HYPERINFLATION

Up until today, I was in the deflationist camp, in that I thought that the Fed along with the Treasury wouldn’t be stupid enough to try to hyper-inflate the U.S. out of this mess. Today, Paulson, after saying he wouldn’t, initiated the talks to have the Treasury print $40billion in Treasuries and hand them to the Fed so the Fed can lend those Treasuries to the banking system. History has shown, that every government who has tried to hyper-inflate a country out of a financial crisis has failed both politically and economically. We may end up being mentioned among the darlings of Weimar, Germany, Argentina, and Zimbabwe. Why does hyperinflation usually lead to political and economic failure? Because lenders simply stop lending when they see that as a result of the government’s printing press their $X they lent out at time (t) is now worth $X/100 at time (t+1). Congrats Ben and Hank, you made Gold skyrocket over 10% today with your $40billion of raw money printing. Also, the market is losing trust in everything except Gold and T-bills. (T-bill yields reached 0.04% today, lowest point since 1954, and only 0.03% away from the low of 0.01% reached in WWII). With the Fed and Treasury bailing out these INSOLVENT institutions, they are instigating the hedge fund shorts to go after the next financial institution (ala GS and MS today). People who watch CNBC and Bloomberg and happen to catch interviews with company insiders or real-money managers who state that their firms are victims of rumor-mongering and naked short-selling, and believe them, are naive and uninformed. These people are lying to the American and International populace. Balance sheets need to become transparent and the Fed and Treasury has to force these firms to mark everything to market and let firms who are found to be insolvent fail. Yes, the repercussions of many of these firms going under will be quite dire, but not as dire as the consequences of the Fed and Treasury printing raw money in order to sweep the problems under the rug in hopes that time will heal all wounds. By printing, they are only postponing the inevitable, and worse, possibly destroying the political and economic system on which our livelihood and lifestyle are built upon. Additionally, by the Fed and Treasury printing, this may lead to foreign central banks stopping to purchase U.S. Treasuries. If that happens, it’s game over. It’s already happening with Agency paper. Deflation may still happen if the Fed and Treasury can’t print as much money as is being destroyed in the financial system, but I’m not taking that bet. Welcome to the United States Socialist Republic. I hope I can find a job in my homeland because this country will only be a shell of what it used to be in the not to distant future.

This is one of the better posts I have read in AF history. Good work. I knew most of this but the way you assembled it is great Gremlin. Willy

cfa_gremlin Wrote: ------------------------------------------------------- > Up until today, I was in the deflationist camp, in > that I thought that the Fed along with the > Treasury wouldn’t be stupid enough to try to > hyper-inflate the U.S. out of this mess. Today, > Paulson, after saying he wouldn’t, initiated the > talks to have the Treasury print $40billion in > Treasuries and hand them to the Fed so the Fed can > lend those Treasuries to the banking system. This is why I’ve been in the hyperinflation/gold camp (and losing my shirt for it) for a while. This administration is so bad that you can almost COUNT on it doing the wrong/selfish/short-term-thinking thing, no matter what the future consequences. Paulson and Ben are smart guys, and probably know they’re doing a dumb thing, but the pressure on them from the rest of the cabinet has got to be too much for them.

This might be semantic, but I think that hyperinflation is political and economic failure. Gov’ts don’t try to hyper-inflate their way out of problems; they print money because they run out of other options and then they get caught in the whirlpool of hyperinflation. I think the US is a long way from hyperinflation. Adding $40 billion of new money is insignificant compared to the monetary base of the country (but the cumulative effect of lots of similar policies is certainly inflationary, IMHO). I posted like 6 months ago that I thought the world felt a lot like 1973 and I still think the world feels like that +6 months. We didn’t have hyperinflation then, just nasty uncomfortable stagflation. We’re going to complicate that this time by sacrifices at the altar of monetarism that will make things worse but I just can’t see hyperinflation happening. Now gold +90 yesterday was very troubling. I completely agree with “This administration is so bad”. I voted for GWB once (I apologize), but I honestly think that this is the second worst administration in US history (Buchanan #1 - if America had been progressive then we would have elected Jessie Fremont and the world would be different).

Yeah, I guess hyperinflation is too alarmist, although I don’t think it’s as unthinkable in the US as it once was. I agree that stagflation is the more likely outcome. However, if one tries to print money to address the stagnation part, particularly if it’s to reduce populist type demands, one can invite hyperinflation a la 1980s Brazil.

