Greetings Fellow Inmates,

It has been a long 20 days since we last convened, so we wish all our readers and friends all around the global penitentiary system a prosperous start to 2010.  We have spent these 20 days on leave in a fruitful little corner in The Yard; we played, we toiled, and return refreshed to our regular routine.   For this first post on the new year, we thought to begin with what will be one of the central themes of our discussions in 2010; money, itself.    In many ways, we have already spent a great deal of time thinking about what constitutes money, its sufficient and necessary conditions, and attempted to come up with some draft definitions.   2010 is likely to be a year that will lead to many people to question very basic notions about risk, wealth (what it means and how to preserve it) and well-being.   Now, let us be clear and specific.   We have thus far made very few predictions about 2010. As many of our readers know, we are weary of prognostication; we mostly like to spot problems and inconsitencies, whose eventual consequences become impossible to time given the chaotic nature of herd behaviour and information absorption coefficients.  We did predict however that by 11.07.10, Uncle Benny will have increased quantitative easing, and put our money where out mouth is.  The most recent Fed Board Minutes confirm our suspicions.   This alone could be enough to trigger a collective “realization” that QE is getting out of control, and in combination with the rising inflation pressures continuing and worsening in 2010 could really lead investors worldwide to seriously question the viability of the current UST/USD-denominated system.   Therefore, we are strongly predicting a very significant lack of confidence in the UST/USD-system, as qualitative as this is.  Will 2010 be enough to break the greenback’s back?  Who knows, but the first flowerings will certainly appear this year.  Make no mistake about it, the coming crisis will be one of confidence, a break of the faith in the system.    A central tenet of the broken faith will be to shift from paper/digital assets into real ones.   When the full crisis is set and done, most of us will have been forced to re-evaluate what constitutes “real” wealth, and how to best store it; a discipline we have long forgotten generationally (since 1933), and will thus lead us to question basic notions about money.

Tonight, our discussion will be framed by an exceptional essay written by one of the most notorious characters in the twentieth century, Judy Greenscam.  As a brief aside, we’d like to direct our readers to “The Enforcers” section, where we have just added a bio sheet for Judy Greenscam.  Once again, this section is highly recommended reading and well worth your while.   Moreover, we would like to announce a contest where the first reader to correctly identify the origin of the nickname “Judy” will win an autographed copy of Judy’s book, The Age of Turbulence shipped anywhere in the world, as well as permanent enshrinement in Judy’s biosheet; we have left ample clues throughout the website.    Anyway, back to the essay.

The piece, grandiosely titled “Gold and Economic Freedom”, first appeared on 01.06.66 in Ayn Rand’s “The Objectivist” Newsletter.  It really is a marvellous brief treatment of the gold standard and how it protects/defines wealth so much better than a paper fiat system.  Imagine that: Judy at one point was succinct, precise, thorough and piercing.   Of course she was!  The whole greenscamspeak charade was nothing but a smoke-and-mirrors show, at which Judy maniacally and hysterically laughed in private.   But that is neither here nor there.   The true value of Judy’s piece, which we recommend you read in its entirety, is its attempt at clear and unquestionable definitions of money, wealth and savings.   Judy’s words ring just as true today as they did in 1966, and will remain true for the foreseeable future: such is the nature of exact and rigid definitions.   We will quote Judy in italics, and we begin with the most basic definition of all. 

Money is the common denominator of all economic transactions. It is that commodity which serves as a medium of exchange, is universally acceptable to all participants in an exchange economy as payment for their goods or services, and can, therefore, be used as a standard of market value and as a store of value, i.e., as a means of saving.

General and robust, we shall adopt it; whenever we use the word “money”, we mean the above.  Beyond this literal definition however we will, of course, still explore all the ontological, philosophical and ultimately practical nuances of properly defining/designing a form of money, or store of wealth.    Judy then proceeds to describe some of the features of such a medium of exchange, in much the same way we have attempted to do many times here at DP.   Quite fundamentally, she asserts that a universally accepted medium of exchange allows market participants to “store wealth”, or rather, “save”.   This is of course, the crux of the issue, and one that we will continue to flesh out in 2010, just as we started way back when back when in “A Brief Commentary on Intrinsic Value and Stores of Value”.

