THE Stagflation Thread (merged)

[MrBill]

so I can only recommend reading Mogambo Guru about inflation. Check him out at dailyreckoning.com or his other haunts.

he has haunts other than the dailyreckoning.com?

Yep you can also find the complete Mogambo Guru HERE

Basically, if you have a healthy economy you do not need inflation to grease the wheels. But when the economy suffers a shock or starts to slow the inclination is to add a little liquidity. A little dab will do you. But unfortunately when you print more money you devalue ALL savings. That may benefit those who have assets that keep their real value, but they can only sell those assets once. For those on fixed incomes and that have no assets that appreciate along with inflation, they are poorer.

One analogy is the debate between old growth lumber and jobs in the forestry industry. Jobs in the forestry industry depend on a constant supply of marketable timber over time. Total allowable cut means you annually harvest trees as fast as they can grow back to maturity. That is the natural carrying capacity of the forest and therefore those jobs.

However, for the greater good of humanity we sometimes set aside old growth, natural forests to protect diversity and the integrity of certain slow growing species of trees. Let us say for argument, 10% or 100.000 hectares out of 1 million hectares. Unfair say some lumberjacks and their communities! We need more jobs. We need to cut those trees down. So they cut the protected area from 100.000 hectares to 50.000 and for a short period of time there are more forestry jobs and everyone is happy. Then they cut the protected acreage from 50.000 to 25.000 and well you get the idea. Pretty soon, there are no protected areas of old growth trees and the whole industry is forced to shed jobs because there can only be enough jobs to match the natural growth rate of trees.

So you can only harvest 1/70th or 1/50th or 1/100th of your acreage per year. That is total allowable cut. Anything more is inflationary, but it is not sustainable. No matter how many 'extra' jobs it creates this year, eventually you will have to return to the long run sustainable average.

The extra growth is an illusion and may be more painful in the end to cut back from 100.000 jobs to 50.000 jobs than if you would have kept it at 50.000 jobs in the first place. Keeping in mind that forestry is a primary industry and secondary and tertiary jobs depend on that reliable, sustainable supply of timber as well. If you expand above the natural carrying capacity of the forest, then those secondary and tertiary jobs will disappear and you will have more economic dislocation than if they would have never been created in the first place.

Another non-monetary economics example would be the Spanish fishing industry. Too many boats, too many fishermen, too many jobs dependent on those fishermen, and TOO FEW FISH! The extra jobs built on those imaginary fish that are not there are inflationary, they are an illusion of more jobs created and faster growth, but ultimately unsustainable.

[Doly]

Mr Bill, I understand your forest example, but I'm not sure if I'm getting the analogy correctly. I will explain how I understand it and please tell me if I am correct.

My understanding is that there is X amount of stuff produced by an economy. The amount of money printed should, theoretically, match exactly the amount of stuff produced, so there is exactly the right amount of money to buy all the stuff that is produced. But what central banks do often is to print some extra money, to increase liquidity. But this is unsustainable in the long term, so you get periods of economic growth followed by recessions.

Is this what you were trying to say?

[MrBill]

Mr Bill, I understand your forest example, but I'm not sure if I'm getting the analogy correctly. I will explain how I understand it and please tell me if I am correct.

My understanding is that there is X amount of stuff produced by an economy. The amount of money printed should, theoretically, match exactly the amount of stuff produced, so there is exactly the right amount of money to buy all the stuff that is produced. But what central banks do often is to print some extra money, to increase liquidity. But this is unsustainable in the long term, so you get periods of economic growth followed by recessions.

Is this what you were trying to say?

Correct. Real wages or real GDP is what is actually produced.

Cost of production as measured in real terms + real value added in terms of labor & intangibles = real economic output.

Inflation = real economic output x increasing money supply

[MrBill]

MrBill, thank-you! My dig against economics is more based on my lack of understanding of it, however, I’ve always puzzled over how willingly economists dismiss, or severely discount, the impact of scarce resources. Many automatically assume demand will “create” them, or force the creation of an alternative. It’s like the economist who is locked in an air tight vault and says that because he demands oxygen, that it will be created. That’s why I said it’s detached from reality

.

