Thursday, October 24, 2013
Exporting inflation, or...
What's it like getting burned in effigy?
I re-read some of the prior posts, and realized I only talked around why I feel there won't be a policy change to end our situation; I never actually defended my position. Why won't (can't?) we stop QE-I've-lost-count, and also raise interest rates a few percent to encourage saving? Well, it was done before, and with painful results. We're in a similar situation now, but with much worse numbers in our ledger.
Before getting into the meat of the discussion, I should explain what exporting inflation means. The ability to export inflation is the primary benefit of being the reserve currency, and this has allowed our debt to balloon to a point unreachable by all but a few nations (Japan). But how does the USA export inflation? Other nations export their products to the USA; we're the world's largest consumer of, well, probably everything. Nations that import to the USA are myriad, but China and Japan are the most commonly cited examples. The notion of exporting inflation works best with China, so we'll use it as an example. We print money, or have 0.5% interest rates, or something similar. This money is then distributed to the local economy in the form of tax rebates, Social Security payments, a public (make) work project, my salary, etc. Americans use this mana from heaven to buy gadgets from China, and the Chinese company goes to the Chinese Central Bank, dollars in tow, to get Yuan in trade for the greenbacks. Whether the bank has to print currency, or has cash on hand, the dollars will go in the vault, and the Yuan gets paid to the employees, vendors, bribes to local officials, etc. Now there's too many Yuan chasing a limited supply of goods and services, and thus inflation is created. If I gave everyone in a small town $1,000,000, but told them they could only buy products in that small town, everything would get really expensive really quick. It would also encourage local production and employment, which is why the Chinese government plays this game, lest the natives get restless and start demanding freedom of speech, fair trials, etc. It's better to keep them working.
Under the Bretton Woods agreement, America had a nominal gold standard and the world reserve currency. We were in charge, but the gold link kept us from abusing our authority. In 1971, Nixon removed this restraint, and the economy went haywire. We hit not with mere inflation (which was probably expected) , but stagflation, where the cost of everything went up, and the economy either wasn't growing, or in recession. Prior to 1965, economic contraction/stagnation and inflation were seen as mutually exclusive. Inflation is supposed to make people, governments, and companies spend money. Just as a falling stock market encourages people to sell shares, the falling purchasing power of a currency is supposed to encourage consumption. If you waited to buy something, it would be more expensive, even much more expensive later. Those of us who remember this facet of the 70's also remember that the decade, for most people, fucking sucked. The stagflation of the 70's was cured, at least according to conventional wisdom, by Paul Volcker's raising interest rates; the Prime rate hit approx. 21.5% in 1981. This stopped inflation, along with any false hope of economic growth.
Effectively, Volcker made a choice. Inflation, for all it's negative consequences, is seen generally as better than a recession, in small enough doses. In the stagflation era, we had rising prices, but without the assumed growth in economic activity. Volcker could kill one bad effect or the other, but not both. He chose to kill inflation, and cause a nasty contraction as well. To use another metaphor, we weren't getting high of the stimulant; we were barely approaching normal even while using. If you'd be normal without the drug, why not just quit cold-turkey? Because it causes withdrawal, and that comes with a great deal of pain. Volcker chose the pain, with only the hope of recovery guiding him. Naturally, he was hated, and he was burned in effigy in his first year. Now he's respected, even lauded, for doing what others didn't have the courage to do. I've read in a few places that his actions didn't actually cure inflation, but the theories are too arcane for a layman like myself to understand.
One can argue that America could have another Paul Volcker come along and curb-stomp us out of this mess, but so far we're appointing people doing just the opposite, and I have no faith in this possibility regardless. In my prior post, I discussed the effects interest rates had on the purchasing power of mortgages. Let's take that and apply it to the national debt. At the end of 1998, we had a national debt of 5.6 trillion, with debt payments of 353,511,471,722.87. Figures are from http://www.treasurydirect.gov/NP/debt/search?startMonth=12&startDay=31&startYear=1998&endMonth=12&endDay=31&endYear=1998
and that means an interest rate of about 6.5%. Today out debt stands at 17 trillion. Our year to date debt payments are a little over 415 billion, with a yearly total of around 498 billion. Our debt has tripled, but our payments are only 1.5 times higher. What happens when interest rates hit 6.5% like 1998? 1 trillion, 100 billion in interest.
These figures is why I believe we'll never have another Volcker. Never mind being burned in effigy; this person would be burned alive. There's no self-directed way out of this save either MASSIVE money creation or outright default. Either action leads to the rest of the world taking away our role as economic stewards. What happens then?
