Now, let’s assume that the old rule of thumb that M3 growth – GDP growth = inflation, although very simplistic, is essentially correct. How fast are those three economic systems growing? Nowhere near as fast as their money supply. Averaged together, somewhere between 2-3%. How much of world GDP do those three systems comprise? According to the IMF, 64%…

Some would say that China and India are soaking up that liquidity, but China and India have inflation problems of their own due, in part, to excessive money supply growth – And many are worried that they are actually exporting inflation, which they probably are.

So, if the world is one giant economic system, where does all that extra liquidity go? A: Stocks, commodities, and housing, which have all had incredible rallies in the last 5-10 years.

Why wouldn’t it show up in the bond market instead? A: Why buy bonds when demand for commodities in a growing world is expected, at the very least, to increase moderately for the foreseeable future – And when investors are, at the very least, suspicious of the US’s continued economic hegemony? Why buy bonds when stock markets and commodities are strong?

Of course, demand from China, India, and various other countries provides the visible catalyst for higher prices, but the tremendous (and growing) pool of extra liquidity floating around, I believe, provides support for rising prices and, as long as it is growing, provides a basically unlimited invisible catalyst for higher prices across the board. Over the last ten years, not once in the US has M3 growth been below GDP growth – And, as Barry pointed out to us on seekingalpha yesterday, it currently stands at an annualized 24% – And as Ben revealed last night, he stands at the ready to use “all available tools” to mitigate economic damage from the housing market, which he expects to be a “drag on the economy” into 2008.

The question I ask myself is: Where will this new money flow to? I think oil is approaching party status, and will head higher, along with, to a lesser extent, nearly all other commodities. Gold and silver still have a ways yet to go until they reach party status, but when they do, gold will skyrocket past $1.5k, and will likely see $2.5k or more. That extra liquidity will also be silently making it’s way into the housing market, and may actually stem a total collapse back to 1997 REAL values. After all, the primary vehicle for monetary injection into the US economy is through loans from banks to consumers and corporations. Much of it will also go into stocks, creating a very large (and very artificial) global rally, as the housing collapse will seem ‘contained.’ Meanwhile, the US consumer will sink lower into debt, worries about “moral hazards” will be put on the back burner, and the US will climb yet another few steps higher on the mountain of artificially induced bubble style economics, and will stand there deliriously until a heretofore invisible catalyst knocks it off.

Doomsdayish? Yes, it is – But that’s how I see things. Am I worried about it? No, but I will bet my money on this happening, and I will continue to “grow” my investments as much as possible until this scenario plays itself out. If I’m wrong, I’m wrong – But I believe that anyone who thinks M3 growth has no discernible effect on the economy or can be ignored is either mad, a delusional economist, or is more interested in facilitating economic cycles than a stable economy.

Just my two cents – Take them with a grain of salt, just like everything else you read on the internet…

As reported by 60 Minutes during their famous love fest with Glenn Kelman of Redfin, the 6% commission

The people who think that inflation is not a problem hardly ever say, “There is no inflation”. They’ll say that inflation is subdued or not a problem. If they don’t say there is ‘no inflation’ why do you?

I’ll tell you why, it is a device to put the other side on the defensive and to avoid talking about real numbers. Its just a debating ploy which is beneath serious discussions and doesn’t help me one whit.

1) Accomodate inflation and cut rates (oops it is the ’70s again). Oh don’t forget the housing bubble popped, so cut more than normal. take it down to 1% or 0%.

2) Cut rates less than in a normal contraction due to inflation (what Buba did in the ’70s). Growth recovery weak but inflation does not get out of hand.

They seem to be leaning toward option 1. they pretend inflation is contained. so instead of taking option 2, they will take option 1 and inflate. destroy the dollar in the process. that is my opinion.

Mises was right on the money about that one.

“With the securitization industry off-loading debt from the banking system, haven’t we in essence been operating with a zero-fractional reserve banking system?
Hasn’t this unlimited debt expansion led us to this point?”

See what Mervyn King, Bank of England Governor said in a 20th of June 2007 speech about the risks associated with this situation:

“”Securitisation is transforming banking from the traditional model in which banks originate and retain credit risk on their balance sheets into a new model in which credit risk is distributed around a much wider range of investors. As a result, risks are no longer so concentrated in a small number of regulated institutions but are spread across the financial system. That is a positive development because it has reduced the market failure associated with traditional banking.

“But the historical model is only a partial description of banking today. New and ever more complex financial instruments create different risks. Exotic instruments are now issued for which the distribution of returns is considerably more complicated than that on the basic loans underlying them. A standard collateralised debt obligation divides the risk and return of a portfolio of bonds, or credit default swaps, into tranches. But what is known as a CDO-squared instrument invests in tranches of CDOs. It has a distribution of returns which is highly sensitive to small changes in the correlations of underlying returns which we do not understand with any great precision. The risk of the entire return being wiped out can be much greater than on simpler instruments. Higher returns come at the expense of higher risk.

“The development of complex financial instruments and the spate of loan arrangements without traditional covenants suggest another maxim: be cautious about how much you lend, especially when you know rather little about the activities of the borrower. It may say champagne – AAA – on the label of an increasing number of structured credit instruments. But by the time investors get to what’s left in the bottle, it could taste rather flat. Assessing the effective degree of leverage in an ever-changing financial system is far from straightforward, and the liquidity of the markets in complex instruments, especially in conditions when many players would be trying to reduce the leverage of their portfolios at the same time, is unpredictable. Excessive leverage is the common theme of many financial crises of the past. Are we really so much cleverer than the financiers of the past?”

In other words, it is highly doubtful that we even KNOW how to properly assess risks of this kind. Talk about a sound financial system!

“Hard assets rising. Bank runs. Super SIVs.

The last step…the whole monetary system founders. Is that really in our future?”

History does not repeat itself but it rhymes. Monetary systems have floundered in the past, since the Roman Empire in fact. I can’t see any indication that human nature have changed for the better since those bygone days.

It boils down to simple mass psychology: fiat money is entirely dependent on confidence (faith). Tinkering with the money system for the sake of unfettered greed and political expediency is a sure recipe for self destruction.

Claiming that inflation is one thing while proving to be another is one of the many things that will eventually breaching the confidence essential to the functioning of the monetary system.

Keep at it and ugly things will happen.

Francois

In the US the FED targets short term interest rates or specifically the overnight funds rate between banks.

It is very important that when inflation is accelerating (I definitely wouldn’t characterize it as hyperinflation) the FED raise short term interest rates high enough to get ahead of the inflation curve.

Negative real rates are unsustainable in the current environment.

lol, as I write this this morning… can we say $87.375? wow, up another $1.25… seems a bit short term toppy… good ol’ resolution against the Turks…

Posted by: Fullcarry | Oct 15, 2007 7:51:57 PM
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During hyperinflation, the market will raise the interest rates, not the FED.
All the FED can do is to pump more paper.