Wednesday, March 27, 2013

The Great Debate: The Doom that Came to Cyprus

It is with no small amount of sadness that I must now face the fact that I am not going to get out of this debate without having to explain mal-investment.  It appears in order to counter Vox's deflation via credit reduction claim... it is absolutely necessary.

Ok so M1... TSM2... Z1...  what is it?

As I stated before...  you've already answered that question for yourself.  Vox can write poetic and convincing lines about the esoteric nature of credit money... and he can explain how the paper just represents a claim on this or that...  and none of it will change the fact that when you hear about what's going on in Cyprus... you have a primal urge to run to the bank and get all of your cash out.  You want the cash.

That's because the cash you want is money.  For now.

The debit card is very convenient.  No question.  But by now you are probably looking at it with much more cynical eye than you were a month or so ago.  Good.

Now that is one way we know Vox's Z1 claim is... not the best option available.  There is another way to demonstrate it as well.  We'll start with Vox's own words.

"The creation of credit money always has an immediate effect on prices because it increases the applicable demand.  I shouldn't need to draw any SD curves, as we can see the effect that expanded home loans had in the housing market, that increased student loans have on the price of tuition, and even in the health care market, where governments borrow the money that is used to pay for the "free" health care delivered to indigent patients.  No cash is being printed, and yet credit money is being created, transactions are taking place, and prices are rising. While these effects are localized to the relevant markets I suspect the reason why economists historically failed to connect them to the broad increase in price levels that is usually described as inflation is because until relatively recently, it was not possible to obtain general, pre-approved credit for even the smallest transactions."

Ha ha!  Credit creation is inflationary says Vox... we know this because price is effected.  Sure... if one only looks at one side of the coin its inflationary.  Vox neglects to consider all the money that is sitting in savings accounts rather than being spent.  That money reduces demand and thus... offsets the inflationary effect.  The Government has to take some action to eliminate the savings link before the inflationary effect is really going to be obvious .. and that is exactly what they have done... as I explained in my previous post in this debate. And I hate to haggle about every little thing but Vox is blatantly wrong about this statement about small purchase general credit claim.  Historically speaking we've had credit based small purchases as long as we've had stores.  The stores provided the credit... not the banks.  Regardless... it was still credit being used for purchases.

But lets take Vox's standard for demonstrating inflation... price... and apply it to his Z1 claims.  Shall we?  Lets review the claims.  Vox says Z1 is the best measure of the money supply.  I say its TSM2.

In 2008 we saw Z1 begin to decline in July of 2008 and didn't start to climb again until October of 2010... and at the same time...we saw m1 and TSM2 begin to spike... and that spike has continued through today.  So lets look at prices between July of 2008 and October of 2010.  What were they doing?

In literally every single area...  Gold... Silver... literally everything... prices went up.  What ever it was you were buying... you were going to pay more for it.  There is only one exception to this... and that is real estate.

What's important to note... is that this is exactly what Austrian economics says should happen.  Through government interference and general banking shenanigans... we created artificially cheap credit... which lead to a bubble in real estate.  It lead to a massive influx of capital that was poured into new home construction... and the fact is... people didn't actually want the new homes.  We call this mal-investment.

Look this is damned important so pay attention.  Its not just important to my case in this debate.  Its an economic concept that is largely ignored in modern economics and if you don't understand it... you are going to get hurt.  I'm not just trying to score points here.  This is a big deal.

Mal-investment is what happens when a company produces something no one wants.  It is the single most malignant economic force there is.  It is a force multiplier for pain and misery. It not only eats up the resources to create the items no one wants... it eats up the resources required to unmake all the means of production... the opportunity costs of those working for and with the company that created the things no one wanted... and the cost of unmaking all the things no one wanted so the resources can be then applied to something people do want.

Lets say I start a company and my company is going to make busts. We're going to make busts of human buttocks out of the feces those buttocks eject.  I want to make sure you understand... that according to John Maynard Keynes... this would be positive economic activity.  I am after all going to employ a lot of people... obviously.  And there will be production facilities... and packaging... and marketing...all of these things are job creators.  John Maynard Keynes says my company is helping.

