Sunday, October 12, 2008

"An inflationary holocaust" - Jim Rogers

TBRRob posts a very useful YouTube interview with big investor Jim Rogers (the best analyses come from people who back their own judgments with their own money).

Despite the recent strengthening of the dollar, he is buying Japanese yen and Swiss francs; and commodities (especially agriculture), because they lead the way out of recession and their fundamentals are (he says) sound.

In the interview, he is challenged on his inflationary hypothesis: surely we are seeing "deleveraging" (reduction in borrowing) and don't we need more money in the system to deal with the liquidity crisis? Rogers cites past history and sticks to his guns

I think it was Marc Faber's comments that first helped me understand why all this public-money-throwing isn't going to help. It's NOT a liquidity crisis: liquidity is what has caused the problems (and anticipating the movement of the money tides is what has helped Faber grow his funds!).

It's a SOLVENCY crisis. If all your possessions are worth less than your total debts, borrowing more money will not help. So when the government creates massive extra funds for you to use, you will not wish to use them. And if your fellows are in the same position, you certainly won't wish to lend them any money you still have.

When you are insolvent, there are two ways out. One is to declare bankruptcy, in which case the money invested in you is lost and so excess liquidity goes down the drain. Good, though it's also painful (personal fortunes lost, people laid off).

The other way is to be unbelievably lucky, and have someone else pay-off your debts. When the government chooses to do the latter for the banks, it has to get the funds from somewhere, and ultimately that is the citizen/loyal subject. In this case, the liquidity is still in the system, and there is no drain to take it away. Sooner or later, it leaks out into the general economy and prices rise, because there is more cash to bid for the usual limited amount of goods and services.

(Or the government increases taxes, and uses the extra to pay-off debt. Nice idea, but increasing taxes slows the economy and creates more benefit dependants, which requires more taxes even as less revenue is coming in because business is suffering because people now have less spending money because taxes are higher, and...)

So there are two problems created: inflation, and moral hazard - the people who have been bought out in this undeserved way have no incentive to change their habits.

You may think that it's only a temporary problem and the government will recoup its investment when things get back to normal. The trouble is, "normal" means house prices dropping to about half what they were worth last year, because they doubled for no good reason in the five-year period before that. In the long term, I understand, houses are priced at 3 times income, not 6 times as during the recent period of monetary inflation.

So either the value of the excess credit is destroyed by bankuptcy, or by inflating away the money saved by more prudent people. Either the guilty (or foolish) suffer, or the innocent.

And here's another either/or: either we go this process again and again, or banks are prevented in future from increasing the money supply in the way they just did.

And the guilty must be punished.


dearieme said...

Let's see, the government's plan is to argue strongly against mortgage fraud, against liabilities hidden off the balance sheet, and against bonuses and golden parachutes. Their main spokesman on these topics will be the Lord Mandelson of Twicesacked.

It will also argue that many banks have been run by senior executies and directors who were not up to the task. I suppose that the main spokesmen for that proposition will be Ent and Dac Milibean.

Sackerson said...

The Milligrams look more like newsreaders than politicians, to me. Or standing illustrations of the difference between being clever, and being wise.

TBRRob said...

The next few years are going to hurt whatever we do. But splurging our money everywhere it's going to make it much, much worse.

I'm just glad I'm young and don't have many financial commitments.

Sackerson said...

Lucky sod. Footloose and fancy-free, eh? Considered "Two years before the mast" or anything similar?

Anonymous said...

Rogers: " .. they should go down to the bar have a drink and do nothing .."

Oh how I wish our politicians would take that advice.