We will find there are no stable regimes of inflation above the 2% target (not that that was stable either). A 5% target will find us with regular periods of 15% inflation within a handful of years. There has been one feedback loop that hasn't yet really kicked in, but is starting to- public employee wage increases of 20-30%. Then we are off to the races.
How do you hedge this? You don't, not really. The best you can do is buy time, but if you do successfully find protection, the government will consider you a lucky ducky who needs to share.
Yes, if you really want to bet against the market on inflation forecasts, you should buy TIPs and short the equivalent -duration nominal bonds. I'm willing to do the TIPS-buying, but I don't have the guts to short nominal bonds.
Are TIPS a useful inflation hedge if you don't believe the CPI is an accurate measurement of inflation?
In addition to some technical problems with the CPI, it has a real fox guarding the henhouse feel. Would the government really want to print a CPI number that cost it money if it was trying to inflate away its debt. Especially with SS and so many of its other expenses linked to CPI.
The financial repression will either eliminate these bonds at some point, or the government will further debase the truthfulness in the inflation measures.
So I'm going to propose something a bit unorthodox.
Have your wife stay home with the kids to beat inflation.
We are about to have our third and we decided its time for her to take a few years off.
Between tax wedges, daycare costs, and inflation eating away at savings its just not worth it. I expect that the desire to "tax the rich" and the automatic increase in tax brackets from inflation will make that second income very low utility. A single income covers our expenses and the second income was mostly going into savings. We are one of those lucky people that refinanced when rates were low so living expenses are low.
Consider responding to the war on savings and productivity by "consuming" time and freedom. I expect the value of time with the kids to outpace inflation.
Arnold - I agree with you on A) Government options B) “crypto” technically not being the answer. C) However, Bitcoin (not crypto - big difference) is quite possibly the answer. Even with or BECAUSE of it’s volatility. The volatility repression regime that our current financial system has been under for the last 12+ years has been extreme and has removed true signal from the market place. The LACK of volatility should scare the pants off of you. Yesterday, the Wall Street Journal had a headline “Houses fall in value for first time in 11 years”. That is crazy. Repressing volatility is delaying and amplifying volatility. Bitcoin has had some extreme volatility, but the trend line from 2010 - today is up and to the right due to it’s properties that Lyn is referring to. Can’t print more of it, can’t confiscate it, can transport it around the world in any denomination cheaper than any store of value ever created. Just look at this volatility of gold against marks in the Weimar Republic.
Trust me - gold was the play if you could get it out of the country. Bitcoin is digital gold that can’t be confiscated. Rethink Bitcoin - have a zoom with Lyn Alden. I’d pay to attend.
My concern is that Bitcoin is on top of a stack. Underneath it is the Internet. Underneath the Internet is the electric grid. Underneath the electric grid is the financial system. Collapsed financial system means no electric grid, hence no Internet, hence no Bitcoin. My line is that the only hedge against a collapse of the financial system is to plant a vegetable garden.
1. If there is a total system collapse, you will first want guns/bullets, then maybe a vegetable garden/chickens, etc... Otherwise I will come take your veggies and chicken.
2. The first thing any community of people in your post-apocalyptic scenario will need is a medium of exchange. If there is no internet, you will want physical gold. (see point 1 about protecting that asset) If there is an internet electricity, Bitcoin can be that medium of exchange. Many electric grids and energy infrastructure companies in the U.S. are building symbiotic relationship with Bitcoin miners due to the need for cheap power. See Texas' partnership via their Ercot grid to build out power capacity to handle multi-sigma peak loads in response to their catastrophic winter in 2021. They can do this build out because bitcoin miners have pledged to buy all the power between the grid's needs and peak capacity (Flexible Load Task Force) - then turn off their mining rigs when peak loads are needed for heat in the winter or AC in the summer.
0% allocation to Bitcoin is riskier than you think. An asset accessible from any computer/phone in the world with an internet connection that can't be seized or debased sounds very attractive in the current environment.
Confiscation is a reasonable concern. Gold's physical properties really push that commodity towards centralization which enables confiscation. Bitcoin is different. It exists in software run by tens of thousands of nodes across the world. You can store your keys (password) offline and make your Bitcoin literally unconfiscatable. Most Bitcoin is held off of exchanges so it can't be confiscated. There are a lot of technical and process reasons that would make it incredibly difficult or impossible to attack Bitcoin as a state actor. China has tried to ban it 5 times. 20% of Bitcoin mining still happens in China. I agree with Balaji that China as a government would be the most competent/powerful nation state to worry about and they haven't cracked the nut. The U.S. Govt can't roll out a healthcare exchange - just no tech savvy. (Also see the book "Soft War" written by Jason Lowery from inside the DOD who is positing Bitcoin as a power projection tool for the state, not a victim of power projection. Very interesting.