"I think the US is a long way from hyperinflation. Adding $40 billion of new money is insignificant compared to the monetary base of the country (but the cumulative effect of lots of similar policies is certainly inflationary, IMHO). " Joey - You’re correct that 40 billion is insignificant, BUT, who says that this is all they will do? Hyperinflation is going to come if Paulson and Bernanke don’t tell firms to mark-to-market and come clean so trust and confidence could start to come back to the system. They said the subprime crisis is contained, they said that order will be restored in the financial system after Bear Stearns, they said that the run on agency paper will halt when FNM and FRE got put into conservatorship. yada yada yada. I am right in the thick of things, and this crisis is CATASTROPHIC. I see whites in the eyes of higher-ups at my firm and I hear ghost voices of salesmen on the other end of my phone conversations. Hyperinflation will be next if they print money at a faster pace than is currently being destroyed because I don’t believe this $40billion injection is going to be the last.

I largely agree with you. Do you really want everyone to mark illiquid securities to market when there is no market? I don’t even know how you would do this (find a buyer for a piece of everything you own?).

JoeyDVivre Wrote: ------------------------------------------------------- > I largely agree with you. Do you really want > everyone to mark illiquid securities to market > when there is no market? I don’t even know how > you would do this (find a buyer for a piece of > everything you own?). The problem is, marking right now, would be the utter death of the entire financial system. I don’t think people really realize that marking securities to short-term markets, is really a stupid thing to do. First off, what is the value of the security? Is it the future payment streams, or what you can sell it for today? If one says “what you can sell it for today”, great, but the price of today could be drastically different than what it was tomorrow, and only so because events outside of the original security’s value, or the future payment streams. For example, many bonds last week were worth far more than today. Not because the payment stream is altered, but because the liquidity premium demanded has pushed interest rates up 100bps or more, in many securities. Is this a real price, or a short-term movement during a market panic? If it is a short-term movement, should we be pricing *everything* to it? If we do, then what happens? As more capital is eroded, more panic ensues, which only triggers successive selling, successive panic, and successive write-downs because of M2M. Essentially, short-term M2M, driven by liquidity premiums, undermines the system. Why? Because without the liquidity premium in crisis, those securities would reasonably be valued at a rational price of their future cashflows. however, there is no rationality in this market beyond CYA, which drives up liquidity premium. Effectively, demanding everybody M2M right now, would be akin to telling all auto borrowers to M2M their vehicles and remit payments to maintain a % equity in their cars. It would be catastrophic, especially in a period where oil is far higher and the used car market is horrible. People would have less money, which would force some to sell vehicles, which would only decrease the price of the current vehicles. Personally, M2M is a horrible experiment at greater transparency and one that has utterly failed us.

I guess they could mark to market when it goes up, collect their bonus, pat themselves on the back … but not when it goes down!

Good post, except that printing money is not happening. This has not happened in the U.S. since the civil war, I think. The Fed buys and sells government securities, it does not print money.

Dreary - “printing money” is a metaphor. In this case, it means increasing the money supply to cover obligations of the gov’t.

What’s the alternative to M2M then? We need some kind of alternative that doesn’t allow people just to post any value they pick out of the air, since we can guess how those rules are likely to be abused. Is there a reasonable way to figure out how much of the discount to DCF valuation is liquidity-based and how much is because we actually think the CFs aren’t going to be there?

spierce Wrote: ------------------------------------------------------- > JoeyDVivre Wrote: > -------------------------------------------------- > ----- > > I largely agree with you. Do you really want > > everyone to mark illiquid securities to market > > when there is no market? I don’t even know how > > you would do this (find a buyer for a piece of > > everything you own?). > > The problem is, marking right now, would be the > utter death of the entire financial system. I > don’t think people really realize that marking > securities to short-term markets, is really a > stupid thing to do. > > First off, what is the value of the security? Is > it the future payment streams, or what you can > sell it for today? If one says “what you can sell > it for today”, great, but the price of today could > be drastically different than what it was > tomorrow, and only so because events outside of > the original security’s value, or the future > payment streams. > > For example, many bonds last week were worth far > more than today. Not because the payment stream > is altered, but because the liquidity premium > demanded has pushed interest rates up 100bps or > more, in many securities. > > Is this a real price, or a short-term movement > during a market panic? > > If it is a short-term movement, should we be > pricing *everything* to it? > > If we do, then what happens? As more capital is > eroded, more panic ensues, which only triggers > successive selling, successive panic, and > successive write-downs because of M2M. > > Essentially, short-term M2M, driven by liquidity > premiums, undermines the system. Why? Because > without the liquidity premium in crisis, those > securities would reasonably be valued at a > rational price of their future cashflows. > > however, there is no rationality in this market > beyond CYA, which drives up liquidity premium. > > Effectively, demanding everybody M2M right now, > would be akin to telling all auto borrowers to M2M > their vehicles and remit payments to maintain a % > equity in their cars. It would be catastrophic, > especially in a period where oil is far higher and > the used car market is horrible. > > People would have less money, which would force > some to sell vehicles, which would only decrease > the price of the current vehicles. > > Personally, M2M is a horrible experiment at > greater transparency and one that has utterly > failed us. The “I largely agree with you” was the stuff about this being a pretty bad spot. I am more a fan of MTM than nearly anyone, but I don’t even think it’s a good idea right now. It’s a terrible spot we have gotten ourselves into…