Judy proceeds to make several bold statements concerning gold’s role as protector and insurer of economic freedom.   It is extremely ironic, yes, but also mind-bogglingly ridiculous that such an intelligent person, capable of emitting such harsh maxims and syllogisms about gold as economic liberator can then become the Chief Architect of the system created specifically to remove said gold standard¸ and thus, according to Judy, created to economically imprison the populace.    If you are unable to see how this is an enormous case of doublethink then we suggest turning off your BlackBerry, your BloomBerg, and stop listening to Barack oBama.  Judy’s following statements about gold are, again, mostly interesting when juxtaposed to the actual system, for which Judy is perhaps most single-handedly responsible.

Thus, under the gold standard, a free banking system stands as the protector of an economy’s stability and balanced growth.

When gold is accepted as the medium of exchange by most or all nations, an unhampered free international gold standard serves to foster a world-wide division of labor and the broadest international trade. 

It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post-World Was I type of disaster. The readjustment periods were short and the economies quickly reestablished a sound basis to resume expansion.

The statements speak for themselves, but we mostly emphasize the nature that gold leads to quick and efficient market corrections, as it inhibits the accumulation of excesses (unlike paper).   There is ample historical evidence for this, and we strongly urge you to verify this yourself.   Perhaps at some point, we will model this in history (some sort of depth studies of recessions on/off gold standard), but for now our intent is not to expound on the nature of the gold standard, nor even evaluate the merits of Judy’s claims.  We merely point out again the deep and troubling irony of Judy’s avowed knowledge about the nature of the gold standard, 21 years before she became Chairman of the Fed, acting directly against the interests of “Economic Freedom” as she defined it here in 1966.   It’s almost like Judy likes playing the “contrapositive”, or the “receptive” end of the negative.  Hmm.

If banks can continue to loan money indefinitely-it was claimed-there need never be any slumps in business. And so the Federal Reserve System was organized in 1913.

This is a marvellous quote that aims a painful arrow of truth at the Fed’s little heart-place-holder.   This is the principal alleged reason why the Fed was created; to eliminate the business cycle.   If a central bank could create liquidity at will, it was claimed, businesses would never run out of money.   Well, this hypothesis has now been unequivocally, often and robustly proven to be false.    Hence, on its outwardly public purpose, the Fed has failed miserably.   It should be abolished, and a new system devised.   The one thing the Fed has done however though, invariably, is to increase inflation.   Just look at the CPI chart in our previous post.   At creating inflation, the Fed has been an enormous and unwavering success.   This, we believe, was the actual real purpose of creation of the Fed: to create a persistent and stable inflation and thus deprive the populace of their wealth.   The people in charge of the world are very successful at achieving their aims, so as the obvious architects and players in the Fed (again, see The Enforcers), we are confident in assuming that the actual purpose of the Fed is precisely that at which it is the most successful, creating inflation.   This amounts to the grandest-scale theft, a gargantuan erosion of the wealth, a mass impoverishment of the world’s peoples.   Some might call us histrionic, but we beg to differ, and so does Judy.   We are simply sticking to definitions, as was Judy back in her 1966 pre-greenscamspeak days:  a system that creates/promotes a persistent inflation is equivalent to a system that discourages long-term saving, erodes wealth and deprives its participants of economic freedom.   Or as Judy says, remember, way back in 1966,

The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods.

Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.

We could have hardly said it any better, right on Judy.   Let us repeat, “Deficit spending is simply a scheme for the confiscation of wealth.”  Scheme. Confiscation.   Strong words.    We would absolutely love to simply sit Judy, Uncle Benny Obummer, Granpa Volcker, and Mayo Larry in a room as ask them to respond, in the most clearly-worded way possible to the above quotes.   They are largely irrefutable, barring any semantic Idea Shape-Shifting such as that Judy would later-on perfect.  Deficit spending causes greater in debentures, which only increases the ratio of claims to assets, leading not only to further economic imprisonment (in time-terms), but also much greater risk of systemic fiat collapse.

It’s amazing to think the kind of world we would currently live in if the person that wrote this article in 1966 would have actually served as the Chief Monetary Authority in the World for 19 years.   Instead, what we got was Judy, one of the puppeteer’s many masks (also one of the most funny-looking ones).    

