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September 10th, 2007:
Speech given at the Foundations and Endowments Investment Summit

pdf version

How Modern Money Operates and the Consequent Investment Implications

by Cliff Viner, III Associates

I’m taking a great risk here today. I’m taking a great risk in presenting statements that may be exactly contrary to what you’ve been led to believe by the media, well known economists, and even by former Fed Governors and chairmen. I know this is a risk because my partner Warren Mosler, as well as myself and our firm, have been actively advancing these ideas for the past 15 years. We have been widely disregarded, with the exception of Cambridge in the UK, and the University of Missouri at Kansas City, being amongst the few notable successes where 40 PhD’s are now training in our program. I personally have been rebuffed at the University of Pennsylvania and the Wharton School, where I graduated undergrad in 1970 and the graduate division in 1972.

But I’m going to take this risk because it’s important to our economic futures, to recognize how things actually work, and because it has policy and investment implications for all of our business decisions. I’m taking the risk because I do not want all of you, who have taken your valuable time out to hear this talk, to have the experience of spending all this time, and not learn anything new of value.

Let’s start with some incredibly simple, but incredibly powerful concepts. All the major currencies in the world are no longer backed by anything. They are not commodity-based or commodity-backed currencies anymore. The only thing the Fed will give you for a 10 dollar bill is two fives. This is called fiat money and this is what we have.

So why do today’s currencies have any value? Simple question. We’re all veteran money managers and we should have the answer. You’ve probably heard answers like it’s the medium of exchange, or a storehouse of value, or the most widely given answer, faith in the currency, which was the only answer given to me when I asked the entire Economics faculty at a major University. So do you believe that the entire multi-trillion dollar world dollar economy is built on faith, as well as the yen and Turkish lire denominated economies?

The answer to why this fiat currency has value is actually on the money. It says “This note is legal tender for all debts, public and private”. The key word is public. The dollar is the only medium for extinguishing tax liabilities to the sovereign government. Money is tax driven, and that’s why it’s valuable.

That’s why we care about dollars, the Japanese care about yen, and why the Turks care about Turkish lire. When the Mexican peso blew up and all faith was gone, why did it only go from 3:1 (dollar) to about 10:1, instead of 100:1 or a million:1, or just vanish completely? When the ruble lost all faith, it only went from 6:1 to about 28:1, it didn’t go worthless or vanish. As long as there are enforceable taxes due, payable in a particular currency, it will have value.

This concept was perfectly understood centuries ago, but forgotten during the commodity money phase. The great Commonwealth of Virginia, established four centuries ago, knew this. They wanted to establish a currency to facilitate commerce. The government could issue currency, or spend in a new currency, but people would laugh and think why should I accept this piece of paper? The first thing Virginia did was establish a tax, let’s just say a 100 card tax per person per year. Now people would ask what they had to do to earn the currency, to be able to pay the tax, and not go to prison. The need for the cards makes the people willing sellers of goods, services, and their labor to get the cards, and avoid penalty for non payment. In this manner, the state can use its otherwise worthless paper to provision itself. The government established the amount of value of the currency, by what it demanded in exchange for these cards. The government is the monopoly issuer. Fiat currencies are tax driven.

Now that we’ve established our state, our tax, and our fiat currency made of these pieces of paper to pay taxes, let’s go further. Let’s say we’re going to be fiscally responsible in our new sovereign state. We’re going to run a budget surplus. We’re going to tax 100 cards, and we’re only going to spend 90.

What is going to happen? There are not enough cards to pay the tax. People will be offering their possessions and their labor for sale to try and get the cards to pay the tax, but sufficient cards are not in circulation to meet their needs. The result is called deflation; people scramble to sell anything to get cards that in the aggregate do not exist.

Okay, so you as Governor of Virginia notice this crisis going on, and you realize your mistake and say, I’ll tax 100 cards and I’ll spend 100 cards. I’ll run a balanced budget. Great. But let’s say I wanted to put one card in my savings account, or keep one around for spending money. I can’t. There are no cards left. The government has spent 100 cards and taxed 100 cards. There is nothing left for what I very carefully call net financial savings.

So let’s talk about savings, or maybe put another way, making money. How can we save money? We see the problem in old Virginia, no cards to save, but it’s the same exact notion for the U.S. dollar savings today. Let’s say that I represent all domestic dollar holders (individuals, pensions, ins cos, banks) and I have a total of one net dollar, meaning net of borrowing. Let’s say you represent all foreign net dollar holders (Toyota, central banks, any foreigners who have net dollars), and you have a total of one net dollar. So there is a total of two net dollars in the world. How are we as a group, going to save money? I guarantee you, that no matter what we do, at the end of the year we’ll all have two net dollars total. You may have $1.50, while I have $0.50, but we’re stuck, the total is two dollars. It’s the same problem as in old Virginia. So, how do we get net financial savings? The answer is, the only way to add to dollar net financial savings, is for the sovereign government to spend money, and not ask for it back in taxes. In other words, deficit spend.

Deficit spending is the source of worldwide net new U.S. dollar financial savings. The national income accounting identity is: the Government deficit EQUALS the non government accumulation of net financial assets.

Notice the word equals. Not approximately, but equals. So when you hear that the deficit is draining our savings, or they show you the National Debt Clock, it’s really the World Dollar Savings Clock. We’ll do more on deficits in a little bit.

Let’s get back to our new sovereign state. We notice that people want to save some cards each year. So as the wise Governor, we decide to tax 100 cards each year, but we will now spend 105 cards. Let’s say that people seem to want to save about 5 cards per year. So here is what’s interesting. We will be deficit spending 5 cards per year, but people want to save these cards, not spend them. Therefore, there is some noninflationary level of the deficit related to the desire to accumulate net financial assets. You can run a deficit without causing inflation if it matches savings desires.

Let’s talk about those 5 cards. At the end of every day, someone is going to have those cards. I could have lent them to you, and you could lend them to a corporation, or even to a bank. But at the end of the day, someone has the cards. How are they going to earn interest overnight? They can’t, not unless the sovereign says, if you give me those 5 cards, I’ll give you a different card, a promise card to pay back those 5 cards with interest. Looks like a Treasury bill to me.

But let’s think about it. Did the sovereign borrow the money to spend? Did the sovereign go begging to the markets for money to be able to spend? No, it’s actually the other way around. The sovereign spends first, and the market begs the sovereign for a security so it can earn interest.

