Sunday, January 18, 2015

Relevant Value Trumps Inflation or Deflation

Several years ago while grabbing a sandwich at McDonalds to get me through the work day I found myself having a conversation with another man in line. The subject of the government debt came up and I was somewhat shocked that not only did this man have absolutely no concern over the growing deficit but he went on to state "The government will never run out of money, they will just print more." The part I found troubling was that he didn't seem to connect the dots as to the ramifications of such a policy or simply did not care. It still shocks me that recent polls show many Americans agree with his attitude and view.

I would like to share a comment from a fellow named Art in response to both a recent article I posted and in regard to comments by other readers, it can be found below;
                ArtJanuary 16, 2015 at 9:45 AM    You guys know double entry accounting, right? Those govt liabilities are someone else's asset, to the penny. Thus, an aging and/or contracting population might require MORE govt liabilities, not less. And as long as they are denominated in the debtor's currency, solvency is essentially a non-issue. The constraint is inflation, which is nowhere in sight, despite what look like "high" levels of debt. 
Also, have you ever heard of a corporate bond analyst comparing a company's debt level to its income? Normally, you compare debt levels to assets, and debt service to income. We should do the same when looking at govt debt. And by that measure, the U.S. is mighty far away from problematic debt levels, unfunded liabilities and all. 

To say I differ with Art's opinion is an understatement, especially when he included "unfunded liabilities and all." You may believe what you want, but I caution you if you have any thoughts that the government or central bankers are anything resembling transparent. Both have been superbly entrepreneurial when it comes to generating Ponzi schemes and advancing the art of pseudo-economics. Over the years economic hocus-pocus has masked reality and allowed the current situation to develop. All these games have stirred up a great number of questions to what is real and muddied the water making it almost impossible to get a clear picture of what lies ahead. All the variables and moving parts have made this very confusing and difficult to get one's head around.

The crux of what is before us may hinge on relevant value rather than inflation or deflation. It is possible this is more multifaceted than most people realize and we have been misled into arguing and debating the wrong issue or are viewing the subject in the wrong light. In what is often referred to as the "end game" or the time the global economy will be forced into resetting, I believe the situation will focus on issues of currency and debt valuations. These "debt valuations" will include both government and private obligations. If someone is caught holding a worthless currency or is owed money that is washed away or not "properly repaid" they will suffer greatly. This means some people and countries will be big losers as value and wealth shifts to the "flavor of the day" driven by demand or searching for a safe haven.

 A very interesting bond exist between value and wealth. It becomes visible when you dive into the issue of where and how wealth is stored. A surprise to many people is where wealth is stored varies from country to country, this is very important. The reason for this variance may be cultural, based on historic values, in reaction to how an economy developed, or because of tax policies. The example I like to use that illustrates this is house prices in China, they are very important to that country because that is where almost 75% of household wealth is stored. Here in America a very large share of household wealth, approximately 71% is stored in financial instruments. This means the end of the housing bubble in China has the potential to become a huge deflationary "house of cards" while in America it appears financial instruments are more likely to be our "Achilles Heel."

One possible reason that inflation has not raised its ugly head or become a major economic issue in America is because we are pouring such a large  percentage of wealth into intangible products or goods. This includes currencies. If faith drops in these intangible "promises" and money suddenly flow into tangible goods seeking a safe haven inflation will soar. Another possibility is that the dollars role as the world reserve currency and cross-border money flows has acted as a shock absorber lessening the impact of our Federal Reserve policies. Like many of those who study the economy, I worry about the massive debt being accumulated by governments and the rate central banks have expanded the money supply.

This is all rather complex and even our terminology tends to get us in trouble, for example, it is really not an "end game", but rather more of a reset with the game resuming under new rules. Another point is that inflation or deflation often has to do with how it is figured or calibrated and can fluctuate greatly. The root issue being one of relevance, meaning what something is worth in relationship to another item. This can be a difficult concept to convey, it is also hard to internalize by people seeking easy answers. We must realize "relevant values are in constant flux" and this situation is unending as we move forward. By that measure, it is foolhardy for anyone to close their eyes and hope to prosper on luck when we live at a time when values can change in a blink of an eye. 

