Wednesday, March 19, 2014

Living Like Parasites

Putin said of America, "They are living like parasites off the global economy and their monopoly of the dollar."

Putin understands something that few do.

Imagine half the dollars are outside the USA and half are in.  Then imagine $1 trillion new dollars are made and owned by the USA.  No real new value is made when this new $1 trillion in money is created.  Eventually all the existing money will be reduced in value because of this new money.  Half of this stolen value comes from reducing the value of the money outside the USA.  So in effect the USA has sucked $500 billion out of the rest of the world.  Living like parasites is a good description.

Sunday, March 9, 2014

The Threat of Dumping Bonds

When the British, French, and Israelis attacked in the 1957 Suez Crisis, America was able to put financial pressure on Britain. It held many British bonds and threatened to start selling them if the British did not stop the attack. From the Wikipedia article:

"Britain's then Chancellor of the Exchequer, Harold Macmillan, advised his Prime Minister Anthony Eden that the United States was fully prepared to carry out this threat. He also warned his Prime Minister that Britain's foreign exchange reserves simply could not sustain a devaluation of the pound that would come after the United States' actions; and that within weeks of such a move, the country would be unable to import the food and energy supplies needed simply to sustain the population on the islands."

Some say this marked the end of the British imperial power and the start of America as a "superpower".

Now Russia is threatening to dump US bonds if the US imposes sanctions on Russia for Crimea.  


Friday, March 7, 2014

Scientific Theories Make Testable Predictions

A common criticism of "people who believe in hyperinflation" (as if it was like the Tooth Fairy) is that we can not reliably say when it will start.   You can see this at Cullen Roche,  Scott Sumner, Mike (Mish) Shedlock, and Paul Krugman.   Several of these have had many posts of the form, "ha, ha, I have been right so far".  However, I have not been able to any real debate from these people over the theory of hyperinflation as in  Hyperinflation FAQ and also Hyperinflation Explained in Many Different Ways.

The average paper money seems to last about 25 years. Big developed countries pull this average up, but even America has had hyperinflation a couple of times.   But for discussion, lets assume hyperinflation happens 1 out of every 25 years in the average country.  This means that 24 out of 25 years there is no hyperinflation.   Someone who just says, "no hyperinflation this year" is like a stopped clock that is right 96% of the time.  And still they are so proud.  :-)

Just to be very clear, if these people don't switch to "there will be hyperinflation this year" right before the hyperinflation starts, then I claim that in all their previous predictions of "no hyperinflation this year", they were just being stopped clocks.

I also like to point out that when you go from 2% inflation to 26% inflation, 30 year bonds will lose 99%  of their real value.  So it is better to be many years early than one year late in getting out of bonds if hyperinflation is coming.

Still, there is some truth to this criticism.     A scientific theory makes testable predictions.  A good theory should make predictions that turn out right.  Not looking to debate if The Dismal Science is a real science.

With my many explanations of hyperinflation we have many good theories of how hyperinflation works.  In general there is a feedback loop.  But most of these theories don't give us much clue about  when the feedback loop will start.   The timing is not really part of these theories.

However, one of these does have timing information.   The backing theory of hyperinflation.   This says that the central bank has to have reserves to support the value of the currency.   If the central bank is burning through these reserves at a rate where they run out after a certain time, we have some handle on the timing.  They may prop up the value of their currency till they are almost out of reserves, but that  is it.  There will be a  day of reckoning.   We can estimate when by how long till they run out of reserves.

When the Argentine government took much of their central bank's reserves, I said to myself that they were headed for hyperinflation.   A reader of this blog pointed out that the Ukraine's central bank did not have enough backing and so seemed headed for hyperinflation.   Both of these were based on the backing theory of hyperinflation.   So to me the backing theory of hyperinflation seems a very good way to predict timing for hyperinflation.   So I would like to try to do this in a public way.  Clearly predictions made in public are far more impressive.

For me the interesting prediction is when a currency will go from something normal like 2% inflation to 26% or higher yearly inflation.  There are also many more making this transition than those that go all the way to 50% per month.

Do any readers have an ideas for countries that now have moderate inflation but where the central bank reserves per note issued are far below the current value of the note?   A government running a big deficit has a harder time bailing out the central bank, so that is an important factor as well. In fact, it is prbably reasonable to just look at foreign reserves if the government has a large deficit, ignoring government bonds.

 I will update this post trying to make an ordered list of hyperinflation candidates.

The central banks in the big reserve currency countries seem to have lots of long term bonds in their own currency.  It would be nice to  know how much these  would drop in value as interest rates went up.   Like if Japan's interest rates go up 2% what does that do to the value of the central bank's reserves?

I have an earlier post on ideas for predicting the timing of hyperinflation.