In Fed speak, securities are offered to drain excess reserves, which are called offsetting operating factors. Sound familiar? This is the way all these fiat currency systems operate. The U.S. government does issue securities, but only to support an interest rate, not to borrow and spend. That’s why the “credit” is good. If that’s too much to believe, think of Turkey. Turkey’s annual lire deficit had been running over a quadrillion lire, inflation was 100% per year, triple digit interest rates, and there was huge currency depreciation. Not much faith there. How come they never defaulted? Either they are the greatest borrowers ever known to man, or it’s simply a reserve drain of extra cards.

Let’s continue with old Virginia and the cards. We just saw how the government can create Treasury bills, which are very much like money, and are really just time deposits at the Fed. So we have Treasury bills. But where do bank deposits come from? Again, the answer is from the very first week of any Money and Banking course, and yet very few people recognize the answer. The answer is that all deposits come from loans as a matter of system accounting. Loans create deposits. Most people believe you need funds, deposits, or savings to lend. Absolutely not true. The loan immediately creates its own deposit. That’s how the accounting of the banking system works. You start a bank with $10 in capital and are allowed to leverage to make about $150 of loans. The bank balance sheet includes $150 of loan assets and $150 of deposit liabilities. Loans create all bank deposits.

So now let’s bring in the Federal Reserve. I have very limited time here, so I’m just going to say that we hear about the Fed injecting reserves, pumping in money, printing money, pumping in liquidity to the banking system, and funds not getting distributed to the right people. This is utter misrepresentation and has no application to the non government sector. The Fed’s only tool is a price tool, the fed funds rate. It has no quantity tools.

The Fed has no direct control, over the quantity of bank deposits being created, or the quantity of any other form of credit. All this reserve management from the Fed, adding or subtracting reserves, is just the management of clearing checks at the bank’s segregated Fed accounts. The Fed acts when system or Treasury operating factors may make some of the pluses and not offset the minuses, or the unusual situation like recently, when banks might be afraid to trade their reserves with another bank in the fed funds market.

The Fed does not supply money the banks use for lending, does not directly affect the quantity of bank lending or what is casually known as money supply, and can’t reflate and pump money to banks or anyone else.

Note that when Barclay’s borrowed from the Bank of England 10 days ago, it was because of a clearing house settlement problem at the Central bank.

Please see me later so I can explain what the Fed did on 8/17. They lowered the discount rate only to control the funds rate better and to raise the funds rate from low levels where it was trading. I’ll show you the 8/16 email which shows exactly this recommendation which we communicated to the Fed.

When Japan pumped 30 trillion of excess reserves into the system, this did absolutely nothing, except insure that the overnight funds rate stayed at zero. All the BOJ did, was not offer any JGBs for sale or normal repo operations. People wanted JGBs. The MOF bill auctions were hundreds of times oversubscribed at a yield of 1bp! Go check it out. People wanted to earn something rather than nothing. People wanted their reserves drained. When the reserves were drained and quantitative easing ended, all the BOJ did was offer JGBs to the banks. The economists talked about how the transmission mechanism of this excess liquidity was not making it a real economy. It can’t. Bank lending to the private sector is never reserve constrained. Bank reserves are inside money at accounts at the Fed, and have nothing to do with lending to the non government sector. Remember, lending creates its own deposits. You don’t need reserves or funds.

Let’s talk about money a little more. Everyone talks about money, money supply, and M1, M2, M3. What are these measures? They are basically deposits in the banking system. So we watch the aggregates grow, creating more money. But is it the stuff of the quantity theory of money? If money is doubled, prices are doubled. Remember, all deposits come from loans. All the money supply is not net money, or the net financial assets I talked about at the beginning, its gross money. You get borrowed money in your account, no net money. People are long or short.

So where else do we see this exact relation of longs and shorts? All this gross money is really like the open interest on the Merc. There’s a long (the guy with the money) and a short (the guy who borrowed the money and spent it). When we analyze wheat prices, yes, we do look at open interest. But we look much more closely at current net stocks of wheat, and whether there will be a good new crop. So let’s think about that. We’d like to know about the current stock of net money. But, we said earlier this stock of net money comes from past deficit spending and becomes Treasury securities, and we’d like to know about the new crop. The new crop of net money comes from new deficits. A budget surplus is not only no new crops at all; it’s burning up some of the stocks in the silos. Take a look at the past dollar fx squeezes during budget surpluses.

If you have huge open interest, or huge open interest growth, in this case, huge growth of bank deposits, that circumstance is probably much more sustainable when the net money is growing to support it. The private sector may be able to sustain large borrowing and spending for extended periods. Without the net money growing beneath it, by definition the system leverage gets higher and the potential debt service burdens get progressively more difficult. This has profound implications for how to look at money, credit expansion, and business cycle phases, overextension and contraction.

So now let’s look at this notion of net money and business activity. The entire World Net Dollar Balance is just the opposite of the U.S. Government Dollar Balance. That’s what we just said about deficits providing net dollar savings. This is accounting, not theory. This is not in dispute.

But, if we’re just talking about the U.S. Domestic sector’s net dollar balance, that equals the opposite of the U.S. Government balance plus or minus the foreign account balance.

So a U.S. Government deficit and a U.S. trade surplus would both add to U.S. Domestic savings. Again, this is not in dispute. It’s an accounting identity, not theory. But so many major economists forget about this basic equation and what it means. What does it mean?

Let’s look at the chart. The first conclusion is to notice that if the U.S. foreign account balance is a bigger negative than the savings we get from U.S. government deficit spending, then the U.S. must reduce its net financials assets (generally borrowing) to finance our current consumption. This again, is an accounting identity.

This next chart shows the course of what’s happened. Look at the recent increases in the financial obligations burden to keep our consumption and aggregate demand growing. The U.S. budget deficit is too small to provide enough net financial savings to U.S. domestics to offset our foreign trade balance. This can persist for awhile, but it is ultimately not a sustainable process.

Let’s talk more about savings. The generally accepted notion is that we have to boost savings to be able to boost investment. Good for the economy. Let’s create more savings plans. Remember, saving is not spending your income. If my wife, inexplicably, decides not to spend our income, and not to buy any more cars, is GM or is Toyota going to invest in a new plant? No way. The paradox of savings has been known for centuries, but forgotten. As a matter of fact, the act of saving will reduce effective demand, not stimulate investment, leave inventory unsold (you produced but didn’t buy all the output) and will most likely reduce employment and income.

So what does happen? Savings does equal investment, but it doesn’t happen that you need savings to make the investment.

