“A British oil trader in line for a $100m (£60m) bonus is expected to pitch his employer Citigroup into direct conflict with the US treasury after a clampdown on excessive pay by the Obama administration.” 1
How big is the trading profit that allows one trader to qualify for a $100m bonus? How big is the trading position (compounded) which yields a profit big enough to reward one trader with $100m?
The Energy Information Administration advises in their July 2009 Short-Term Energy Outlook that “world oil consumption was down an average of 3.0 million barrels per day (bbl/d) from the fourth quarter of 2008 through the second quarter of 2009.” They further report that US retail sales of electricity in the industrial sector declined by 12% during the first quarter compared to previous year levels. Brent crude was averaging around $45 from Nov 08 to March 09 and then joined the stock exchange rally to trade around $70 at present. The economic dichotomy is the possibility that the oil price increases when demand is falling. Not just any increase but increase by around 56%.
The answer is simple. Speculation. Speculation that the oil price would be higher in the future. This would normally be based on speculation that demand would increase and that would be based on speculation that the economy may be in recovery. What kind of recovery is a speculation driven price increase of 56% anticipating?
I would assert that there is not sufficient evidence of an economic recovery to even claim economic recovery and there is certainly not enough evidence to suggest that such a recovery will explode demand into a market suffering from over capacity to cause a price spike of 56%. Thus this speculation has nothing to do with economic recovery or any expectation of a major improvement in demand.
This speculation has to do with money, piles of it. The “printing press” has been plugged into the trading desks of the “Investment Banks” and they are using it. Clearly having access to unlimited liquidity at near zero interest rates with not nearly enough quality borrowers to lend it to, is no deterrent to channelling the cheap money into other banking activities.
The absolutely obvious destination is anything that would qualify as a store of value. Gold use to be the preferred vehicle but that would invite the anger of the Central Banks. Oil is a very suitable substitute. Liquidity getting out and a market large enough to absorb the flow of liquidity are prerequisites. Sufficient depth and scope in derivatives also help. Stock exchanges are another good destination. Who cares about demand or silly economic theories? We make our own, remember Goldie Locks?
Members of the Pile High Club just plug the liquidity into the Oil market and watch the oil price rise when demand is falling. Soon the crowd realises that the place to be is in oil and a stampede starts. Timing is everything, the Pile High Club exits while the crowd is coming in and guess who then become “investors with a 2-3 year view”?
“He is credited with buying every available oil futures contract in 2003, when they were priced on the basis that crude prices would remain stable. Over the next few years the demand for oil surged and prices soared to more than $150 a barrel, making Hall and Salomon Brothers owner Citigroup hundreds of millions of dollars.” 1
There is doubt about the “surging” demand for oil over the period 2003 to 2006 but then who cares?
“Net revenues in Trading and Principal Investments were $10.78 billion , 93% higher than the second quarter of 2008 and 51% higher than the first quarter of 2009.” 2
How big was the quarterly pile at Goldman Sachs to yield $10.78 billion in trading profits?
Assess this strategy. The liquidity will create demand and will inflate the asset class. It creates a bubble and the bubble collapse when the liquidity driven trades are withdrawn from the asset class. Those in first and out first always win. The members of the Pile High Club. The playing field is tilted at 85 degrees in their favour, they can never lose (not so?). Unless they overstay their welcome, then the trading wipes out the bank overnight. It is also a zero sum game, which means someone will lose. Sometimes the Pile High Club is operating in concert in a market and then there are casualties (just ask Society General about the huge rouge trade which was funded but no-one knew about it).
The Pile High Club will trade the futures, options, in fact all available derivatives and even the physical.
“Morgan Stanley hired a supertanker to store crude oil in the Gulf of Mexico, joining Citigroup Inc. and Royal Dutch Shell Plc in trying to profit from higher prices later in the year, two shipbrokers said.” 3
“"Storage continues to be an option for traders and we see bookings running through at least the end of August, with several of them adding options to extend storage into September," a shipbroker said. U.S. investment bank JPMorgan Chase & Co (JPM.N) has hired a crude supertanker to store gas oil off Malta's coast, a unusual sign traders were looking to take advantage of the weaker crude oil freight rates to store distillates. [ID:nL3650783] The ship would have to be cleaned to hold the refined fuel.
Crude rallied to over $69 a barrel this week, the highest in seven months, as optimism about the global economy outweighed concern about poor fundamentals in oil markets.
Crude oil in floating storage fell in late May to around 90 million barrels from around 100 million barrels as prompt crude prices rose and narrowed the discount to prices further out. [ID:nLS679181] That discount was key to traders storing oil at sea to make profits by selling it later.” 4
The reality is that the access to unlimited liquidity opens the door to a speculative strategy for the Pile High Club which can ignore any economic reality for as long as they can “Cash and Carry”. Thus they can anticipate higher prices when demand is falling. It is like playing poker at a table where bets can be raised without limits and one or a small number of players have pockets deep enough to clear the table every time irrespective of the hand of cards that they hold.
Trade with the money you say, surely you must realise that you can only see the money after it had entered the market and will only realise that it has left after it has gone. Playing at the table with the Pile High Club is dangerous and soon the only players at the table are the members of the Pile High Club. It is then when the accidents happen.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
28 July 2009
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
1. Phillip Inman, 26 July 2009, Citigroup set to clash with Washington over executive pay, guardian.co.uk; http://www.guardian.co.uk/business/2009/jul/26/citigroup-executive-pay-bonuses
2. 14 July 2009, Press Release, Goldman Sachs.