Let us say your economist is not peak oil aware because he is looking at 'how much energy an expanding economy would need' without being a petroleum engineer or geologist, and not realizing that not only is crude oil a finite resource, but a depleting one with few alternatives. Okay, he is guilty of ignorance of peak oil, but does that make his forecast useless?

Let us say that today suppy of 85 mbpd = demand of 85 mbpd at $75 per barrel for all intents and purposes.

Now our economist buddy says, in order for Chindia to catch-up to the West their economies will need to use more energy in absolute terms. Let us say, 100 mbpd over the next few years.

I do not know if in the short term we can boost production to 100 mbpd or keep it there, but let us assume, no, 85 mbpd is all the crude we can exploit now given the limitations of our technology and known reserves.

Supply 85 mbpd cannot equal demand of 100 mbpd and not at $75 per barrel.

We have to assume substitution of stationary power away from crude oil to natural gas, coal, hydro, nuclear, wind, solar, geothermal, tidal, etc. even if it is at the margins and not a signficant portion of overall supply. Also, we have to assume some coal to liquids via bio-fuel production for transport fuels.

But bottom line 'latent demand' for crude is 100 mbpd even if supply is stuck at 85 mbpd. As we assume that crude is our preferred source of transport fuel due to energy per volume we can assume gasoline or diesel from crude will elbow out any inferior substitutes. So we can also assume any gasoline or diesel that gets made will get burned and zero excess capacity.

By simple extrapolation 100 / 85 x $75 = $88.25 in real, inflation adjusted terms as the new equilibrium price needed so that Chindia can continue to grow.

If Chindia and the world need 150 mbpd and supply shrinks to 75 mbpd then the new equilibrium price will be 150 / 75 x $75 = $150 assuming several things all of which you may argue about. For example is the price relationship linear or non-linear? What about demand destruction from higher prices? How scalable are any of those alternative sources of energy? Etc.?

So even though the economist is naive about peak oil and geology what he is saying is that in order to grow, the world will need a certain amount of energy, and if that energy is not available, it will not grow to that point and/or the price will be much higher. The forecast still has value, you just have to work a little harder to extract that extra information that the economist being human missed because you hang-out on Peak Oil and know better.

Here is a great article from Paul Samuelson. In it he questions the benefits from trade that many economists take for granted. He basically suggests that comparative advantage can be arbitraged away in an open, global economy, so that the terms of trade are more important than many assume.

Really, it is worth a very close read as he attacks some of the assumptions that he has defended over the years. And getting back to your point, this revision in his thinking is an attempt to link economic theory to the real world.

Where Ricardo and Mill Rebut and
Confirm Arguments of Mainstream
Economists Supporting Globalization
Paul A. Samuelson

Samuelson Questions Ricardian Theory

So it is not that U.S. jobs are ever lost in the long run; it is that the new labor-market clearing real wage has been lowered by this version of dynamic fair free trade. (Does Act II forget about how the United States benefits from cheaper imports? No. There are no such neat net benefits, but rather there are now new net
harmful U.S. terms of trade.) Finally, the Epilogue will comment on the robustness and relevance of the spelled out analyses in the two Acts. Qualitatively my Ricardian theorems do for the most part remain relevant.

Okay, just like your Samuelson & Scott, Introduction to Economics textbook in the uni, he is a little dry. Nobody said it would be fun? ; - )

[jaws]

Samuelson is a confused, ignorant, overrated former communist. Who cares what he thinks?

[MrBill]

Samuelson is a confused, ignorant, overrated former communist. Who cares what he thinks?

Well, I do not care what Samuelson, Keynes or Friedman say per se, but I do care what economists have to say because inevitably their arguments are seized upon by politicians and become part of public policy. So if we are trumpeting free trade based on comparative advantage, we better also make sure we have fair trade as well.

[FatherOfTwo]

An air tight vault isn't an economic problem, it is a physical problem. The vault does not obey the laws of economics, only human beings do that. When economists say that natural resources are created, they mean that what converts an inert naturally occuring substance into a resource is human demand. For example when oil was "discovered" in the mid 19th century, it was because a use for oil was discovered. Oil had always been around, and if at any point before in history it had been discovered people would just have considered it a useless, harmful substance to be cleaned up. It was the invention of mechanical power that made oil highly valuable.