As far as "how useful is it if you can't trade it for money?" - Bitcoin IS money. I bought a sandwich with it last week and the transaction was faster than visa. (Research the lightning network.) I don't give investment advice, but I do believe that anyone under 80 with a 0% allocation to Bitcoin is carrying the same or more risk as someone with 100% of their money is U.S. dollars in the bank.
bank deposits - $20T, public stock capitalization - $100T, private company capitalization - ?, Real Estate - ? (US homes $40T), commercial bonds? municipal bonds? federal public debt - ~$30T
Aside: Not that I'm typical but bank accounts are a tiny portion of my assets. Throw in money market funds and it isn't much bigger. The rest in stocks, bonds, real estate.
Thoughts:
Not my first thought but making alternatives to bank deposits illegal would seem closer to impossible than just absurd. Maybe you are just referring to that relatively tiny $20T of bank deposits but I don't know how you'd regulate to force that asset class not shrink.
My first thought was that they can't inflate away the govt debt problem because too many of the expenditures are inflation adjusted.
Inflating is at best a temporary delay of inevitable pain. Poor countries have to inflate to pay debts because they have no alternative. US has lots of wealth and therefore has alternatives.
Maybe most importantly, I don't think anyone can argue that trying to inflate away federal debt and expenditure problems would be good for the economy. A strong economy is key to the best outcome. Therefore taming inflation is the only reasonable objective.
I'm not saying what US will do, only that it is not even close to a foregone conclusion that inflation will remain.
"The form that regulation is likely to take is a requirement that banks undertake less lending to the private sector and instead hold more of their assets in the form of government securities."
Could happen, but what _ought_ to happen is on the margin banks should lend more to the private sector at variable rates.
I understand the bank problem is depositors are wisely moving deposits out of banks to purchase government debt, which pays a higher interest rate. What banks need to do is pay a higher interest on deposits!
That's not the best solution. Government debt should NOT pay higher interest; it is safer than private sector debt. Banks need to invest (more, not exclusively of course) in private sector debt that does not expose them (as much not zero) to interest rate mismatch.
Increases/decreases in ST interest rates would still affect spending even if banks had more VR investments. Indeed, maybe the impact would be broader if it did not hit sectors financed with LT fixed rate debt (housing) so hard.
I think this is now the best and most succinct explanation of what we face. One angle I remember a commentator speculating on is whether the government would require ETFs/Mutual Funds to hold some amount of treasuries as a way to force buying.
What are the prospects for a major increase in productivity, thanks to breakthroughs in Artificial Intelligence technologies? (It has sometimes occurred that positive technology shock transcends the drag of political economy.)
This came up briefly in our discussion. I mumbled "The Geek Rapture scenario." Yes, if GDP goes up by a factor of 10, then the debt/GDP ratio goes down by a factor of 10 (approximately).
My early take is that AI can make significant inroads in education, health care, and a variety of other services. You could probably replace a phalanx of administrators and even nurses with a chat bot. I could also see using a lot fewer teachers and using the chat bot as the primary educator
Explain how a chatbot is going to replace the teachers union? Which local politician do you believe is going to fire all those people and survive?
People are useless and redundant now and you can't get rid of them. They closed schools and didn't even work for over a year and you can't get rid of them.
the technology deflation scenario (geek rapture, ha!) could MAYBE solve our problems, but in the interim it would require both government and corporations to “allow americans to be poor” for a short to medium amount of time. not sure anyone has the guts for that (see also entitlements spending)
I made this point in our conversation Monday night. I think genetic engineering also has a chance of dramatically impacting productivity but it will take 5 years minimum for the technologies to diffuse and make a measure able difference.
The "you" and "government" is a silly dichotomy. Of course different policies have different distributional and growth consequences, but that is for all the "you's." The "you/government" framing is at least as bad as arguments about how policy affects "firms" that ignore that "firms" have owners.
not silly. government is the collective account. you is the individual accounts. The absurdity of killing individual accounts to save the collective account is irrelevant to what AK says.
Pretty much explained in a nutshell the factors underlying my vague sense of unease regarding the economy since lockdown began seemingly intentionally putting small businesses out of business and up to reading about the complete depositor bailout at SVB.