That's because John Maynard Keynes was a moron.

No one... exactly no one... is going to buy my rude product.  Somewhere a whole factory... that could've been producing cool motorcycles... or personal jet packs... or something awesome like that... was occupied making poo products and dysentery   My company is going out of business.  All the money that was dumped into it to capitalize it was dispersed hither and yon.  The factory has to be... ok well... realistically it probably has to be burned down and rebuilt completely... which takes up more resources.  All of the employees have to be retrained to work in new factories.  Its a nightmare.

Now lets look at how mal-investment applies to the US housing market.  Jump on Google Earth and look around Florida.  You'll see whole unfinished neighborhoods... where there are streets and sidewalks poured and laid... but no houses built.   You can see that in places from Tennessee to Arizona.  Many of the houses that got built during the boom... are now sitting empty... and slowly collapsing on themselves.

Before any of that land can be used for something people want...  those empty streets or those collapsing houses have to be un-built.  So not only did we spend the money to build something no one wants... before we can build something someone does want... we have to spend the money and resources to undo what was previously done.  The key here though... is you have a bunch of things for sale that no one wants.  You have things that are literally worth zero.

Now Inflation is like division.  It cuts up purchase power into smaller pieces.  But something that has no value to anyone has no price to divide.  0 divided by 100 is?  Well in monetary terms... its zero.  In 1900 something no one wanted cost 0.  In 1950 something no one wanted cost 0.  In 2013... something no one wants... still costs 0.  Clear?


So... Z1 is going down... and TSM2 is going up... and prices are going up... except in the one massive area where the mal-investment bubble popped.  By Vox's own metric... he is wrong.

Its really time to move along now... but before we do I really need to answer Vox's questions.  Sadly some of these are less impactful now than they were over the weekend when the events were actually unfolding.  I apologize for not being able to respond quickly enough to make predictions that could be reasonably judged.  I simply did not have time to produce a quality response.

Vox asked:

1) if the expected outcome is, as he suggests, inflationary, due to the central bank printing presses why has the European Central Bank not simply used the bank holiday to print the required 13.5 billion euros and allowed its customers to withdraw as much of it happens to suit them?  

Not being a European Central Banker... they didn't think to inform me of their decisions... so I can't actually say.  I can think of a number of reasons... but its all speculation.  These reasons range from simply hating Cyprus and wanting to punish it... to hating paper money.  I lean towards the notion that Cyprus was an experiment.  Printing the money was not part of the experiment.  I believe we had some statements to support this point of view.

2) Why is the ECB risking the Cypriot banking system, the wrath of the Russian depositors, and the fate of the European Union itself on these various schemes rather than simply printing the cash and permitting its withdrawal? 

Again... the proper answer here is... I don't know.  The motivations of Eurotrash Central Bankers are beyond the kin of decent moral economically non-suicidal people.  I think I can reasonably say though... They just didn't think it was as big a deal as you do.  They even thought to leave the Russians a nice way out.  Which suggests they were well aware of the dirt nap potential before hand.  I do feel it necessary to point out that there is a very important distinction between "won't" and "can't".   And one can get into quite a quagmire when the two are confused.  They certainly have the ability to print the money... or create the money from thin air as they see fit.  To put the magnitude of the Cypriot Crisis in perspective...  Remember we're talking about 16 billion euro.  Now that sounds like a lot of money.  Until... one considers that the current public debt for the EU which is 14.9 trillion euro. So... I'm not quite certain the Central Bank is terrified of that .11%  increase in public debt.  I just thought it would be nice to demonstrate just how small these numbers are to central bankers.  Do you realize we're at a stage where 16 billion euro is nothing?  Again... this supports the claim that Cyprus was an experiment.  For more perspective... the FED monetized 204 billion dollars in the last 2 months alone.  So see... 16 billion just isn't a big deal.

3) Imagine an American analog, where a bank with billions in deposits but already emptied of all its cash was simply shut down without the usual FDIC shell game of "transferring its deposits" to another bank.  Would this be a deflationary action?


