Krugman Totally Discredited

Ever since I started this blog, one of my favourite targets has been Paul Krugman and Keynesian economists in general. Typically, debating economic theories is exhausting. But Krugman makes it easy - constantly spewing the most ridiculous economic fallacies with reckless disregard for simple logic.

A number of other financial blogs have taken Krugman to task of late, and never being one to pass up a good opportunity, I feel obliged to pile on in hopes that perhaps one more knock on his credibility will be enough to unseat him as a legitimate economist. This is something that should have been done a long time ago. Before he started writing for the NY Times and before he was awarded a Nobel Prize for, uh, what exactly?

The most recent barrage of attacks on his legitimacy has been in regards to his self-defense of what his proposed policies were in the aftermath of the dot.com collapse. Krugman is the prototypical Keynesian. A government bureaucrat's best friend. His solution to any problem is for government to spend more money and for central banks to create more money. So naturally, after the bubble had popped in 2001, Krugman was egging Alan Greenspan on to do more - even as interest rates were being slashed and lending standards were being thrown in the dustbin of history.

I had, perhaps foolishly assumed, that Krugman would at least own up to this misjudgment, this massive overraction. I had thought he would have issued a mea culpa along the lines of, "hey, at the time things looked pretty bleak and only in hindsight can we see that was the wrong course of action." I assumed his loyal social democrat fans had simply brushed off this rather large misstep and given him the benefit of the doubt. But here, I have committed one of the most crass of Keynesian errors: I assumed too much.

Far from actually owning up to his poor judgement, Krugman has actually gone so far as to deny his stated intent at the time. Thankfully, we have the internet. And the internet never forgets.

To start, we look at Krugman's post this week:

One of the funny aspects of being a somewhat, um, forceful writer is that I’m regularly accused of all sorts of villainy. I was personally responsible for the demise of Enron; my nonexistent son worked for Hillary; etc.. The latest seems to be that I called for the creation of a housing bubble — in fact, the bubble is my fault! The claim seems to be based on this piece.

Guys, read it again. It wasn’t a piece of policy advocacy, it was just economic analysis. What I said was that the only way the Fed could get traction would be if it could inflate a housing bubble. And that’s just what happened.

I knew this was a pile of crap before even looking into it further. Krugman (and all Keynesians) explicitly advise inflation as a matter of public policy during every recession. It goes hand in hand with insistence on an "elastic currency" (ie. inflatable currency). But not only is his denial inconsistent with basic Keynesian economics, but it is a total cop-out, and a very typical one at that. It is a bit of a trend that I have noticed for economists to do this. Krugman argues for a certain policy measure to be taken from the vantage point of someone else (in this case Greenspan). This way, if it doesn't work out, one can say that it was not explicit advice. If it does work out, all the credit can be taken. Kind of like saying, "if I were you, I'd order the steak dinner." When the person says the steak was terrible, you can respond by saying, "aha, I said 'if I were you.' But I'm not you, so you can't blame me for ordering it."

Of course, there's far more evidence to suggest Krugman is not only shrewdly playing with words or being inconsistent. He explicitly stated on his very own blog a number of times his desire for a housing bubble to replace the tech bubble. And it is clear that he is advocating it as policy - policy that was, as we know, adopted into practice.

Senior fellow at the Ludwig von Mises Institute, Mark Thornton, combed through Krugman's old posts. What he found is posted below:

German Interview, undated

http://www.pkarchive.org/global/welt.html

"During phases of weak growth there are always those who say that lower interest rates will not help. They overlook the fact that low interest rates act through several channels. For instance, more housing is built, which expands the building sector. You must ask the opposite question: why in the world shouldn't you lower interest rates?"

May 2, 2001

http://www.pkarchive.org/column/5201.html

I've always favored the let-bygones-be-bygones view over the crime-and-punishment view. That is, I've always believed that a speculative bubble need not lead to a recession, as long as interest rates are cut quickly enough to stimulate alternative investments. But I had to face the fact that speculative bubbles usually are followed by recessions. My excuse has been that this was because the policy makers moved too slowly -- that central banks were typically too slow to cut interest rates in the face of a burst bubble, giving the downturn time to build up a lot of momentum. That was why I, like many others, was frustrated at the smallish cut at the last Federal Open Market Committee meeting: I was pretty sure that Alan Greenspan had the tools to prevent a disastrous recession, but worried that he might be getting behind the curve.

