Thursday, April 11, 2013
Will Cyprus trigger inflation?
Now that bank deposits have been revealed as unsafe, will people rush to spend their money before they lose it? China has been on a worldwide buying spree for a few years now. They don't trust the value of all those greenbacks they hold and want to exchange them for more tangible things. Maybe they know something.
When people and institutions stop spending -- as has happened in recent years -- economists call it "a collapse in the velocity of circulation of money". But if people suddenly do the opposite and start to spend up big time that will bid up the prices of everything -- which will also bring about destruction of the value of savings. So you can only win by getting in early -- JR
The balance sheet of the bank in which you deposit/lend your hard-earned savings should always be a matter of keen interest to you. Any scheme that supposedly de-risks deposits without truly reflecting the cost of removing such risks is just allowing them to accumulate to unsustainable levels - with predictable consequences as we have seen in Cyprus.
I do believe some good will come of the events in Cyprus. Middle class savers have had their eyes opened and are now being forced to pay attention to:
1) bank balance sheets - deposit insurance schemes are a global fiction which, in part, have allowed modern banks to become the highly leveraged, opaque, risk agglomerating machines that they are;
2) alternatives to bank deposits as capital preservation tools with consequences for the velocity of money and inflation; and
3) the risk of outright wealth confiscation and sudden capital controls as the new in extremis method of financing bankrupt states.
There has been much discussion about the collapse of the velocity of money since 2008. Despite certain reservations that the concept of the velocity of money may be simply an accounting identity with no real existence outside of economics textbooks, there has certainly been an increased preference on the part of the middle class to hold money balances with the idea that deposits at banks, although they generate meagre returns, will not generate nominal losses.
That fiction is being stripped away. Middle class wealth is the only the source of funds to bail out the insolvent state and financial sectors and what remains of that capital is largely held in bank deposits and pension plans. To date, it has been sufficient to "appropriate" this wealth slowly via negative real interest rates, but as events move progressively more swiftly in the bankrupt developed world, the well proven gradual process appears to be failing to yield the requisite funds - hence the transition to bail-ins and outright deposit confiscation. A steady 5-6% a year real interest rate tax is not sufficient when 30% or more is required overnight.
Where such confiscations are imposed, capital controls will not be far behind in order to prevent any remaining middle class wealth from fleeing, worsening state and financial sector solvency further and depriving the political class of future emergency funds. Will the next stage of the developed world financial crisis witness confiscatory bail-in schemes followed by severe clampdowns on all ways to get capital to safe harbours?
This leads me to my point on the velocity of money. If bank deposits are finally revealed to be vastly more risky than the 1-2% nominal interest rates they provide and capital flight is going to be progressively more difficult, then perhaps we are about to see an increase in the velocity of money, whereby middle class capital rotates into real assets outside of the financial system - passive, un-leveraged hard asset investments with reliable cash generating capacity where possible.
Think of the growing interest in investing in farmland and other productive assets as examples. Time will tell, but we may look back on the events in Cyprus as the catalyst for an upswing in headline rates of inflation - at least in real assets. Ask yourself if a physical gold holding is now really more risky than a European bank deposit and the consequences this may have on nominal real asset prices?
In Tribute To The Iron Lady: The 25 Greatest Quotes From Margaret Thatcher
If we had more leaders with Margaret Thatcher's heart, courage and wisdom, this would be a different, better world. As you read these quotes from one of the towering figures of the 20th century, you'll see why.
25) "Being powerful is like being a lady. If you have to tell people you are, you aren’t."
24) "I too have a certain idea of America. Moreover, I would not feel entitled to say that of any other country, except my own. This is not just sentiment, though I always feel ten years younger – despite the jet-lag – when I set foot on American soil: there is something so positive, generous, and open about the people – and everything actually works. I also feel, though, that I have in a sense a share of America."
23) "They’ve got the usual Socialist disease — they’ve run out of other people’s money."
22) "My policies are based not on some economics theory, but on things I and millions like me were brought up with: an honest day’s work for an honest day’s pay; live within your means; put by a nest egg for a rainy day; pay your bills on time; support the police."
21) "If you want to cut your own throat, don’t come to me for a bandage."
20) "Constitutions have to be written on hearts, not just paper."
19) "I never hugged him, I bombed him." -- Thatcher on dictator, Muammar Gaddafi
18) "I always cheer up immensely if an attack is particularly wounding because I think, well, if they attack one personally, it means they have not a single political argument left."
17) "It is always important in matters of high politics to know what you do not know. Those who think that they know, but are mistaken, and act upon their mistakes, are the most dangerous people to have in charge."
16) "I think we have gone through a period when too many children and people have been given to understand 'I have a problem, it is the Government’s job to cope with it!' or 'I have a problem, I will go and get a grant to cope with it!' 'I am homeless, the Government must house me!' and so they are casting their problems on society and who is society? There is no such thing! There are individual men and women and there are families and no government can do anything except through people and people look to themselves first… There is no such thing as society. There is living tapestry of men and women and people and the beauty of that tapestry and the quality of our lives will depend upon how much each of us is prepared to take responsibility for ourselves and each of us prepared to turn round and help by our own efforts those who are unfortunate."
15) "The choice facing the nation is between two totally different ways of life. And what a prize we have to fight for: no less than the chance to banish from our land the dark, divisive clouds of Marxist socialism and bring together men and women from all walks of life who share a belief in freedom."
