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.

25 comments:

  1. Vincent, how come you didn't restate your prediction about Japan in the post? I restated it again for you here:

    https://thefaintofheart.wordpress.com/2014/03/06/its-really-a-sing-dance-among-fomc-members/#comment-13159

    You're welcome. :D

    ReplyDelete
  2. BTW, do you want to add any time period to your 2% per month prediction for Japan? Are you going to declare victory if that happens for a single month?

    ReplyDelete
  3. ... and BTW, you've been making that prediction for at least a month now (probably more), so shall we say in the next 23 months? :D

    ReplyDelete
  4. Tom, lets say my educated guess is Japan will have 2% monthly inflation by the end of 2015.

    But I would like to have a theory that predicted the timing and not just an educated guess. For a country like Argentina or the Ukraine I claim that we could see they were going to run out of reseves within 2 years and so use the backing theory to say hyperinflation would be within 2 years. it is a much stronger theoretical basis for the timing that I want.

    ReplyDelete
    Replies
    1. No, I would not declare victory if it was only one month. I mean that I expect Japan to have the first month of 12 months making 26+% inflation and 3 years making 100% inflation.

      Delete
    2. Are you willing to say anything about how many months of above 2% inflation there will be? Say Dec, 2015 they have their 1st month of 2% / mo or above inflation, but then for every month in 2016 they're back under that. Do you declare victory?

      I hear you on being able to predict better... that's an interesting question, but I have little of interest to say on the topic. :(

      Delete
    3. Vincent, sorry you answered while I was asking again! Ignore. And thanks.

      Delete
  5. Marcus is not thrilled with our "trash" Lol...
    https://thefaintofheart.wordpress.com/2014/03/06/its-really-a-sing-dance-among-fomc-members/#comment-13173
    Oh well... we got some good feedback before we wore out our welcome. :D

    ReplyDelete
  6. Vincent, I have to hand it to you... even if people scoff at your test for hyperinflation, at least you made a very specific prediction. And I don't think you're the type to re-define inflation (like Schiff did) if it doesn't work out. I don't know of any other hyperinflationists making such a specific prediction. Not many non-hyperinflationists will sign up for those kind of predictions either... although Marcus comes close, saying Japan would have to be "Houdini" to get to 2% a month in two years. I think we can assume that Sadowski says "no" to your prediction too.

    I'll tell you what, I'm a coward in general, but I'll stick my neck out and say you're going to be wrong. Lol... :D

    ReplyDelete
    Replies
    1. Do you know any other hyperinflationists with any good debates on their blogs?

      How about one with more than one theory for hyperinflation?

      Delete
    2. Vincent, I do not. Hands down you are the best hyperinflationist I'm aware of. :D

      Delete
    3. Thanks Tom! You seem to travel a lot of econ blogs, so to me that seems a big complement!

      Delete
  7. Nothing new. When the hyperinflation happens, all these "Mish-es" will merely sit down and say that they can't believe what the government just had done. In other words, the hyperinflation will never happen the right way, the way for them to acknowledge they were wrong.

    mava

    ReplyDelete
  8. Vincent, Benjamin wants to come out and play:
    https://thefaintofheart.wordpress.com/2014/03/06/its-really-a-sing-dance-among-fomc-members/#comment-13179

    ReplyDelete
  9. Tom Brown: See the latest Historinhas...I am rolling up my sleeves....

    ReplyDelete
    Replies
    1. I just ran over here to alert Vincent that he's now the subject of a Benjamin Cole guest post on historias! Awesome... Now I'll go back and read it. :D

      Delete
    2. Sorry, "Historinhas" not "historias."

      Vincent, just to make it super clear, here's the link:

      https://thefaintofheart.wordpress.com/2014/03/08/the-kings-new-suit-of-clothes-costs-1345-or-800-in-1980-or-279-in-1999/

      Delete
    3. I posted. Awaiting moderation.

      Delete
  10. I guess everyone was wrong; QE does not cause much inflation. Stephen Williamson has blogged that QE is disinflationary but his reasoning and explanations are so tortured that no one can figure them out.
    My guess is that deflation and weak demand are the twin devils going forward. ...

    ReplyDelete
    Replies
    1. So many people are so wrong, the potential for huge investment gains is just amazing.

      Delete
  11. Hey Vincent, I just had a thought I thought I'd run by you: As you can tell I'm awfully enamored of that story about the native Californians watching in dismay as crazed white men tore everything apart that they valued and which sustained their way of life (i.e. the environment) in the white man's insane pursuit of useless yellow rocks (back in the 1850s).

    Of course it's true that by mutual agreement humans from "more civilized" parts of the world do seem to value those yellow rocks... just as we do certain scraps of paper (e.g. reserve notes). However, if they both essentially fulfill the same function (money). Isn't it perhaps a bit of a misallocation of resources to chose a money that you have to dig out of the Earth like that?

    Here's another take: how about the Yap money: those giant stone wheels that the Yapese would go to great lengths to acquire... canoeing a great distance across the Pacific to Palau to carve them out of stone and then transport them back to Yap (BTW, I was in Palau and saw one of the rejects they left behind). The Palauans must have thought they were nuts!

    That also seems like an inefficient money. It reminds me of the Easter Islanders who apparently at one point put a lot of importance on carving giant stone heads and transporting them across their island. To be sure, nobody really knows what kind of madness happened there, but it seems as if from the accounts of the infrequent visitors there from Western sailors over the centuries that something in that plan went very very wrong at some point... and for some reason (perhaps deforestation to help move the heads) the Easter Islanders seem to have snapped out of their collective insanity and abandoned the cult of the stone heads, pushing many of them over in the process. I think it's true that the Island suffered a major decline in population about that time too... it probably got to be an ugly scene there. What if those silly stone heads were some kind of "money" for them, like the Yapese giant stone wheels? Of course I'm just speculating here, but my point is that maybe money itself should be something that can be more efficiently constructed... since it seldom has any real intrinsic value (I dare say that applies to gold as well... or perhaps should... probably the decimated native Californians would have agreed with me on that score!).

    ReplyDelete
    Replies
    1. ... BTW, I'm not suggesting that we somehow try to outlaw gold or deprive it of it's value... it has value whether or not it's used for money I realize, but if we were to go to some insane environment destroying lengths to acquire it (like we know we have in the past), then there's always a possibility that our collective insanity will actually put us into the position of those Easter Islanders: i.e. nearly destroying ourselves over non-sense. For example, imagine that a new way to mine for gold was discovered which involved detonating hydrogen bombs. Technically it's made an illegal activity internationally (much like trade in ivory or rhinoceros horns is today), but nobody can stop the "gold poachers" from detonating them to get their booty!... Hmmm... perhaps that's the makings of an interesting science fiction story... what do you think? ... at some point the retarded humans realize that the yellow rocks really aren't that valuable... but by that point their civilization and their environment has already been destroyed. :D

      Delete
  12. Vincent, good news in Japan from Sumner!
    http://www.themoneyillusion.com/?p=26342

    "But it will boost growth modestly, and has the potential (if pushed more aggressively), to help reduce their debt burden."

    :D

    ReplyDelete
  13. " A reader of this blog pointed out that the Ukraine's central bank did not have enough backing and so seemed headed for hyperinflation. " I'm looking for more infor on this, was it in a comment, where can I read more? Thanks!

    ReplyDelete
  14. QUANTUM BINARY SIGNALS

    Get professional trading signals delivered to your mobile phone daily.

    Start following our signals right now and make up to 270% daily.

    ReplyDelete

Looking for polite debate on ideas. Never attack a person. Be nice.