It is what we do that creates natural resources. By changing what we do, we change natural resources available.

This still doesn’t pass the smell test with me.
I think you will agree that the peaking of world oil production is a physical, geological problem.
Replacing the energy lost as oil production peaks could be described as an economic problem, provided that there is:
a) a single or group of alternates that can be called upon to not just replace the lost oil but also allow for growth and
b) that deploying these alternates in significant enough quantities in the short time frame required, is feasible

If a) is proved to be false, would the economist still argue that it is an economic problem?
If b) is proved to be false, I would argue that this is no different than not having the alternate available for harvesting in the first place. Not enough energy = not enough energy and the economists dogma is that we’ll always have enough energy.

Solar is a great example. It clearly satisfies condition a). Yet it’s clear we are currently in no position to start harvesting it in significant enough quantities. No amount of economic pressure will change that in the short term, there are just way too many real world hurdles.

Now perhaps economics will force the roll out of as much alternate energy as is possible and we’ll bottom out at TodaysTotalEnergyConsumption-X%. If that happens economists could still say it was an economic problem. But if we’re using economics to drive how we direct our lives, and these economic rules have put us through an unsustainable growth spurt, only to fall back flat on our faces, then economics, as they are currently defined and implemented, is a fatally flawed science.

[EnergyUnlimited]

In respect to economy as "fatally flaved science".

Well, I hardly consider it to be a science at all.
In current form it is only a theoretical instrument helping to maintain certain level of order in given society for a very limited period of time (decades or may be centuries at best).

Should we get rid of "ethernal exponential growth" paradigm, than we could get rid of an absurdity element, which prevents economic theories to work for longer periods of time.

But with demand - supply I do not see much problem.
Unlucky guy locked in the box could demand more oxygen, and so what, if the price equals infinity?
That's all fine - he wont get it, because he cannot pay.
At least one consumer less to worry about...

[jaws]

Economics is just an explanation of human behavior. It does not create a society, it only explains how it will behave.

[rogerhb]

it only [s]explains[/s] guesses how it will behave.

[mattduke]

it only [s]explains[/s] [s]guesses[/s] describes how it will behave.

[rogerhb]

it only [s]explains[/s] [s]guesses[/s] describes how it [s]will [/s]would have behaved if event xyz had not happened.

[MrBill]

I think you will agree that the peaking of world oil production is a physical, geological problem.
Replacing the energy lost as oil production peaks could be described as an economic problem, provided that there is:
a) a single or group of alternates that can be called upon to not just replace the lost oil but also allow for growth and
b) that deploying these alternates in significant enough quantities in the short time frame required, is feasible

If a) is proved to be false, would the economist still argue that it is an economic problem?
If b) is proved to be false, I would argue that this is no different than not having the alternate available for harvesting in the first place. Not enough energy = not enough energy and the economists dogma is that we’ll always have enough energy.

No, supply = demand works just as well when supply = 0 or is a negative number.

Zero supply = zero demand (i.e. post peak oil depletion)
Negative supply = imported supply = demand (i.e. US current account deficit funded by Chinese current accout surpluses)

When there is no more oil, there will be no more demand to burn oil. There may be a latent need for energy to replace that oil. But the oil will not be available, so it will have no price. The replacement energy, whatever it is will be

replacement supply = replacement demand

There is no law that says the replacement energy has to be as good as the original source of fossil fuels.


There is no law that says that a given level of economic output has to be sustained. That is clearly false.

Less inputs = less growth
Zero inputs = zero growth

That may be an uncomfortable truth, but do not blame it on the laws of economics.

If you have based an unsustainable lifestyle based on living off your credit cards and you lose your job, that style of living comes to an abrupt end. Zero new inputs of cash or credit = zero personal economic expansion.

If you have an economy based on an endless supply of cheap energy and you lose that source of cheap, endless energy, then that style of living comes to an abrupt end.