We must make a central part of our overall financial planning the idea that as we move forward we continue to replace diminishing assets for those higher up the chain. If not we risk "dying" a financial death that can come slowly, as value erodes, or quickly such as in the case where we have been scammed or robbed. As I fleshed out this post I found myself questioning exactly how much meat or relevance it contains, but it is clear the concept of "relevant value" is more important than the debate about inflation or deflation when it comes to protecting our wealth.  Remember it is a dangerous world out there where few people hold your financial interest above their own.

 Footnote; Added Sept.11,2015  Your comments are welcome and encouraged. If you have time check out the archives for another post that may be of interest to you. The two post below delve deeper into how the value of money can quickly change,



  1. The funny thing is when the Krugman fanbois start in with their business accounting tricks and debt doesn't matter spiel they never understand Nations don't follow accounting rules, general income trends or even debt levels for that matter. What matters in the end is the well being of the majority of the population and how they perceive they are treated. Fact is the US has reached it's tipping point and right now a large segment and growing feel they are getting shafted to coddle others. The fight between the government and the tax payers has already started as the government puts the squeeze on and begins collecting record amounts of income each year. Trouble is while doing so they are hollowing out a large part of their income base which will eventually make the entire thing crumble from within.

    Up until that end the government will be printing numbers that make everything look like unicorns and rainbows but it will be the Black swan events that set the ball rolling as the desire to deal with them leaves the populace. Try as you might you can't put that into an account book.

  2. When CONSUMERS started drowning, COMPANIES followed; who were lent a helping hand by respective COUNTRIES; that got CURRENCIES involved; and ultimately, its the CITIZENS who will have to bear the brunt of this CRONY CAPITALISM!!!

    The end - game? There shall be none, as HIGH & MIGHTY (POLITICIANS & CHOSEN FEW CAPITALISTS) will change RULES OF THE GAME after every loss in order to let the ball rolling.

    As far as CLASSIC THEORY OF CAPITALISM goes, WE SHOULD HAVE ALREADY RESET in 2008 - 2009. But, instead of stopping this highly dangerous game that really affects every individual, stakes were raised multi-fold.

  3. Can you please analyse indian economy which most economists are bullish now? Esp real estate and IT sector...

    1. Thanks for your comment, the economy of India is often overlooked by many Americans. I will put your request high on my list and have a go at such an article in the near future.

  4. You may not be right about inflation. Minsky studied economic cycles and came up with his Financial Instability Hypothesis.

    The fact that the CBs have been able to super extend this cycle does not mean that they have prevented the natural cycles from ever taking place. I believe that they have exacerbated the consequences rather than fixed anything.

    Owning any leveraged asset will diminish your base when the inevitable happens. The real issue is when. Having control of an appreciating asset is always good and that is especially true during times of inflation. But there are maintenance cost and you have to be prepared for them during a deflationary cycle or you will lose what you thought you held.

    Why I believe what I believe is because debt has to be serviced. There is productive debt that retires itself and then there is unproductive debt that just drags. When you borrow to eat, you still have to eat but then you have to pay back what you previously borrowed. Do this long enough and there isn't enough left to eat because all your income goes to making payments on what you already spent. At that point you crash. Servicing unproductive debt is a total drag.

    So the government thought it could create some more debt and paper over the losses at the TBTF institutions. Then the FED thought it could fix things by first buying up some of that debt. Well it sort of worked but because the consumer (70+% of the economy) wasn't bailed out, things just continued to slow down. Yet the TBTF and the FED forced prices up in certain sectors thus actually leaving less after tax disposable income for most. Add in Obamacare and well, the consumer really isn't well and neither is Main Street.

    No the paper over is just more and more unproductive debt that is a drag on the system and at some point, something will happen and everyone will be standing around wondering what the hell happened.

    I have no idea when or what but I do know it is coming. It is just as inevitable as Winter follows Fall and Spring follows Winter. The timing is more unpredictable because man is involved, trying to manipulate and game the system. A system that is just as natural as gravity. Debt has to be serviced.

    As you pointed out, there are two sides to a balance sheet. One is debt and the other is an asset. When the debt starts collapsing so will the value of the assets and the income derived. When this happens, even those holding leverage free assets will have their net worth devastated. Even those who's asset was under the normal times, self liquidating. Those holding cash will have the advantage. Just a cycle, read Minsky. How things turn out for any individual will be determined whether they are following the herd or out on a limb. Right now the limb is holding cash.