However, what if this uncharacteristic full bailout of account holders isn’t part of the implementation of systemic regulation of banks coming down the pipe? What if this bailout is just more of the same from 2008, special treatment for the wealthy? Most depositors at this bank were more like the well heeled bankers that served them, rather than ‘regular people’.
Re: "in the 1940s and 1950s, tax revenues exceeded non-interest spending, bringing down the ratio of government debt to GDP. Now, the large government deficits are in front of us. The need to spend on Social Security and Medicare means that tax revenues are projected to be below non-interest spending. The outlook is for the ratio of government debt to GDP to keep growing until. . .until. . .well, something has to give."
Might the something-that-will-give be *tax rates*? What is your subjective probability that tax rates will increase substantially?
Has any government ever stopped inflation without making the real interest rate positive?
Once inflation makes almost all real interest rate negative it shifts credit allocation to just being less negative and not demanding real positive ROI's on investments. This will make credit allocation be non-optimal and rob high ROI investments of funding while increasing leverage in the finance economy that doesn't make real wealth and is just dividing up the wealth being lost by negative real interest rates.
The 2% goal is more achievable than Arnold believes, because consumables remain cheap to produce. Then a return to asset inflation. The government wants lower inflation and lower interest rates, not clear the trade offs. No big reduction in government spending until Democrats ask for reductions.
Governments around the world have been doing this for 15 years now, it's the only political option. Net negative interest rates are a stealth tax on the increasing portion of the population with significant assets held in income-yielding investments. Why the outcry now?
We will find there are no stable regimes of inflation above the 2% target (not that that was stable either). A 5% target will find us with regular periods of 15% inflation within a handful of years. There has been one feedback loop that hasn't yet really kicked in, but is starting to- public employee wage increases of 20-30%. Then we are off to the races.
How do you hedge this? You don't, not really. The best you can do is buy time, but if you do successfully find protection, the government will consider you a lucky ducky who needs to share.
The market is unconvinced - TIPS breakevens aren’t much above 2% for all durations.
Which also makes for a nice investment option.
Yes, if you really want to bet against the market on inflation forecasts, you should buy TIPs and short the equivalent -duration nominal bonds. I'm willing to do the TIPS-buying, but I don't have the guts to short nominal bonds.
Can now buy via RINF ETF as well (but 30bp fees).
Are TIPS a useful inflation hedge if you don't believe the CPI is an accurate measurement of inflation?
In addition to some technical problems with the CPI, it has a real fox guarding the henhouse feel. Would the government really want to print a CPI number that cost it money if it was trying to inflate away its debt. Especially with SS and so many of its other expenses linked to CPI.
Yeah, the actual numbers re: TIPS just aren't good enough.
I-bonds may actually be good enough. There's a reason you're limited to investing $10k/year in them.
The financial repression will either eliminate these bonds at some point, or the government will further debase the truthfulness in the inflation measures.
Believing this hypothesis, what should a relatively unusual homeowner salary man do with their savings, 401k, etc.?
So I'm going to propose something a bit unorthodox.
Have your wife stay home with the kids to beat inflation.
We are about to have our third and we decided its time for her to take a few years off.
Between tax wedges, daycare costs, and inflation eating away at savings its just not worth it. I expect that the desire to "tax the rich" and the automatic increase in tax brackets from inflation will make that second income very low utility. A single income covers our expenses and the second income was mostly going into savings. We are one of those lucky people that refinanced when rates were low so living expenses are low.
Consider responding to the war on savings and productivity by "consuming" time and freedom. I expect the value of time with the kids to outpace inflation.
Arnold - I agree with you on A) Government options B) “crypto” technically not being the answer. C) However, Bitcoin (not crypto - big difference) is quite possibly the answer. Even with or BECAUSE of it’s volatility. The volatility repression regime that our current financial system has been under for the last 12+ years has been extreme and has removed true signal from the market place. The LACK of volatility should scare the pants off of you. Yesterday, the Wall Street Journal had a headline “Houses fall in value for first time in 11 years”. That is crazy. Repressing volatility is delaying and amplifying volatility. Bitcoin has had some extreme volatility, but the trend line from 2010 - today is up and to the right due to it’s properties that Lyn is referring to. Can’t print more of it, can’t confiscate it, can transport it around the world in any denomination cheaper than any store of value ever created. Just look at this volatility of gold against marks in the Weimar Republic.
https://twitter.com/balajis/status/1637506678177566720?s=61
Trust me - gold was the play if you could get it out of the country. Bitcoin is digital gold that can’t be confiscated. Rethink Bitcoin - have a zoom with Lyn Alden. I’d pay to attend.
How secure is a Crypto Blockchain against a state actor with near limitless computing power?