3. Alaric Nightingale, 19 Jan 2009, Morgan Stanley Hires Supertanker to Store Oil in Gulf (Update2), Bloomberg; http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aIbVHft2R3SE
4. Luke Pachymuthu, 4 Jun 2009, Oil products stored at sea jump to 41 million bbls, Reuters; http://www.reuters.com/article/GCA-Oil/idUSTRE5534JQ20090604
Tuesday, July 28, 2009
Thursday, July 16, 2009
Twin Peaks – Update to 15 July 2009
I published charts in Twin Peaks – “The Past, The Future?” up to 22 May 2009. Readers have asked for an update. My calculations are based on indexing the two market peaks in terms of each other. It is almost eight weeks later. Are the twins still twins? Here is the update to 15 July 2009. You be the Judge.
Click on chart to enlarge.
Click on chart to enlarge.
Click on chart to enlarge.
Short notes:
• The correlated Nikkei peak is shown as the middle of August 2009.
• The Nikkei correlation index peak is calculated at 9180 correlated to 10 August 2009.
• The DJIA peak is now 8799.26 on 12 June 2009.
• The Nikkei correlated point for 15 July 2009 is 9105 against the DJIA at 8616.21.
I have previously used a percentage change calculation but I find that reading the points off the data table is a better method for establishing reference points.
Please note that this is a correlation exercise and not a prediction of the future. The correlation can break down at any time or it may continue to be useful to track. I will update the charts again in about two months.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
17 July 2009
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
Click on chart to enlarge.
Click on chart to enlarge.
Click on chart to enlarge.
Short notes:
• The correlated Nikkei peak is shown as the middle of August 2009.
• The Nikkei correlation index peak is calculated at 9180 correlated to 10 August 2009.
• The DJIA peak is now 8799.26 on 12 June 2009.
• The Nikkei correlated point for 15 July 2009 is 9105 against the DJIA at 8616.21.
I have previously used a percentage change calculation but I find that reading the points off the data table is a better method for establishing reference points.
Please note that this is a correlation exercise and not a prediction of the future. The correlation can break down at any time or it may continue to be useful to track. I will update the charts again in about two months.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
17 July 2009
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
Thursday, July 9, 2009
Debate on "War on Savings"
From: Douglas Porter Owen
Sent: 09 July 2009 2:41 AM
To: Sarel Oberholster
Subject: Japan and Deflation
Dear Sarel Oberholster,
Thank you for your blog. It has helped me greatly in my attempt to understand these interesting times that we live in. I believe that these times will become even more interesting. I am not an economist and have never before worried about things like central banks and what is money, but now I feel impelled to learn more about economics.
I especially like your concept of Debt Saturation which I had not really understood before.
The way that I first found your work was I was searching on the internet on the
topic of Japan and its lost decade (or two) as I thought that the Japanese experience might inform my thinking about the present US and world situation, much as it has yours.
One fact that I don't understand is how so much Yen could be created and injected into the Japanese economy without price inflation. Since the US is doing similar things now, will this or will this not cause inflation?
I thought that maybe that the Yen, like the US dollar, left the country of origin to be used in other countries as legal currency such as the US dollar is used in Panama or maybe in the underground economy (such as drug dealing). But I have found very little information stating this is so for the Japanese yen.
In your publication, War on Savings, on page 20, you state "Cash preferences have almost no application in the modern world of electronic banking, internet payments and ready access to credit. The dated Keynesian theory of cash preferences simply no longer applies."
Then I found information saying that older Japanese may have high cash preferences, much higher than other populations in the developed world.
Japan is suffering a demographic implosion. From various articles on wikipedia you get the following information.
http://en.wikipedia.org/wiki/Japan#Demographics
http://en.wikipedia.org/wiki/Demographics_of_Japan#Total_fertility_rate
http://wiki.answers.com/Q/What_is_the_average_age_for_men_and_women_in_Japan
http://en.wikipedia.org/wiki/Aging_of_Japan
Japan in 2008 had 128 million people. It had fast population growth in the last 19th and early 20th century. This has now slowed due to a failure of Japanese women to have children.
The total present fertility rate in Japan is 1.23 !!!! This is children per woman over her entire reproductive life. 2.1 is considered to be the necessary for a break even replacement rate.
The average age in Japan is 42 years, the highest in the world and increasing rapidly. They are also the longest living population in the world surviving on average to age 81.
Japan is a very homogeneous, non-diverse society. They have not and probably will not have a large influx of foreign workers in the future. This avoids many problems for societal harmony but it is doom for a population that is failing to reproduce.
At some level, people in Japan understand this. If you have ever been around a lot of kids as in a Boy Scout troop meeting/campout or around a lot of old people as in a nursing home, you will understand that there is a real difference in the energy level or the atmosphere depending upon the age of the group in which you operate. I have never been to Japan, but I believe at some level the profound failure of Japanese society to reproduce will be demoralizing to the Japanese. After all the bottom line to life is not really about making money. I believe it is about having and raising kids, so a failure to do so would be profoundly disheartening on a societal level. It really says that the women of the society think they have better things to do than have and raise kids.
