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.