Paradoxical Deflation coming?
- Thread starter noob_trad3r
- Start date
You're right, but I don't think for the reasons you seem to think you're right.
I could be misreading you, so I'll just state what I think simply: if a place is an attractive place to invest AND a foreigner can develop reasonable confidence that a) over a reasonable timeframe he won't lose a substantial amount to currency devaluation, and b) over a reasonable timeframe he can get his money out on demand (no capital controls) then you will see currency appreciation over and above what you would expect to see given a country's current account position.
And vice versa.
However, unless a country is a habitual defaulter like Argentina, the current account will win out over the longer term. This gets expressed in inflation differentials, since a favorable current account position allows a nation to be less of a price taker in re imported goods and services.
The exception to this is the issuer of the reserve currency, since that status means that country is obliged to run a current account deficit to finance global growth, and also means it is, by definition, the most desirable place for foreigners to invest.
Morganist, you know I like to speak directly and clearly about what I am talking about and I like to reduce things to process level. I don't have a lot of patience for talk about 'factors' and 'underpinning' of value when you never identify any factor, any underpinning or explain the process of how that effects 'value of a currency' or inflation or deflation.
Currency is just a form of sovereign credit. It is a zero interest demand note, usually in small denomination. It is part of a sovereign's spectrum of credit...it marks the bottom of a Sovereign's credit yield curve. The value of the currency is determined by the credit worthiness of the Sovereign that issues it. Currency is created by Sovereigns through the purchase back of their own interest bearing notes and bonds. If there is no private market for a Sovereign's notes and bonds then the value of their currency will drop. If a Sovereign does not have access to private credit markets, if it cannot sell its notes and bonds to third parties, then its currency will have no value. Fiat currency is backed by debt and the good faith of the Sovereign to honor that debt, there is no collateral.
So, you must see that currency is not an investment vehical. It is more like a yard stick, it is how we measure value of goods and service in trade. The goods and services have value and the money we price them in only has value because the Sovereign's credit is good and we accept that credit for the value of the goods and services in trade. We represent that value in currency. The best the monetrary authority can do is to maintain a stable measure of value over time. If the proper management of currency is to create a stable measure of value over time, it would hardly make a suitable investment.
When you think one currency will appreciate over another currency in time you saying too things...one, the depreciating currency is not as stable a measure of value; and you do not have good place to invest you money so you are leaving it in currency.
In a deflation, as I stated above, value is flowing out of tangible and enterprise assets, flowing out of longer term financial assets, and into currency; not as an investment but as a liquid holding place. The problem today is that the world is in search of good money as it deleverages and the CB's are not managing the currencies for stability; at the same time the Sovereigns continue to borrow to fund annual operations in deficit which brings thier creditworthiness and so their currency into question. As the CB's fight the deflation with their interest rate reductions, ZIRP policies, LTRO policies, QE's and Twists, they compress thier Sovereign Yeild curves so there is no material difference between the demand note zero interest currency and multi year Sovereign Bonds.
In this environment with assets bleeding down to demand note currency and the management of currency is to reduce its value the best that can be done is achieve liquidity and a slower loss of currency value than asset value. That is why the demand for the U.S. 10 year treasury, Japaneese Bonds and the Bund are so high. They are not being purchased as investment, they are currency substitutes and they are being purchased as a place of liquidity. It has nothing to do with investment.
Currency is just a form of sovereign credit. It is a zero interest demand note, usually in small denomination. It is part of a sovereign's spectrum of credit...it marks the bottom of a Sovereign's credit yield curve. The value of the currency is determined by the credit worthiness of the Sovereign that issues it. Currency is created by Sovereigns through the purchase back of their own interest bearing notes and bonds. If there is no private market for a Sovereign's notes and bonds then the value of their currency will drop. If a Sovereign does not have access to private credit markets, if it cannot sell its notes and bonds to third parties, then its currency will have no value. Fiat currency is backed by debt and the good faith of the Sovereign to honor that debt, there is no collateral.
So, you must see that currency is not an investment vehical. It is more like a yard stick, it is how we measure value of goods and service in trade. The goods and services have value and the money we price them in only has value because the Sovereign's credit is good and we accept that credit for the value of the goods and services in trade. We represent that value in currency. The best the monetrary authority can do is to maintain a stable measure of value over time. If the proper management of currency is to create a stable measure of value over time, it would hardly make a suitable investment.
When you think one currency will appreciate over another currency in time you saying too things...one, the depreciating currency is not as stable a measure of value; and you do not have good place to invest you money so you are leaving it in currency.
In a deflation, as I stated above, value is flowing out of tangible and enterprise assets, flowing out of longer term financial assets, and into currency; not as an investment but as a liquid holding place. The problem today is that the world is in search of good money as it deleverages and the CB's are not managing the currencies for stability; at the same time the Sovereigns continue to borrow to fund annual operations in deficit which brings thier creditworthiness and so their currency into question. As the CB's fight the deflation with their interest rate reductions, ZIRP policies, LTRO policies, QE's and Twists, they compress thier Sovereign Yeild curves so there is no material difference between the demand note zero interest currency and multi year Sovereign Bonds.
In this environment with assets bleeding down to demand note currency and the management of currency is to reduce its value the best that can be done is achieve liquidity and a slower loss of currency value than asset value. That is why the demand for the U.S. 10 year treasury, Japaneese Bonds and the Bund are so high. They are not being purchased as investment, they are currency substitutes and they are being purchased as a place of liquidity. It has nothing to do with investment.