Japanese over the age of 65 are old enough to have been profoundly affected by the events before, during, and after WW II. I do not know any Japanese, but I have heard my father and my grandparents talk about the Great Depression and I have heard elderly Germans talk about the hyperinflation of Weimar, Germany. From my reading of the events of WWII I understand that not only did the Japanese live through atom bomb attacks on two cities but also the fire bomb destruction of all the Japanese cities of any size. I am sure that no one who lived through it or their kids who heard about it would ever forget about those hard times or the measures that had to be taken to live through it.
Japan experienced an economic miracle that ended when the NIKKEI stock market crashed in 1989. If you were a Japanese with memories of hard times and you saw the stock market crash would not your cash preference levels increase? As time went on and you understood that at some profound societal level there was disfunction not only economically but in the desire of society to participate in the business of life, and that maybe you would have to take care of yourself in your old age because your kids and the Japanese social net would not, would this not lead to increased cash preferences?
As a attempt to see if these arguments are reasonable and not as an attempt to be factually accurate look at the following numbers.
If 20% of the Japanese population was 65 or over in 2004 as stated in one of the articles cited above, that means that 25 million Japanese were born before 1939 (in 2004). Thus say 30 million Japanese experienced WW II and its aftermath.
If 30 million Japanese kept $ 10,000 each stuffed under the mattress then that would equal $ 300 billion or (at 100 yen/US$) 30 trillion yen.
http://www.xe.com/news/2009-07-01%2020:16:00.0/524757.htm?c=1&t=
A recent estimate of the Japanese monetary base is 90 trillion yen. So back in the 1990's when it looked like the world was coming to an end in Japan maybe the people just stuffed yen under the mattress.
http://www.xe.com/news/2009-07-01%2020:16:00.0/524757.htm?c=1&t=
30 trillion yen is 1/3 of 90 trillion yen. So stuffing yen under the mattress could be of a sufficient magnitude as to affect the monetary base and cause significant deflation in Japan. I have not tried to be consistent as to dates or to track the repeated fiscal and monetary stimulations in Japan.
Some people like Nathan Lewis define value of a nation's currency as its worth compared to gold or in other words in the case of Japan how many yen does it take to buy an oz of gold. Nathan Lewis has a graph showing that Japan by this definition suffered very strong deflation in the 1990s. He states that from 1985 to 2000 the value of the yen tripled in relation to gold.
http://www.newworldeconomics.com/archives/2008/041308.html
Nathan Lewis is not an Austrian economist but rather is more neo-classical or Supply Side, but he writes most intelligently.
I do not believe a thing that I hear coming out of the fiscal and monetary authorities' mouths of the US (Obama, Bush, Geitner, Paulson or Bernanke.) I would bet the Japanese are the same way about their monetary and fiscal authorities.
So in summary
The Japanese
1. do not trust banks or their monetary/fiscal leaders
2. have a society whose age is climbing and which is failing to reproduce
3. have few children to take care of them in their old age
4. are stressed by the economic stagnation
5. have zero interest rates so there is no reason to keep the money in a bank
6. have money that is appreciating in value due to deflation
Is there a reason for Japanese not to hold cash money at the house under the mattress?
Then I found these articles:
From the New York Times article in 2004
http://query.nytimes.com/gst/fullpage.html?res=9B05E7D81E3DF931A35752C1A9629C8B63&sec=&spon=&pagewanted=all
The NYT in part says, "The trick in Japan is to unlock the mattress money, the futon money," Jesper Koll, chief economist for Merrill Lynch Japan, said. "In Japan, coins and notes account for about 15 percent of national income, which compares to 6 percent in Germany and 3 to 3.5 percent in America. Until Japan's banking crisis hit a decade ago, 7 percent of the national income was held in cash."
So cash preferences in Japan went from 7% to 15% in about 10 years.
and
from the Times in June 2009
http://business.timesonline.co.uk/tol/business/economics/article6531299.ece
The Times says in part, "To fight deflation, abolish cash. Could Japan make reality of ‘science fiction’? Leo Lewis Asia Business Correspondent, "With recovery elusive, a population doddering into old age and perhaps a decade of deflation in prospect, Japan may start mulling the most radical monetary policy of all — the abolition of cash. Unorthodox, untried and, said one Bank of Tokyo Mitsubishi strategist,
“in the realms of economic science fiction”, the recommendation has nevertheless begun floating around Tokyo’s corridors of power and economists have described Japan as particularly suitable as a testing ground."
and
"Nevertheless, the country remains a wholeheartedly cash-based consumer society. Currency in circulation is about 16 per cent of its GDP, compared with the levels of 2 to 3 per cent in most developed countries. Reducing that 16 per cent to zero would be a wrench but would come with considerable benefits, Mr Jerram said. But just as Japan’s cultural attachment to cash may prove hard to dislodge, some economists
believe that the same may be true of deflation. The country’s growing population of elderly people mainly hold cash or cash equivalents and, compared with its US and European counterparts, the Bank of Japan has come under virtually no political pressure to be more belligerent in its war on deflation. It is unlikely, added Mr Jerram, to brook anything as radical as abolishing cash."
