Inflation, QE, Stocks & Assflation

Nima discusses an article by Cullen Roche on about the Federal Reserve, Quantitiative Easing (QE), interest rates, consumer price inflation, and asset price inflation (assflation).


Let’s Talk About QE and Assflation (

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Alternative Inflation Theories

Many economists generally agree that inflation is caused by bank credit expansion or by “money printing” by the Federal Reserve Bank.

But recently I came across a paper written by economics professor L. Randall Wray where he makes a pretty good case that in a “monetary production economy” (that is, an economy where production usually begins and ends with money), there are several alternative causes, but he also explains in more detail exactly why and how inflation can occur via bank credit expansion.

Incomes Inflation

The paper explains how prices are generally set in a monetary production economy: An entrepreneur can more easily obtain loans when he has market power. Market power, without delving into details, is the ability to push up prices for goods and services.

Post Keynesians adopt an aggregate markup theory of pricing in which price is determined at the macro level as a markup over labor costs. The price of consumption goods must be high enough above wages in that sector so that some consumption goods will be left for workers in other sectors. This allows some workers to be put in the investment sector (and government and trade sectors) to produce the surplus (goods and services) that workers cannot buy.

One of the main purposes of business credit is to facilitate the capital development of the economy, that is to allow entrepreneurs to buy factors of production to improve output per worker. When business credit is extended, and new checking account money is created out of nowhere, the workers building the machinery, computers, software, etc. in question, will end up buying consumer goods as well. So the price for consumer goods needs to be sufficiently high above wages per unit in order to keep the workers producing consumer goods from consuming their own entire output, and in order to make room for workers in other sectors.

Bank loans are often extended under the assumption that the receiving entrepreneur will be able to achieve a certain price markup over labor costs, so you can see how price plays a big role in the process of obtaining business credit for capital expansion.

It is of course possible that the price increases are moderated or counterbalanced by the subsequent increase in productivity. However, capital expansion projects can also fail, so it’s not unreasonable to expect a certain tendency for prices to rise over time in a fiat monetary production economy.

But price pressure can also result from workers’ desire to raise wages:

As Ingham (2000) notes, money prices are the result of complex power struggles–both between capital and labor, and among capitalists. When labor is strong, it can push up wages; in order for individual firms to maintain markups from which profits are derived, they must raise prices in compensation. This could be called “cost-push” inflation, and would be more likely to result from decentralized wage bargaining in the presence of strong labor unions, with each individual union trying to obtain larger-than average wage increases for members and possibly generating a wage-price spiral. On the other hand, “markup” or “profits” inflation results when firms are able to raise the markup over wage costs.

The paper then explains why some refer to this type of inflation as “incomes inflation”:

Inflation caused by rising wages or rising markups is often called “incomes inflation” to indicate that it results from a struggle to increase the income of either labor or capital.

Spot Price Inflation

The paper also recognizes another type of price pressure that can be caused by entities that are monopoly price setters:

In addition to incomes inflation, overall price increases can be induced by rising “spot prices”. The best example would be an increase of energy prices such as those experienced during the mid and late 1970s, and repeated on a lesser scale in 2000. Rising energy prices of course affect the cost of production of almost all goods and even of most services. Firms will attempt to pass these along in the form of higher prices of intermediate and final goods. If energy prices are increased only once, this could cause only a one-time “price shock” resulting in a higher aggregate price level. By itself, this would not be defined as inflation, which implies continuing price increases. However, the price shock could set off a struggle by workers to maintain nominal income shares (and real–inflation adjusted–wages), which could generate a wage-price spiral if firms attempt to maintain markups.

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Belarus Currency Devaluation & Inflation Spreads Panic

Business week writes Belarus devaluation spreads panic:

A sharp devaluation of the Belarusian ruble has spread panic throughout the country, with people sweeping store shelves and queuing up at currency exchange offices on Wednesday in a desperate attempt to protect their savings.

President Alexander Lukashenko promised that the national currency will remain stable following the devaluation enacted a day earlier, but experts warned the Belarusian ruble will continue its nosedive if Russia doesn’t provide a quick bailout.

The ruble lost nearly half of its official value against the dollar Tuesday, when the National Bank ordered a devaluation. The new official rate is 4,930 rubles per dollar, up from the previous 3,155 but the perceived value of the local currency is much lower — on the black market it takes 6,000 rubles to buy a dollar.

To make matters worse, there is a physical shortage in the country of dollars and euros, which companies and households desperately want to own to protect themselves from a worse devaluation in the future.

The government has tightly regulated sales of hard foreign currency and its own reserves are badly depleted. Exchange offices have run out of foreign currency because they are allowed only to sell what they buy from clients.

Andrei Krylevich, 42, has spent a week in lines outside an exchange booth in downtown Minsk without a chance to buy a single dollar. The computer company he works at has sent its employees on an unpaid leave, and he urgently needs to pay back a $9,000 loan to a bank.

“In just one month, I have virtually turned bankrupt, the entire country has gone bankrupt,” Krylevich said.

Most Belarusian industries are state-owned, and the government has tried to keep its scarce currency reserves for vital imports. On Tuesday, it set tight limits on interbank currency trading, effectively stifling the market.

The flamboyant Lukashenko, in power for nearly 17 years, has kept an unusually low profile in recent weeks as his government has been pleading Moscow for a vital loan. Russia has been reluctant to provide it, pushing Belarus to sell its industrial assets.

Russia’s Finance Minister Alexei Kudrin said Tuesday that Belarus can get the total of $3 billion in loans from an economic alliance of several ex-Soviet nations over the next three years, including the first $800 million disbursement that could be delivered next month. Kudrin added that Belarus could earn another $7.5 billion by privatizing its industries, most of which remain in state hands.