We thus conclude this little post.  We will now resume regular postings on DP after our little vacation.  We will resume many of threads we began late last year and cover some of the most pressing developments in our financial and economic universe.    Ultimately, it is important for DP staff to constantly evaluate and reiterate the purpose of our little endeavour.   We are truly immersed in a life-quest to unravel the different risks and economic shackles that imprison us.   We have found that some of the simplest questions pose the most difficult conundrums and are the most problematically dealt with in our current world.  We do not, however, believe we are bound for eternal failure.   It is entirely within the grasp of human intellect to arrive at sound and robust definitions of value and money, to at least a modicum of self-consistency, and build an economic system around them that does not violate or “fuzzy-up” these definitions.    We will attempt this exercise for ourselves, as it will offer invaluable insights for the rearranging of our own lives and risk, and we will fervently hope that our discussions here help further the mental discourse of at least a few survivors that will shape the system of tomorrow.

May your capital be safe and your investments prosperous,

MAAA

Greetings Fellow Inmates,

Today we will take a break from the URC series for a speculative, fun post of Numbers!  We will use one of our three trusty abaci to finally explore a statement we made initially in Count The Money v2.0: “The [US] debt WILL NEVER BE PAID OFF”.    The following is a greatly simplified model, and as such we will properly outline its variables, parameters, equations, simplifications, assumptions, uncertainties, weaknesses and inflection points, as we promised we’d do in the About Us section.   We will then of course weave this “technical” picture into a coherent story.  Please stick with the first half where we lay down the premises of the experiment, we want to make sure you understand the foundations of our thought experiment.   The real cool, mind-bending stuff and results are in the second half.  We promise that even for those NON-technical amongst you, we will provide enough visual support to clearly and vividly illustrate our points.   We will leave the actual equation definitions for our first-ever appendix, in order to not distract the less-math-prone Inmates.

We are setting out to construct a model to attempt to answer the following question.   Given the United States of America’s current TOTAL PUBLIC DEBT SECURITIES and the total size of the US economy, as measured by NOMINAL GDP, what is the likelihood the that United States debt will ever be paid off?  Remember, as we always say, that the TOTAL DEBT SECURITIES (ie, US Treasuries mostly) is not the total amount of debt since the government has many other liabilities that are equally enormous, such as Medicare, Medicaid, GSEs, etc.   So, in any real thorough analysis of the likely evolution of the economy and the debt, these additional liabilities would have to be taken into account.   Clearly, they would make the situation, the current system, even more unsustainable than it already is.    This falls outside the purview of the following model, where we will attempt to demonstrate through simple math that even when just looking at the securities, which are just part of the total debt, the system is already guaranteed to fail.  

OK, on to the basics of the model.    We have split up the exercise into two parts.   In the first experiment, only the INTEREST on the debt securities is paid down.    In the second, the INTEREST is paid down, as well as some PRINCIPAL, with the intent of eventually paying down the debt, as a percentage of total GDP.   In both cases, we assume that NO MORE DEBT IS ISSUED IN EXCESS OF THAT INTENDED TO PAY DOWN INTEREST, or at least until the end of our simulations, in 2333.   This is a very important point, as any deductions, conclusions or recommendations we derive from this model will be predicated upon this assumption.     It is clear a priori that the only chance for the debt to be paid off is if the US starts paying down some of that principal.    This, we will see, can only come from real economic output.

For those of you that are math, reason, logic and rigour junkies such as Ourselves, we strongly urge you at the moment to stroll down to the appendix and read the description of the model before returning to read right here.    It’s a very simple model.   For starters, we assume that there is a fixed interest rate and economic growth.   Of course, this is a far cry from reality, and we will not repeat nor apologize for the simplicity of this model.  It is intended to be simple, it is in fact conservative, since what we are trying to demonstrate is the inherent instability of The System.   And the great thing about the little Excel abacus is that we can make it dynamic, and allow you to play around with it, to really wrap your mind around the absolute ridiculousness of it all.   When you play around with some of the parameters you realize the sheer absurdity of our current system and where it is likely to lead us in the future.   The over-simplifications in the model are of course not trivial and thus impede precise predictive power, but you can say the same about most anything.   The over-simplifications are meant for the simple reason that they illustrate certain key points without the cloudiness of confusion, and because OUR POINT is not to predict the future, but rather clearly demonstrate the nonsensical foundations of our monetary system.   In this purpose, the oversimplifications of the model become marginal, in our humble opinion.

