Jul 12, 2019
Welcome to Finance and Fury, the Furious Friday edition!
I’ve been thinking a lot about what we are taught in economics,
the basic ‘101’. Specifically, if you print a lot of money you get
hyper-inflation.
There are plenty of stories to back this up
- Germany Weimar republic, and Venezuela right now – there are
plenty of countries with hyperinflation
- Central banks around the world (and at home) are trying for
more inflation, and have increased their money supply over
time.
- But we’re ending up with lowering inflation. This is puzzling
on the surface, though it has a pretty simple answer.
- Inflation and CPI – What we’re told they are - quantitative
measure of the rate at which the average price level of a basket of
selected goods and services in an economy increases over a period
of time.
- Rise in the level of prices – why a $1 today is worth more than
$1 in 1 year, let alone 100 years
- CPI is what is used to measure the basket of goods
- RBA monetary policy – Try to keep between 2-3% inflation
through influence on money supply.
The issue with percentage targets is Compounding
- Compounding is a very powerful tool, it can be your friend or
your foe, it really depends what is compounding – Returns (growth),
interest, or inflation
- Returns – for an Investor who owns assets or cash, it’s
good.
- Interest – if you owe money it’s bad
- Inflation – for an Investor or individuals/consumers it’s bad,
but if you owe money it’s actually very good
Inflation is bad for us – especially when it’s compounding and
is controlled.
We want things to be cheaper. But unless our wages keep up
(which is determined by the economy) we suffer pricing
squeezes.
Plus, unless you have massive amounts of debt your savings and
investments give lower real returns.
This is why inflation is great for Governments!
If you have no real assets but are cash rich from income each year
from tax payers – You need to either budget well or borrow for
funding shortfalls – Every nation in the G20 is in debt – to
who?
Debt goes one level further in relationship to currency/fiat
monetary system – When you get shut off (ex-communicated) – nobody
will buy the debt off you to print money – currency collapse –
creates additional inflation due to the relative cost of imported
goods
Can cripple a country that has their debt valued in another
currency – impossible to pay back
- Example - Germany with war reparations - Gold or other peoples’
currencies
- Crippled them – First - Currency is backed to your supply of
gold back then – so lost supply of what backed currency
- If you have to pay reparations in someone else’s currency, or
give up your gold supply that is backing your currency, what will
happen to the price?
- Today – IMF is the bail out bank for nations – But bail them
out in debt based on USD
- International debt (government or private bonds) dates back a
way – The 5 Rothschild brothers (Salomon – Austria, Nathan –
England, Calmann – Italy, Jacob – France, Amschel – Germany) opened
their banks up to international markets – increasing connectivity
through lending capacity across boarders – Governments of the day
welcomed it
- Quote – Revolutions are generally triggered of by deficiency of
money. By preventing such deficiencies, the Rothchild system may
serve to preserve peace in Europe. This system or rather Nathan
Rothschild its inventor is still providing for such peace. It does
not inhibit one state from making war on another exactly as before,
but it does make it difficult for people to overthrow the
established authority.” - Heinrich Heine – German Journalist wrote
in 1830– he goes on for a while, gets deep about how religion can
be replaced by money. Unfortunately, though – as this system grew,
the magnitude of war exponentially increased – whoever has the most
money in war wins – most kingdoms of the past eventually ran out
when fighting prolonged wars
- But still faced a problem. These bonds were valued in Sterling
which in turn was backed by gold, while there was an increase in
money supply from fractal banking reserve – still limited to the
finite level of gold/sterling to back it. There was almost no
inflation under the gold standard – debts had to be paid – no
inflating them away
But the biggest debtors were the Governments of the day (mostly
monarchy’s)
- Napoleonic war 1815 – almost £10 million pounds lent out
- Rebuild - 1818 £5 million loan to the Prussiangovernment
and the issuing of bonds for government loans-
collateral
- Continued on like that until Governments got their own way of
producing funding
- Had central banks already – but still limited by gold. Not
anymore, they print as much as they want
Theory of money supply
- Increase money, you get inflation. It makes sense – the more of
something you have the less valuable it is
- Inflation – devalue of the dollar in real terms - $100 stays
$100 – but can’t buy as much (hidden tax)
Why don’t we see this today? Money supply has increased
massively since we went to the Fiat system – to achieve the target
of 2.5% p.a.
- M0: includes bank reserves, so M0 is referred to as the
monetary base, or narrow money.
- M3: M1 Money base plus substitutes (M2) plus large and
long-term deposits.
Money Supply – M0 – 2000 – 30bn – 2019 – 110bn – 7.5% growth
p.a. - M3 – 400bn to 2.2trn over same time – 10% p.a.