These evidences I believe would tend to indicate that cash preferences could increase significantly in a society like Japans and help significantly ameliorate price inflation due to an increase in the monetary base. If you have time I would appreciate your thoughts on this. Once again, thank you for your blog.
Porter Owen
On Thu, Jul 9, 2009 at 9:40 AM, Sarel Oberholster wrote:
Dear Douglas
My work has had the effect that I get challenging communications from intelligent observers such as you. It has inspired more research and philosophising in my search for understanding. I greatly appreciate the time and effort that you had devoted to your e-mail and research of my work. I hope to reply in kind.
Perhaps I should clarify the research base for War on Savings. The Japanese experiments in monetary policy certainly were irresistible for its clarity of purpose and for being a real time test for modern monetary policy ideals. Japan however was only a part of the process. Austrian business cycle theory played an important part. Most of all I had drawn on my experiences as a financial engineer, specialising in cash flow design, to build my theories. Having a love for and grounding in economics often placed me at odds with reality when I did designs. A lot of monetary theory just could not survive any design manipulation. I often found that I had to abandon known and relied upon theory as plain incorrect before I could solve important design conflicts. And that is where the journey leading up to War on Savings started. I also often had to present my designs to, at times paranoid Central Bankers, which process brought its own insights. Just observe the complete suspicion that bureaucrats have for financial innovation, a process as important and vital to human development as any other innovation. I have witnessed the destruction of delicate designs which were simply efficient but complex tools due to a total lack of understanding and comprehension of consequences. It reminds of burning “witches” on a stake.
Next I need to deal with my statement on p20 as quoted. Here it would be useful to look at the Keynesian cash preference theory generally. I place a cut and paste explanation from this link http://tutor u.net/economics/content/topics/monetarypolicy/demand_for_money.htm :-
"KEYNESIAN DEMAND FOR MONEY - LIQUIDITY PREFERENCE
TRANSACTIONS DEMAND - this is money used for the purchase of goods and services. The transactions demand for money is positively related to real incomes and inflation. As an individual's income rises or as prices in the shops increase, he will have to hold more cash to carry out his everyday transactions. The quantity of nominal money demand is therefore proportional to the price level in the economy. (Note: the real demand for money is independent of the price level)
PRECAUTIONARY BALANCES - this is money held to cover unexpected items of expenditure. As with the transactions demand for money, it is positively correlated with real incomes and inflation.
SPECULATIVE BALANCES - this is money not held for transaction purposes but in place of other financial assets, usually because they are expected to fall in price."
My fundamental problem with this theory is the clear remnants of theory based on commodity money or commodity linked money in a payment system driven by settlement in “cash”. The world has moved on. I for instance settle about 98% of all my transactions electronically. In fact I have found my cheque book has become almost redundant. I use my credit card “in shop” to settle my purchases. Now let’s analyse just my behaviour for a moment. I settle my transactions by means of allocating digital money from my accounts and there may or may not have been a “deposit”. (“Deposit” comes from the practice of placing gold on “deposit” with a goldsmith and refers to the early development of money and banking. It really is necessary to renew thought patterns away from commodity money.) In fact I could use a purely debt based system such as a credit on a credit card to settle my transactions. I could manage my credit card by transferring credit from another credit card once a month to satisfy “repayment” requirements and simply draw it down to limit soon after. No deposits need be in sight. Rolling debt and moving debt around electronically is what we do in a global economy with electronic banking and digital money. Can I extrapolate my behaviour to a global economy? Certainly. I would assert that a global assessment of settlement of transactions would yield a similar result.
I thus reviewed the Keynesian liquidity preference theory and judged it archaic. Any relevance that it may have will be limited to special (as opposed to general) economic conditions and even then it would have limited general impact on a global economy as a relevant explanation for human behaviour. Our behaviour in a world of digital money and easy access to debt has severely undermined the usefulness of any of the present measurements of Money Supply which is founded in part on exactly these types of archaic economic theories which were built upon gold pieces jingling in my pocket or deposited with a gold smith. Our ability to settle any type of transaction is thus a function of our access to digital money whether in debit or credit form (debt or “deposit” form). It follows that Money supply which measures only defined types of “deposits” is wholly inadequate to base any economic planning upon (if one is so inclined and I am generally opposed to economic meddling by bureaucrats.)
Credit Theory in War on Savings engages a “need” for stores of value, thus demand for Savings in the form of a store of value. Again conventional economic theory would give “money” a special place as a store of value and often gold is perceived as special with regards to being a store of value. Here I had to break free from thinking in terms of “money” when thinking in terms of preserving savings. There are many forms of preserving the relative value (and it is always about relative value) of one’s savings. Money in digital form controlled in supply by a central bank with an inflationary bias is not a good store of value. Gold, when monetary demand overwhelms physical jewellery demand is but a faith based store of value. Oil in an environment of austerity would also suffer as a store of value. The real problem is that some economic participants had managed to obtain “Unfunded Monetary Credits”, money created digitally by a central bank and now the race is on to convert the digital money into “real value”. It is a process which will always rob someone. Even a single cent yield in swapping the created digital $ (Unfunded Monetary Credit) for value will be a gain from its worthlessness. Here it is relevant to mention that the law of maximising productivity will cause a drop in prices over time and asserts a general downward price force into all economies where this condition prevails (which is generally everywhere). Simply put, we are always looking for better and cheaper ways to produce (and we are generally very successful) and thus producer inflation will be producer deflation in the absence of special conditions (market supply and demand imbalances would be temporary under free market conditions) such as an abundant supply of unfunded monetary credits.
