Sunday, October 31, 2010

8 Phase Economic Cycle in Central Banking System and Fed's Next Stimulus

                October was a busy month and hence could not write much, but a lot happened over this month. Federal Reserve started talking about confirming Stimulus II / QE II (Printing Money out of thin air and Spending it once again). It was highly anticipated since last few months. Now before jumping into impact of Quantitative Easing on us, let's try to understand some basic economic cycle in Central Banking.

Here is the presentation that I believe will be useful to understand the same. I have articulated "8 Phase Economic Cycle in Central Banking System"  that has been running since beginning of Central Bank system e.g. (1913 in US). Please open it in separate window to see completely.

In order to prove demonstrated cycle, see graph below from Federal Reserve's site that shows both Interest Rate and (Recession periods with gray bars.) What you can clearly observe is,

# Every time recession comes i.e. we enter in gray area, Central Bank lower interest Rates.
# Baring early 90s recession for all other cases, higher interest rates have become pin for recession.

US Recessions

From 1980s till date Interest Rates are clearly going down as a trend. In US. (Reason why everyone has some connection with US monetary policy is that USD is world reserve currency and all currencies are pegged to USD except few. Hence everyone is impacted by USD in some or other way)

What differentiates 2008 crisis than all previous recessions are below facts.
# Continuing it's downward trend, Interest Rates are actually touched "0" (indicating weak and phony system) and economy still could not come up.
# So as additional measure, Lot of money was printed out of thin air in 2008-2009 (Which has never happened to this extent) and FED is speaking to "Act More"!!! 
#Graph below shows base money which is very sensitive thing. As you can see since 1910, this is the first time it has been increased this high.
#During 80s, Reason for 20% + Interest rate was to soak out 13% additional liquidity introduced in 70s. Here Base has increased by 120% and they are speaking of increasing it even more in QE II. Just imagine interest rates in 2020. 

US Money Supply

In short since we are stuck in Phase 1 out of 8 Phase cycle, as demonstrated on Presentation above, FED is printing huge money to send economy to Phase 2,3, 4. Obviously consequences are clear as there are only 3 Roads that go from here.

# If we succeed to Go to Phase 2, 3, 4 we will have great economy to begin with and very low unemployment in theory, but later it will turn out to be Zimbabwe style Hyperinflation, Price Controls and so on in whole world except few creditor nations.
# If we never succeed Go to Phase 2, 3, 4 (like till now ) we will end up in Stagflation i.e. both high unemployment and high inflation (But not hyper).
# If someone like Paul Volker comes again, who understand system better, for restoring currency value he will raising interest rates significantly and will allow severe but essential recession  (this is rare as it won't get political buy in.). But the only possible solution for survival in long term.

Let's see where we go...

Tuesday, October 5, 2010

Billionaire Beggars

“Billionaire Beggars” It may sound funny / crazy / or even stupid term, but looking into speed at which liquidity is flowing into the system with no control whatsoever, this term will become reality one day in near future. May be as early as next (5-10 Years). Unless Central banks act aggressively in reverse direction than their current approach.

I heard story of one such “case study” from an old respectable man last Sunday  here in Milwaukee at Coin exhibition. He and his wife sell world paper currency as a side business. Old man is highly knowledgeable in history, currencies and economics, and very kind to share his knowledge. According to him “Every currency note has a story”. 

This time around we bought currency notes of 5 Million-Deutsch Mark during Weimar Republic and asked him story behind it. He said, “This is a 1923 Vaimar Republick note” pointing to his wife he continued, “ Her father was in Germany during those days (1918 – 1923). He was paid twice a day with notes that may fit in a large suitcase. With those notes they used to stand in line for bread and soup. By the time they enter in queue till they reach the window, prices used to increase.” He added that “There used to be around 60 Printing presses all over the Germany that run 24*7 to print money”.

In short “Billionaire Beggar was reality of those days” As if one don’t have job, even if he possess a billion Deutsch Mark cash, he is not able to buy anything with it since 1 pound of bread would cost 3 billion by Nov 1923. And there was Inflation rate of 29,500% making price double every 3.7 days. So with just 1 Billion-Deutsch mark in hand and no Job, one is both Billionaire and Beggar.

As you can see in image, Inflation in the Weimar Republic made it cheaper for this woman to burn money than firewood to keep her home warm.

When I asked him that is that not the same thing we are doing now a days (Printing Money like crazy) and will there be similar results in his opinion? With a big pause he said, “I hope we are not. But I am worried that we actually are. Nixon just declared that currency is not backed by anything and we accepted the dollar the way it is… And see what’s happening today… And you know who wins at the end? …… It’s Farmer. As you have to give your everything to him… If you are left with anything ”.

So definitely it’s a big time possibility that we are about to enter in that era. Let’s see this time how high the price of bread goes. Also this era will be slightly different as it will be global synchronous phenomena.

However on very interesting note, Germany who has this history of hyper inflation is now very worried about stimulus and it’s impact and is 1st to at lease speak about unwinding stimulus and introducing austerity. It will be interesting to see if Germany can learn from history and avoid repeating it. Or will eventually join the flow…