It is the act of investment that creates both real and financial savings. Savings are the accounting record of an investment having been made. By definition, investment is spending money to produce a capital good that is not able to be currently bought or consumed. There is nothing to buy, so you must save. The workers have the money they were paid, and their only choice is to save and invest, directly or indirectly, in the capital good. You can individually try to save, but as a whole we can not determine to save. The level of investments will determine the level of saving.

Let’s talk about U.S. saving. You at this conference are the driving force in the powerful structure of incentives to save in the U.S. A large portion of personal income is encouraged to go, and does go, to IRAs, Keoghs, life insurance reserves, pension fund income, endowment income, and other money that compounds continuously and is not spent. Even much of what foreigners get, such as foreign Central Bank dollar accumulation is not spent. We call all this savings demand leakage. This U.S. structure of tax advantaged savings has probably caused the U.S. private sector to desire to be a net saver.

There are two important things about this situation. We do not need these savings for investment. So there’s no need to promote all these plans and incentives. Sorry guys. As we previously pointed out, this desire to not spend will reduce aggregate demand and result in unsold output, causing declining economic activity and declining prices. So what has happened? All these savings plans have allowed the government to deficit spend, to offset all this structurally reduced aggregate demand, without causing inflation. Once we recognize that savings does not cause investment, it follows that the solution to unemployment or low capacity utilization, is not to encourage more savings.

Let’s continue to talk about foreign balance. If we’re running a trade deficit, foreigners are sending us goods and we are sending them dollars. We’re buying their stuff instead of domestic stuff. For that amount of demand, our employment and output is being reduced. So we get underemployment in the U.S. unless we manage to keep domestic demand sufficiently high as we have been doing. When we do that, the notion of comparative advantage is at work and we have a net gain. We’ve been benefiting from this process and should not be fighting imports.

Now remember our identity of the domestic balance is the government plus foreign balances. If we have a 5% foreign trade deficit, but the government is giving us savings with a 5% budget deficit, we’re still only at zero net financial savings. The implication is that now the government can spend a 5% deficit to fully employ our resources without inflation. The government could deficit spend even more to satisfy the desire for positive net financial savings.

Let’s explore this trade deficit for a little bit. There’ so much talk of how vulnerable we are because foreigners won’t keep financing our foreign trade deficit. There is no such thing as foreigners financing the trade deficit.

I go to Citibank and I borrow money. My account is credited with 50K in deposits and Citi has an asset of 50K in loans. I take my deposit, buy a car. The foreign seller of the car has the money, first as a deposit at a U.S. bank. Everyone is happy, no imbalances and there is no borrowing of foreign capital. Citibank financed the borrowing for my purchase. The foreigner has dollar savings. Domestic credit creation funds this entire foreign savings, all $700 billion. There is no imported capital to fund the trade gap.

Let’s examine this trade deficit further. The U.S. government is begging China to revalue their currency upwards. Are we nuts? Why do we want to pay more for Chinese goods? Why do we want to give the Chinese a pay raise? We don’t allow our own workers minimum wage raises, and yet we want to give those raises to the Chinese.

They’re selling their goods below fair value which is dumping, and what we know to be an unfair trade. Let’s examine that. Dumping is a political problem, not an economic problem. Let’s put aside the issues of whether they’re incurring pollution costs or other social costs, counterfeiting, patent infringement and the like. Let’s say the Chinese are dumping, selling us goods at 35% of fair value. Here in the U.S. we complain. But what is selling us goods at 35% of fair value? It’s selling us 35 goods at fair value and 65 goods for nothing. There is no way, in the aggregate, that we can be worse off when they take their resources, capital, labor, technology and education and sell us goods for nothing. We are better off. The problem, as I said, is a political problem. Because they sell us goods for nothing, there are workers in the U.S. without incomes. But as we showed before, the U.S. government can now deficit spend so we can get the Chinese goods for nothing, and employ or reemploy these workers in the same, or different areas of the economy, to reestablish employment and aggregate demand without causing inflation.

Just two more comments on the foreign trade balance. We are so worried. We’re worried that they own all these paper assets and might sell them. But let’s think of who is at risk. We have the goods and they have these pieces of paper. They have no idea what those pieces of paper are going to be worth in the future. If they dump dollar assets, the value of their remaining holdings is going to fall dramatically. Who’s at risk? We have the cars, clothes and golf clubs. They have the indeterminate value of the paper.

The conventional wisdom is we want the Chinese and the Japanese to start spending on consumer goods, solve the unsustainable world trade imbalances. I don’t. Who wants to be competing for goods with 1.4 billion Chinese? What will happen to the price of all the items we’re consuming once there is competition for those goods? Nope, I want them to work 16 hours a day, sell us everything we need for nothing, have them never buy anything from anyone, and we play golf all day. The conceptual summation of all this is that exports are a cost and imports a benefit. Think about it.

So let’s conclude with some thoughts about the U.S. economic outlook. My partner Warren Mosler, who focuses on economic analysis and has an exceptional command of these dynamics, has helped offer some of these thoughts about the situation.

The U.S. budget deficit continues to contract. As our little identity equation showed before, the result is that net financial assets are not being added fast enough to support the gross dollars and credit structure, to help both support aggregate demand, and to satisfy the desire for savings engendered by all the incentive savings plans represented by this audience. It calls for budget balancing only making all of this worse.

As such, the financial obligations ratio rises to where the U.S. consumer can no longer continue borrowing at previous growth rates. Allocations to passive commodities by pension and endowment institutions actually exacerbated aggregate demand in the past two years. You are all supposed to buy stocks or bonds, but wound up buying all sorts of commodities. Now this phenomenon is cresting, and should also slow aggregate demand. Exports should be a help as they are picking up, but will probably not accelerate sufficiently to maintain fast GDP growth.

On the inflation front, we still see inflation as a problem despite U.S. economic weakness. It is our view that the Saudis basically set the price of oil and let quantity vary. They are the swing producer. They are comfortable with oil in this price range, so we do not expect price declines. Cost push of these prices is still occurring throughout the U.S. and world economy. Agricultural commodities are now linked to energy sector prices through the biofuels industry and are causing a second wave of food inflation. The Fed is very concerned about inflation, and that’s overall inflation, not just core inflation. If we have 0.2 month to month CPI increases for the balance of the year, YOY headline inflation will be well above 4%. The Fed is adamant about the importance of expectations, and those types of CPI numbers will worry the Fed about losing the 25 years of inflation progress they’ve made. With the labor market still tight, low levels of unemployment and high levels of capacity and resource utilization, the Fed is actually hoping for growth to slow substantially to contain this inflation. It may take much more slowing than that or a significant fall in energy and gasoline prices, for the Fed to ease.