Here, War on Savings deals with the process of creating Unfunded Monetary Credits and channelling the digital money into debt which in turn is channelled into bureaucratically desirable types of utilisation of the unfunded monetary credits (the here and now - July 2009 - is that it is undesirable for “stimulus money” to flow into speculation in Oil). That is why it has the title “War on Savings”. Savings can be the value you hold from a productive process which you plan to spend in five minutes, five years, or anytime. You will lose value if unfunded monetary credits were to compete with you at any time between your receiving/producing the productive surplus and when you exchange it for something you need. (I have built a simplified economic model in Praxeology of Commodity Pricing see http://sareloberholster.blogspot.com/2008/08/praxeology-of-commodity-repricing.html )
Having built a foundation I can now move on to the holding of cash by Japanese consumers. First we need to recognise that unusual and special conditions prevail in Japan but Credit Theory is fully capable to explain the special conditions. Japan is in Stasis with Debt Saturation prevailing. Thus the unfunded monetary credits are destroyed in bad debts; the market for goods, services and assets must content with demand deprived of access to sufficient new unfunded monetary credits; and new supply of unfunded monetary credits is constrained in dysfunctional distribution channels (banking and debt distribution channels) for unfunded monetary credits. These conditions require a greater supply of savings (absolutely not to be confused with liquidity) and the savings will actively be searching for suitable and good stores of value. The best store of value would be the one that will at any time in a time horizon of choice be worth the most relative to the needs of the saver net of costs of converting into a suitable from of settlement. The present reality in Japan is that Yen notes will be a good store of value, already in zero conversion cost form for settlement. It will therefore be a suitable store of value for many Japanese.
Now we need to assess the desire of some economic players to get access to the “mattress money”. I would content that they are simply expressing a desire to have Japanese savers change their preference for storing savings in “yen notes” to a preference to storing in into something else. Say I desire to see share prices rise due to an increased supply of savings, then I would suggest that the secret would be to convert mattress money into shares. Japanese savers would certainly do it if I could convince them that the shares would be a good store of value, not only for the reason that more money is now chasing that form of investment. It is a scoundrel’s statement when the intent is simply to coerce savers into my desired business activity or to return their money to the banks without allowing them to earn rent. The yen will flow from the mattresses to alternative stores of value or spending according to the needs of the saver. The absence of debt induced manic spending and the desire for its return is expressed in the statements which aim to push the yen out of the mattresses.
Mr Jerram’s desire is for the mattress money to become available for spending. The reality of mattress money is problematic generally as the money is sterilised from recycling in the economy. I have fully dealt with the reason why this happens in War on Savings. The manipulation of the interest rate to near zero has robbed the savers of the rent (interest) that they aught to get while imposing default and government intervention risks upon them. Free the market for savings and debt from unfunded monetary credits. Interest rates will call the money from the mattresses in no time.
It is therefore wholly consistent with my theories in War on Savings that the Japanese will hold mattress money when monetary intervention has robbed them of the total of their rent at zero interest rates. The Japanese monetary authorities have abolished interest rates and now everyone moans that the spiteful Japanese savers will not part with their savings without it. The only trick required is to allow the market to set the interest rate free from monetary (or fiscal) interventions.
Thank you again for your very informed and well expressed views.
Please give me your permission to post your e-mail (with my reply) to my blog as I think it will have appeal to others who search for understanding as we do.
Kind regards,
Sarel Oberholster
From: Douglas Porter Owen
Sent: 09 July 2009 8:59 PM
To: Sarel Oberholster
Subject: Re: Japan and Deflation
Sarel,
Yes, feel free to post my comment and your reply.
Porter
Sent: 09 July 2009 2:41 AM
To: Sarel Oberholster
Subject: Japan and Deflation
Dear Sarel Oberholster,
Thank you for your blog. It has helped me greatly in my attempt to understand these interesting times that we live in. I believe that these times will become even more interesting. I am not an economist and have never before worried about things like central banks and what is money, but now I feel impelled to learn more about economics.
I especially like your concept of Debt Saturation which I had not really understood before.
The way that I first found your work was I was searching on the internet on the
topic of Japan and its lost decade (or two) as I thought that the Japanese experience might inform my thinking about the present US and world situation, much as it has yours.
One fact that I don't understand is how so much Yen could be created and injected into the Japanese economy without price inflation. Since the US is doing similar things now, will this or will this not cause inflation?
I thought that maybe that the Yen, like the US dollar, left the country of origin to be used in other countries as legal currency such as the US dollar is used in Panama or maybe in the underground economy (such as drug dealing). But I have found very little information stating this is so for the Japanese yen.
In your publication, War on Savings, on page 20, you state "Cash preferences have almost no application in the modern world of electronic banking, internet payments and ready access to credit. The dated Keynesian theory of cash preferences simply no longer applies."
Then I found information saying that older Japanese may have high cash preferences, much higher than other populations in the developed world.