Ed, that is one of a very few things you have written that not only do I agree with, but it is actually correct. And Ed, they can bail indefinitely, and not only that but their bailing equipment is formidable. They have enormous bilge pumps! And there is a very smart guy in charge of the those pumps. Smarter than even you Ed.
Furthermore the hole in the boat is repairable, and in time will be repaired. The U.S. will get through this so long as international confidence in the dollar is not lost. So far, there is no sign of that, none!
Swan Noir and Morganist have something worthwhile to say. What Swan writes of worries me some, but I am guessing, only guessing, that the power and skills of the Fed and Treasury combined is great enough to prevent deflation. But even if the Federal government leverages up sufficiently to hold price deflation at bay, I still worry that great segments of U.S. society will suffer painful, long lasting declines in their standard of living and that the ranks of the poor will grow before we exit from this calamity we have brought upon ourselves.
Congress has the power to head the ship in the right direction before the pain becomes unbearable for many, but i've lost confidence in their will to all row in the same direction at once. If the ship does eventually sink, I doubt seriously that it will, it will be Congresses fault, not the President's.
If you want a good read, read Daniel Patrick Moynihan's "Secrecy", (Yale Press) It is about way more than secrecy in government. It is about how and why we wasted a huge portion of our national treasure on illogical, counter productive spending, how we became a paranoid nation, and how we blew the tremendous economic lead we once had. Just one factor, but an important one in getting us to where we are today.
But cheer up, Ed, the ship of fools is unlikely to sink. Rescue crews are on the way.
Piezoe, I have been trying to offer here a specific discussion of how inflation and deflation work as processess in direct response to the original paradox question that noobtrad3r posed to start this thread. I did not contradict Swan Noir nor did I directly disagree with Morganist, we have a tangent discussion about domestic v. international inflation/deflation...I suggest there is a different, more finance based way to look at how the credit markets are the transmission mechanism where the macro economic effects of what we measure as inflation or deflation are manifest.
With regard to the back and forth between you and I, your comment has nothing to say about the process details I offered; you write that you have faith in the Fed to deal with all macro economic matters because they have all the tools and they are very smart. That is an opinion that you present as a matter of faith so, OK; that is your opinion.
My comments attack that faith in that I have suggested that the Fed and really all G20 CB policy to combat the tide of deflation process that continues is based on the Quantity Theory of Money. My suggestion is that this tool does not work when the private credit market is contracting. We have already reduced interest rates to Zero and we have, in the U.S., increased the Fed balance sheet by $2.2T...on a percentage basis the ECB has increased its balance sheet more...so has the U.K. When the CB's take this action they weaken thier currencies and they risk the credit worthiness of thier Sovereigns. At the same time they reduce the earnings of thier banks and direct aggregate interest earnings to themselves; they add liquidity but they allow solvency to continue to slide. When you say they have unlimmited power, I disagree. By not allowing the markets to clear, by distorting the price signals in the credit markets, they make the private banks dependencies that are not capable of facilitating an increase in 'velocity,'; the expansion of aggregate private credit.
With regard to the back and forth between you and I, your comment has nothing to say about the process details I offered; you write that you have faith in the Fed to deal with all macro economic matters because they have all the tools and they are very smart. That is an opinion that you present as a matter of faith so, OK; that is your opinion.
My comments attack that faith in that I have suggested that the Fed and really all G20 CB policy to combat the tide of deflation process that continues is based on the Quantity Theory of Money. My suggestion is that this tool does not work when the private credit market is contracting. We have already reduced interest rates to Zero and we have, in the U.S., increased the Fed balance sheet by $2.2T...on a percentage basis the ECB has increased its balance sheet more...so has the U.K. When the CB's take this action they weaken thier currencies and they risk the credit worthiness of thier Sovereigns. At the same time they reduce the earnings of thier banks and direct aggregate interest earnings to themselves; they add liquidity but they allow solvency to continue to slide. When you say they have unlimmited power, I disagree. By not allowing the markets to clear, by distorting the price signals in the credit markets, they make the private banks dependencies that are not capable of facilitating an increase in 'velocity,'; the expansion of aggregate private credit.
1) China, Iran and Russia are trying to do some their oil dealing without involving any USD.
2) Suggestions (reiterations) on a global reserve currency have been made, in the wake of all the media attention on the mountain of US government debt.
3) Some countries with current account surpluses will run them down as their populations retire - Japan and China are aging fast. Here it is not a matter of confidence, but a necessity of retirees to withdraw some of their savings. Part of their savings is held in US treasuries
4) China are taking baby steps to open up their currency. If the Chinese RMB becomes an open currency, it will inevitably compete with the USD for the role of reserve currency.
Sidenote: I think Saudi Arabia is forced to deal in USD, war could even be declared if they tried to switch.
Ed, I would love to here how you relate the credit mechanism to foreign holders of US treasuries.In my view, the international supply and demand of treasuries should affect the exchange rate, which in turn affects prices in the US. Their actions would then have big impact on inflation/deflation.
Love the thread by the way.
Yup, yup, yup, yup. Iran's been trading oil using Euros for some time now. So far seems any divesting of U.S. treasuries, has been fairly innocuous. Granted, the Fed has been there to take up any slack at auction time and keep prices high, rates low.
What would be of concern would be a sudden dumping by anyone. But the U.S. has everyone over a barrel so to speak. If everyone rushes for the exit at once there would be huge losses for the last ones through the door. The world is awash in dollars and dollar denominated paper, I am thinking the CB's around the world are finding it in their interest to continue to support the dollar.