However, let's give credit where credit is due: Mr. Greenspan has cut rates since then. And while some of us may have been urging him to move even faster, the Fed's four interest-rate cuts since the slowdown became apparent represent an unusually aggressive response by historical standards. It's still not clear that Mr. Greenspan has caught up with the curve -- let's have at least one more rate cut, please -- but the interest-rate cuts do, cross your fingers, seem to be having an effect.

If we succeed in avoiding recession, this will mark a big win for let- bygones-be-bygones, and a big loss for crime-and-punishment. And that will be very good news not just for this business cycle, but for business cycles to come.

July 18, 2001

http://www.pkarchive.org/economy/ML071801.html

"KRUGMAN: I think frankly it's got to be -- business investment is not going to be the driving force in this recovery. It has to come from things like housing, things that have not been (UNINTELLIGIBLE).

DOBBS: We see, Paul, housing at near record levels, we see automobile purchases near record levels. The consumer is still very much in this economy. Can he or she -- or I should say he and she, can they bring back this economy?

KRUGMAN: Well, as far as the arithmetic goes, yes, it is possible. Will the Fed cut interest rates enough? Will long-term rates fall enough to get the consumer, get the housing sector there in time? We don't know"

August 8^th 2001

http://www.pkarchive.org/economy/ML082201.html

"KRUGMAN: I'm a little depressed. You know, inventories, probably that's over, the inventory slump. But you look at the things that could drive a recovery, business investment, nothing happening. Housing, long-term rates haven't fallen enough to produce a boom there. The trade balance is going to get worst before it gets better because the dollar is still very strong. It's not a happy picture."

August 14, 2001

http://www.pkarchive.org/column/81401.html

"Consumers, who already have low savings and high debt, probably can't contribute much. But housing, which is highly sensitive to interest rates, could help lead a recovery.... But there has been a peculiar disconnect between Fed policy and the financial variables that affect housing and trade. Housing demand depends on long-term rather than short-term interest rates -- and though the Fed has cut short rates from 6.5 to 3.75 percent since the beginning of the year, the 10-year rate is slightly higher than it was on Jan. 1.... Sooner or later, of course, investors will realize that 2001 isn't 1998. When they do, mortgage rates and the dollar will come way down, and the conditions for a recovery led by housing and exports will be in place.

October 7, 2001

http://www.pkarchive.org/economy/ML071801.html

"Post-terror nerves aside, what mainly ails the U.S. economy is too much of a good thing. During the bubble years businesses overspent on capital equipment; the resulting overhang of excess capacity is a drag on investment, and hence a drag on the economy as a whole.

In time this overhang will be worked off. Meanwhile, economic policy should encourage other spending to offset the temporary slump in business investment. Low interest rates, which promote spending on housing and other durable goods, are the main answer. But it seems inevitable that there will also be a fiscal stimulus package"

Dec 28, 2001

http://www.pkarchive.org/column/122801.html

"The good news about the U.S. economy is that it fell into recession, but it didn't fall off a cliff. Most of the credit probably goes to the dogged optimism of American consumers, but the Fed's dramatic interest rate cuts helped keep housing strong even as business investment plunged."

Those are just the applicable quotes from 2001. Other astute investigators have pulled out this quote:

NYT Editorial, August 2nd, 2002

http://www.nytimes.com/2002/08/02/opinion/dubya-s-double-dip.html

To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

It should be absolutely clear what Krugman's intention was. It was the same intent that drives all inflation proponents - to confiscate wealth from savers in order to benefit special interests, notably the banking industry, and to ensure that government has the means to waste money on social projects, wars, and the enrichment of bureaucrats and policy advisors (of which Krugman is exhibit A).

So it should be no surprise to us that Krugman and other notable Keynesians are unconscionably advocating that government attempt to inflate its way out of this mess as well. Anything to save the utopian bloated government that they worship. Anything to save the confiscatory system that has enriched them to this point. They know as well as anyone else, that a liquidation of the malinvestment they created would leave them standing naked. So they scratch and claw to keep their perceived legitimacy.