With regard to the all important credit structure, I believe there is a very significant shift underway. In the recent past, lending (gross money) has been made easily available for all sorts of lending, business plans, assets and other leveraged ventures. These gross dollars have fueled both current cyclical economic activity and the rise in dollar asset prices around the world. I believe this is changing through both a repricing of the cost of assuming lending risk, and in a change of the simple willingness to lend or the availability of credit. Remember, loans create all deposits. No loans, no deposit growth. The Fed may be willing to oversee this significant contraction. Why? All of us, and the Fed, watched all these non-regulated lending or investment entities with much higher risk parameters go out and snub their noses at regulated entities and seemingly pass them by in good times. The Fed is not likely to want to provide a safety net and reward them for this type of frowned upon behavior. The Fed will probably be happy to see assets come back to the banking system, under their rules, regulations, and purview. In addition, the Fed will be happy for the greater stability it will bring to the capital structure of the markets and economy because the funding on bank’s balance sheets is anchored by FDIC insured deposits that don’t flee. The U.S. learned this lesson in 1934 with the establishment of deposit insurance to prevent runs on bank funding. The current voluntary termination of lending agreements (loans roll off), or withdrawal of CP deposits, and even withdrawals from hedge funds, highlight the system fragility of highly leveraged enterprises that are subject to liquidity redemptions. The sectors of the market and economy that relied upon these lending and securitization structures for funding will likely suffer, and the lending or credit participants in these sectors will likely be replaced by banks and GSEs.

Fiat currency sovereign issuers are not at risk. However, corporations, municipalities, leveraged loan and investment structures (LBO, private equity), and foreign countries issuing in denominations other than their fiat currency are at risk.

I’ll even present the notion that European government debt is at risk because a strict reading of Maastricht has created municipalities, not sovereigns, without the ECB to provide support. Did you notice that Saachsen Bank had to be bailed out by the German Savings Bank Society?

However, I have one note of caution or caveat to this notion of contraction and rationality. The financial engineering genie is out of the bottle. Financial engineering really began to accelerate when I entered the bond side of the business in the late 1970s with the advent of GNMA futures, Treasury bond and bill futures, currency and stock futures, and then the monumental creation of the interest rate swap, that became the foundation for modern derivatives such as caps, floors, swaptions, total return swaps, all variety of structured notes and even the recent explosion of credit derivatives. These instruments provide the ability to create huge notional exposures, with notional exposures in this credit arena that are hundreds of times the risk in the real economy. IBM used to have 1BB of bonds outstanding. That was the credit risk. Now the credit risk exposure taken by participants can be hundreds or thousands of times the size of the bond issue itself. While the risk may be more diversified or less concentrated, the huge notional size causes great market dislocations. But what I’m saying, is that in cycle after cycle, because it’s so difficult to make real spreads make real returns or real alpha, investors will again seek out the new product, the new leverage, the new derivative (like CDOs, CLOs, CDS) that allow the investor to greatly leverage to seemingly earn superior returns, only to see the eventual risks come to roost and the underlying risks exposed. It will happen again, the form will be different, but it will happen again.

I want to thank everyone for their great courtesy in attending today, and I hope this time together has accomplished something towards my goal, that you won’t be looking at the world economic scene in quite the same way again, and that maybe with a new understanding you’ll be an instrument for positive change in how we should conduct our economic lives.

Thank you very much.

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Cliff Viner writes:

This is important. We’ve mentioned it before. And although the article is about Japan, it applies to many of China’s other export markets.

Yes, the whole global backdrop shifted from a deflationary to an inflationary bias over the last couple of years.

Also, with all of our outsourcing, these imports costs or some extent replace what was unit labor costs in previous cycle.

So in that sense, labor costs are rising faster than our domestic labor numbers indicate.

China Switches From Deflation Exporter To Inflation Exporter

(Nikkei) The prices of Chinese goods are rising in Japan, with sharp increases hitting anything from clothing to audio equipment. If the rise persists, China, which has long underpinned Japan’s steady price structure with its inexpensive products, could become a factor in lifting Japan’s overall price level.

According to a Bank of Japan check on the July prices of imported products, of which more than 50% are supplied by China, polo shirts and gloves cost some 9% more than in July last year. Pajamas and sweat suits also were up 4%. As made-in-China items make up 80% of Japan’s total clothing imports, higher costs can translate into higher price tags at retailers down the road.

The price rise is not limited to clothing. Imports of toys, of which 90% come from China, shot up 10% in July on the year. The price tags on bags, 50% of which originate in China, also climbed 9%. Of audio and video equipment, with the Chinese import ratio of more than 50%, audio devices increased 3-4%. Among other items, China-made cotton cloth, used mainly for bedding and dress shirts, rose to nine-year highs indicating that rising prices of Chinese imports now run the gamut.

Running to a value of 15 trillion yen in fiscal 2007, Chinese products now account for some 20% of Japan’s total import bills. According to trade statistics compiled by the Ministry of Finance, the price index of Chinese imports, which had been falling, rebounded to positive territory in fiscal 2004 and climbed 7.7% on the year in fiscal 2007 with the uptick still continuing.

Increasing prices of Chinese imports are caused in large part by rising wages in that country. Average wages of China’s urban workers rose 18.7% during 2007 over the previous year. Moreover, labor costs in China are destined to rise further with the passage of the labor contract law in January this year which encourages employers to give employees longer contracts.

The substantial appreciation of the yuan is also to blame for increasing the costs of Chinese imports. The yuan’s value rose 20% against the dollar over the three years since Beijing revalued the currency’s exchange rate in July 2005.

So the Chinese factor is casting increasingly dark shadows over Japan’s price picture. “Attention tends to focus on soaring crude oil prices as the main culprit for the recent bout of inflationary pressure, but nearly 10% of the overall increase in imported products is attributable to the Chinese factor,” said Toshihiro Nagahama, chief economist at Dai-ichi Life Research Institute. This is perhaps why many Bank of Japan economists see China as switching, as far as Japan is concerned, from a deflation exporter to an inflation exporter.

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There’s nothing credit issues can do to GDP that fiscal policy can’t handle.

Congress has seemingly figured that out and probably the rest of the world as well as evidenced by the new proposed fiscal packages popping up around the world.