You might also notice that of course the model must be iterative, as a simplified model such as this must clearly be; meaning that the total NOMINAL US GDP and TOTAL US DEBT SECURITIES OUSTANDING (the two main variables in which we are interested) in any given year depend on the values in the preceding year.   This exactly parallels reality, so this model assumption is safe.

Below are the results of our experiment, for a sample CASE STUDY.    You can download the full Excel file here.   We highly recommend you download it, since you can simply play with the parameters, in the RED BOXES, to see the wild outcomes that come out, in other words, you can make ANY SAMPLE CASE you want.   You are encouraged to explore all the embedded functions, check them for consistency, modify them, use them, distribute them, no copyright.    For our purposes we chose as parameters the following: an interest rate of 5% (equivalent to weighted average yield of outstanding US debt securities), and economic growth of 4%.   Of course, we are being somewhat generous given what we expect of the economy, but since our simulation is over 322 years at the max, 40 years at the least, we figure this would be a good “average” value to use over that horizon.    As for the interest rate, we are also being generous, ie “pro”-system-biased, by assuming that the IR will be only 5%, given that we are likely to see SuperInflation and much higher yields in the mid-term future.     So, all in all, we would call these estimates for GDP and DEBT safe, pheasible and conservative ballparks.  Remember, this is the base case we are going to work with where annual GDP growth = 4% and the yield on US bonds is 5%

The following chart shows the result of a case study with the preceding parameters.   Notice that the chart is divided in two parts, the left when ONLY INTEREST IS PAID, and the right, where INTEREST AND PRINCIPAL are paid.   In the second case, in which we assume that principal is paid down, we show that parameter in another RED BOX, as % of GDP.      Notice that for both parts, we calculate the ratio of DEBT/GDP and of GDP/DEBT.   In our CASE STUDY, we assume that the US designates 2% of its annual real economic output to pay down principal on the debt.   

We can notice several things.   Let’s start in the case where the US only pays down its INTEREST.   Then we see that by 2020, the total DEBT/GDP ratio will be 0.90.   By 2050, 1.20 (ie, the total DEBT outstanding is 20% larger than the size of the total US economy).   By 2333, the total DEBT will be 78 times larger than the economy!     In the case where the US uses 2% of its annual GDP to pay down PRINCIPAL, in addition to the interest, then we see that it is actually WORSE.   Up until 2050, things look pretty similar, but they begin to diverge about 2100.   In this case, by 2200, the total DEBT will be 297 times larger than the economy.    Then, in 2207, the GDP goes negative!  Clearly this is a sheer absurdity and the model has “broken down”, partly indicating a “systemic failure”, since remember that THEY do want us to believe that the system works in such simple fashion and there aren’t any nefarious Invisible Hands lurking around. 

Now, why exactly does the GDP go negative? Well, that happens because the debt NEVER stops growing (at least in this base case we are working with now), so at some point the interest payments on the debt become so large that even if we only pay 1% of the interest with real economic output, the cost is so large relative to the economy that it eats it all up.   Everyone dead.   Everything approaches zero; somehow our “system” managed to complete eradicate ALL VALUE FROM ALL THINGS.    Let’s look at what happens to our base case (GDP growth = 4%, Yield = 5%) when we only pay INTEREST and where we use different distributions of DEBT and OUTPUT to pay down the principal.   In other words, at some point we will pay some of the interest with mostly new debt, run the spectrum, until we pay for the interest with mostly real output.   Here are the graphic results.

Yikes!  Notice that given our base case, paying for 99% of the interest by issuing new debt, is the only level shown that prevents GDP from turning negative by 2333.   Anything less than that, even 95/5 is bound to result in sharply negative GDP eventually, with increasingly parabolic results.   In all cases, the debt grows parabolically, but such is the nature of compounding interest and we shouldn’t be surprised.    Perhaps you think we are being facetious by extrapolating all the way to 2333, I mean, really, who cares about what happens to their GreatGreatGreatGrandchildren?   So, let’s take a smaller-window view into the exact same thing, and selfishly look only until 2050.

Very interesting.   For starters we notice that of course, the discrepancy is not as huge.   When we change from paying for the interest with almost all NEW DEBT all the way to paying for the interest with almost ALL REAL OUTPUT, the outcomes are largely the same.    Between 2030 and 2042, the TOTAL US PUBLIC DEBT will surpass the size of the economy.    Big surprise.  