> Balance sheets need to become > transparent and the Fed and Treasury has to force > these firms to mark everything to market and let > firms who are found to be insolvent fail. Imagine if you have a loan with a bank and the value of your house declined. And this same bank required you to fork over the difference between what the house is worth and what your outstanding loan balance is, in two days or else they will foreclose your home. Even though your income is sufficient to cover the mortgage payment, you just dont have the big dollars to cover the decline in house price… how would you feel? That my friend is how banks are feeling right now with MtoM accounting. The crisis is caused by MtoM accounting. The market is very illiquid right now. What you suggest is foolhardy. Companies are taking massive write-down of CMBS when the loss experience of those securities have been minimus, ditto for corporate paper. How is that fair? What is causing firms to fail is NOT the write downs necessarily, but the collateral and liquidity issue. For example, AIG is not going bankrupt, they just need a credit line for liquidity purpose. LEH didn’t get that credit line and had liquidity issue (not able to meet collateral). These companies are not insolvent as you suggest, they’re victim of a credit crunch.

bchadwick Wrote: ------------------------------------------------------- > What’s the alternative to M2M then? We need some > kind of alternative that doesn’t allow people just > to post any value they pick out of the air, since > we can guess how those rules are likely to be > abused. > > Is there a reasonable way to figure out how much > of the discount to DCF valuation is > liquidity-based and how much is because we > actually think the CFs aren’t going to be there? I have thought about this at length and I haven’t had any great ideas. Pricing on current rates, which bakes in a huge amount of liquidity premium, just doesn’t work. Take, for example, overnight ABCP (asset backed commercial paper). In some cases, some ABCP trades, overnight, for “A” rated, full liquidity and letter of credit supported, AA banks, went out at 7.00%, when, the night before, they went out at 2.5%. Should those securities then be repriced because of that? M2M in a liquidity constrained world just doesn’t work. It’s just a self-fulfilling prophecy feeback loop. What’s the answer? Stripping out the liquidity premium may work. Other ideas would be using averages. I feel sorry for people trying to revalue I/O strips or other residuals for FAS140 transactions. Not that I like FAS140 (I hate it), but what a bitch to manage in these environments.

bchadwick Wrote: ------------------------------------------------------- > What’s the alternative to M2M then? We need some > kind of alternative that doesn’t allow people just > to post any value they pick out of the air, since > we can guess how those rules are likely to be > abused. > There’s transparency. We live in an Internet age where there is just no reason that a company can’t post their valuation models for securities they own (these aren’t trading models, they are valuation models and they just aren’t sophisticated). > > Is there a reasonable way to figure out how much > of the discount to DCF valuation is > liquidity-based and how much is because we > actually think the CFs aren’t going to be there? I wish. DCF valuation doesn’t do it either because with many securities the cash flows are unknown. I don’t even really know how to quantify “liquidity” for many securities, to say nothing of assign a value to it. For one thing the liquidity of a security may well depend on how much of it you own and how much of it you want to sell and how quickly. That’s fundamentally different from the securities valuation that takes no account of what youare trying to do with the security.

swtxlady, thanks for your post… that makes the m2m issue really clear! I guess the worry if you have your house underwater is that you could “walk away,” keep your cash flows to yourself, and the bank has to eat the difference in the home price. Does that analogy hold too?

I’m hoping for deflation as I have cash on the side. Hyperinflation will eat up my savings unless rates go through the roof.