Moving on...

The question of can't vs won't is a big one.  Because the answer to that question is critical to Vox's case.  The deflationist position... at the risk of over stepping Vox here... is that the Central Bankers have their hands full just keeping things at par and while they would like to inflate... they are doing everything they can and they just can't get it done.  Vox has elaborate and well reasoned explanations for why they can't.  I concede that.  Vox asks... Can they break the credit link?

Sadly... The most well reasoned explanations must bow to observable reality.

 I must quote Vox here...

"The narrower sense of fiat money is clearly the sense Mises was using the term when he declared "most of those kinds of money that are not commodity money must be classified as credit money" and questioned whether fiat money had ever existed."

and previously...

"So, we recognize that while fiat money can potentially exist in theory, the question of its actual existence, in the United States or anywhere else, is not settled."

So... According to Vox and Mises... fiat money has likely never actually existed.

Given that...  we must conclude therefore that both Zimbabwe and Wiemar were credit money systems.  So hyper-inflation is not only possible in a credit money system... it has happened.  In fact... it has happened 56 times.

And thus the question of "won't" vs "can't" is answered... and Vox is reduced to a physics professor standing on an airport runway explaining why something must be lighter than air to fly.  Boeing be damned.

In the next installment... I will be explaining how hyper-inflation works... and why it is inevitable.  

*** The title is a reference to a short story.  Bonus points to anyone that spots it. ***


Van said...

I worked summers at a beach resort; my job was to keep air in the floats used by the guests. So I think I know a little about inflation, and it's really a pretty minor part of the economy.

Nate said...


Roundtine said...

It's a modern phenomena to walk into a bank (or obtain a credit card) and walk out with the ability to spend cash however you like, not have to explain it to anyone, and not even promise to repay by a certain date.

In the past, small credit transactions were not inflationary because they were quickly paid. There was always a small rising amount of credit, aside from credit bubbles and wars, and could be viewed as a part of working capital, the grease in the financial machine. When you see a steady and rapid increase in credit, it is not being repaid as fast as more credit is being issued. This is inflationary.

As for Zimbabwe and Wiemar, I would argue they both issued fiat. Mises saw Wiemar and didn't think it was fiat; I have to assume Zimbabwe skipped the banking step, but I haven't found info on it.

Germany had an operating banking system that did gangbusters during the hyperinflation, but the government also printed cash for spending. Bresciani-Turroni's account is a must read. One reason I still prefer the deflation argument here is that during hyperinflation the financial sector booms and becomes a huge industry. That's what happened from 1980-2008. If you predict a hyperinflation via the traditional route (not a currency devaluation driven event), then you would expect the financial sector to take off once more and total credit to start taking off.

Van said...

It seems that credit isn't money, and - as long as lenders and spenders are respnsible - doesn't influence s/d enough to act as money. A temporary spike in demand would very quickly be offset by reduced future spending.

But when lenders and spenders become reckless, massive student loans mean other spending can continue, consumers pile up the credit card debt to live beyond their means, etc., then the boosted supply is sustained long enough to increase prices. In this case, the credit would act as money (even if it really isn't), and cause inflation.

However, sustain the demand long enough, and production catches up, increasing supply and lowering prices.

So where are we? The only thing I feel confident in is our economy is a sham, and it's about to crumble.

Res Ipsa said...

"I am not going to get out of this debate without having to explain mal-investment."

You already won the debate. It was a three round dance excercise. You hit Vox a couple of times and he hit the mat!

Life is won by those who show up. Vox hasn't even made a effort in almost two weeks. Maybe you shouldn't have hit him so hard!

I like Vox and I think he had a interesting take on the topic, but he pussed out.

Nate said...

Roundtine... I agree. I'm just pointing out that Vox claimed that they had to be credit money... and if they were credit money... then he certainly can't claim that hyper inflation is impossible in a credit money system.

There is a reason I am doing it the way I am doing it.

Nate said...

Res... Well.. that's a pretty big feather in my cap then ain't it?