Alright, so it has now been unequivocally shown that in this simple base case, the US can NEVER be paid off if they limit themselves to paying only the interest.   We believe that this statement of course applies to all debt, anywhere, at any time, but we would welcome some debate on the matter.    Now, let’s see if there is any chance of paying off the debt if the US actually intends to pay principal.

In the CASE STUDY presented in the first chart, we saw that using 2% of GDP to pay down the principal actually resulted in a WORSE economic condition and faster deterioration towards ZERO GDP, or the ELIMINATION OF ALL VALUE.   However, by playing around with the parameters we realize that this is NOT always true.   We found that if the US were to designate 6% of all REAL ECONOMIC OUTPUT to paying down the INTEREST, then the DEBT would be in effect paid off, before GDP hit zero.     Voilá! Using 6% of GDP to pay down interest would result in the DEBT being paid off in 2074, and please look at the Excel file and notice how GLORIOUS it is that after the debt is paid down, the GDP begins to grow parabolically.   Of course!!! This is what SHOULD happen, in a RATIONAL DEBT-FREE world.    Below is a graphical sample of simulations all the way to 2100, using different values for the percentage of GDP assigned to pay down PRINCIPAL.

Wow, many interesting things once again.   Notice that when the US designates ONLY 5% of its GDP to pay down the debt the debt begins to decrease (as does GDP of course), but there is a point in which the debt begins to rise again, and once again runs away.       Why does this happen? Well, as GDP decreases, so does the amount of principal the US is able to pay, at some point, the principal payment becomes LESS than the mounting interest, so debt begins to rise again, never to fall for the rest of time.   At 6% however, this “barrier” is overcome and the debt can in fact be paid down.   So, between 5-6% we have another inflection point.      If 6% is designated, then the debt would be paid off in 2074; if 10% is designated, then it would be paid in 2033, and if 15% is designated the US would be debt free by 2023.  

So what are the chances of this happening?   Slim to none.   All we did was show under what circumstances it would even be possible to pay down the US debt.    So, if reality actually mirrored this greatly simplified model (it doesn’t), if Americans learned to live frugally for an entire generation (they can’t), if the macroeconomic conditions actually maintained the levels of our base case (they won’t), and the US government instituted serious fiscal reforms to bring this about (hahaha), then the US DEBT COULD BE PAID OFF.

Ultimately however, it is important to remember that THEY don’t want the debt to be paid off.   Of course not, that is how they keep us slaves.   But enough about blaming THEM.   It is time to blame OURSELVES.   Here it is, in vivid TechniColor, the sheer absurdity of this House of Cards, this Tower of Basel.   So why do you still participate in this system Inmates? 

“Because I must”  Why? 

“Because I have no other choice”  Why? 

“Because I don’t have enough firepower” Why do you need firepower? 

“Because the system gives me benefits and comforts which I’m happy to pay for?”  Even at the risk of death?

“Because I don’t care enough”  You should.

May your capital be safe and your investments prosperous,

MAAA

——————————————

APPENDIX

Let:

gOD(Y) = gross Outstanding US Debt securities on year (Y),

IR = representative interest rate of total US debt securities, ie, the yield on the weighted average maturity of outstanding US debt ,

INTEREST(Y) = the interest rate cost on year Y, equal to gOD(Y)*IR

GDP(Y) = nominal US GDP on year Y,

GDPchg  = the annual percentage change in nominal US GDP, in decimal units,

DebtPer = percentage of the annual interest cost that will be paid through new debt issuance,

OutputPer = percentage of the annual interest cost that will be paid through real economic output

PrinPer = percentage of nominal US GDP to be used to pay down principal,

PRINCIPAL(Y) = the total principal payment on year Y, equal to PrinPer*GDP(Y)

Then, the model stipulates that:

GDP(Y) = [ GDP(Y-1) – OutputPer*INTEREST(Y-1) – PRINCIPAL(Y-1) ]*[1 + GDPchg];

gOD(Y) = gOD(Y-1) + DebtPer*INTEREST(Y-1) – PRINCIPAL(Y-1) ;

where

GDP(Yi), and gOD(Yi) are the initial conditions, in our case

gOD(2010) = $11.9tr

GDP(2010) = $14.5tr



*******************************

ADDENDUM

*******************************

As per Discipulus’ suggestion, we incorporated inflation into the model, it is fairly straightforward, simple and relatively immune to bias, in our opinion.   The model is modified as follows.   All the above PREAMBLES still apply.   We add this preamble.