Yes, we can lose a bank or two, and lending standards tighten further, but GDP will continue to muddle through even if that means a series of fiscal measures.

And Congress was born to spend; so, they are all over this one.

The only thing that might slow them down is inflation, and so far they’ve seemed to support the Fed trying to step hard on the inflation pedal, rather than ‘tighten’ which presumably helps inflation.

And no one seems to notice the 8000lb bear in the room.

Our response to Russia reminds me of Monty Python’s coconut clapping Arthur trying to intimidate the French defenders of the fort with his credentials.

We threaten them with diplomatic isolation, trade sanctions, etc. as if they care.

They don’t care.

They do care about the new missiles going into Poland.

And we are committed to considering an attack on Poland or any other NATO member as an attack on US soil, as Rice reminded them and even maybe dared them to try something.

We can’t defend anyone against against Russia with our own troops without risking nuclear war.

And Russia will be a lot quicker to that trigger than we will.

And they still have maybe thousands of nuclear warheads aimed our way.

Their next step for Russia is probably to make an offer to the rest of the ex-Soviet Union members they can’t refuse.

Russia sells the Eurozone something like 30% of their oil and gas and can do it at any price they want, and demand any real terms of trade they want.

The risk is we try to draw a line in the sand in some nowhere place over there, and it escalates to where we back down or get involved in lobbing nukes.

I suppose it’s just another case of this administration not seeing the forest for the trees.

We’ve let Russia be reorganized by the ex-KGB leadership that’s a lot smarter than ours, and now we’re paying the price.

Both the inflation and cold war of the 1970s is back, except this time our opposition is far stronger.

There is no even semi-quick supply response to dislodge the Saudis and/or Russians from setting any terms of trade they want.

The Russian consolidation is on the way up supported by a bath of capitalist type riches rather than crumbling under its own weight of a failed socialist economy.

Apart from that, I’m optimistic.

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Highlights:

 
 
 
Article snip:

ECB Leaves Interest Rates at Seven-Year High to Fight Inflation (Bloomberg) - The ECBkept interest rates at a seven-year high to fight inflation even as evidence of an economic slump mounts. ECB policy makers meeting in Frankfurt left the benchmark lending rate at 4.25 %, as predicted by all 60 economists in a Bloomberg News survey. The bank, which raised rates last month, will wait until the second quarter of next year to cut borrowing costs, a separate survey shows. The ECB is concerned that the fastest inflation in 16 years will help unions push through demands for higher wages and prompt companies to lift prices. At the same time, record energy costs and the stronger euro are strangling growth. Economic confidence dropped the most since the Sept. 11 terrorist attacks in July and Europe’s manufacturing and service industries contracted for a second month. ECB President Jean-Claude Trichet will hold a press conference 2:30 p.m. to explain today’s decision.

Same as UK, less costly to address inflation now rather than support growth and address inflation later if it gets worse.

It’s been said in the US that the Fed needs to firm up the economy first, and then address inflation. To most Central Bankers this makes no sense, as they use weakness to bring inflation down.

In their view that means the Fed wants to get the economy strong enough to then weaken it.

The Fed majority sees it differently.

They agree with the above.

However, for the last year they have been forecasting lower inflation and lower growth were willing to take the chance that supporting growth would not result in higher inflation.

Now, a year later, the FOMC is faced with higher inflation and more growth than the UK and Eurozone, and systemic ‘market functioning’ risk remains.

The FOMC continues to give the latter priority as they struggle with fundamental liquidity issues that stem from a continuing lack of understanding of monetary operations.

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The mainstream view remains the cost of a near term recession in order to bring prices under control now is far less than the cost of a recession later if you support growth now and let prices continue higher.

Bank of England holds interest rate at 5%

by Gary Duncan, Grainne Gilmore

The Bank of England rebuffed mounting concerns over the rapidly weakening economy today and held interest rates at 5 per cent as it pursued its drive to quell soaring inflation.

The tough verdict from the Bank’s rate-setting Monetary Policy Committee (MPC) brushed aside pleas from business leaders and trade unions for a cut in base rates to shore up Britain’s growth, amid growing fears that the country is on the brink of recession.

The Bank’s decision came after headline consumer price inflation leapt to a 10-year high of 3.8 per cent in June, well above the Bank’s 2 per cent target, and amid expectations that it could hit 5 per cent over the summer, following swingeing increases in household gas and electricity bills imposed by utility companies.

The MPC had been widely expected to spurn pressure for a rate cut today in a bid to make clear its determination to bring inflation back to the target set by the Chancellor. The committee will almost certainly have discussed raising rates this morning, as it did last month, when Professor Tim Besley, voted for an immediate increase. He is expected to have done so again today, and may have been joined by other hawkish MPC members.

The Bank will set out its thinking more clearly next week when it publishes its latest forecasts for the economy in its quarterly Inflation Report. That is expected to emphasise the dilemma that the MPC confronts, with inflation set to soar far above target in the next few months, even as the economy slides towards a severe downturn.

The quandary facing the Bank was underlined yesterday as the International Monetary Fund sharply cut its forecasts for Britain’s growth this year and next, while issuing a warning that it saw “little scope” for interest rates to fall, although it also saw no need for an immediate rate rise.

Today’s no-change verdict by the MPC came despite bleak economic news in recent days, which have produced danger signs of recession.

Concern that Britain’s growth had ground to a virtual halt last month, and could even be in the grip of recession, were inflamed this week after bleak figures revealed growing frailty in the most critical parts of the economy.

These included shrinking activity in the services sector, the economy’s engine room that account for three quarters of the UK’s output, as well as in manufacturing.

The services sector, spanning businesses from cafes and leisure centres to accountancy and law firms, shrank for a third month in succession last month, according to the latest purchasing managers’ survey, regarded by the Bank as a key gauge of economic conditions.

Although services activity edged up from a seven-year low that was plumbed in June, the survey pointed to an even sharper slowdown ahead, with levels of outstanding business for the sector’s companies falling for a tenth month in a row, and inflows of new business dropping to a record low.

At the same time, it emerged that manufacturing is suffering its first sustained run of decline since 2001, after its output fell in June for a fourth month in a row, dropping by 0.5 per cent.

The figures were among the latest data confirming the dire plight of the economy, and came after official confirmation that the pace of Britain’s overall growth slowed to just 0.2 per cent in the second quarter, its weakest rate of expansion for three years.