Thanks mate.

Vidad said...

Great response, Nate. I am impressed.

Salt said...

is that the Central Bankers have their hands full just keeping things at par and while they would like to inflate... they are doing everything they can and they just can't get it done.

Can the fed continue to keep it all At Par indefinitely?

If not, the forces that have held it from achieving that "inflate" you mention shall be in the driver's seat.

Since it's not inflate that's keeping them from doing it, what could it be?

Giraffe said...

Trying to distill this down.

Lets see if I grok.

You are saying we have inflation because prices are up everywhere, and money supply is too. The bigger money supply is causing the higher prices.

The only fly in the ointment is housing, but that can be explained away because someone built a poop factory.

That about right?

Salt said...

Oh, and Nate, the only Great Debate I can think of was Lincoln - Douglas.

FALPhil said...

"Ha ha! Credit creation is inflationary says Vox... we know this because price is effected. "

Actually, in the context of your sentence, price is "affected". Three is a distinct difference between "effected" and "affected".

Overall, an interesting a great response. The problem with economics, particularly when coming up with an analogy, is that nothing about economics exists in a vacuum. Therefore it will be extremely interesting to see how Vox responds. I can think of at least one way he could counter, but I am not as smart as either of you guys, so I won't embarass myself.

Toby Temple said...


That is one powerful counter.

And were you referencing to this?

Batman: The Doom that Came to Gotham

Toby Temple said...

Nope. You were referencing to the short story by HP Lovecraft...

Res Ipsa said...


The person arguing the affirmative position normally has a harder go of it in a debate. When I’ve judged debates I generally have a bit more sympathy for the person going first, doing the work, defining the terms and enlightening the audience. Lets face it, those things are harder to do than going second and picking apart minuet threads of thought. You came out swinging and you defined your topic and have done an excellent job exploring the issue. Vox, when he has bothered to respond, has mostly nit picked.

Vox (in a blog post, and article or a debate) normally makes one or two concise points that are very specific. He seldom puts together a system of thought that requires multiple ideas to work in harmony with each other in order for the conclusion to be true. I expected that he would do basically the same thing with this debate. Which is what he did.

I didn’t expect you and Vox to be very far apart based on the fact that you are both from a similar school of thought. I expected that most of the debate would be about minor points of contention that neither one of you would be able to conclusively demonstrate your point of view to be absolutely correct. I didn’t expect Vox to lay down and die.

You’ve done well.

I expect Vox will get around to a comprehensive response to your posts sometime after he finishes the sequel to “Rebel Moon”.

Joe Doakes said...

I was with you until the bit about division, then you lost me. I get that inflation reduces the purchasing power of each of my dollars, so that's like dividing them into smaller dollars - it takes more to buy anything. Got it. But how does that show the by Vox's own metric, he is wrong?

TSM2 more closely tracks observed food prices going up and Z1 more closely tracks observed home prices going down, so are they both right and we're experiencing simultaneous inflation and deflation?

This is a serious question. I've read every post on both sides and I'm still not getting it.

Nate said...

Res... Don't be to hard on the guy. As one of the few people that has an idea of just how many projects he has going on... I can say honestly I considered calling the debate off because I just didn't think he was gonna be able to devote the time to it. I don't know I think it was almost like playing Micheal Jordan one on one... but only when he is on crutches because of major sprain or something.

He's a big boy though. It would be insulting to him to not give it my best... so I'm not pulling any punches.

Nate said...

Its not just food prices. Its food prices, commodity prices, dry goods prices... everything.

What we saw was prices going up everywhere but housing... because housing had already been insanely inflated through mal-investment. This always happens... the bubble pops... they print crap loads of money to try to inflate everything away to minimize the damage of the bubble popping.

So yes... home prices came down... but not nearly as much as they should have. They should've come down way way more... but the dollars that we were pricing them in were also losing value because of the constant printing.

Vox's metric was price. Price showed that Vox was wrong.

Z1 applies to housing and practically nothing else.

TSM2... applies to everything.

Nate said...