Let:

CPI = annual rate of inflation, in decimal units

YieldDiff = a higher borrowing cost (yield) since the inflation will make investors push yields up to get real returns.   This is estimated to be same as CPI.    We have not yet verified whether this is a reasonable estimate, we would be happy to oblige anyone that would really care enough for us to find out and even happier if any one of you told us the answer.  

Then the EQUATIONS are modified as follows:

GDP(Y) = [ GDP(Y-1) - OutputPer*INTEREST(Y-1) – PRINCIPAL(Y-1) ] * [1 + GDPchg + CPI],

gOD(Y) = gOD(Y) = gOD(Y-1) + DebtPer*INTEREST(Y-1) – PRINCIPAL(Y-1) ; (stays unchanged).

We have uploaded a new EXCEL file with the inflation study.   Below are the graphs of the results, for 6 different CPI levels (0,1,3,10,25,100), because we can.    A lot of interesting things immediately become apparent.  For this study, we assume only 1% of GDP is used to pay for PRINCIPAL.

At a CPI of 0.0%, we notice that once again, eventually, the DEBT surpasses the economy in terms of total size and will never come back, this time it happens in 2032.  If the CPI rises modestly, to 1.0%, then, once again, violá, the economy continues to grow (or inflate) at a faster pace than the DEBT.   If inflation reaches the allegedly comfortable level of 3%, then we see that by 2050, GDP has grown substantially faster than the DEBT.   At a CPI reading of 10% we notice that interestingly, not only does GDP grow dramatically faster, but the DEBT is even paid off in the year 2050.   If SuperInflation, or a CPI of 25%, does come to pass then we see that the DEBT would be paid off in 2038.   If we reach the wild crazy, “impossible” levels of 100%, then the debt would only be paid off in 2029.   Meanwhile, during the same 40 year period, the US GDP would have grown by a multiple of 500,000 times, in nominal terms?

Does this sound even remotely like the kind of world you want to live in?   Nope, no it does not Dorothy, not by a long shot.   

Greetings Fellow Inmates ,

We reiterate our apology for not having fixed the layout yet due to lack of time since our Unfortunate Internet Incident (UII).   We promise that soon enough we will be back full steam and glory and you will finally have the web space you deserve, making your time in this little prison a little more bearable.   For the next few days we will be boldly taking our 77 Caprice Classic on the road, through a narrow and crooked path that we can walk with love and reverence.   This trip will be first real high-impact and far-reaching project in Please Help Ireland (PHI), so it will quite interesting.   However, that means that for the next few days we will be unable to update the site at all.   But rest assured that we spend many a sleepless night here in the damp concrete, as always, thinking, thinking, thinking.   

The models we have entertained of late are about to get a MAJOR upgrade, true Trusty Abacus III (TAIII) style, you will enjoy.    Also, we have brought that coward’s book, John Maynard, with us to try to weave through his “general” Theory of Web of Debt-Death.   Needless to say, the first few pages alone already reveal inconsistency, a hidden agenda, a manipulation of truth, and ultimately, and this is the kicker, simply FAULTY equations.

As a case in point, we will shortly prove that “G” SHOULD NOT be in the equation, it should not be in the system.    That sacred letter 7 has been nothing but degraded by those conniving knaves that bamboozled Man with a great show of hand-waving while surreptitiously slipping this “variable” into the equation, thus engineering our enslavement.

MiltonKeynesSmith is wrong, and we will demonstrate it.   It might take us three years, and we will go step by step, and we will continue next week!  On a special note for all our readers that love Jesus, the man, the christ, the savior, the whatever, we wish you have a wonderful Holy Week and Easter.    For you ancients out there, continue to bask in this glorious March equinox, it will be one for the ages!

We re-release this great little video due to the increasing talk of inflation of late in our discussions.   It is clear that a big part in the upcoming inflation agenda is the shaping of public consciousness and inflation propaganda will be a fundamental part of this.