14) "A man may climb Everest for himself, but at the summit he plants his country's flag."
13) "Whether it is in the United States or in mainland Europe, written constitutions have one great weakness. That is that they contain the potential to have judges take decisions which should properly be made by democratically elected politicians."
12) "The defence budget is one of the very few elements of public expenditure that can truly be described as essential. This point was well-made by a robust Labour Defence Minister, Denis (Now Lord) Healey, many years ago: ‘Once we have cut expenditure to the extent where our security is imperiled, we have no houses, we have no hospitals, we have no schools. We have a heap of cinders.’"
11) "...The larger the slice taken by government, the smaller the cake available for everyone."
10) "Whether manufactured by black, white, brown or yellow hands, a widget remains a widget – and it will be bought anywhere if the price and quality are right. The market is a more powerful and more reliable liberating force than government can ever be."
9) "To be free is better than to be unfree – always. Any politician who suggests the opposite should be treated as suspect."
8) "During my lifetime most of the problems the world has faced have come, in one fashion or other, from mainland Europe, and the solutions from outside it."
7) "There is much to be said for trying to improve some disadvantaged people’s lot. There is nothing to be said for trying to create heaven on earth."
6) "Left-wing zealots have often been prepared to ride roughshod over due process and basic considerations of fairness when they think they can get away with it. For them the ends always seems to justify the means. That is precisely how their predecessors came to create the gulag."
5) "It is one of the great weaknesses of reasonable men and women that they imagine that projects which fly in the face of commonsense are not serious or being seriously undertaken."
4) "...Conservatives have excellent credentials to speak about human rights. By our efforts, and with precious little help from self-styled liberals, we were largely responsible for securing liberty for a substantial share of the world’s population and defending it for most of the rest."
3) "Oh, but you know, you do not achieve anything without trouble, ever."
2) "Look at a day when you are supremely satisfied at the end. It's not a day when you lounge around doing nothing; it's when you've had everything to do, and you've done it."
1) "Of course it's the same old story. Truth usually is the same old story."
Since when has it been considered smart to tell your enemies what your plans are?
Yet there on the front page of the April 8th New York Times was a story about how unnamed "American officials" were planning a "proportional" response to any North Korean attack. This was spelled in an example: If the North Koreans "shell a South Korean island that had military installations" then the South Koreans would retaliate with "a barrage of artillery of similar intensity."
Whatever the merits or demerits of such a plan, what conceivable purpose can be served by telling the North Koreans in advance that they need fear nothing beyond a tit for tat? All that does is lower the prospective cost of aggression.
When the Japanese bombed Pearl Harbor, should we have simply gone over and bombed a harbor in Japan? Does anyone think that this response would have stopped Japanese aggression? Or stop other nations from taking shots at the United States, when the price was a lot lower than facing massive retaliation?
Back before the clever new notion of "proportional" response became the vogue, our response to Pearl Harbor was ultimately Hiroshima and Nagasaki. And Japan has not attacked or even threatened anybody since then. Nor has any war broken out anywhere that is at all comparable with World War II.
Which policy is better? There was a time when we followed the ancient adage "By their fruits ye shall know them." The track record of massive retaliation easily beats that of the more sophisticated-sounding proportional response.
Back in ancient times, when Carthage attacked Rome, the Romans did not respond "proportionally." They wiped Carthage off the face of the earth. That may have had something to do with the centuries of what was called the Pax Romano -- the Roman peace.
When Argentina invaded the Falkland Islands in 1982, the British simply sent troops to take the islands back -- despite American efforts to dissuade Prime Minister Margaret Thatcher from doing even that.
For more than a century since the British settled in the Falkland Islands, Argentina had not dared to invade them. Why?
Because, until recent times, an Argentine attack on a British settlement would be risking not only a British counterattack there, but the danger of a major British attack on Argentina itself. That could mean leaving Buenos Aires in ruins.
Today, Argentina's government is again making threatening noises about the Falkland Islands. Why not? The most the Argentines have to fear is a "proportional" response to aggression -- and the Obama administration has already urged "negotiations" instead of even that. When threats are rewarded, why not make threats, when there are few dangers to fear?
Can you think of any war prior to Iraq and Afghanistan where the United States announced to the world when it planned to pull its troops out? What has this accomplished? "By their fruits ye shall know them." What have been the fruits?
First of all, this constant talk in Washington about not only pulling out, but announcing in advance what their pullout timetable was, meant that Iraqi political leaders knew that a powerful Iran was on their border permanently, while Washington was a long way away and intended to stay away.
Should we be surprised that the Iraqi government has increasingly come to pay more attention to what Iran wants than to what Washington wants? Once more, vast numbers of American lives have been sacrificed winning victories on the battlefield that the politicians in Washington then frittered away and turned into defeat politically.
What about other countries around the world who are watching what the American government is doing? Many have to decide whether they want to cooperate with the United States, and risk the wrath of our enemies, or cooperate with our enemies and risk nothing.
There is no need to respond to a North Korean artillery barrage by wiping North Korea off the map. But there is also no need to reassure the North Koreans in advance that we won't.
What announcing the doctrine of "proportional" response does is lower the price of aggression. Why would we want to do that?
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Posted by JR at 12:34 AM