Thankfully for us, the internet doesn't forget. Keynesians cannot deny that they caused the crash like they did in the 30's. The evidence is as clear as the sky is blue. And no matter how hard they try to blow, there is no bubble big enough to replace the housing/consumption/derivatives bubble that has preceded this. People are sick of the serial bubble blowing and they won't play along any longer. The massive credit creation attempts are being met with the sound of crickets. Consumers aren't borrowing - even at low rates. In fact, they're paying back debt instead. Corporations aren't borrowing to invest in productive capacity. They're firing workers and paying off debt as well. Like all credit bubbles, the chickens are coming home to roost. Government spending isn't even close to being able to replace the private sector. The deflationary spiral that Keynesians have promised to be a relic of the past, isn't. It was only postponed. Instead of experiencing a couple of months of deflation every 4 years, we're getting 80 years of it at once. It is going to be terrible. It is going to be vicious.

But if there's one positive that we can take away it's this: a century of baseless theories that have plagued us without end will be relegated to the dustbin of history. After what we are about to go through, no possible justification for the rampant inflationism, thoughtless interventionism and morally backward focus on price stability will ever be tolerated again.

And economists like Paul Krugman will be a mere footnote in books that nobody will bother reading.


Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Sick of the Spin

Folks, I know being a card carrying member of the alternative media likely makes me biased. But I don't know how to explain the below other than simply atrocious financial journalism with at least an attempt at maliciousness via a misrepresentation of information.

Housing start numbers were released for the US today and there was really very little to report either way. But Yahoo took matters into its own hands:



The full text of the article follows:

WASHINGTON (AP) -- Construction of new homes jumped in May by the largest amount in three months, an encouraging sign that the nation's deep housing recession was beginning to bottom out.

The Commerce Department said Tuesday that construction of new homes and apartments jumped 17.2 percent last month to a seasonally adjusted annual rate of 532,000 units.

That was better than the 500,000-unit pace that economists had expected and came after construction fell in April to a record low of 454,000 units.

In another encouraging sign, applications for building permits, seen as a good indicator of future activity, rose 4 percent in May to an annual rate of 518,000 units.

The better-than-expected rebound in construction was the latest sign that the prolonged slump in housing is coming to an end, which would be good news for the broader economy.

The current recession -- the longest since the Great Depression -- was triggered by a collapse in the housing market that led to soaring loan losses and a banking system crisis. A healthy home market is needed to support an economic recovery.

President Barack Obama is scheduled to unveil on Wednesday the administration's plan to overhaul financial regulation in an effort to crack down on the lending abuses that triggered the most severe upheaval in the nation's financial system in seven decades.

Even with the encouraging news, analysts don't expect a quick rebound in housing, since the economy is still shedding jobs and home prices are falling in many places, making people hesitant to commit to buying a new home.

Many economists say home construction likely will stop falling in the current quarter but any sustained rebound isn't expected to take hold until next spring.

That's partly due to the huge overhang of unsold homes and a record wave of mortgage foreclosures dumping more unsold homes on the market.

The 17.2 percent rise in housing construction for May still left activity 45.2 percent below where it was a year ago.

The jump reflected a 7.5 percent rise in construction of single-family homes. Construction of multifamily units rose 61.7 percent in May to an annual rate of 131,000 units. This volatile part of the market plunged 49.4 percent in April.

Minuets later, Calculated Risk reports:



Housing Starts May

Total housing starts were at 532 thousand (SAAR) in May, rebounding from the all time record low in April of 454 thousand. The previous record low was 488 thousand in January (the lowest level since the Census Bureau began tracking housing starts in 1959).

Single-family starts were at 401 thousand (SAAR) in May; above the record low in January and February (357 thousand) and above 400 thousand for the first time since last November.

Permits for single-family units were 408 thousand in May, suggesting single-family starts will remain at about the same level in June.

Here is the Census Bureau report on housing Permits, Starts and Completions.

Building Permits:
Privately-owned housing units authorized by building permits in May were at a seasonally adjusted annual rate of 518,000. This is 4.0 percent (±1.7%) above the revised April rate of 498,000, but is 47.0 percent (±2.1%) below the May 2008estimate of 978,000.

Single-family authorizations in May were at a rate of 408,000; this is 7.9 percent (±1.5%) above the revised April figure of 378,000.

Housing Starts:
Privately-owned housing starts in May were at a seasonally adjusted annual rate of 532,000. This is 17.2 percent (±14.4%) above the revised April estimate of 454,000, but is 45.2 percent (±5.8%) below the May 2008 rate of 971,000.

Single-family housing starts in May were at a rate of 401,000; this is 7.5 percent (±14.2%)* above the revised April figure of 373,000.

Housing Completions:
Privately-owned housing completions in May were at a seasonally adjusted annual rate of 811,000. This is 3.3 percent (±20.6%)* below the revised April estimate of 839,000 and is 28.8 percent (±11.1%) below the May 2008 rate of 1,139,000.

