uptick from them. BTW, if you want to see the effect of these checks, just watch this video of the queue of ships from China waiting to unload at the  port of Long Beach. This show graphically that the economy being stimulated is the Chinese economy, not the U.S..

Anyway, the many trillion dollar question is what happens to interest rates. Any serious uptick in inflation will drive the whole yield curve into negative real rates, of course the short end is already there. No doubt the Fed will monetize massively in an attempt to contain nominal rates, but it is not clear to me that they will be able to do so without simultaneously crushing confidence in the US dollar and its status as the primary reserve currency. Get out the popcorn, this should be an interesting time (as per the ancient Chinese curse).