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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: mishedlo who wrote (15058)	11/8/2004 8:26:54 AM
From: el_gaviero	Read Replies (3) \| Respond to of 116555

Answer to question for hyper-inflationist. I'm not a "hyper-inflationist" but here is an answer: Go back to the basic money equation: PQ = MV, that is “price times quantity = money times velocity.” The idea behind “PQ” is that every transaction in the economy involves the sale at some price of some quantity of hours worked or pounds of something, or the sale at some price of a unique thing like a house. Add up all these transactions and you get GDP. MV is money in circulation times the rate at which it is spent, i.e. velocity. The idea here is that a certain amount of money in circulation facilitates all the transactions that make up GDP. Theoretically a small amount of money could permit a large number of transactions if velocity is high, or a large amount of money would not lead to a rise in PQ if velocity is low. If you hold velocity constant, then a rise in M would imply a rise in PQ. On the other hand, you could have a fall in PQ with a rise in M, (e.g., your Japanese charts), if V is falling fast enough. The fall in V would show up as “savings,” i.e. unspent purchasing power, i.e. high rates of saving, which is what we see in Japan “Velocity” is a nebulous concept but useful and valid. Theoretically, you could have inflation with no increase in money. What would be happening is that people, as soon as they got their hands on some M (however measured), would immediately go out and spend it. This is what Russ is talking about when he talks about a “flight to real goods.” Of course, M (i.e. money, i.e. purchasing power) can itself be demanded. That is to say, people may want to save more. If people want to save more, then they spend less. PQ goes down. M goes up. Where does it balance out? V goes down. Given the huge number of dollars that have been created (i.e. “facilitated” into existence by the Fed), you could clamp down on M and still get a rise in PQ via an increase in V. Of course, the real world is a complicated place. You have a vast number of assets denominated in US dollars (treasury bills, agency debt, etc etc. etc. ). If people get antsy about holding this dollar debt, they might start making changes in their portfolios, e.g., sell T-bills..... buy gold. Richard Russell talks about dollar debt as an implied short on the dollar. (To get rid of their dollar debt, they first have to sell it for dollars.) But surely Russell is not carrying his analysis far enough fast enough. The anxious people who sell their debt for dollars don’t hold the dollars. They use them to buy something real. In terms of my little equation, PQ = MV, they cause an increase in demand for M (money denominated in dollars), but also an increase in V (since they immediately get rid of those dollars). With M going up and V going up, PQ has got to go up. Voila: inflation.

To: mishedlo who wrote (15058)	11/8/2004 12:08:21 PM
From: CalculatedRisk	Read Replies (3) \| Respond to of 116555

You make a strong argument, but what happens if we have a currency crisis? I would think the FED would raise interest rates to attract foreign investment. On the surface, that would be a double whammy to the US economy since we would have higher prices for imported goods AND higher interest rates for the domestic economy leading to a slowdown in interest rate sensitive businesses, and most likely leading to a serious recession. But what if the FED responded by reducing interest rates and increasing the money supply in an attempt to keep the economy out of recession? Now you would have a downward spiral: a lower dollar leads to higher money supply leads to lower dollar, etc. That would be very inflationary. Inflation vs. deflation depends on how the FED reacts going forward. My guess is the FED will choose the first option (raise rates). It also depends on how foreign CBs react. Of course if the Euro becomes fixed to the dollar (don't laugh, this is being discussed), all bets are off... "Second, there is some noise -- at least from Morgan Stanley analysts like Eric Chaney -- that the ECB may conclude that it should intervene to protect Europe from the dollar's weaknesses during Bush's second term. While I don't agree with the Bretton Woods two argument that a new system of fixed exchange rates will make the US current accou[n]t deficit sustainable for twenty years, I should note that the proponents of Bretton Woods two long have been arguing that Europe would eventually have to join Asia in pegging to the dollar. The Bretton Woods two system of fixed exchange rates will expand before it collapses ... European intervention would be a way of spreading the "burden" of supporting US consumption growth that exceeds US income growth and the US budget deficits beyond Asia. I am not sure Europe wants that role. Jacques Chirac hardly wants to bailout George W. Bush. Japan may feel like it has no choice. I suspect there is a bit of a game of chicken now going on in the foreign exchange market. If central banks don't step in and provide some of the financing the US needs, then something will have to give -- since private investors don't seem willing to step in and buy US dollar assets at current US interest rates and current US exchange rates. " roubiniglobal.com