Single-family housing completions in May were at a rate of 491,000; this is 9.4 percent (±13.8%)* below the revised April figure of 542,000.

Note that single-family completions of 491 thousand are still significantly higher than single-family starts (401 thousand). This is important because residential construction employment tends to follow completions, and completions will probably decline further.

It is still too early to call the bottom for single family starts in January, however I do expect single family housing starts to bottom sometime in 2009.

So tell me, if you were objectively trying to obtain information where would you turn? To the multi-billion dollar conglomerate with the power of the American Press at its side? Or to the guy who runs the same information out of his living room while maintaining the same kind of turnaround time (more or less)?

I'll let you decide. But to me, the choice is clear. There is absolutely no reason to continue reading newspapers, watching television or even visiting mainstream financial websites. The dissemination of information has been left to the free market, and guess what? The natural competition that has arisen is destroying the former media monopolies.

Good riddance.

Update:

A totally unrelated, yet far more disturbing development I came across this morning:

ABC Turns Programming Over To Obama

(this is now a confirmed report by the RNC - no tinfoil required)

ABC TURNS PROGRAMMING OVER TO OBAMA; NEWS TO BE ANCHORED FROM INSIDE WHITE HOUSE
Tue Jun 16 2009 08:45:10 ET

On the night of June 24, the media and government become one, when ABC turns its programming over to President Obama and White House officials to push government run health care -- a move that has ignited an ethical firestorm!

Highlights on the agenda:

ABCNEWS anchor Charlie Gibson will deliver WORLD NEWS from the Blue Room of the White House.

The network plans a primetime special -- 'Prescription for America' -- originating from the East Room, exclude opposing voices on the debate.

I have said for a long time that America has transformed into a fascist state. It started with Bush and is accelerating under Obama. The logo you see above is that of the Obama Administration - the rising sun of sorts over the American flag - now juxtaposed with the ABC logo. I would be hypocritical to not point out, however, that Fox News appears to be doing the same with the Republican Party.

It may seem a bit sensational to some for me to equivocate Obama/Bush with fascism. But I let the evidence speak for itself. And the evidence tells me that the major corporate interests (including the media) and the interests of the government are one and the same. That, taking place anywhere else, is undeniably fascist.

But that's okay. I'm sure everything will work itself out. No need to do anything about it. You may return to your regular programming...

Update #2: You didn't really think they were going to just stop reading our e-mails and intercepting telephone calls when Bush passed the baton, did you? Of course not, so this isn't surprising to anyone.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

No Way Out

For those condemned to a perpetual stream of American-centric financial media, I will continue pointing out the issues confronting Europe.

Ambrose Evans-Pritchard continues as one of the only remaining mainstream writers with a sense of journalistic integrity. Yesterday, he delved into the highly explosive issue of Latvia and how the centralized decision making in Brussels has doomed it to an ill fate. Unfortunately, AEP comes armed with the neoclassically fallacious idea that debt deflation is always and everywhere an evil, rather than a blessing, that "deflation" and "depression" are synonymous, and that government stimulus spending is a legitimate method of inducing economic recovery. Nevertheless, he manages to consistently turn over rocks in search of termites. And guess what, he finds them. Furthermore, he displays a rare ability to weight the significance of his findings through a causal-realistic interpretation of economic history.

From the Daily Telegraph:

Contrary to revisionist talk, Argentina was not a basket case. Its imbalances were no worse than those of the Baltics, Balkans, Spain, or Greece, and arguably better.

It ran a trade surplus in 1999 and 2000 until dollar revaluation against Brazil and Europe crushed exports. The economy shrank 5pc in 2001, mild compared to Latvia's 20pc slump this year.

Yet Argentina span out of control very fast in December 2001 when President Fernando de la Rua stopped cash withdrawals from banks. There was a national strike. Co-ordinated mobs stormed supermarkets.

On the 17th, de la Rua ordered a 20pc cut in public spending. (Like cuts just passed by Latvia's parliament). It set off three days of rioting fanned by Peronist agitators. De la Rua declared an emergency. The army refused to act without backing from congress. Police lost control. Some 27 people were killed on the 20th.

Trapped in the Casa Rosada by furious crowds, De la Rua fled in an air force helicopter. After five presidents in two weeks, Argentina ended a half-baked dollar union that had lured its people into a debt trap. Dollar mortgages − 90pc of home loans − were switched into pesos by decree. Foreign creditors received a 70pc haircut.

