rb
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Posts posted by rb
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I have a couple of questions to the board:
1) Do any of you think that there could be a benefit to a country like Italy leaving the Euro? And if Italy were to leave, is that the domino that breaks apart the Euro?
2) Regarding the HK dollar. Do you think it's a foregone conclusion that they not longer peg it to the US$? If so, then do they make it a floating currency or peg it to the Yuan? It would seem to me that China would like to have it pegged to the Yuan.
Thanks,
AtlCDore
1) There'd be great benefits for Italy. They could devalue their currency, inflate away their debt and export more goods to Germany. They'd probably have a domestic investment boom and could thereby get rid of their high unemployment.
2) Seems reasonable to me that they'd want to to peg it to the Yuan. Sooner or later China will want to "merge" HK into China – though that might be some years down the road – and pegging the currencies might be one step towards this goal. On another note, China doesn't seem to intervene directly in the currency markets at the moment because the Yuan is relatively weak. – Though the decision to cut rates is essentially another form of intervention to keep their trade surplus where it is.
I don't think that HK will break the peg to the USD. It's really engrained in the HK economy and they are prepared to defend it. I know there's a lot of financial data on this somewhere but I'm a bit busy right now to look it up for you guys. Also to Ni-co's point, the HKD is already kinda pegged to the yuan if you think about it. The yuan is loosely pegged to the USD and HKD is pegged to the USD. Thus transitively the HKD is loosely pegged to the yuan.
In regards to Italy exiting the euro. I'm sorry, I don't think they will, and the benefits aren't that big for them.
Firstly, they don't need to devalue their currency. Italy is running a trade surplus of 2.3% of GDP, so unit labor costs are competitive.
As for debt, yes Italy has high gov debt, but they always had high gov debt. And their public finances are not in that bad a shape. They have a deficit of 2.3% of GDP, but also a primary surplus of 2.2% which is very good. And the deficit should decrease as they roll over debt on lower rates. Furthermore Italy is not very levered. Yes gov debt is high, but has little private debt so as a country they're actually doing pretty good.
Where Italy would gain by going off the Euro, is getting their own currency, central bank and monetary policy. That way they could stop bank runs and do some of their own monetary stimulus to bring the economy towards full employment as it looks like the unemployment is due to sluggish domestic demand. But I don't think that Italy would like to endure the bank runs and all that nasty stuff that comes with a Euro exit just to shave 3% off the unemployment rate.
The countries that would really benefit from Euro exit are Greece, Portugal, and Spain. In those cases I'm pretty sure that the Euro survives Greece and Portugal, Spain--- I don't know.
rb
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Interesting that deflation after the civil war in 1865 to 1890 was 2.84%!
Yet you had highest gdp growth ever at 4.54% for 25 years.
I wonder what debt gdp was over that period? That tells you, you don't need inflation to stimulate consumers or investors. If the opportunities are there, people will spend and invest.
So what is happening is really politics influenced economics to say that inflation is good, so politicians can borrow more money to get more power? Even though it is complete bullshit. Allthough at some point it becomes necessairy to inflate away the excessive debt. But at the expense of the common man.
The period after the civil war was completely different than what you have now. Back then was a period of significant technology advancement. So you had supply side disinflation. Basically supply increases, and GDP increases with inflation going down. On top of that, back then you had the gold standard so a really rigid money supply. It's actually likely that if the money supply was more loose you would have had even greater GDP growth. Maybe 10-12% vs 7.4%.
Getting back to inflation, it's not just politicians that say inflation is good. Actually from what I read politicians tend to be against inflation. But some stable inflation truly is good.
Firstly, there is nothing really wrong with inflation per se when it's stable. Think of it like a math constant. You multiply an equation with a constant and nothing changes. So say you have c% inflation per year.... then you expenses go up by c%, your income goes up by c%, so your buying power stays the same. And generally you cannot have inflation without incomes going up.
Secondly inflation is good because it stimulates consumption. If you have some inflation you're more incentivized to buy stuff vs hoard currency. You also probably want inflation to be higher rather than 2%, maybe 4-5%. This is for your monetary policy to have traction. Let's say that you have 1% inflation, real rates of 1% and full employment. Then ur nominal rates are 2%. You get a recession, interest rates drop and you've hit zero bound and you can't lower rates to stimulate the economy. But if you had 4% inflation, nominal rates were 5%, and when they drop you still have monetary policy traction.