Japan is suffering a demographic implosion. From various articles on wikipedia you get the following information.
http://en.wikipedia.org/wiki/Japan#Demographics
http://en.wikipedia.org/wiki/Demographics_of_Japan#Total_fertility_rate
http://wiki.answers.com/Q/What_is_the_average_age_for_men_and_women_in_Japan
http://en.wikipedia.org/wiki/Aging_of_Japan
Japan in 2008 had 128 million people. It had fast population growth in the last 19th and early 20th century. This has now slowed due to a failure of Japanese women to have children.
The total present fertility rate in Japan is 1.23 !!!! This is children per woman over her entire reproductive life. 2.1 is considered to be the necessary for a break even replacement rate.
The average age in Japan is 42 years, the highest in the world and increasing rapidly. They are also the longest living population in the world surviving on average to age 81.
Japan is a very homogeneous, non-diverse society. They have not and probably will not have a large influx of foreign workers in the future. This avoids many problems for societal harmony but it is doom for a population that is failing to reproduce.
At some level, people in Japan understand this. If you have ever been around a lot of kids as in a Boy Scout troop meeting/campout or around a lot of old people as in a nursing home, you will understand that there is a real difference in the energy level or the atmosphere depending upon the age of the group in which you operate. I have never been to Japan, but I believe at some level the profound failure of Japanese society to reproduce will be demoralizing to the Japanese. After all the bottom line to life is not really about making money. I believe it is about having and raising kids, so a failure to do so would be profoundly disheartening on a societal level. It really says that the women of the society think they have better things to do than have and raise kids.
Japanese over the age of 65 are old enough to have been profoundly affected by the events before, during, and after WW II. I do not know any Japanese, but I have heard my father and my grandparents talk about the Great Depression and I have heard elderly Germans talk about the hyperinflation of Weimar, Germany. From my reading of the events of WWII I understand that not only did the Japanese live through atom bomb attacks on two cities but also the fire bomb destruction of all the Japanese cities of any size. I am sure that no one who lived through it or their kids who heard about it would ever forget about those hard times or the measures that had to be taken to live through it.
Japan experienced an economic miracle that ended when the NIKKEI stock market crashed in 1989. If you were a Japanese with memories of hard times and you saw the stock market crash would not your cash preference levels increase? As time went on and you understood that at some profound societal level there was disfunction not only economically but in the desire of society to participate in the business of life, and that maybe you would have to take care of yourself in your old age because your kids and the Japanese social net would not, would this not lead to increased cash preferences?
As a attempt to see if these arguments are reasonable and not as an attempt to be factually accurate look at the following numbers.
If 20% of the Japanese population was 65 or over in 2004 as stated in one of the articles cited above, that means that 25 million Japanese were born before 1939 (in 2004). Thus say 30 million Japanese experienced WW II and its aftermath.
If 30 million Japanese kept $ 10,000 each stuffed under the mattress then that would equal $ 300 billion or (at 100 yen/US$) 30 trillion yen.
http://www.xe.com/news/2009-07-01%2020:16:00.0/524757.htm?c=1&t=
A recent estimate of the Japanese monetary base is 90 trillion yen. So back in the 1990's when it looked like the world was coming to an end in Japan maybe the people just stuffed yen under the mattress.
http://www.xe.com/news/2009-07-01%2020:16:00.0/524757.htm?c=1&t=
30 trillion yen is 1/3 of 90 trillion yen. So stuffing yen under the mattress could be of a sufficient magnitude as to affect the monetary base and cause significant deflation in Japan. I have not tried to be consistent as to dates or to track the repeated fiscal and monetary stimulations in Japan.
Some people like Nathan Lewis define value of a nation's currency as its worth compared to gold or in other words in the case of Japan how many yen does it take to buy an oz of gold. Nathan Lewis has a graph showing that Japan by this definition suffered very strong deflation in the 1990s. He states that from 1985 to 2000 the value of the yen tripled in relation to gold.
http://www.newworldeconomics.com/archives/2008/041308.html
Nathan Lewis is not an Austrian economist but rather is more neo-classical or Supply Side, but he writes most intelligently.
I do not believe a thing that I hear coming out of the fiscal and monetary authorities' mouths of the US (Obama, Bush, Geitner, Paulson or Bernanke.) I would bet the Japanese are the same way about their monetary and fiscal authorities.
So in summary
The Japanese
1. do not trust banks or their monetary/fiscal leaders
2. have a society whose age is climbing and which is failing to reproduce
3. have few children to take care of them in their old age
4. are stressed by the economic stagnation
5. have zero interest rates so there is no reason to keep the money in a bank
6. have money that is appreciating in value due to deflation
Is there a reason for Japanese not to hold cash money at the house under the mattress?
Then I found these articles:
From the New York Times article in 2004
http://query.nytimes.com/gst/fullpage.html?res=9B05E7D81E3DF931A35752C1A9629C8B63&sec=&spon=&pagewanted=all
The NYT in part says, "The trick in Japan is to unlock the mattress money, the futon money," Jesper Koll, chief economist for Merrill Lynch Japan, said. "In Japan, coins and notes account for about 15 percent of national income, which compares to 6 percent in Germany and 3 to 3.5 percent in America. Until Japan's banking crisis hit a decade ago, 7 percent of the national income was held in cash."