The country recovered, as countries do once suicidal policies of monetary deflation are halted. In a sense, Argentina did what Britain and America did in the 1930s by coming off gold. Creditors didn't like that either, but Anglo-Saxon democracies at least survived to save capitalism.

Latvia looks well-advanced in this political chain. As our Moscow correspondent reports, three of Latvia's eight Euro-MPs elected last week are pro-Kremlin. The Harvest Party of ex-Communist strongman Alfreds Rubiks came first in local elections, backed by both ethnic Russians and disgusted post-capitalist Latvians.

If the purpose of Baltic euro pegs is in part to keep Putin's Russia at bay by locking the region deeper into the EU Project, the strategic gamble has gone badly wrong. It has created a reservoir of Russian irredentism in both Latvia and Estonia that gives Moscow a pretext to intervene at any time. The Baltics are being offered to Putin on a platter.

Latvia is firing a third of its teachers. The welfare state is being dismantled. Pensions for those in work will be cut 70pc. The salaries of doctors, nurses, and police (nota bene) will be cut 20pc. Unemployment has risen from 6pc to 17pc in a year, and is still rising. Jobless benefits for most will run out in the autumn, reducing support to £40 a month. "It is time to take to the streets," said union leader Valdis Keris.

So why is Riga persisting with peg crucifixion? The central bank has burned a tenth of its reserves in a fortnight. Overnight rates have topped 200pc. Why go on? No doubt devaluation would be a shock for middle class Latvians with euro and Swiss franc mortgages, but they face punishment either way – slowly by debt deflation, fast by devaluation. Swedish banks with $75bn of exposure to the Baltics have already thrown in the towel, accepting that it might be better for all to lance the boil.
The usual IMF strategy in these cases is to devalue by 30pc or so, which allows boom-busters to export their way back to health. Further rescue loans change little without this liberating action. They add debt, and draw out the agony.

We know from leaked documents that the Fund advised Latvia to ditch the peg last year. IMF experts were overruled by Brussels. The reason, of course, was to prevent: 1) a chain of falling dominoes in Eastern Europe; 2) a default shock for West European banks with $1.6 trillion (£970bn) of exposure to the region; 3) leakage from Bulgaria across the EU line into Greece – euroland's Achilles heel.

Latvian society is being sacrificed to buy time for EMU's dysfunctional system. It is the designated martyr for the EU Project.
When Latvians wake up to what is being done to them, more than a wretched peg will go.

Pritchard gets it right in his comparison with Argentina. He could have used any number of other relevant examples such as Thailand 3 years earlier.

But what he has left out is that currency pegs never work. They always blow up because of the incentive governments and central banks have to juice the supply of money and credit to achieve political ends. In this case, Latvia experienced an enormous boom following its adoption into the EU. Foreign investment caused a boom that made Southern California look rational. The money supply expanded enormously, forcing the central bank to defend the peg that was imposed by the EMU as a precondition to eventual adoption of the Euro. The enormous cost of doing this put huge pressure on the government budget, causing fears that the government would not be able to make good on its claims. Those fears were realized when CDS spreads started blowing out, interest rates started rising and its sovereign credit rating was cut.

Latvia has no way out. The conditions AEP mentions above are precisely what needs to happen in order to correct the malinvestment made over the last decade. The debt, which is denominated primarily in Euros and Francs will be defaulted on, while the currency slowly erodes away to nothing - its true value.

It is with these kinds of conditions that hyperinflation is inevitable. However, for those currencies which have large amounts of their money supply outstanding as debt, the opposite is the case. The scramble to pay back debt combined with the default of yet more debt, first by frightened foreigners worried of their real debt burdens skyrocketing, followed by domestic investors who see asset prices falling, will experience the paradoxical phenomenon of their currencies rising. Paying back debt, defaulting on debt and saving are all theoretically synonymous. They are expressed the same way even though they appear characteristically opposite.

The currencies that will experience the most of this deflation are those which have the highest ratio of debt:money, for the demand for money to pay back the debt will be highest. Naturally, the currency that was granted "reserve status" was the one which had inflated credit the most during the boom and subsequently exported it to the world. It is for precisely this reason that Charles A Conant tirelessly agitated for American economic imperialism around the turn of the 20th C. And it is for precisely this reason that Montagu Norman did the same in England during the interwar period. The gold-exchange standard (not to be confused with a gold standard) that both of these men advocated, naturally collapsed due to the ever-increasing amounts of debt being sold and skepticism over the ability to repay in gold. But in the end, they both deflated relative to other currencies (like the franc, lira, mark, peso, etc).