I re-read some of the prior posts, and realized I only talked around why I feel there won't be a policy change to end our situation; I never actually defended my position. Why won't (can't?) we stop QE-I've-lost-count, and also raise interest rates a few percent to encourage saving? Well, it was done before, and with painful results. We're in a similar situation now, but with much worse numbers in our ledger.
Before getting into the meat of the discussion, I should explain what exporting inflation means. The ability to export inflation is the primary benefit of being the reserve currency, and this has allowed our debt to balloon to a point unreachable by all but a few nations (Japan). But how does the USA export inflation? Other nations export their products to the USA; we're the world's largest consumer of, well, probably everything. Nations that import to the USA are myriad, but China and Japan are the most commonly cited examples. The notion of exporting inflation works best with China, so we'll use it as an example. We print money, or have 0.5% interest rates, or something similar. This money is then distributed to the local economy in the form of tax rebates, Social Security payments, a public (make) work project, my salary, etc. Americans use this mana from heaven to buy gadgets from China, and the Chinese company goes to the Chinese Central Bank, dollars in tow, to get Yuan in trade for the greenbacks. Whether the bank has to print currency, or has cash on hand, the dollars will go in the vault, and the Yuan gets paid to the employees, vendors, bribes to local officials, etc. Now there's too many Yuan chasing a limited supply of goods and services, and thus inflation is created. If I gave everyone in a small town $1,000,000, but told them they could only buy products in that small town, everything would get really expensive really quick. It would also encourage local production and employment, which is why the Chinese government plays this game, lest the natives get restless and start demanding freedom of speech, fair trials, etc. It's better to keep them working.
Under the Bretton Woods agreement, America had a nominal gold standard and the world reserve currency. We were in charge, but the gold link kept us from abusing our authority. In 1971, Nixon removed this restraint, and the economy went haywire. We hit not with mere inflation (which was probably expected) , but stagflation, where the cost of everything went up, and the economy either wasn't growing, or in recession. Prior to 1965, economic contraction/stagnation and inflation were seen as mutually exclusive. Inflation is supposed to make people, governments, and companies spend money. Just as a falling stock market encourages people to sell shares, the falling purchasing power of a currency is supposed to encourage consumption. If you waited to buy something, it would be more expensive, even much more expensive later. Those of us who remember this facet of the 70's also remember that the decade, for most people, fucking sucked. The stagflation of the 70's was cured, at least according to conventional wisdom, by Paul Volcker's raising interest rates; the Prime rate hit approx. 21.5% in 1981. This stopped inflation, along with any false hope of economic growth.
Effectively, Volcker made a choice. Inflation, for all it's negative consequences, is seen generally as better than a recession, in small enough doses. In the stagflation era, we had rising prices, but without the assumed growth in economic activity. Volcker could kill one bad effect or the other, but not both. He chose to kill inflation, and cause a nasty contraction as well. To use another metaphor, we weren't getting high of the stimulant; we were barely approaching normal even while using. If you'd be normal without the drug, why not just quit cold-turkey? Because it causes withdrawal, and that comes with a great deal of pain. Volcker chose the pain, with only the hope of recovery guiding him. Naturally, he was hated, and he was burned in effigy in his first year. Now he's respected, even lauded, for doing what others didn't have the courage to do. I've read in a few places that his actions didn't actually cure inflation, but the theories are too arcane for a layman like myself to understand.
One can argue that America could have another Paul Volcker come along and curb-stomp us out of this mess, but so far we're appointing people doing just the opposite, and I have no faith in this possibility regardless. In my prior post, I discussed the effects interest rates had on the purchasing power of mortgages. Let's take that and apply it to the national debt. At the end of 1998, we had a national debt of 5.6 trillion, with debt payments of 353,511,471,722.87. Figures are from http://www.treasurydirect.gov/NP/debt/search?startMonth=12&startDay=31&startYear=1998&endMonth=12&endDay=31&endYear=1998
and that means an interest rate of about 6.5%. Today out debt stands at 17 trillion. Our year to date debt payments are a little over 415 billion, with a yearly total of around 498 billion. Our debt has tripled, but our payments are only 1.5 times higher. What happens when interest rates hit 6.5% like 1998? 1 trillion, 100 billion in interest.
These figures is why I believe we'll never have another Volcker. Never mind being burned in effigy; this person would be burned alive. There's no self-directed way out of this save either MASSIVE money creation or outright default. Either action leads to the rest of the world taking away our role as economic stewards. What happens then?