So cash preferences in Japan went from 7% to 15% in about 10 years.
and
from the Times in June 2009
http://business.timesonline.co.uk/tol/business/economics/article6531299.ece
The Times says in part, "To fight deflation, abolish cash. Could Japan make reality of ‘science fiction’? Leo Lewis Asia Business Correspondent, "With recovery elusive, a population doddering into old age and perhaps a decade of deflation in prospect, Japan may start mulling the most radical monetary policy of all — the abolition of cash. Unorthodox, untried and, said one Bank of Tokyo Mitsubishi strategist,
“in the realms of economic science fiction”, the recommendation has nevertheless begun floating around Tokyo’s corridors of power and economists have described Japan as particularly suitable as a testing ground."
and
"Nevertheless, the country remains a wholeheartedly cash-based consumer society. Currency in circulation is about 16 per cent of its GDP, compared with the levels of 2 to 3 per cent in most developed countries. Reducing that 16 per cent to zero would be a wrench but would come with considerable benefits, Mr Jerram said. But just as Japan’s cultural attachment to cash may prove hard to dislodge, some economists
believe that the same may be true of deflation. The country’s growing population of elderly people mainly hold cash or cash equivalents and, compared with its US and European counterparts, the Bank of Japan has come under virtually no political pressure to be more belligerent in its war on deflation. It is unlikely, added Mr Jerram, to brook anything as radical as abolishing cash."
These evidences I believe would tend to indicate that cash preferences could increase significantly in a society like Japans and help significantly ameliorate price inflation due to an increase in the monetary base. If you have time I would appreciate your thoughts on this. Once again, thank you for your blog.
Porter Owen
On Thu, Jul 9, 2009 at 9:40 AM, Sarel Oberholster
Dear Douglas
My work has had the effect that I get challenging communications from intelligent observers such as you. It has inspired more research and philosophising in my search for understanding. I greatly appreciate the time and effort that you had devoted to your e-mail and research of my work. I hope to reply in kind.
Perhaps I should clarify the research base for War on Savings. The Japanese experiments in monetary policy certainly were irresistible for its clarity of purpose and for being a real time test for modern monetary policy ideals. Japan however was only a part of the process. Austrian business cycle theory played an important part. Most of all I had drawn on my experiences as a financial engineer, specialising in cash flow design, to build my theories. Having a love for and grounding in economics often placed me at odds with reality when I did designs. A lot of monetary theory just could not survive any design manipulation. I often found that I had to abandon known and relied upon theory as plain incorrect before I could solve important design conflicts. And that is where the journey leading up to War on Savings started. I also often had to present my designs to, at times paranoid Central Bankers, which process brought its own insights. Just observe the complete suspicion that bureaucrats have for financial innovation, a process as important and vital to human development as any other innovation. I have witnessed the destruction of delicate designs which were simply efficient but complex tools due to a total lack of understanding and comprehension of consequences. It reminds of burning “witches” on a stake.
Next I need to deal with my statement on p20 as quoted. Here it would be useful to look at the Keynesian cash preference theory generally. I place a cut and paste explanation from this link http://tutor u.net/economics/content/topics/monetarypolicy/demand_for_money.htm :-
"KEYNESIAN DEMAND FOR MONEY - LIQUIDITY PREFERENCE
TRANSACTIONS DEMAND - this is money used for the purchase of goods and services. The transactions demand for money is positively related to real incomes and inflation. As an individual's income rises or as prices in the shops increase, he will have to hold more cash to carry out his everyday transactions. The quantity of nominal money demand is therefore proportional to the price level in the economy. (Note: the real demand for money is independent of the price level)
PRECAUTIONARY BALANCES - this is money held to cover unexpected items of expenditure. As with the transactions demand for money, it is positively correlated with real incomes and inflation.
SPECULATIVE BALANCES - this is money not held for transaction purposes but in place of other financial assets, usually because they are expected to fall in price."
My fundamental problem with this theory is the clear remnants of theory based on commodity money or commodity linked money in a payment system driven by settlement in “cash”. The world has moved on. I for instance settle about 98% of all my transactions electronically. In fact I have found my cheque book has become almost redundant. I use my credit card “in shop” to settle my purchases. Now let’s analyse just my behaviour for a moment. I settle my transactions by means of allocating digital money from my accounts and there may or may not have been a “deposit”. (“Deposit” comes from the practice of placing gold on “deposit” with a goldsmith and refers to the early development of money and banking. It really is necessary to renew thought patterns away from commodity money.) In fact I could use a purely debt based system such as a credit on a credit card to settle my transactions. I could manage my credit card by transferring credit from another credit card once a month to satisfy “repayment” requirements and simply draw it down to limit soon after. No deposits need be in sight. Rolling debt and moving debt around electronically is what we do in a global economy with electronic banking and digital money. Can I extrapolate my behaviour to a global economy? Certainly. I would assert that a global assessment of settlement of transactions would yield a similar result.
I thus reviewed the Keynesian liquidity preference theory and judged it archaic. Any relevance that it may have will be limited to special (as opposed to general) economic conditions and even then it would have limited general impact on a global economy as a relevant explanation for human behaviour. Our behaviour in a world of digital money and easy access to debt has severely undermined the usefulness of any of the present measurements of Money Supply which is founded in part on exactly these types of archaic economic theories which were built upon gold pieces jingling in my pocket or deposited with a gold smith. Our ability to settle any type of transaction is thus a function of our access to digital money whether in debit or credit form (debt or “deposit” form). It follows that Money supply which measures only defined types of “deposits” is wholly inadequate to base any economic planning upon (if one is so inclined and I am generally opposed to economic meddling by bureaucrats.)