This is the incentive for having a dollar reserve currency. They can issue as much debt as they want to foreigners and reap the apparent immediate benefits of an elastic money supply (ie. permanent inflation). Yet when the time comes for those debts to be either paid off or defaulted on, the lone adverse symptom (to the monetary imperialists) is an increased demand for dollars either via bank loan/loss additions or foreign exchange transactions.

This is where, it appears, the "hyperinflationist camp" seem to be missing the boat. They see the public debt owned by China, Japan, etc as looming supply, ready to be repatriated at any moment. Yet they ignore the many times greater private debt that is denominated in dollars, which represents looming demand for dollars and de facto looming supply of foreign currencies that need to be sold in order to pay off those debts.

To summarize, there appears to be three different types of situations present:

1) Foreign creditor nations (China, Japan, Oil exporters) who own dollar denominated public debt as currency reserves and therefore represent future demand for their own domestic currencies when the debts are repatriated to the US. The relevance of this debt is dependent on the amount of private debt denominated dollars that is in existence. For example, how many Chinese companies have obtained their financing for infrastructure projects in dollar denominated loans? Loans that are now sitting on the books of some foreign bank waiting to be paid back in dollars. The Chinese company would then have to collect its expected revenue in Yuan, convert those to dollars and pay back the debt. My question is not rhetorical. I do not have the answer, nor do I know where to find it. Perhaps such a practice is forbidden in China and only Yuan denominated debt is permitted. That would not surprise me. If this is the case, then China would appear to be facing its own deflationary pressures. But if there are private obligations outstanding in derivatives, mortgages and commercial paper that far exceed the $1.4 Trillion in US Treasury assets, then the opposite force should prove superior.

2) Foreign debtor nations (Latvia, Mexico, Hungary, Poland and dozens of others) who thought it more prudent to borrow money in foreign currencies because they either thought their own currencies would rise, or because obtaining a loan at a low rate of interest was far easier in Dollars or Euros than in their own domestic currencies. The collapsing export markets of these countries is putting massive pressure on government budgets and the perceived risk of insolvency is, in turn, putting downward pressure on the domestic currencies, and an increase on domestic borrowing rates. The accompanying skyrocketing unemployment and rising interest rates puts downward pressure on asset prices even while the currency inflates. This panics borrowers of foreign currency at both ends - 1) their purchasing power is falling and 2) their debt/equity ratio is getting smashed. The panicky borrowers in these countries will either a) scramble to pay back the debt, requiring the sale of their domestic currency and the purchase of the foreign currency in forex markets or b) default on the debt, pressuring domestic asset prices and requiring foreign lenders to boost loan/loss reserves. Both outcomes perpetuate the problem.

3) Imperial debtor nations (US, EU, UK, Switzerland) which have large public deficits which are visible, but have enormous private banks that act as creditors to developing nations. As mentioned above, the foreign private outstanding credit likely outsizes the public debt by a considerable margin. And that does not include derivative contracts which are a total wildcard. This private outstanding debt represents future demand for dollars/euros/pounds in the forex markets. In the event that it is defaulted on, the losses will either have to be monetized (which is contingent on an appetite for debt and the political ability to do it) or realized via balance sheet deleveraging to free up capital for loan/loss reserves. The case of the former is neutral to the total supply of money/credit, the latter is obviously very deflationary. The deflationary impact could be heightened in the event that one of these imperial debtors were to default on their public debt. This would decrease the looming supply of dollars/pounds further, while the private debt would still remain.

For each of the respective groups, I see no way out of the present situation. I am still trying to determine the implications for countries that don't really fit any of the descriptions (primarily Canada, Australia and New Zealand). None of these countries made much in the way of loans to foreigners, nor is much of their public debt owned by foreigners, while there was little incentive for their citizens to take out foreign denominated loans for domestic purposes.

This post has dragged on far longer than I originally intended. But perhaps my rambling will prove thought provoking enough to stimulate conversation on the matter. I scarcely have the resources at hand to try and quantify this, nor do I think that any attempts to do so would be extra-illuminating due to the lack of transparency in foreign capital flows. But I'm interested in knowing what my readers, who often prove smarter than I, think of this.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.