Friday, November 22, 2019

Simulating the Difficulty of Putting the Inflation Genie Back in the Bottle

I have updated my Hyperinflation Simulation so it will pause after some level of inflation and you can adjust the sliders to try to stop the inflation.  So if the first pause is at 10% inflation you might increase taxes and set the second pause to be at 20% inflation and then continue.   This makes it an interactive learning experience, almost a game.  It really is very hard to put the inflation genie back in the bottle.   The above link is the ongoing latest version, here is a link to version as of 11/22/19.   Here is a link to my 2013 post about my simulation.

Most people think that if inflation gets too high the government can just increase taxes or reduce spending to stop it.  In particular the MMT types believe this (increasingly popular among Democrats).  If you believe this you don't see any big problem with printing money.   In fact, some people think there is no need for taxes until the inflation starts.   For more on MMT please see this post.

This simulation shows the error in the MMT way of thinking.  Once inflation gets to where people are fleeing bonds the money supply can increase so fast that taxes can not keep it in check.  If the government is running a deficit the central bank has to be willing to buy bonds when nobody else is, or the government shuts down.   In all cases so far the central banks rather print money and buy bonds than see their government shut down and their jobs and paycheck go away.   Sometimes laws were changed or the head of the bank was changed, but in the end they always seem to buy the government bonds.  The new money from debt monetization can be many times the flow of taxes, so taxes can not compensate for it.  

Another problem is that taxes take awhile to collect.  If we imagine that on average there is a 30 day delay between a taxable event and when the citizen pays the government, then it is as if taxes are on the GNP of 30 days ago.  Normally this does not matter, but in hyperinflation it means the government is collecting far too little taxes and so has to keep printing.

The core of this simulation is using the equation of exchange to calculate price.   It also uses Hussman to estimate the velocity of money.   There is a good explanation for the math of hyperinflation.   I believe this is the most reasonable and educational simulation of hyperinflation on the Internet (also the only one :-)) but that it could be improved.  I wish I had data for debt, quantity of money, inflation rate, interest rate, monetization, price level, etc for a bunch of different hyperinflations. I don't have any real world data to get  delays/anticipations to plug into the model.    How fast things happen in the model probably does not show how fast they happen in the real world.

I would love to have people play with the simulation and suggest better formulas or defaults.  Report any funny behavior.    You can also clone this simulation and adjust all the formulas.  Please comment with a link if you do.

Historically people have noticed the difficulty of "putting the inflation genie back in the bottle".  This hyperinflation simulation shows why it is so hard.  Hyperinflation is best seen as a "debt monetization death spiral".  Once you enter a death spiral it is hard to get out.   I think if people really understood the difficulty they would be far more concerned about preventing inflation from starting.

Tuesday, April 5, 2016

Keynesian Leaches

There was a time when doctors would prescribe leaches for certain health problems.  When it did not work they often just increased the dose, with more leaches.   Often the leaches would kill the patient.  The Keynesian economists today do a similar thing.  They prescribe money creation.  When that does not work, they prescribe an increased dosage of money creation.   Eventually the patient, the economy, dies.

Thursday, March 31, 2016

James Rickards on Japan

"Jim is increasingly convinced that Japan is ground zero for some very serious problems coming in the global economy. "     I think so too.

Wednesday, March 16, 2016

Shape of graph for BOJ holdings of JGBs

In an article on the BOJ holdings of JGBs they have the above graph.  Note that BOJ is Bank of Japan and JGB is Japanese Government Bonds.  The red curve above is actual data and the blue part is a projection.   I think the projection is wrong.  The red part looks like it is curving up while the blue projection is linear.  If the curve is really an exponential growth curve, and the projection is linear, then after a few years the projection will be way off.  Even with this linear projection they get to owning about 50% of the JGBs within about 2 years.  I don't believe there is any historical case of any country monetizing such a large fraction of such a large debt without very high inflation.  If inflation picks up you can be sure everyone will want to dump their JGBs, since fixed rate bonds lose value fast as inflation picks up.  This will make the BOJ buy even faster.  So I expect the real graph will keep curving up.

Tuesday, February 23, 2016

All you need to know

People think central banks have "lots of different tools to work with" but really they have one trick, they can make more money.   The details on on how they do the trick, the words, and the smoke, can change, but at the end of the day their only "secret weapon" is making more money.  If the only tool you have is a hammer, you treat every problem as if it were a nail.  If you try to fix your car, or the economy, with a hammer, it probably won't be a happy ending.