Just like when it is minus forty degrees outside and you are burning your fire nice and hot because your wood pile is full. Life is great until you throw that last log on the fire because once that log is gone, so is the warmth against the cold outside. That is economics. No more fuel inputs, no more fire. Supply = 0. No economist is going to build you a model that assumes that more firewood will magically appear, so if you have based your assumptions on that, it is you that is sorely mistaken!

And the pipeline is full, there is no more supply, so prices will rise and demand will have to fall, until extra capacity is magically found....

Analysts and market sources have speculated that Kinder Morgan Canada, Kinder Morgan's Canadian unit, might be able to take more crude through its 225,000 barrel-a-day TransMountain (TMX) pipeline, which runs from Edmonton, Alberta, to refineries in the Washington state, Puget Sound area. Crude can be shipped from Washington to markets in California, and Kinder Morgan currently loads about two tankers a month at its West Coast dock for Californian markets.
However, shipper demand is already greater than the pipeline can take, Kinder Morgan Canada spokesman Philippe Reicher said.
"We're actually seeing apportionment on that pipeline and there's no spare capacity," Reicher said. Apportionment is when nominations for the pipeline exceed its capacity to carry crude.
On Sunday, BP said that it would begin shutting down all production at Prudhoe Bay, the largest producing field in the U.S., after discovering severe pipeline corrosion and a small oil leak. The move will cut crude supplies by about 400,000 barrels a day, dramatically curtailing the pool of crude available to refineries on the U.S. West Coast.

Kinder Morgan Canada says it can't take more crude to West Coast

[CrudeAwakening]

But if we’re using economics to drive how we direct our lives, and these economic rules have put us through an unsustainable growth spurt, only to fall back flat on our faces, then economics, as they are currently defined and implemented, is a fatally flawed science.

Milton Friedman once famously asserted that, in economics, "assumptions don't matter". I think you can see that the scientific basis of economics would be on shaky ground if this were truly the case. To make matters worse, he claimed that it was the accuracy of the predictions that mattered, rather than the veracity of the assumptions. And economics is notoriously erratic in its ability to predict.

What you won't hear economists discuss very often, are the wobbly foundations of their subject. And an intellectual edifice built on wobbly foundations may, unsurprisingly, lead to problems.

[rogerhb]

What you won't hear economists discuss very often, are the wobbly foundations of their subject. And an intellectual edifice built on wobbly foundations may, unsurprisingly, lead to problems.

It should take it's rightful place amongst astrology, tea leaves and animal entrails.

[Shadizar]

One thing I've noticed that is conspiciously missing from this argument is the rate of money growth and how it contributes to inflation.

From doing some of my own research (including the Mogambo Guru)I've found this is probably more influencial to inflation (or deflation) than interest rate changes.

It doesn't do much good if you raise rates while simultaneously pumping enormous amounts of money into the system (like the U.S. has been doing). At least thats my take on it.

-Shadizar

[Ferretlover]

Oil in a freefall. Gold trading @ $588, also freefalling. Housing prices stagnant or falling. Haven't heard much on the stagflation front lately. I remember reading at the Daily Reckoning a couple months ago about a deflationary scenario being a real possibility about now. Is this deflationary situation any better than a hyper-inflationary reaction? Isn't the Fed much more terrified of a deflationary economy?

[Revi]

Things do seem to be cooling off really quickly. At least the price of basic commodities isn't skyrocketing out of people's ability to buy them. The price of oil has come down about 10 bucks, and the price of silver has come down off it's high of around $15 an ounce. The price of everything seems to be going down a bit. Real estate is all reduced, or has a "new price". It seems like everybody has cashed in or is waiting. It could be the beginning of a deflationary spiral. We'll see...

[strider3700]

how many people are cashing in their investments to cover their mortgages or to keep that spending spree going? Savings rates can only be negative for so long before there's nothing left to spend.

[Revi]

Sounds like oil is down for a while. It may go down to around $52 before it rebounds. Check out what Jack Chan has to say:

http://www.321energy.com/editorials/cha ... 91106.html

It seems like this is a little downturn in the energy bull market. Maybe there is some demand destruction going on. People can't afford to continue the lifestyle they have at high energy prices, so they are dipping them a bit to keep all the addicts hooked. (and voting for the pusher man in November)