Also... its not possible to have deflation and inflation at the same time.

The money supply cannot grow and shrink at the same time.

The money supply was growing.. and a bubble was popping.

That's all.

Salt said...

Remember Nate, Vox admits that there is inflation. Government (banking) infusions are slightly ahead of the credit deflation that is happening. Eventually when gov't stops its infusions deflation should take over.

The question here, which you keep saying, is that we are heading for HYPER-INFLATION. A wholy different animal than mere inflation.

as you said here

is that the Central Bankers have their hands full just keeping things at par and while they would like to inflate... they are doing everything they can and they just can't get it done.

If they can't inflate, how in the hell will they accomplish Hyper-Inflation?

People could pull their savings, spend, and cause inflation, but is there enough savings to cause Hyper-inflation? Hell, supposedly savings are at a low.

Rally said...

How can I order a Fecal Buttock Bust? Will there be volume discounts? Can I buy them on credit?

Van said...

I've always thought of in/deflation strictly in terms of changed in money supply. Did I understand Vox's point correctly (increased demand from credit causes shortage of supply, causing price to increase) that price changes can also be in/deflationary?

tz said...

we know this because price is effected.

I think you mean affected.

You have things with not a ZERO but with a NEGATIVE worth. Consider an EPA superfund site. In this case the derivatives were the toxic waste.

To answer Vox in general, they can print ONCE. If they print for Cypress, they have to print for Spain, then Italy, and Ireland will demand paper backfill, as will Greece. This will turn the Euro into the Reichmark, and the north of europe has at least this much racial/genetic memory.

tz said...

We are at the crux of the matter, but perhaps not in the way either party expects.

mal-investment is the key, but is a specific way. If these half-built or the bubble mortgaged houses are kept on the books of the banks at near full value (assuming they are going to be finished or that the market will go back), they represent an "asset" where the bank (or MBS and the retirement fund or the person) can pretend or doesn't know they have already lost 90% of the value).

A mal-investment with debt often becomes a zombie investment. And the banks, zombie banks. See Japan in the early 1990's. Everyone pretends it is worth X when it is really worth X/10. In the S&L crisis they had a term "Trading the dead horse for the dead cow", so it was zombie beast investments. But if bank A and bank B exchange zombies they paid $300k for and say they cost each other $500k, FASB (which nuked "mark-to-market") says the banks can book them at $500K. But Zombism is infectious. The Zombie mortgages, MBS, CDOs, and the banks turn the banks into zombies. With Frannie, Feddie (Nightmare on Wall Street!), the FDIC, etc. all afraid of the truth.

Nate is ultimately correct that the Fed could (and it would be better than the acquisition driven self-zombification) "print money" and "burn the mortgages". They can burn every mortgage in the US in a bonfire of paper. But then the US Dollar would be on the same funeral pyre and part of the reset.

The reset can either be a default or debasement. (Capital controls, etc. is default).

Japan has been limping since 1990 when the Nikkei bubble burst. So you can extend it a long time. But only at the expense of making the entire economy into a zombie.

Nate said...

Because they haven't really even tried to inflate yet.

look boys... they monetized 204 billion in two months. So you think they can't monetize 600 billion? or a trillion?

They sure as hell can.

They have no yet BEGUN to inflate. We're just barely getting started.

On top of that... what you guys are thinking is going to be the primary mechanism for this... is just one possibility... and it is NOT the most likely option.

Salt said...

Nate, first you said this -

the Central Bankers have their hands full just keeping things at par and while they would like to inflate... they are doing everything they can and they just can't get it done.

Then this -

They have no yet BEGUN to inflate. We're just barely getting started.

Which is it?

Flannel Avenger said...

So, you've gotten me thinking about something that has bothered me since I had my high school econ class. And that is the idea that money can just disappear and that's what causes deflation.

I have always had an issue with the idea, because I have always considered it problematic for money to disappear. I suppose that you could say that part of what I consider the definition of money is that it cannot just disappear into the ether. Which I suppose the core of why I think you're right and Vox is wrong.