The falling housing market remains a key source of economic anxiety, with the Nationwide Building Society reporting that house prices tumbled by a further 1.7 per cent last month, leaving them down 8.1 per cent on last year - their sharpest annual pace of decline since 1991.

The high street is also being badly hit by the downturn, with official figures showing that retail sales plunged by 3.9 per cent in June - their biggest monthly drop for 22 years.

Yesterday, the International Monetary Fund added to the mood of pessimism as it cut its forecast for Britain’s growth this year and next to only 1.4 per cent, and 1.1 per cent, respectively. The prediction of the UK’s worst performance since the end of the last recession raised the spectre of two years of economic misery.

In May, Mervyn King, Governor of the Bank, was forced to write an explanatory letter to the Chancellor, required by law, explaining why inflation had risen more than 1 point above its 2 per cent target, after it climbed to its then-high of 3.3 per cent. Mr King has admitted that he expects to write more such letters this year.

The Bank’s inflation headache has been further aggravated by signs of further severe price pressures in the pipeline to the consumer, Manufacturers’ costs rose at a record 30 per cent annual rate in June, and prices for goods leaving factories rose by a record 10 per cent. Inflation is being stoked by a sharp slide in the pound, by about 12 per cent over the past year, which lifts Britain’s bills for imported products.

However, there has been some let up in international food and energy costs, with oil prices tumbling by 13 per cent in a month, and prices for food products are also on the slide.

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(an email exchange)

>   
>   
>   On Wed, Aug 6, 2008 at 12:25 AM, Prof. P. Arestis wrote:
>   
>   Dear Warren,
>   
>   Just received the piece below. The situation over here is getting
>   worse but pretty much as expected.
>   
>   Recession signalled by key indicators of British economy
>   
>   
>   Best wishes, Philip
>   

Dear Philip,

Yes, seems tight fiscal has finally taken its toll and is now reversing the ugly way - falling revenues and rising transfer payments.

Without support from government deficit spending, consumer debt increases sufficient to support modest growth are unsustainable.

And with a foreign monopolist setting crude oil prices ‘inflation’ will persist until there is a large enough supply response,

It’s the BoE’s choice which to respond to, though ironically changing interest rates is for the most part ceremonial.

All the best,
Warren

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In case there was any doubt things have changed.

from his July 28 speech:

Policymakers, academic economists, and the general public broadly agree that maintaining a low and stable inflation rate significantly benefits the economy. For example, low and predictable inflation simplifies the savings and retirement planning of households, facilitates firms’ production and investment decisions, and minimizes distortions that arise because the tax system is not completely indexed to inflation. Moreover, I interpret the available economic theory and empirical evidence as indicating that a long-run average inflation rate of about 2 percent, or perhaps a bit lower, is low enough to facilitate the everyday decisions of households and businesses while also alleviating the risk of debt deflation and other pitfalls of excessively low inflation.

The rationale for promoting maximum sustainable employment is also fairly obvious: Recessions weaken household income and business production, and unemployment hurts workers and their families.

No mention of lost real output. Must have been an oversight.

As I have outlined elsewhere, these two objectives are typically complementary and mutually reinforcing: that is, done properly, stabilizing inflation contributes to stabilizing economic activity around its sustainable level, and vice versa.

Hence the dual mandate is met by sustaining low and stable inflation rates.

Nevertheless, it’s important to note a fundamental difference between the objectives of price stability and maximum sustainable employment. On the one hand, the long-run average rate of inflation is solely determined by the actions of the Federal Reserve.

And they do believe that. They believe it’s all a function of the interest rates they select.

On the other hand, the level of maximum sustainable employment is not something that can be chosen by the Federal Reserve, because no central bank can control the level of real economic activity or employment over the longer run.

And they are not responsible for the level of economic activity, only the rate of inflation.

In fact, any attempt to use stimulative monetary policy to maintain employment above its long-run sustainable level would inevitably lead to an upward spiral of inflation with severe adverse consequences for household income and employment.

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Rising inflation hits German confidence

by Matt Moore

Same theme: ‘inflation’ hurting buying plans.

Expectations theory says ‘inflation’ expectations will accelerate purchases.

Different kinds of ‘inflation’ at work…

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Highlights:

U.K. Hometrack House Prices Fall the Most Since 2001

by Brian Swint

(Bloomberg) The average cost of a residential property in England and Wales slipped 4.4 % in July from a year earlier to 168,500 pounds ($336,000), Hometrack Ltd. said. Prices fell 1.2 % from June. “With no immediate end in sight to the current uncertainty, activity levels are likely to remain suppressed with prices remaining under pressure into the autumn,” said Richard Donnell, director of research at Hometrack. Prices “are now back to levels last seen in October 2006.” Demand for housing has declined 20 % in the past three months, Hometrack said.

Note how much higher prices are vs the US.

It’s another case of going up very fast and now working its way down towards a more historically normal trend line.

But as in the US, they never come down quite that far before turning up on a new path from a higher base as much of past ‘inflation’ remains indefinitely.

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Published letter to the editor in FT.

Expect public-sector deficits and oil prices to go on rising

by Prof Philip Arestis, Dr John McCombie and Mr Warren Mosler.

Sir, Public-sector deficits and crude oil prices will probably both continue rising. Chris Giles’ reports, “Treasury to reform Brown’s fiscal rules” and “Treasury sees storm clouds gathering” (July 18), recognise the inevitability of growing deficits due to economic weakness while also implying public-sector deficits are per se a “bad thing”.

What the articles fail to appreciate are three dimensions to the argument: the first is that public-sector deficits do not present a solvency issue, only an “inflation” issue. Second, public-sector deficits equal total non-government (domestic and foreign) savings of sterling financial assets and are the only source of non-government accumulation of sterling net financial assets. Third, public-sector deficits provide the net financial equity to the non-government sector that supports the private-sector credit structure.

It is the case that the public-sector deficit will increase in one of two ways. The “nice” way would be pro-actively with sufficient tax cuts or spending increases (depending on one’s politics) that support demand at desired levels. The “ugly” way is from a slowing of demand that reduces tax revenues and increases transfer payments. If, instead, the government tries to suppress the current deficit with any combination of tax increases or spending cuts, the resulting accelerated slowdown of the economy will then increase the deficit the “ugly” way.

In any case, the current “inflation” is the result of Saudi Arabia acting as swing producer as it sets the oil price at ever-higher levels and then supplies all the crude demanded at that price. Our institutional structure then passes these prices through the entire economy over time, and there is nothing interest rates or fiscal policy can do to change these dynamics.