Related question, how valuable is Bitcoin if there is no easy way to convert it to "money"?
I think confiscating gold and confiscating crypto are similar challenges that determined state actors may pursue to strengthen their economic control.
My concern is that Bitcoin is on top of a stack. Underneath it is the Internet. Underneath the Internet is the electric grid. Underneath the electric grid is the financial system. Collapsed financial system means no electric grid, hence no Internet, hence no Bitcoin. My line is that the only hedge against a collapse of the financial system is to plant a vegetable garden.
1. If there is a total system collapse, you will first want guns/bullets, then maybe a vegetable garden/chickens, etc... Otherwise I will come take your veggies and chicken.
2. The first thing any community of people in your post-apocalyptic scenario will need is a medium of exchange. If there is no internet, you will want physical gold. (see point 1 about protecting that asset) If there is an internet electricity, Bitcoin can be that medium of exchange. Many electric grids and energy infrastructure companies in the U.S. are building symbiotic relationship with Bitcoin miners due to the need for cheap power. See Texas' partnership via their Ercot grid to build out power capacity to handle multi-sigma peak loads in response to their catastrophic winter in 2021. They can do this build out because bitcoin miners have pledged to buy all the power between the grid's needs and peak capacity (Flexible Load Task Force) - then turn off their mining rigs when peak loads are needed for heat in the winter or AC in the summer.
https://cointelegraph.com/news/bitcoin-miners-look-to-software-to-help-balance-the-texas-grid
0% allocation to Bitcoin is riskier than you think. An asset accessible from any computer/phone in the world with an internet connection that can't be seized or debased sounds very attractive in the current environment.
If we get to the point of no electric grid, I doubt you will have a vegetable garden to call your own either.
Confiscation is a reasonable concern. Gold's physical properties really push that commodity towards centralization which enables confiscation. Bitcoin is different. It exists in software run by tens of thousands of nodes across the world. You can store your keys (password) offline and make your Bitcoin literally unconfiscatable. Most Bitcoin is held off of exchanges so it can't be confiscated. There are a lot of technical and process reasons that would make it incredibly difficult or impossible to attack Bitcoin as a state actor. China has tried to ban it 5 times. 20% of Bitcoin mining still happens in China. I agree with Balaji that China as a government would be the most competent/powerful nation state to worry about and they haven't cracked the nut. The U.S. Govt can't roll out a healthcare exchange - just no tech savvy. (Also see the book "Soft War" written by Jason Lowery from inside the DOD who is positing Bitcoin as a power projection tool for the state, not a victim of power projection. Very interesting.
As far as "how useful is it if you can't trade it for money?" - Bitcoin IS money. I bought a sandwich with it last week and the transaction was faster than visa. (Research the lightning network.) I don't give investment advice, but I do believe that anyone under 80 with a 0% allocation to Bitcoin is carrying the same or more risk as someone with 100% of their money is U.S. dollars in the bank.
Here's what I found in a really quick search.
bank deposits - $20T, public stock capitalization - $100T, private company capitalization - ?, Real Estate - ? (US homes $40T), commercial bonds? municipal bonds? federal public debt - ~$30T
Aside: Not that I'm typical but bank accounts are a tiny portion of my assets. Throw in money market funds and it isn't much bigger. The rest in stocks, bonds, real estate.
Thoughts:
Not my first thought but making alternatives to bank deposits illegal would seem closer to impossible than just absurd. Maybe you are just referring to that relatively tiny $20T of bank deposits but I don't know how you'd regulate to force that asset class not shrink.
My first thought was that they can't inflate away the govt debt problem because too many of the expenditures are inflation adjusted.
Inflating is at best a temporary delay of inevitable pain. Poor countries have to inflate to pay debts because they have no alternative. US has lots of wealth and therefore has alternatives.
Maybe most importantly, I don't think anyone can argue that trying to inflate away federal debt and expenditure problems would be good for the economy. A strong economy is key to the best outcome. Therefore taming inflation is the only reasonable objective.
I'm not saying what US will do, only that it is not even close to a foregone conclusion that inflation will remain.
And yet, Mr. Kling, in five years we'll probably have economists complaining again about inflation being too low.
Yea!
My GOVCO Needs Me.
Mmmmm. Yummy toast.
"The form that regulation is likely to take is a requirement that banks undertake less lending to the private sector and instead hold more of their assets in the form of government securities."
Could happen, but what _ought_ to happen is on the margin banks should lend more to the private sector at variable rates.
