Tuesday, 23 April 2013

Take Our Choice: Zimbabwe or Weimar Republic? Argentina or Brazil?

El Gringo Viejo has not been on the run or in jail. We had a busy stay of it down at our place. A little bad news and a lot of good news. He returns to kind messages to both him and to the OROG community, thereby proving that Earth actually does require his humbly noble existence in order to remain in orbit around some distant sun.

   Folks who have a conservative and rational understanding of economics know that any kind of socialist, progressive, or Keynesian approach to financing the buying of cake or vodka for the masses, paid for with government free money results in the ruin of the country  under concern.   The inflation of the money supply....not rising prices....is the cause of the ruin.
     Simple cases of prices rising due to free market conditions ....(such as eggs for 5.00 dollars each in Anchorage in 1900 was due to an oversupply of miners and a shortage of chickens)...is different from Luis Echeverria Alvarez, as a socialist, deciding that the way to give Mexicans lots of money and make them rich was to force the Bank of Mexico to borrow shiploads of money and give it away, essentially in helicopter drops over populated areas.
      LEA's Obama-like spread-the-wealth notion, expressed on steroids worked fine....and please do not worry....Luis Echeverria Alvarez made sure to get his spread of the wealth.   And Mexicans were soon paying 20 pesos for a hamburger that had cost one peso the year before.

     So...we watch here and wait....but the shoes will fall, sooner rather than later.    The explanation forwarded by Lee is presented  by Professor Steve Hanke, a very solid thinker, and a Senior Fellow at the Cato Institute.    The work is somewhat dry....but it reads well.  It is also pleasantly short enough to read twice.

     In a way, it points out that the reason that we have as little "inflation" as we do is because of our shirts being the cleanest of all the shirts in the dirty clothes basket.   European unemployment and social welfare obligations remain at grotesque levels, and their governmental budget deficits are ghastly.    Mexico and Canada have had several years of balanced (or some semblance of balanced) budgets and fairly steady rightward governance.  That is why the American dollar is losing against the other two nations' currencies.



    This may be an explanation why the dollar has not declined in value as fast as I had expected.
Nothing “Hyper” About US Inflation
By Steve Hanke
While inflation seems to be on everyone’s mind these days, misconceptions abound. Indeed, few concepts in economics are as misunderstood as inflation. This month I take a look at some common questions about inflation, and a few that I wish more people were asking.

Is hyperinflation coming to the U.S.?

No. Hyperinflation arises only under the most extreme conditions, such as war, political mismanagement, or the transition from a command economy to a market-based economy. If you compare the U.S. to countries that have experienced hyperinflation — think Iran, North Korea, Zimbabwe, and the former Yugoslavia, for example — the U.S. doesn’t even come close.

Hyperinflation begins when a country experiences an inflation rate of greater than 50% percent per month — which comes out to about 13,000% per year. Although it experienced elevated inflation around the time of the Revolution and the Civil War, the United States has never passed this magic mark. At present, the U.S. inflation rate, measured by the consumer price index (CPI), is less than 2% per year. So, to say that the U.S. is on its way to hyperinflation is just nonsense.

But what about Quantitative Easing? Won’t that cause high inflation?

No, at least not under the current QE program. What many people fail to understand is that the money created by the Fed, through programs like Quantitative Easing, is what’s known as “state money” (monetary base). In the U.S., this makes up only 15% of the money supply, broadly measured. The remainder is made up of “bank money” — the allimportant portion of the money supply produced by banks, through deposit creation.

So, while the Fed has more than tripled the supply of state money since the collapse of Lehman Brothers, in September 2008, this component of the money supply is still paltry compared to the total money supply. In fact, when measured broadly, using a Divisia M4 metric, the U.S. money supply is actually 6% below trend (see the accompanying chart).

There are a number of factors that affect the growth of money, but there are two main factors that have hampered broad money growth in the United States since the financial crisis. Not surprisingly, they are both government created. The first is the squeeze that has been put on the banks, as a result of Dodd-Frank and Basel III capital- asset ratio hikes. By requiring banks to hold more capital per dollar of assets (read: loans), the regulators have put a constraint on bank’s balance sheets, which limits their ability to lend. In consequence, money supply growth has been slower than it would have otherwise been.

The other factor is the credit crunch created by the Fed’s zero- interest-rate policy. This has dried up the interbank lending market, because banks have little financial incentive to lend to each other. Without a well-functioning interbank lending market to ensure balance sheet liquidity, banks have been unwilling to scale up or even retain their forward loan commitments.

The end result is a loose state money/tight bank money monetary mix. And since bank money makes up 85% of the total, the money supply in the U.S. is still, on balance, tight and below trend. That said, the broad Divisia M4 measure of the money supply has started to show signs of life in recent months.

How Can The Fed Avoid Inflation Going Forward?

The Fed should start paying attention to the dollar. While operating under a regime of inflation targeting and a floating U.S. dollar exchange rate, Chairman Bernanke has seen fit to ignore fluctuations in the value of the dollar. Indeed, changes in the dollar’s exchange value do not appear as one of the six metrics on “Bernanke’s Dashboard” — the one the chairman uses to gauge the appropriateness of monetary policy. Perhaps this explains why Bernanke has been dismissive of questions suggesting that changes in the dollar’s exchange value influence either commodity prices or more broad gauges of inflation.

The relationship between the dollar’s value and inflation has been abundantly clear for the last decade. As Nobelist Robert Mundell has convincingly argued, changes in exchange rates transmit inflation (or deflation) into economies, and they can do so rapidly. This relationship was particularly pronounced during the financial crisis (see the accompanying chart).

Indeed, from 2007-09, the monthly year-over-year percent changes in the consumer price index and in the USD/EUR exchange rate have a correlation of 0.75. As can be seen in the chart, there is a roughly two-month lag between changes in the USD/EUR exchange rate and in the CPI; when we factor in this lag, the correlation strengthens to 0.94.

By ignoring this, Bernanke was “flying blind” in the initial months of the crisis. In consequence, the Fed failed to stabilize the USD/EUR exchange rate, which swung dramatically in the months surrounding the collapse of Lehman Brothers.

Accordingly, the Fed acted too slowly in cutting the federal funds rate to stabilize inflation, which swung from an alarming rate of over 5% (year-over-year), to a negative (deflationary) rate in a matter of a few short months. If Bernanke had been monitoring the USD/EUR exchange rate, he would have realized that he was engaging in an ultra-tight monetary policy in the early months of the financial crisis. He would have known then to act much sooner than December 2008 — almost two months after the Lehman bankruptcy. Perhaps if he had tried to stabilize the value of the greenback, the bankruptcy may never have occurred in the first place.


Steve Hanke
for The Daily Reckoning

Ed. Note: Steve H. Hanke is a Professor of Applied Economics at The Johns Hopkins University in Baltimore and a Senior Fellow at the Cato Institute in Washington, D.C. You can follow Prof. Hanke on Twitter: @Steve_Hanke1