Right now this is the problem. Let's say that currently the interest rate required for full employment is -2.5%. But you have 0 rates and 1% inflation. So real rate is -1%, which is too high, so you get deleveraging, low demand, unemployment, and economic slack to the tune of $1Tn per year. If you had 3% inflation, then you could have 0.5% rates and problem solved.
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Zachmansell:
Your table, way of thinking about and tracking the CPI/Deflation investments made by FFH and updates are very helpful. Much appreciated.
Wondering where you are getting the data that allows you to track the CPI indices. I found the attached CPI Index data and am having trouble replicating the CPI numbers you are using. Biggest variance is for the UK numbers. What am I missing?
Is there a different CPI index that is the correct apples to apples comparison for the Fairfax deflation investments? As you know there are a bunch of variants for each CPI index (ex-energy, ex-pretty much anything you want to ex :)
Would love to keep track of the bets independently and would appreciate you directing me to the correct data source that applies to the specific FFH investment bets.
Thanks.
All of the CPI data and related strikes come from Fairfax regular releases. I haven't ever tried to look up, or correlate the index myself, but I would assume they're using a different index or measure of consumer prices than what you're using if the figures don't align.
There are many way's to measure inflation. The Fairfax deflation investments are OTC derivatives. This means that they have to be based on a majour inflation index. But inflation can be measured in different ways, CPI, Core CPI, CPE Deflator, etc. My advice, if you want to find the right one is to go to FRED at St. Louis Fed, go to inflation and try each one until you hit the right one.
I know this may not be that much help, but short of FFH disclosing the terms of the derivatives is the most sure way to get to the right answer.
rb
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Yahoo and google are both great. I prefer google, and it is also better from an international perspective.
Both can be made extremely valuable and versatile in excel with a little bit of VBA magic.
rb
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I think people are a bit too fixated at the supply side because that's what's immediately relevant to the U.S. right now. But look at the way demand for most hard commodities is developing – China has been stock piling them basically since 2009 and the market is telling you that they couldn't keep it up any longer. This is at least as much a demand as a supply story. In my opinion the demand side is even far more important. Oil is hit especially hard because all the increases in supply came at just the wrong time. But that's really more of a distraction.
I'm a bit confused by your post. Maybe I don't really understand it.
Are you saying that China has been hoarding oil? I don't think that they have the capacity to store meaningful amounts of it - say one year consumption. But let's assume they do. That means that the gap between supply and demand is even bigger because China had artificially high demand because of hoarding.
If you're saying that the outlook for oil demand is positive because the Chinese are gonna consume more and more of it - that's possible. But price is established by both supply and demand. So China is going to consume more. Ok, how much is it going to cost to meet that demand? There seems to be plenty of shale and at $80 it was drill baby drill! So obviously at $80 they're making money so equilibrium price is probably somewhere lower. Btw, I don't think it's $50, so somewhere in between. It could be a while until we figure it out.
rb
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I don't see how $10/bbl is anywhere close to reality. Shale, oil sands, and offshore costs are way over 10. So for marginal barrel to be $10 you must assume that the world is oversupplied by at least 20 million barrels a day.
rb
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I don't think that you have any reason to worry about inflation right now.
That being said, insurance companies do poorly in times of inflation because they generally hold long dated bonds which take a beating.
And to answer the Pete's original question: yes, you missed what the impact of inflation will be on the rate of return that insurance companies will be able to earn on their float. In the current low rate environment that is almost zero, but when rates go up they gain earning power.
In regards to how profitability is impacted on earnings on float, this depends on the duration of float and competitive factors. If interest rates rise and float is short lived then a higher % of the float is invested at the higher interest rates. But keep in mind that insurance is a commodity business so if they can earn more on float they'll compete more on price and that reduces underwriting profits.
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Also studying the great delevering of the UK, or Great brittain is an interesting study here. If someone can explain to me where their inflation came from...
Between 1947 and 1969 they had 4% inflation on average each year.
Nominal wages increased 5.8%, their m0 money supply decreased, and productivity increased by 2.5% each year.
yet total debt/gdp went from 400% to 160%....
And real GDP increased 2.82% a year.
That is what I call a beautifull delevering!
So where did the 4% inflation come from? Why are they trying to get inflation right now, and we are still levering up, yet still near deflation! They delevered from 400% gdp to 160% gdp, and got 4% inflation in the process, and their m0 money supply went down...
Right now US m0 money supply is up by trillions of dollars. Does that mean there was a lot to invest in in the 50's and 60's? So the printed money never entered into the m0 money supply, but straight away went into m1 and m2? But right now there are simply no interesting investing opportunities? So the money goes back to the central bank.
Then what was so interesting to invest in back then? even with sky high debt levels.