The ability to set crude prices can only be broken by a sufficiently large supply response, such as in the early 1980s when net supplies increased by more than 15m barrels per day, helped considerably by the US deregulating natural gas production, which allowed substitution away from crude oil products.

In sum, the deficit will go up either the nice way or the ugly way, as it always does when markets work to grant the private sector the desired net financial assets, which can come only from government deficit spending. “Inflation” will continue higher as long as the Saudis remain price-setter and continue to post ever-higher prices to their refiners.

Philip Arestis,
University Director of Research,
Cambridge Centre for Economic and Public Policy

John McCombie,
Director,
Cambridge Centre for Economic and Public Policy

Warren Mosler,
Senior Associate Fellow,
Cambridge Centre for Economic and Public Policy,
University of Cambridge, UK

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Interesting how reports of higher inflation have often meant stronger currencies in the short run due to higher anticipated rates from the CB.

Inflation, however, by definition means the currency buys less of most everything; therefore, inflation and a weakening currency are one and the same.

But it can take a long time for markets to discount this.

Emerging-Market Currency Rally Dies as Inflation Hits

by Lukanyo Mnyanda and Lester Pimentel

(Bloomberg) The five-year rally in emerging- market currencies is coming to an end as central banks from South Korea to Turkey struggle to contain inflation, say DWS Investments and Morgan Stanley.

The 26 developing-country currencies tracked by Bloomberg returned an average 0.86 percent in the past three months, down from 1.63 percent in the first quarter, 8.2 percent for all of 2007, and 30 percent annually since 2003. For the first time in seven years, investors are less bullish on emerging-market stocks than on U.S. equities, a Merrill Lynch & Co. survey showed last week.

Confidence in the Indian rupee is weakening after inflation accelerated at the fastest pace in 13 years, stoked by soaring food and energy prices. South Korea’s won will drop this year by the most since 2000, while Turkey’s lira will reverse its biggest gain since at least 1972, the median estimates of strategists surveyed by Bloomberg show.

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When in roam, pay fees of 40¢ per minute.

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The last few Michigan surveys had one-year inflation expectations over 5%.

This is not lost on an FOMC that believes inflation expectations cause inflation.

Chairman Bernanke said this yesterday after outlining the inflation expectations/inflation process:

“A critical responsibility of monetary policy makers is to prevent that process from taking hold.”

‘Prevent’ implies action, not ‘monitoring’.

Might just be a poor choice of words.

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This is what happens when non residents are scrambling to reduce their hoards of USD financial assets.

Exports rising like this along with the still falling dollar indicates the current $60 billion monthly trade gap is still too high - non-residents simply don’t want to accumulate USD financial assets at that rate.

This adjustment process continually aligns the ‘real’ (price adjusted) trade gap to levels that equal foreign $US ’savings desires’.

For the US this currently means a weak USD and a combo of rising exports and rising traded goods prices.

GDP muddles through as government spending and exports support demand, with continuing weak domestic demand and declining real terms of trade crushing the US standard of living.

• US Exports
• US Exports YoY

US Exports

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US Exports YoY

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This is the deflation argument.
(See below)

Never seen a split quite like this with calls for both accelerating inflation and outright deflation.

Which will it be?

My guess is inflation for the US as our friendly external monopolist continues to squeeze us with ever higher crude prices.

The political process is ensuring they will be passed through as sufficient government ‘check writing’ (net government spending) is sustained to support real growth.

(Bear Stearns, housing agencies, fiscal rebates, fiscal housing package, etc.)

And the dollar continues to adjust to the sudden, politically induced shift in foreign desires to accumulate USD financial and domestic assets.

Various private Q2 GDP estimates are now up to 2% - more than sufficient to support demand and pass through the higher headline prices.

Government is never revenue constrained regarding spending and/or lending.

The limit to government check writing is the political tolerance for inflation, which grows with economic weakness.

This inflation looks to me to be far worse than the 1970s.

Back then, we were able to muster a 15 million bpd positive supply response in crude that broke OPEC by deregulating natural gas.

We don’t have that card to play this time around.

From HFE:

July 14, 2008

WORLDWIDE:

• Global Disinflation Is Going To Be The Next Big Move For The Bond Markets - Weinberg
• Commodity And Oil Prices Cannot Rise Forever… There Is No Inflation - Weinberg
• Bonds To Benefit - Weinberg

UNITED STATES:

• STOP PRESS: Treasury, Fed To Make Credit Available To GSEs; Treasury To Seek Authority To Buy Their Stocks - Shepherdson
• This Is A Lifeboat, Not a Bailout; Aim Is To Prevent Uncontained Failure - Shepherdson

CANADA:

• We Cannot Rule Out A Rate Cut Tomorrow - Weinberg

EURO ZONE:

• Core CPI Shows No Medium-Term Inflation Risks - Weinberg
• Production Data Will Be Really Soft - Weinberg

GERMANY:

• Core CPI Still Under 2% And Steady, ZEW At New Record Low - Weinberg
• … Tighter Money Is Unhelpful Here - Weinberg

UNITED KINGDOM:

• Starting Point For August QIR Forecasts To Emerge In This Week’s
• Reports: Most Inputs To The Forecasts Will Be Stronger - Weinberg

FRANCE:

• Not-Too-Scary Inflation Report Exported: Core Prices Are Steady - Weinberg

JAPAN:

• Three Soft Report This Week Will Keep Investors Moving Out Of Stocks, Into Bonds - Weinberg

AUSTRALIA:

• CPI Report For Q2, Due Next Week, May Rekindle Inflation Worries - Weinberg

CHINA:

• Exploding Foreign Borrowing Diminishes Foreign Currency Reserve Adequacy; Trends Suggest Further Decay - Weinberg
• GDP Will Be Below Recent Trend In This Week’s Report - Weinberg

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more inflation.

Prices are up due to short supplies due to biofuels and weather.

And the political response is handing out funds to those in need, even though that doesn’t create more to eat.

As previously discussed, governments have no choice but to step on the inflation pedal.

Whether it be for food support payments or financial sector support.

That’s how ‘democracy’ works.

(And democracy is way better than the second choice!)

World Bank’s Zoellick: Food prices high until 2012

by Alexandra Hudson

World Bank President Robert Zoellick said on Saturday he expected food prices to remain above 2004 levels until at least 2012 and energy prices would also remain high and volatile.

He repeated that with food and fuel prices in a “danger zone” there was a need for $10 billion to provide food and cash handouts for the world’s poorest.

