Inflation v/s Deflation

Cassandra has a post on Inflation v/s Deflation that highlights and links to some interesting points-of-views on the debate. The most interesting bit she quotes from Dr. Perrry Mehrling is:

Everything in the post is correct, and very much on the minds of every Fed watcher. The question is, what does it mean? I have what may be a contrarian view.

It seems to me that what we are seeing is simply the balance sheet consequences of the Fed's decision to take the wholesale money market onto its own balance sheet. Banks (and other entities) that used to lend to one another, are now lending and borrowing through the intermediation of the Fed. This is so not just domestically but also internationally (the huge swap line), since foreign banks used to fund dollar asset holdings in the dollar money market.

In this view, inflation seems much less likely. Why not? If the original wholesale money market borrowing and lending was not inflationary, then why should its substitute be inflationary? Indeed, the real question is whether the expansion of the Fed's balance sheet is keeping pace with the contraction of money market credit more generally. If not, then the consequence may be deflationary.

David Pearson argues in comments that inflation and deflation are also impacted by velocity. The arguments by Cassandra and David Pearson are interesting to say the least.

My thoughts are more aligned with fluid dynamics when thinking of money flow. This is not a laminar flow or a standard textbook turbulent flow. This is, to my mind, a special case of turbulent flow. I think big money will swamp certain markets testing the regulatory strengths of gate-keepers - while we have dry patches of liquidity crunch at some other places. The "tipping point" (as David puts it) is going to be realisation of true value of US treasuries. That will start a true "dance of the headless chickens" in the big-money space.

Capitalism Fundamentalist

I have often mentioned that the balance of power between corporates and citizens is misaligned. Naomi Klien in her book The shock Doctrine Rise of Disaster Capitalism tries to examine that same issue. Here is Naomi in interview with Charlie Rose. There are three different issues involved. First, corporations do get favoured status v/s the citizens and that hurts vast majority citizens to favour a few. Second, this is usually forced at the time of crisis. Third, usually government is the one that enables the favouring of status.

Naomi, further, gets into a debate with Milton Friedman's ideas. However, in certain areas, she does mention that she is simply against this collusion between governments and MNCs. Ithink this is playing wrongly on the word "shock" and mis-construing Milton Friedman. Kindly note that I do not fully endorse Friedman's policies but I agree about his views on difference between "intent" and "experience" of soft-hearted well-meaning policies. Austrian Economists has post on Milton Friedman's arguments against Naomi Klein in the video editing (there are 6 other videos if you like this one).

Charlie Rose asked her about India and China - she does mention about China but ignores India. India is real example as it followed the traditional middle-ground between socialism and capitalism. Indian constitution states the country as "socialist". And Indian experience shows correct example of her first quote "Only a crisis actual of perceived produces real change - when the crisis hits the change depends upon ideas that are lying around." India is a classic case of this being done in right fashion. Indian 1991 balance of payment crisis led us on reform path that has put more people out of poverty than 40 years of semi-socialist administration.

I believe she is correct in her observation of collusion between corporates and governments. I believe that this is being "streamlined" and this threatens the very roots of capitalism - as even Milton Friedman would argue. I am hoping that experts like Prof. Elizabeth Warren will restore this balance. I am hoping this "credit shock" will be a good time to "push this reforms"! :)

Monetary policy of China - is it a fault line?

Prof. Micheal Pettis is one of best commentators on China. His latest post on monetary conditions in China is a little scary. I have few points:

1. I don't think China will be able to undertake fiscal expansion to the scale required.
2. A monetary contraction is higly likely to impair Chinese financial system.

Essentially China is exactly where US was in Great Depression. The scale is different and scale can be China's enemy no.1! Further China agreeing to fund further US treasury expansion looks unreasonable. It will possibly compound the problems - as China cannot accept the entire lot US dishes out and retain enough capacity to wait it out. It is at this point fair income-distribution structure prevents social unrest. China will have to fix this urgently.

In sum, thats a whole lot of trouble heading China's way. Thankfully, Chinese government acts fast - let us hope it does so now as well. Else all the world is going to be in trouble!

Is Bernanke-Paulson outsmarting all of us by front-ending bailouts?

If bailouts are front-ended and funded through G-secs then at least US gets more money/treasury than it will at a later date. After the world discovers that US is going to default - no one is going to be ready to buy the treasuries and their prices will fall through the floor.

So in effect, Us will already have all the money they need to actually bailout the companies BEFORE investors panic. And then even if the world shuts its doors to US treasuries - so be it!

Its not unfair - but it is just saving your own skin!

Satyam and types of scams

There are essentially two kinds of scams

• First where money is siphoned off by paying higher to related parties as suppliers
• Second where profits are added to show higher performance - typically if pay is related to profits / share prices.

The interesting part of Satyam (assuming Mr Raju's statement to be true) is that it went from second type to first type scam. I think thats where it became unmanagable. I would like to believe it is an isolated case but I would not bet my money on this. Ajay Shah has interesting piece on three zones of corporate governance. Type 1 scam affects Zone I and Zone II in big way with large number of cases, less money involved, not easy to recognize for outsiders. Irony is that powerless individual investors are involved hence not much is impacted.

We are surely going to see more uncovering of scams in coming months.

Bullshit Promises

Professor Elizabeth Warren has a pointer on bullshit promises. Dr. Warren, my favourite on the subject, has been at it for quite a while now - battling powerful lobbies. Bullshit promises are about overtly promising something really appealing but actually using disclaimers actually promising exactly opposite - sort of trapping a consumer. Authors Curtis Bridgeman and Karen Sandrik dissect bullshit promises in great detail. Another of my favourite blogger, Yves Smith at nakedcapitalism, comments on key points.

One of the outcomes of this financial crisis I am looking forward is reversing this balance. For long we have corporate enjoying more benefits against consumers. Prof. Elizabeth Warren intends to change that. When she succeeds, we will have much better balance of power between buyer and seller that is core to revival.

Links:

Bridgeman and Sandrik Paper on Bullshit Promises

Elizabeth Warren pointer on Bullshit Promises

Nakedcapitalism on Bullshit Promises