For historical sake and entertainment, here is a video from 1933 from MGM, aptly entitled “Inflation”.   It is truly hilarious, really, and quite vividly illustrates the nonsensical nature of our current monetary system.    Please consider this, do you feel a little bit embarrassed for the intended audience of this video?  Can you see how easily they are getting advantage of, the obvious contempt the creators have for the viewers?  Are these viewers not SIMPLETONS?

Ask yourself these questions before buying a ticket to “The Inflation Project 3D”

debtorsprison asked: Does this feature work as it should?

Yes, I believe it does Watson

Greetings Fellow Inmates,

Due to the Unfortunate Internet Incident (UII) earlier in which our site became inaccesible, we had to quickly regroup and put this back up!  Welcome to our new internet home, same little corner in The Yard though.   This is a temporary fix and we will return all our sections in due time.   As all crises, this offers many opportunities;   mainly, to shake up the old site layout and add new features.  You will find that this new platform is more user friendly and has more Web 2.0 bells and whistles.   We will be playing around the next few days with layouts and cosmetics, please be ruthless in your feedback!   Help us come back stronger and better!

MAAA

Greetings Fellow Inmates,

Today’s will be a pithy post that aims to estimate the amount of inflation we could expect if the monetary machine returns to “normal” functioning. This is the same great question Discipulus has been asking for months. It is a VERY central question to our discussions for the following reasons. We have postulated many times that Uncle Benny’s monetary adventures with his FedBS will result in great inflation down the line. More specifically, we have estimated that we will reach Super-Inflation levels, which we have defined at a CPI reading of 25%. There are a many reasons that lead us to believe that inflation will rise that dramatically over the next 3 years. To begin with, simple explosion in the size of the monetary base is reason enough to believe inflation will be great down the line. Why? Well, those TRILLIONS of dollars that have been pumped into the base of the economy (we’re not even talking about the trillions of dollars given as fiscal bailouts) through the increase in Excess Bank Reserves (EBR) on the FedBS are SITTING IDLE STILL. As the story goes, allegedly, once the banks start lending again and the economy fully recovers (such that there is both credit supply and demand), then we expect all that high-powered money in the form of EBR will “trickle down” to the economy and result in a growth in the broad monetary aggregates. Remember, the broad monetary aggregates, in this case M2, measure the total amount of “liquid” money in the economy at large, as gauged by the cumulative totals of a range of deposit classes.   

As the traditional picture goes, each dollar in the monetary base gets lent through the fractional reserve banking system and then gets “multiplied” through the economy, and eventually results in about $10 total deposits in the banking system. In other words, each $1 of EBR is supposed to create roughly $10 in the economy at large. Normally, this, “multiplying” effect is measured by something called the Money Multiplier. Quite simply, all you do is divide M2 by M0 (or the monetary base, which includes EBR and cash in circulation) and you get the M2 Money Multiplier. Now, bear in mind that the Money Multiplier model has been discredited, but it doesn’t matter for this experiment if M0 leads M2 or the other way around. In other words, the “textbook” model says that banks turn around and lend the cash only AFTER Uncle Benny has created reserves in their account. Reality shows the opposite:  banks lend as much as they want and THEN Uncle Benny creates the necessary reserves for them to meet their requirements.

Ultimately this distinction matters naught for now. All we will do is attempt to answer the question: What kind of CPI can we expect if we return to a normal M2 Money Multiplier?  Perhaps we should backtrack a bit. Below is a chart of the M2 Money Multiplier from 2006 to today.

Notice that there was a very sharp drop following the Lehman bankruptcy. The reason for this is that M0 (the monetary base, EBR) absolutely exploded, while M2 barely grew at all as people’s “money” was being destroyed. All these EBR, this great increase in M0, is still sitting idle in the banks’ accounts, they are still refusing to lend (yeah, yeah, remember that?) Therefore, it is a very good question to ask, well, what happens when everything recovers (as all the talking heads everywhere are falling over themselves telling you it is so close they can smell it) and the banks lend again and we return to a “normal” level of an M2 Money Multiplier?   Presumably, all those EBR will trickle out and M2 will rise tremendously as it “catches up” with M0.

Why do we care about what happens with M2?  Well, to quote MiltonKeynesSmith, “inflation is always and everywhere a monetary phenomenon”. In other words, what happens with the AMOUNT OF MONEY, M2, is primarily responsible for any increase in inflation. We can clearly see that this is the case in the following chart. All the data come courtesy of Uncle Benny and we have aggregated all the relevant data into an XLS file, for your convenience.