I understand the bank problem is depositors are wisely moving deposits out of banks to purchase government debt, which pays a higher interest rate. What banks need to do is pay a higher interest on deposits!
That's not the best solution. Government debt should NOT pay higher interest; it is safer than private sector debt. Banks need to invest (more, not exclusively of course) in private sector debt that does not expose them (as much not zero) to interest rate mismatch.
I concur. But the Fed sees the funding rate as its primary control knob for regulating the money supply. What would be the preferred replacement?
Increases/decreases in ST interest rates would still affect spending even if banks had more VR investments. Indeed, maybe the impact would be broader if it did not hit sectors financed with LT fixed rate debt (housing) so hard.
I think this is now the best and most succinct explanation of what we face. One angle I remember a commentator speculating on is whether the government would require ETFs/Mutual Funds to hold some amount of treasuries as a way to force buying.
Re: "Have a nice day."
What are the prospects for a major increase in productivity, thanks to breakthroughs in Artificial Intelligence technologies? (It has sometimes occurred that positive technology shock transcends the drag of political economy.)
Hope springs eternal?
This came up briefly in our discussion. I mumbled "The Geek Rapture scenario." Yes, if GDP goes up by a factor of 10, then the debt/GDP ratio goes down by a factor of 10 (approximately).
When Arnold writes, "Have a nice day", that's like Kurt Vonnegut writing, "So it goes", in Slaughterhouse Five."
Only scarier!
Problem is where we most need productivity is where it’s hardest to make happen: housing, healthcare, education, services.
My early take is that AI can make significant inroads in education, health care, and a variety of other services. You could probably replace a phalanx of administrators and even nurses with a chat bot. I could also see using a lot fewer teachers and using the chat bot as the primary educator
Explain how a chatbot is going to replace the teachers union? Which local politician do you believe is going to fire all those people and survive?
People are useless and redundant now and you can't get rid of them. They closed schools and didn't even work for over a year and you can't get rid of them.
You could probably replace a phalanx of administrators with nothing and be better off, but more likely is more administrators.
the technology deflation scenario (geek rapture, ha!) could MAYBE solve our problems, but in the interim it would require both government and corporations to “allow americans to be poor” for a short to medium amount of time. not sure anyone has the guts for that (see also entitlements spending)
I made this point in our conversation Monday night. I think genetic engineering also has a chance of dramatically impacting productivity but it will take 5 years minimum for the technologies to diffuse and make a measure able difference.
The "you" and "government" is a silly dichotomy. Of course different policies have different distributional and growth consequences, but that is for all the "you's." The "you/government" framing is at least as bad as arguments about how policy affects "firms" that ignore that "firms" have owners.
not silly. government is the collective account. you is the individual accounts. The absurdity of killing individual accounts to save the collective account is irrelevant to what AK says.
Pretty much explained in a nutshell the factors underlying my vague sense of unease regarding the economy since lockdown began seemingly intentionally putting small businesses out of business and up to reading about the complete depositor bailout at SVB.
However, what if this uncharacteristic full bailout of account holders isn’t part of the implementation of systemic regulation of banks coming down the pipe? What if this bailout is just more of the same from 2008, special treatment for the wealthy? Most depositors at this bank were more like the well heeled bankers that served them, rather than ‘regular people’.
Re: "in the 1940s and 1950s, tax revenues exceeded non-interest spending, bringing down the ratio of government debt to GDP. Now, the large government deficits are in front of us. The need to spend on Social Security and Medicare means that tax revenues are projected to be below non-interest spending. The outlook is for the ratio of government debt to GDP to keep growing until. . .until. . .well, something has to give."
Might the something-that-will-give be *tax rates*? What is your subjective probability that tax rates will increase substantially?
They will, but how high can tax rates get before people dodge or stop working.
The amount of revenue that gets collected seems robustly stable regardless of tax rates.
Has any government ever stopped inflation without making the real interest rate positive?
Once inflation makes almost all real interest rate negative it shifts credit allocation to just being less negative and not demanding real positive ROI's on investments. This will make credit allocation be non-optimal and rob high ROI investments of funding while increasing leverage in the finance economy that doesn't make real wealth and is just dividing up the wealth being lost by negative real interest rates.
The 2% goal is more achievable than Arnold believes, because consumables remain cheap to produce. Then a return to asset inflation. The government wants lower inflation and lower interest rates, not clear the trade offs. No big reduction in government spending until Democrats ask for reductions.
Governments around the world have been doing this for 15 years now, it's the only political option. Net negative interest rates are a stealth tax on the increasing portion of the population with significant assets held in income-yielding investments. Why the outcry now?