Sunday, February 7, 2016

Studies of Failed Currencies

Somehow I have been credited with a study of 599 failed currencies, though I have not done such a study.   There have been studies of the history of failed currencies and it seems good to have a post where we can collect such studies into one place.   If anyone knows of other interesting studies  please post them in the comments and I will add them to this list.

1) History of Fiat and Paper Money Failures by Mike Hewitt.

Has a list of 177 current currencies and when they were started. I count only 16 of these as existing prior to 1900.

It has a list of 609 currencies that no longer circulate and says 153 of these died of hyperinflation.

2) Inflation and the Fall of the Roman Empire by Arto Bendiken

Detailed history of Roman inflation.

3) Fiat Currency: Using the Past to See into the Future by Nick Jones at Daily Reckoning.

Looks at Rome, China, France, and Germany. Says China's paper money was called "flying money" was because "because it could just fly from your hands.". To clarify, people would spend hyperinflating paper money as fast as they got it and hold onto silver coins.

4) Fiat Money Inflation in France by Andrew Dickson White

Fantastic book (free online) with detailed history of a French hyperinflation.

5)  5 Failed Currencies And Why They Crashed by Investopedia

Looks at Germany, Argentina, Zimbabwe, Peru, and Chile.

Referenced but not located studies.

1)  " 775 fiat currencies by" but the domain does not work.  Wonder if someone has a copy.

Saturday, January 2, 2016

Stock Market Omen

The S&P 500 recovered much more from the Aug drop than the Russel 2000 did. When people start to get nervous they move from smaller "risky" stocks to larger "safer" stocks. This often happens before a big crash.

Sunday, December 20, 2015

Expect Surprising Inflation

The velocity of money is a function of interest rates and inflation rates.   As interest rates go up, the velocity of money will go up.  Originally the Fed claimed they had an exit strategy to reduce the money supply and prevent inflation.   However, they no longer seem to have a strategy for reducing the money supply.   The money supply is still going up, not down.  With an increasing velocity of money and increasing money supply, the equation of exchange predicts inflation will go up.    Since inflation also increases the velocity of money, and so further pushes up inflation, the risk of "run-away-inflation" is real.   Since few other people expect this, most people will be surprised.  Now that interest rates have started going up, we should expect surprising inflation.

At least that is what my theory predicts.   It will be interesting to watch the experiment unfold and the results come in.

Tuesday, December 8, 2015

How Dynamic Hedging Will Fail

I expect dynamic hedging strategies to fail badly sometime in the next couple years.

There are companies that sell options and use dynamic hedging.  This means they make frequent adjustments to their overall position so that on net it remains neutral for small movements in the market.   They have to keep adjusting their position all the time in order to sort of be hedged.   For example, if they sell some calls on a stock and just the right number of puts on the same stock then for small changes of the stock in either direction the gains and losses on the puts and calls can compensate each other.  But after the stock moves a bit it will take a different number of puts and calls to balance each other, so they must either change the quantity of puts/calls they hold or buy/sell some of the stock so that once again they are net neutral for small changes in the stock.

 It is not a true hedge though.    In the event of a crash, they can not adjust their position fast enough and so they are not net neutral during the crash.   In the call/put example above, the calls become nearly worthless and the puts very valuable.  What they lose by being short the puts is far more than the gain being short the calls.   As they try to adjust their positions, say by shorting the stock as it goes down, they will contribute to the crash.   In a crash, companies using dynamic hedging could go bust.  

It is kind of similar to the portfolio insurance that people were doing around the time of the 1987 crash. It all looks ok on computer simulations which assume nice continuous pricing changes and that their buying and selling does not change the price much. However, after an investment idea is popular, large numbers of people doing the same thing means things do not work like they did in the computer simulation.   The people using the idea can drive the price and the price can move so fast that the idea can not be implemented as planned.    So the very activity of "portfolio insurance" or "dynamic hedging" done by many people can cause a crash. When the hedging algorithm fails, companies based on it will go bust.

A company selling a put on the S&P but using dynamic hedging is like a company selling insurance against a crash while not really being in a position to pay off on the policy in the event of a crash.   If too many companies selling such options go under, it could be very messy.

Murphy's Law says that anything that can fail will eventually fail.  Dynamic hedging can fail.