Events like these are likely to occur more and more in Europe, in particular Eastern Europe, but also in many other emerging markets.

Note how the dollar is still well accepted as a stable flight to safety when other currencies fail. That’s why I marked that one part in bold: This is a perfect example for what happens when credit crunches hit emerging market economies.

Global deleveraging is always rather likely to exert an upward pressure on the Dollar and on gold as well as the chickens of cheap global credit come home to roost.

By the way: It’s comical, but absolutely typical, for any actions taken by government officials, that “Lukashenko promised that the national currency will remain stable”! As if the affected people had any choice in the matter to begin with!! =)

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Public Credit Expansion Fuels Inflation

Are the current price increases we see across the board inflation? Well, price increases are never in themselves inflation, but they can be signs of inflation.

Inflation, as I have explained before, is an increase in the supply of money and credit.

Let’s see what’s been happening in the US over the past year.

Total Loans and Leases:

Total Loans and Leases still had their peak in 2008. In early 2010 there was a big spike and they have been declining since then.

Total Bank Credit at Commercial Banks:

A similar pattern can be observed with Total Bank Credit ad Commercial banks as you can see above.

Together those two numbers give you a pretty good and complete indication as to how private credit has contracted in the in US and still continues to contract from peak credit.

However, the most complete picture of credit in the US is, as always, a number in the Fed’s Flow of Funds Report “Total Credit Market Debt Owed”:

Here we can see that indeed through 2010 there has been a resurgence in credit, in spite of a contraction in private credit. The reason is that public credit, that is money owed by governments, has soared:


Yes, we have been back in inflation mode indeed, but without the private sector playing along on a long term basis, I don’t think that this one can last very long. All that this has done is fuel speculation and bubbles again in commodities, junk bonds, and stocks. A few jobs may have been created as a result of that, a few more may get created. However, these developments are completely unsustainable. Government intervention in the past crisis has ensured that this will be a long, ongoing, and painful period, and we are witnessing it right now.

We are now in a desperate repetition of what I already warned about in 2007 when I wrote “Credit Expansion Policy“:

The policy of credit expansion has been pursued by governments time and time again. It has become prevalent in the United States under President Woodrow Wilson after the establishment of the Federal Reserve Bank under the Federal Reserve Act during the Christmas Holiday of December 1913. Since then, it has caused major credit booms and crunches in the form of asset booms and subsequent crashes and economic booms and subsequent recessions. In particular this has been the case in the years of 1929, 1987, and 2001, and will be visible in 2008 and the following years. It has always precipitated precisely the effects outlined above. Its workings and effects have been fully explained by this theory of the business cycles. No one has ever refuted the correctness of this theory.

Yet, to date economists and politicians appear completely riddled as to what causes booms and crashes. It is claimed to still be a matter of discussion amongst experts. It has been attempted to impute it upon humans’ greedy nature and natural exuberance. Whenever a crisis emerges the pundits, experts, central banks and politicians will try and regulate the market to stave off the impending crunch. They forget or don’t have the intellectual capacity to understand that it has been their own policy that has caused the crisis in the first place.

As long as the central banks keep pursuing this policy, there is no need to be surprised when the next credit crunch occurs. Neither is there any need to be surprised about the fact that all countermeasures taken by the government will turn out to be utter failures that will accomplish nothing but aggravate the crisis. For if the cause of the problem has been too much government intervention, then more government intervention will only add to it.

The only difference now is that private sector credit is not playing along anymore. In fact, private sector credit is doing precisely what it should be doing: contract.

When the next crash comes, I expect that we’ll be back in deflation mode again in no time at all, snapping back into the long term pattern of this contraction. Like I said before:

Thus the long term outlook for the US economy is the fate Japan took: A long lasting correction supercycle with one failing “stimulus” program after another, and with on and off periods where the economy slips out of and back into recessions from time to time.

And most importantly … when the next crash comes, I sure hope people will point their finger at the root causes, and not at whatever lying politicians and media minions will tell them to.

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Deflation or Inflation – Is Public Credit Setting Off Contraction in Private Credit?

I want to follow up on something Marc Faber said the other day in the second clip.

He said that it is true that private credit is contracting, but it is being offset by a government credit expansion.

Let’s examine this suggestion a little more closely.

I regularly publish the total contraction of total private loans and credit:


This is, however, only a subset of the total credit picture. What is missing are things like corporate and government bonds, and probably some other non financial obligations.

The most comprehensive data on the total of pretty much ALL credit issued in the US is really the Federal Reserve’s Flow of Funds Report, in particular the subsection “Level tables”.

The current flow of funds report can always be accessed here and for March 11, the latest release shows us the following:


Based on these numbers we can see that total credit, when measured across all sectors, has indeed been declining throughout 2009, by roughly $466 billion, in spite of a massive ramp up in public debt.

This simply shows us the magnitude of the deflationary forces in action.

I would also add to this that we could easily double the total credit outstanding above if we included the federal government’s Medicare and Social Security obligations which nominally amount up to $43 trillion and will never be fully paid back. There is no official number to track for this since these obligations are not reported on any balance sheet and are not traded on any markets. Thus we can only assume that their present value is declining by at least the current rate of decline in the remaining credit volume (about 0.8% through 2009).

This would bring the total contraction in credit up to around $810 billion through 2009.

I’m also not sure to what extent other municipal and state pensions are covered in the flow of funds number, but I rather doubt they are included at all. A lot of those lavish union pension plans are going to have to cut back on their commitments soon, probably the next big events to shake the markets, along with commercial real estate defaults and property values declining.

And last but not least, it is rather unlikely that the current numbers are all marked to market. Government regulations across the board have ensured that banks and corporations can be rather creative in their reporting.

Either way, all this is a rather strong indication that Marc Faber’s assertion may not me correct.

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