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More on StagFlation … Ambrose Evans-Pritchard is one of my favorite financial writers. Here’s his recent article. Quoting:

“ … The current stagflationary phase will turn out to be longer and more serious than most people believe.”

Back to the 1970s, or the early 1920s? http://blogs.telegraph.co.uk/business/ambrosevanspritchard/may2008/backtothe20s.htm

More Ambrose with Yves Smith’s commentary as a lead-in:

My own view … is that the M3 surge is a false alarm … This rise is almost entirely due to a “bearish” flight from stocks and suchlike. Nervous investors have parked their wealth in money funds for safety until the crisis blows over. These money funds are distorting the M3 data … It reinforces my fear that we are heading into a deflationary crunch. No doubt the Fed, ECB, the Bank of England , et al, will ultimately flood the system with money and set off another asset bubble. We are not there yet.

Has the Fed really flooded the world with dollars? http://blogs.telegraph.co.uk/business/ambrosevanspritchard/may2008/fedfloodeddollars.htm

I am inclined to agree. If/When there is a money flood, both private investors and foreign central banks will see future inflation and further Dollar decline, and that may push interest rates and gold (and oil?) further upward. The Fed really is between a rock and a hard place.

So much of the “Inflation versus Deflation” debate gravitates around definitions and in this complex financial world, it is confusing. Is inflation driven by the quantity of money (and how is “money” defined? – see below) or is it simply prices? What about the demand and supply of/for real goods? There is also demand and supply for the various forms of money.

So what is money? What follows may be boring to some, interesting to others, so you’ve been forewarned -- read on at your own risk.

Money

Printed on your Dollar bill is: “THIS NOTE IS LEGAL TENDER FOR ALL DEBTS, PUBLIC AND PRIVATE”. Technically it is a “Federal Reserve Note”, not specifically money, but we use it that way. It is because the Fed says that it is, although not in those words, and the Federal Reserve and Federal Government are powerful and not inclined to debate it with us. The language on the Federal Reserve Note is, well, tricky. Nonetheless, nice work if you can get it and who cares if it works?

J. P. Morgan, on the other hand, said, a long time ago: “Gold is money”. Who to believe? Well, we’re forced to believe both, I suppose, in varying circumstances.

Money isn’t all that complicated. It is, or is supposed to be, a medium of exchange, a unit of account (quantitative) and a store of value (http://en.wikipedia.org/wiki/Money). On the first count, the Federal Reserve Note (or in fact its digital counterpart) qualifies in spades. Money can move almost at the speed of light. On the middle count, it’s self-evident. Against the last standard, however, all of Washington, D.C., has its fingers crossed behind its back. Gas and food prices these days suggest that it’s not holding its value at all well. Gold seems to be doing fine, however. Food for thought …

I’m 65 and have been a “money guy” all my adult life, which is to say I’ve been involved with obtaining money and keeping it safe for others, including corporations, the essential point being that it gives some perspective on the subject, always assuming I’ve been paying attention. I remember Sunday, August 15, 1971, when President Nixon “floated” the Dollar, that is, de-linked it from gold and we have prospered greatly as a nation since then, have we not? (with the caveat that real wages have not increased since the 1970’s). More food for thought.

The role of gold has historically been to discipline the politicians. If they printed too many units of paper currency, the holder of that currency could demand a predetermined amount of gold. And gold doesn’t grow on trees, as we all know. That discipline is gone and it has had something greatly to do with the financial soup we now find ourselves in, in my humble opinion, but that is not to say that the concurrent vast expansion of credit that has not lifted our standard of living. But debt is a drag on our freedom and future. So how can that “just right” mix of the two, issuance of paper currency and debt, be found. I suggest that it cannot, that the politicians, being human and always “needing” to buy votes in a democracy, will always spend more paper wealth than they can tax away or borrow until someone or something says “stop”. Don’t expect them ever to admit it, though.

Now there is a demand and supply curve for the Dollar. It is always in balance; i.e. demand = supply, with “price” the adjustor. Price in what? Well, price in price. These self-referential conundrums are difficult, when it comes to economics. But the academics could have a field day. More Dollars for the same goods and services methinks. So then what do we have? Inflation and asset bubbles. To the extent those Dollars have been created by debt and the debt cannot be repaid … Poof! The Dollars disappear. The tricky part of the larger equation is that a substantial portion of those Dollars are unique in the world, a reserve currency pool of liquidity held by foreign central banks that is somewhat “sterilized” because they are a supposed holder of value, there to allow for later need on the part of the non-US holder. But they are ALSO debt, in that they are a claim on our future. How much is too much? Who knows? But that semi-sterilized pot has become very large and someday there is likely to come a tipping point. Paul Volcker would understand. Will it be reached before the rest of the world holds claims on us sufficient to buy every US asset, lock, stock and barrel? Who knows? But I think it is not controversial to say that there are now too many of them out there and that that will not be cured in any painless way. A man can eat only so many steaks. The world can eat only so many Dollars.

Feel free to post a comment or send me an e-mail if you wish to discuss any of this. Thanks.

H. F. Pete Nelson

Senior Loan Originator

License #510-LO-34002

PNelson@NormandyMortgage.com

(206) 890-6815