I cannot find m1 and m2 data that far back.
This inflation thing is just a mystery to me. Everytime I think I understand where it comes from, I see something like this and then I dont get it.
Hi YadaYada,
I'm new here and I haven't gotten all the technical aspects down yet, so I apologize if the post looks funny.
Inflation is actually a topic that isn't very straight forward and tends to be muddled a lot. It's a big subject and I don't want to make the post too too long so I"ll try to keep as tight and summarized as possible.
Inflation isn't something mechanical. It's not like someone prints more money and inflation magically appears. It happens through the mechanism of supply and demand. There are two kinds of inflation. Supply side and demand side.
Supply side is the nasty one. It happens when something bad happens to your factors of production like a war or a commodity shock. Then you get inflation and unemployment. Really bad.
The other is demand inflation when people have money and jobs and want to buy more than the economy can produce and the economy overheats - wages go up, inflation goes up and unemployment is below NAIRU (normal unemployment). This may seem unpleasant to some but it's actually not so bad.
For deleveraging you reference the case of UK after WW2. That wasn't really a deleveraging like we have now. The debt (nominal) hasn't really been paid back. The stats you quoted are indicating a robust economy which is working very well. The inflation (4% isn't that much and it's skewed by higher supply side inflation right after the war) is mostly demand side of ppl having money and buying stuff.
Let's look at the debt ratios now. I don't know where you got your numbers but I'm going to assume they are correct. Gov debt to GDP peaked in 1949 at 250-270% depending on the source. Let's say it was 270. Then private debt/GDP was 130. In 1969 Gov debt/gdp was 55%. This means that private debt/gdp was 105%. During that time nominal GDP increased by 6.82% per year. That means that in that period nominal GDP increased by 274%. This means that nominal gov debt increased by 80% and nominal private debt increased by 202%. The ratios improved not because anybody paid down debt, but because of GDP growth, a bit of inflation, and war debt forgiveness from the US.
I also wouldn't read too much into money supply numbers until you have a solid grasp on mechanisms of inflation transmission, esp into M0. For example, one way that M0 declined in that period is the evolution of banking and ppl using less physical currency.
Today you have totally different situation. Today you have zero interest rates and nominal private debt paydown. This is because equilibrium interest rates are negative and even at zero interest rates are too high for people to borrow (debt markets out of equilibrium) so they pay money back. This depresses demand and you get low inflation and bad economy and weird M0 movements. The antidote would be for Gov't to increase spending and counter these demand effects. But in the age of austerity this isn't happening.
This is getting really long now, so I'll close with a snapshot of how money supply effects work. In a normal economy, central bank lowers interest rates by increasing M0 by creating bank reserves. The banks take those reserves and make loans and spend those loans. In today's environment central bank creates reserves, but nobody wants to borrow the money cause interest rates are too high so the banks keep the new reserves on deposit with the central bank. And no you won't get inflation when M0 starts to go down in the future.
rb
"Macro" Musings
in General Discussion
Posted
YadaYada,
It's hard to get evidence on inter-temporal purchase decision based on inflation since it's not something you can really count. The best evidence to that you can find is that when Japan got deflation, the only thing that was selling really well over there were safes. Besides that there is academic stuff that covers it. But it doesn't really matter too much, cause for you need some inflation for other purposes such as monetary policy traction, avoiding debt and deleveraging spirals, etc. The main thing to not rock the boat is not so much the level of inflation but the volatility of it. You want to keep it steady.
My point in regard to Italy is that they won't leave the Euro because I don't think that the benefits are greater then the cost. They don't need to devalue (trade is pretty much balanced). The fiscal situation is not that bad either. Yes, the gov debt is quite high, but the deficit is not that big and will shrink and they have a primary surplus. So here to improve the debt situation they just need nominal GDP to growth to be a bit bigger than the deficit and they'll be ok. They're problems are mostly related to domestic demand. Probably a bit too much austerity. So going off the euro will probably help with that. But is it worth it just to lower unemployment by 3-4%?
The question about the banks is yea, there will be bank runs if the exit gets more imminent. But even if you do it over a weekend and impose capital controls, then the banks have assets in Lira and liabilities in Euro, then even a 10% decrease in Lira/Euro would wipe out the banks capital.
When it comes to household debt, no it's not just because they are poorer. I'm looking at debt/GDP ratios here. And the corporate debt is also quite low. Total private non-financial debt to gdp for Italy is 120.8%. They just don't have a lot of debt. For comparison, private debt/gdp for Germany is 111.6%.
rb