Wow, it is clearly evident that M2 and CPI are in fact related. Basing ourselves on this evidentiary support, we can proceed to make yet another very simple model that will illustrate a few key things. For this exercise we shall use our Trusty Abacus # 3 (TA3). For those of you that have a similar abacus, we will also begin posting all our M-Files so that you can dissect, check for accuracy and modify until your heart’s content!Here is the M-file for all the following experiment.

First, to corroborate the evidence that bases our assumption that projecting future M2 should be a good indication of future CPI, we calculated the correlation coefficient between M2 and CPI, using data going back to 1960. Clearly, when calculating correlation coefficients for such fundamental macroeconomic variables, using a longer time-frame gives you a more robust estimate. What we found was that for the past 50 years, CPI and M2 are 97% correlated!  So, we proceed safely.

The premise of our model is very simple. We assume that M0 stays at current levels, meaning that Uncle Benny does not extend QE, and no more monetary bailouts are undertaken. There is a fat chance of this happening and in fact we have prognosticated that Uncle Benny will greatly ramp up QE once people start to refuse to buy Treasuries. But as always, we like to counter our own biases for the sake of the model. It is also a very safe assumption since, as we have said many times, Uncle Benny is stuck with all those long term assets on the Asset side of the FedBS, so M0 (the liability side of the FedBS) will likely remain at these levels for a while. 

We then assume that the M2 Money Multiplier will recover as quickly as it deteriorated. By “recover” we mean return to “normal” pre-crisis levels.   We calculated the average M2 Money Multiplier from January 2000 to August 2008, right before Lehman. We found this “characteristic” number to be 8.20.   In the past 18 months, M2 Money Multiplier went from 8.92 in August 2008 to 3.96 in February 2010. Therefore, we will assume that it will go from 3.96 in February 2010 back to 8.20 by August 2011, in an equivalent 18 month period.

Once we have that, it is quite simple to extrapolate M2 and project it into the future, at least into August 2011, using the simple formula:

As you might imagine (and can see in the graph below), M2 proceeds to grow quite rapidly for the next year and a half.   

We only need one more step to use this to estimate CPI. Since their growth is correlated, it follows that as M2 grows, CPI must grow proportionally where the coefficient of proportionality is the correlation coefficient. In other words:

Below are the results of our study, which includes all data from 1960, and the projection onto August 2011. The red vertical line marks the line where we began our projections.

Wow! So many interesting and ghastly things! For starters, of course, as the model predicted, M2 grows monotonically at a constant rate. This is by construction since we assumed that M0 was constant and that the M2 Money Multiplier would grow in tandem. Notice in the second panel that the CPI Index grows quite dramatically as well, as could be expected. And for the real kicker, the bottom panel shows the CPI Index ANNUAL PERCENTAGE GROWTH. Yikes!   Notice that under the current assumptions, it will get as bad as it did in the 1970s, under Grandpa Volcker’s watch. Please see How would today’s SuperInflation compare with the 1970s? to learn about the difficulties Uncle Benny is up against when trying to fight this inflation monster.  Below, we zoom in for a closer look.

Same information here, but perhaps much more visceral. Notice that CPI is expected to cross the 20% barrier; it should hit 21.27 % in February 2011! Bear in mind that we are NOT contemplating inflation expectations at all. Neither are we contemplating the inflationary effects of the much higher yields that will result when people start dumping US assets as a result. Both of these factors might end up being perhaps even STRONGER engines of inflation than purely the monetary mechanism.

In summation, given the following assumptions:

1.  M2 is significantly correlated with CPI, enough to use it as a predictor.  (They are 97% correlated in reality)

We conclude that:

CPI would hit 21.27% in February 2011, assuming the M2 Money Multiplier returns to its “normal”, pre-crisis levels in 18 months time.

Well there you go, it doesn’t get a lot clearer than that. Adding in the additional variables previously mentioned, expectations and yields, we are quite confident in our SuperInflation prognostication. We do expect CPI to hit the 25% mark at least within 3 years.

We don’t like to give investment advice, nor interfere with anyone. We think the implications for your own investment portfolio are quite clear, and we won’t make them explicit for now. But PLEASE, we do beg you to think about this and begin to take actions to protect your capital YESTERDAY.

May your capital be safe and your investments prosperous,

MAAA