And so to that end, I think that your discussion of malinvestment is very helpful to me in figuring out how to articulate what I think is going on in the world. A lot of the forces that are supposedly deflationary are more accurately described as malinvestment in that the money didn't really disappear.

So, now I must sit down for a while and think about what constitutes malinvestment and what would be deflationary. I am thinking that sub prime loans are clearly malinvestment. Whereas the Quantitative Easing may in fact be a deflationary force in that it is keeping the hyperinflation from hitting.

But I digress. I am still trying to think about how things are all working out.

Joe Doakes said...

Nate, thanks for the explanation, now let's see if I understood it. I'm still unclear on the mechanics of how this leads to hyper-inflation.

The federal government authorized banks to create credit money on easy No-Doc, Alt-A ARM terms for minorities to buy houses, inflating housing prices into a bubble, purchased by mortgages repackaged and sold as derivatives to investors.

When the ARMS came due and mark-to-market made it clear values were inflated, that bubble burst. The federal government took loans from the privately-owned federal reserve bank to bail out derivative investors (and their risk insurers, except for Lehman Brothers).

Simultaneously, the federal government took away the easy money authority, reducing the number of people who could afford houses and thereby bringing down home values as fewer dollars chased constant homes. Deflation in the housing market because the supply of housing-targeted money dried up.

Since TARP, the federal government has borrowed more money to subsidize home mortgages through HARM and HAMP, plus student loans, Social Security, Medicare, and every other program including buying bullets for DHS. After the Chinese quit lending, the federal reserve took over lending to the federal government, to the tune of $100 billion per month.

That money is seeping into the general economy to partly off-set the fact we can't use the equity in our houses any more. But that federal deficit-spending borrowed-money scheme has been going on for decades, under both parties. The present rate of price increases doesn't seem much worse lately than in the past 20 years. Why does it lead you to predice hyper-inflation is coming? Why isn't it merely cushioning the blow from the housing bubble collapse, giving us that "soft landing" that I keep reading about?


Nate said...

"the Central Bankers have their hands full just keeping things at par and while they would like to inflate... they are doing everything they can and they just can't get it done."

That is Vox's position. That is the deflationist position.

I was stating Vox's position mate. Not my own.

John Williams said...

Yep, my read on the title was a Lovecraft work

Stilicho said...

"Z1 applies to housing and practically nothing else."

? Do tell.

Look, the bansters want and need steady, "stable" inflation to get the bulk of the extant money in the hands of the financial sector before deflation occurs and makes it relatively more valuable. It's just a wealth transfer mechanism to them. However, the financial sector only thrives (and survives) if everyone else still accepts the money they've collected as money. Hyperinflation results in no one accepting that money as money, which leaves the financial sector royally screwed. So the banksters desperately try boil the grog slowly, knowing that too much too soon results in the frog jumping out of the monetary pot and into gold, land, etc. Can the Fed inflate? Sure, Bernanke once wrote a paper where he suggested that the Japs should monetize ketchup to illustrate his point about the ability of the central bank to create inflation by monetizing anything. Why hasn't he done so here? Because he also knows that too much too soon risks crossing the hyperinflationary event horizon from which there is no return. Of course, slow boiling gives those who can see the emerging patterns time to get out of the system and the more the heat increases, the faster such people hop out. To do it properly would require an overnight inflation followed by an overnight deflation once the banksters have the cash. In sum: can he? Possibly. Will he? Unlikely. Mechanism? Possibly an enormous, instant inflation, followed by a monetary agreement converting dollars to say..Mammons at a set, deflationary ratio. Personally, I expect the attempts at a slow boil to continue while deflationary pressure builds and unfolds too rapidly for the Fed to counter.

Ron @ spinoff stocks said...

I remember seeing that same receipt photo a few months ago and it definitely pissed me off. I'm not really sure where I stand politically on the issue though. People will always abuse generosity and policies that are made to help them.

I'd like to see a cashier or store manager step in and stop the transaction in this case, but that's not how the system is set up and that's not the responsibility of the store and its employees as of right now.