Soaring oil and food prices have fueled inflation across the globe at the same time as economies slow, posing a sharp dilemma for lawmakers.

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From Chairman Bernanke’s July 07 speech:

As you know, the control of inflation is central to good monetary policy. Price stability, which is one leg of the Federal Reserve’s dual mandate from the Congress, is a good thing in itself, for reasons that economists understand much better today than they did a few decades ago. Inflation injects noise into the price system, makes long-term financial planning more complex, and interacts in perverse ways with imperfectly indexed tax and accounting rules. In the short-to-medium term, the maintenance of price stability helps avoid the pattern of stop-go monetary policies that were the source of much instability in output and employment in the past. More fundamentally, experience suggests that high and persistent inflation undermines public confidence in the economy and in the management of economic policy generally, with potentially adverse effects on risk-taking, investment, and other productive activities that are sensitive to the public’s assessments of the prospects for future economic stability. In the long term, low inflation promotes growth, efficiency, and stability–which, all else being equal, support maximum sustainable employment, the other leg of the mandate given to the Federal Reserve by the Congress.

Note that the current anti-’inflation’ argument within the FOMC is that the high prices for imports take discretionary income from consumers that reduces domestic demand and reduces the ability to service domestic debt. There was no thought or mention of that reason for ‘inflation’ being a ‘bad thing’ a year ago.

I suppose one could argue that this problem is due to there not being inflation, as with wages ‘well-anchored’ there is only a relative value story. If we did have ‘real inflation’ with rising wages, we wouldn’t have the problem of insufficient consumer income to support domestic demand, but we would have the traditional negatives from inflation.

But Bernanke’s response to Congress was that exports are replacing domestic consumption and that is a ‘good thing’ as it brings the US trade back to ‘balance’ and restores ‘national savings’ - the old mercantilist, gold standard imperatives. But it does leave weak domestic demand and rising prices. That brings us back to the tail end of Bernanke’s statement:

Admittedly, measuring the long-term relationship between growth or productivity and inflation is difficult. For example, it may be that low inflation has accompanied good economic performance in part because countries that maintain low inflation tend to pursue other sound economic policies as well. Still, I think we can agree that, at a minimum, the opposite proposition–that inflationary policies promote employment growth in the long run–has been entirely discredited and, indeed, that policies based on this proposition have led to very bad outcomes whenever they have been applied.

Seems that either way you look at it, rising prices (whether you call it inflation or not) lead to ‘bad’ outcomes.

And it sure looks to the dissenters in the FOMC that this is exactly what is happening. Only time will tell, but all Fed speakers now agree the risk of inflation is elevated substantially, and we will soon see if they still agree the cost of letting the inflation cat out of the bag is far higher than letting a near-term recession run its course and (hopefully) contain prices and keep a relative value story from turning into an inflation story.

Also, not how the Fed continues to use ‘other tools’ for market functioning as Bernanke just now indicates they will keep lending directly to their primary dealers.

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Impossible - as long as wages are well anchored it’s not inflation…???!!!

Or at least not here?

Inflation surges to double-digit levels in 1 in 4 countries worldwide

by Rachel Beck

There is nowhere to hide from inflation.

Prices in one in four countries, many of them in emerging markets, are accelerating at a double-digit pace, which puts them at least two and a half times the 4 percent annual U.S. headline inflation rate, according to new research from Morgan Stanley.

That should be a wake up call for anyone counting on investments abroad to prop up their portfolios as U.S. stocks teeter on the edge of a bear market.

Sure, the “decoupling” strategy worked for investors in the recent past. Foreign holdings fared better because international economies were outperforming U.S. growth.

The U.S. economy has slowed to nearly a standstill in the last year because of the mounting inflation and the collapse in the housing and mortgage markets. Other industrialized countries have seen about a 2 percent average rate of growth while emerging economies have topped 7 percent.

That growth is now being threatened by inflation. And remember: In the developing world, a larger portion of household expenditures tends to go to the most inflationary items — food and fuel.

Food prices have jumped 39 percent from February 2007 to 2008, led by wheat, soybeans, corn and edible oils, according to the International Monetary Fund.

That hits residents of emerging markets much harder than those living in more advanced economies. People in countries like Vietnam, Russia, Egypt and India put at least 30 percent of their total spending toward food, well above the 6 percent allotment for U.S. households, according to U.S. Department of Agriculture.

That’s why Morgan Stanley economists Joachim Fels and Manoj Pradhan said they were “flabbergasted” by their findings that 50 countries had double-digit inflation rates. On that list were six of the 10 most populous countries in the world, including India, Indonesia, Pakistan, Bangladesh, Nigeria and Russia.

In total, those facing such pricing pressures accounted for 42 percent of the world population.

“In other words, close to three billion consumers are currently experiencing double-digit rates of price increases,” they wrote in a note to clients.

Soaring inflation is not easy to tame. Some countries, such as India where inflation is running at around 11 percent, may have no choice but to boost interest rates.

The Reserve Bank of India earlier this month announced an inter-meeting rate hike. It said in a statement accompanying the move that the “overriding priority for monetary policy is to eschew any further intensification of inflationary pressures and to firmly anchor inflation expectations.”

Others, however, will balk at tightening monetary policy because they don’t want their currencies to surge, which would then raise the price of their exports.

Many emerging-market economies also link their currencies to the dollar, and because of the U.S. Federal Reserve’s loose monetary policy stance right now — the central bank has aggressively cut interest rates in response to the credit crisis — that has helped feed inflationary pressures.

The longer inflation remains elevated, the more damage it will do to long-term economic growth.

“There is plenty of reason to worry about the continuation of the bull story for emerging markets, especially in those countries that have seen a sharp acceleration in inflation, are unable or unwilling to tighten policy sufficiently, and are commodity consumers rather than producers,” the Morgan Stanley economists wrote in their report.

But even as prices surge, earnings forecasts aren’t coming down in many global markets. That may give investors false hope that many countries will bypass the inflation storm.

For instance, in Asian countries outside Japan, earnings forecasts are still for 11.6 percent growth over the next 12 months and 15.1 percent growth in calendar year 2009, according to Barclays Capital.

Those estimates “are implicitly assuming that inflation will either miraculously disappear on its own accord or that central banks are not going to bother doing anything about it neither is particularly believable,” wrote Tim Bond, head of global asset allocation at Barclays.

Barclays is recommending that investors either avoid owning stocks in that region or that they short shares, meaning b