Chicago Boyz

                 
 
 
What Are Chicago Boyz Readers Reading?
 

 
  •   Enter your email to be notified of new posts:
  •   Problem? Question?
  •   Contact Authors:

  • CB Twitter Feed
  • Blog Posts (RSS 2.0)
  • Blog Posts (Atom 0.3)
  • Incoming Links
  • Recent Comments

    • Loading...
  • Authors

  • Notable Discussions

  • Recent Posts

  • Blogroll

  • Categories

  • Archives

  • Timely Topic

    Posted by Mitch Townsend on September 30th, 2010 (All posts by )

    Sept. 30, 2010: IASB proposes Severe Hyperinflation amendment to IFRS 1. “The amendment proposes guidance on how an entity should resume presenting financial statements in accordance with International Financial Reporting Standards (IFRSs) after a period when the entity was unable to comply with IFRSs because its functional currency was subject to severe hyperinflation.” This is good information, and I expect to study it closely.

    I’m exaggerating to make a point here. Hyperinflation is unlikely in the US and EU. Inflation, long term, is nearly certain. Why? Because government debt is denominated in inflatable currency. The debtor has the means to determine the real value of the debt. Inflation would also permit the return of “bracket creep.” This prospect is delightful to the political class, as it passively increases taxes through wage inflation, while permitting nominal “tax cuts” through rate/bracket adjustments that can be artfully timed to coincide with the electoral cycle.

    If you’re looking for the Bernanke Helicopter as a sign of coming inflation, you may already be too late. The Bernanke Submarine has already delivered its cargo and returned safely to base. The Federal Reserve’s politically invisible policy of paying interest on excess bank reserves has already created a monetary overhang of $1 trillion. So far, the expanded money supply has amounted to a subsidy for banks, as they can get the equivalent of the overnight Fed funds rate on all their reserves, not just the statutory requirement. The government has essentially printed new money, then borrowed it back in order to buy government and agency debt (quantitative easing).

    This strategy, which has worked in the past in Japan as a countermeasure to deflation, creates its own risks. First, it has a tendency to reduce whatever stimulating effect other measures might have by soaking up money and taking it out of circulation. Why should banks lend money to businesses and consumers when they can safely lend to the Fed? Second, it can be difficult to exit. At 0.25%, the Fed is up against the limit of zero interest rates, so the effectiveness of quantitative easing as an anti-deflation device is near its limit. But even if it stops being effective for the purpose, the Fed has a wolf by the ears, and can neither hang on indefinitely nor let go safely. To unwind the position, it would have to sell government and agency debt in the open market. Done abruptly, it would effectively raise interest rates by depressing the price of government debt, immediately inflating the currency. It would have the same effect as an overt currency devaluation, and carries a risk of hyperinflation. Done gradually, it has the risk of continuing to lock up money in the banking reserves and restricting growth. Done clumsily, welcome back stagflation.

    The only good exit from this bind is a growing economy. A small amount of inflation is always a by-product of vigorous GDP growth. To the extent that other government policies discourage GDP growth, the Fed’s strategy could make matters worse.

     

    4 Responses to “Timely Topic”

    1. Scott Eudaley Says:

      This strategy, which has worked in the past in Japan as a countermeasure to deflation, creates its own risks. First, it has a tendency to reduce whatever stimulating effect other measures might have by soaking up money and taking it out of circulation. Why should banks lend money to businesses and consumers when they can safely lend to the Fed?

      I believe that is exactly what is happening now. In conjunction with the dramatic increase in capital requirements, this is a big reason why all this spending has had zero stimulative effect. Banks, especially small banks, are simply not lending. I’ve heard several heads of smaller banks complaining that the new capital requirements alone will prevent them from any new lending at all for several years.

      Although it hasn’t been reported in the press, I believe the Federal Reserve is putting a lot of pressure on banks to buy Treasury debt. Foreign creditors like the Japanese and Chinese are getting very skittish about the levels of US debt and have certainly slowed down their purchases significantly. That debt has to be bought by someone and if the foreigners won’t, only US banks are left.

      When a bank can get a decent return at virtually no risk and satisfy their real masters (the Fed) at the same time, why lend at all?

    2. mlyster Says:

      Precisely.
      I have a medical device company. Doing OK, considering the economy, but we’d considered a small business loan in 2009.
      In a word: forget it. The old joke about having to prove to the bank that you don’t need the money to qualify for a loan? Barely scratches the surface. Fortunately, plenty of investors out there have money on the sidelines and are looking to put it somewhere. Perhaps it’s a necessary weeding-out process for marginal businesses, but: exactly when things are tough for a lot of otherwise viable businesses, our government has rendered ‘bridge loans’ effectively unobtainable.
      I’ve seen more than a few posts suggesting that large companies have been passive or active supporters of tight money, as it enables them to further consolidate their positions in their respective market niches. They, in contrast have established revenue streams that, even if attenuated are still a running tap. Newcomers or narrow niche producers? They lack the diversification or market depth to withstand a substantial blow like the economy of the past two years. The Fortune 500, in essence plays the “Useful Idiot” to the administration. Thanks, guys: your foresight and citizenship is touching.

    3. Scott Eudaley Says:

      I’ve seen more than a few posts suggesting that large companies have been passive or active supporters of tight money, as it enables them to further consolidate their positions in their respective market niches. They, in contrast have established revenue streams that, even if attenuated are still a running tap. Newcomers or narrow niche producers? They lack the diversification or market depth to withstand a substantial blow like the economy of the past two years. The Fortune 500, in essence plays the “Useful Idiot” to the administration. Thanks, guys: your foresight and citizenship is touching.

      I’m not sure I buy that. Undoubtedly, US corporations are sitting on a massive amount of cash (in excess of $2 trillion) that they aren’t investing in any business, including their own. I also agree that large businesses often act as “useful idiots” for the authoritarian rent-seeking in any administration. I long ago learned that the last place to look for any understanding of, respect for or defense of a free-market capitalist system is the Fortune 500.

      I think the primary reason is that old bugaboo–uncertainty. Everywhere you look today there is uncertainty.

      Many have noted the uncertainty over taxes, regulations and health care. How high will my taxes be? What new regulations will I face? How much will my healthcare cost? No one really knows.

      Many others have noted the uncertainty in the broader economy. Are we going to “double-dip” or not? Will job growth return, and if so, how much? Are we facing inflation or deflation? No one really knows.

      The primary uncertainty for businesses, however, is that the marketplace is radically different than it was 3 years ago. What will people buy? Who will buy it? Where will they buy it? How much will they spend? No one really knows.

      I sure as hell don’t know and I’ve been a successful investor for 25 years. I’m sitting on 70% cash right now and don’t know what to do with it. Neither do my very smart financial advisors. I think there’s money to be made, but I can’t even guess what a reasonable risk-reward equation would look like. It is going to take time to figure out the answers to all these questions and I would rather wait than take an unknown risk for an unknown return.

      I think there’s a lot of other people just like me. I can hardly fault a business for doing the same thing I am doing.

    4. tyouth Says:

      Interest rates on the excess reserve are .25%; borrowing from the Fed is also .25% (or less, I guess depending upon how they feel that day?)? WTF?