Credit Theory in War on Savings engages a “need” for stores of value, thus demand for Savings in the form of a store of value. Again conventional economic theory would give “money” a special place as a store of value and often gold is perceived as special with regards to being a store of value. Here I had to break free from thinking in terms of “money” when thinking in terms of preserving savings. There are many forms of preserving the relative value (and it is always about relative value) of one’s savings. Money in digital form controlled in supply by a central bank with an inflationary bias is not a good store of value. Gold, when monetary demand overwhelms physical jewellery demand is but a faith based store of value. Oil in an environment of austerity would also suffer as a store of value. The real problem is that some economic participants had managed to obtain “Unfunded Monetary Credits”, money created digitally by a central bank and now the race is on to convert the digital money into “real value”. It is a process which will always rob someone. Even a single cent yield in swapping the created digital $ (Unfunded Monetary Credit) for value will be a gain from its worthlessness. Here it is relevant to mention that the law of maximising productivity will cause a drop in prices over time and asserts a general downward price force into all economies where this condition prevails (which is generally everywhere). Simply put, we are always looking for better and cheaper ways to produce (and we are generally very successful) and thus producer inflation will be producer deflation in the absence of special conditions (market supply and demand imbalances would be temporary under free market conditions) such as an abundant supply of unfunded monetary credits.
Here, War on Savings deals with the process of creating Unfunded Monetary Credits and channelling the digital money into debt which in turn is channelled into bureaucratically desirable types of utilisation of the unfunded monetary credits (the here and now - July 2009 - is that it is undesirable for “stimulus money” to flow into speculation in Oil). That is why it has the title “War on Savings”. Savings can be the value you hold from a productive process which you plan to spend in five minutes, five years, or anytime. You will lose value if unfunded monetary credits were to compete with you at any time between your receiving/producing the productive surplus and when you exchange it for something you need. (I have built a simplified economic model in Praxeology of Commodity Pricing see http://sareloberholster.blogspot.com/2008/08/praxeology-of-commodity-repricing.html )
Having built a foundation I can now move on to the holding of cash by Japanese consumers. First we need to recognise that unusual and special conditions prevail in Japan but Credit Theory is fully capable to explain the special conditions. Japan is in Stasis with Debt Saturation prevailing. Thus the unfunded monetary credits are destroyed in bad debts; the market for goods, services and assets must content with demand deprived of access to sufficient new unfunded monetary credits; and new supply of unfunded monetary credits is constrained in dysfunctional distribution channels (banking and debt distribution channels) for unfunded monetary credits. These conditions require a greater supply of savings (absolutely not to be confused with liquidity) and the savings will actively be searching for suitable and good stores of value. The best store of value would be the one that will at any time in a time horizon of choice be worth the most relative to the needs of the saver net of costs of converting into a suitable from of settlement. The present reality in Japan is that Yen notes will be a good store of value, already in zero conversion cost form for settlement. It will therefore be a suitable store of value for many Japanese.
Now we need to assess the desire of some economic players to get access to the “mattress money”. I would content that they are simply expressing a desire to have Japanese savers change their preference for storing savings in “yen notes” to a preference to storing in into something else. Say I desire to see share prices rise due to an increased supply of savings, then I would suggest that the secret would be to convert mattress money into shares. Japanese savers would certainly do it if I could convince them that the shares would be a good store of value, not only for the reason that more money is now chasing that form of investment. It is a scoundrel’s statement when the intent is simply to coerce savers into my desired business activity or to return their money to the banks without allowing them to earn rent. The yen will flow from the mattresses to alternative stores of value or spending according to the needs of the saver. The absence of debt induced manic spending and the desire for its return is expressed in the statements which aim to push the yen out of the mattresses.
Mr Jerram’s desire is for the mattress money to become available for spending. The reality of mattress money is problematic generally as the money is sterilised from recycling in the economy. I have fully dealt with the reason why this happens in War on Savings. The manipulation of the interest rate to near zero has robbed the savers of the rent (interest) that they aught to get while imposing default and government intervention risks upon them. Free the market for savings and debt from unfunded monetary credits. Interest rates will call the money from the mattresses in no time.
It is therefore wholly consistent with my theories in War on Savings that the Japanese will hold mattress money when monetary intervention has robbed them of the total of their rent at zero interest rates. The Japanese monetary authorities have abolished interest rates and now everyone moans that the spiteful Japanese savers will not part with their savings without it. The only trick required is to allow the market to set the interest rate free from monetary (or fiscal) interventions.
Thank you again for your very informed and well expressed views.
Please give me your permission to post your e-mail (with my reply) to my blog as I think it will have appeal to others who search for understanding as we do.
Kind regards,
Sarel Oberholster
From: Douglas Porter Owen
Sent: 09 July 2009 8:59 PM
To: Sarel Oberholster
Subject: Re: Japan and Deflation
Sarel,
Yes, feel free to post my comment and your reply.
Porter
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