Very consistent – looking back to 1976 - around when we started
adopting Fiat – been 10% growth p.a.
Comparing Inflation over this time – 2.4% since 2000 – been
trending down – since 1975 – peak of 16% - trend down to 1.8% - RBA
done well to keep it within the band of around 2.5% since late
1990s when it was introduced.
Thanks to the interconnective nature of the monetary system
there’s no shortages of banks and governments willing to demand the
level of debt, bonds to meet the increased supply of money. But
also, this gets directed into ‘hard asset prices’ and compounds the
price of everything massively.
- Property prices, due to every increasing borrowing
capacity.
- As the flow on effect of money supply is that you have low
interest – at least this supply/demand relationship seems to
work.
In the past – before early 90s inflation got a bit wild – some
years it was up.
Why are the same things tried over and over again, does this go
on and on with a different result?
Imagine that you put your whole life into a theory/assumption –
how easy is it to admit you are wrong when presented with
new/conflicting evidence?
- If you can be paid
- Not when you make money off teaching that theory based around
expertise
- But now imagine that a new theory came out, or you ignored
evidence that contradicted major assumptions – and one of your
students wanted to write their thesis on this – never get
accepted
- What happens when over a 70-year period this cycle continues –
the same theory is incentivised to be regurgitated regardless of if
it outdated
- A lot of economic theory is based around a world without
globalisation and instant transactions, some even electricity – no
wonder the models have a hard time predicting if they cant
adapt
- Dad Joke – What do economists and Major League baseball hitters
have in common? Both get paid regardless of if they strike out 70%
of the time.
But those declines were correction years to help with
affordability and the large increased were normally due to an
economic shock – like a WW.
Where an average target is dangerous if back testing data to fit
a model (talked about in last ep)
What average would you prefer as a return
- 10% or 5% average? 10% obviously – but what if now – prob of
50/50 either 20%, or 0%, versus compounding of 10% - compounding of
10% every day –
- Sometimes you might want the scenario of an average of 5% over
10%
- Took an average rate as a target that worked well when the
economy was growing – but this was back testing
- And neglected to look at the importance of corrections – price
drops/low inflation
- Example – low inflation when Rockefeller (Standard Oil) flooded
the market with cheap oil – and saved the whales (unintended
consequence) – This was a massive benefit to any countries lucky to
participate in this early through having free markets to adopt this
technology –
- Issue with inflation – doesn’t just create a strain on
household spending if wage growth cant also keep up
Business side of things – Their prices are what inflation
measures -
- Are businesses borrowing? Not so much here -
- Inflation in their costs of inputs – Not from money supply but
increased regulations and taxes
- Taxes – like GST – companies had to put up their prices by 10%
- companies do get to claim back some of the GST on expenses – but
not on all expenses – like wages – instead they not only cover the
PAYG for the employee, but also pay around 4-5% depending on state
in tax on wages if they are paying their employees too much
- Creates an artificial strain on businesses to keep up with
increasing costs of their own while not being able to pay
additional costs of employing people – there is nothing wrong with
high inflation – as long as it can be allowed to correct and that
the inflation being outstripped by wage growth – coming from
company profits
Where has the money been going?
- What isn’t measured by CPI – Hard asset price increases –
property, shares, etc.
- e. inflated hard asset prices through compounding growth – from
increase of money supply -
- Why is inflation good? The Government – who else can borrow
billions of dollars at low rates and let inflation eat away
repayments? No need for fiscal restraint if you can let inflation
eat away your debt on a 70 year bond.
- At 2.5% $1bn turns to $177m over that time – interest is
covered by tax payers – or another bond
- But with money supply going up and up in ‘uncollateralised
debt’ – Governments may not be able to afford the increased
interest repayments if rates do go back up
- What the target does is switch the old models from a simple
interest outcome, to a compounding one – has drastic exponential
factors the longer it goes on
- Analogy of after big night of drinking – Wake up and on the
verge of a hangover
- I’ll admit there has been one or two times I have woken up
hungover and kept drinking
- What happens the next day when the party is over? Hangover is
worse than normal –
- We should have had a hangover by now – there is a backup plan
the IMF is looking into to increase global inflation – trying to
escape the true horrors of a 2 day hangover, or in this case debt
collapse
- How to avoid a hangover from a credit crunch? Work towards that
answer in the next FF ep.
https://www.rba.gov.au/education/resources/explainers/inflation-and-its-measurement.html
https://www.abs.gov.au/websitedbs/d3310114.nsf/home/abs+chief+economist+-+70+years+of+inflation+in+australia