Saturday, March 12, 2011

+ 23.87 % YTD For Our Galaxy Combined Portfolio Systems

Anche nel mese di Marzo il nostro Galaxy Combined Portfolio Systems sta ottenendo ottimi risultati, che portano a 23.87 % il risultato complessivo dello stesso da inizio 2011. I risultati storici di Galaxy Portfolio System sono disponibili ai seguenti link: http://www.box.net/shared/static/nz7u0ztnbp.xls, http://box.net/shared/b9cg6kfa6s. I risultati dei singoli trading systems sono a disposizione al seguente link: http://www.box.net/shared/5vajnzc4cp

Also in March our Galaxy Combined Portfolio Systems is getting good results, bringing to 23.87 % the overall results since the beginning of 2011. Historical results of Galaxy Combined Portfolio System are available at the following links: http://www.box.net/shared/static/nz7u0ztnbp.xls, http://box.net/shared/b9cg6kfa6s. Historical results of single trading systems are available at the following link: http://www.box.net/shared/5vajnzc4cp

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Inflation and Hyperinflation

By John Mauldin

Bankruptcies of governments have, on the whole, done less harm to mankind than their ability to raise loans.
—R. H. Tawney, Religion and the Rise of Capitalism, 1926
~~~
By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.
—John Maynard Keynes, Economic Consequences of Peace
~~~
Unemployed men took one or two rucksacks and went from peasant to peasant. They even took the train to favorable locations to get foodstuffs illegally which they sold afterwards in the town at three or fourfold the prices they had paid themselves. First the peasants were happy about the great amount of paper money which rained into their houses for their eggs and butter. . . . However, when they came to town with their full briefcases to buy goods, they discovered to their chagrin that, whereas they had only asked for a fivefold price for their produce, the prices for scythe, hammer and cauldron, which they wanted to buy, had risen by a factor of 50.
—Stefan Zweig, The World of Yesterday, 1941
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I have had a lot of questions about my thoughts on inflation and hyperinflation of late, especially in the new “Ask Mauldin” section on www.johnmauldin.com. Unfortunately, the answer is not short and simple. The good news is that my new book has an entire chapter on inflation and hyperinflation, and today, as I fly to La Jolla (more below), I give you that chapter as this week’s letter. The letter will print a little long, as there are a lot of charts. Hopefully it will encourage you to want to read the rest of the book!

Please note, my co-author (Jonathon Tepper) and I have different views on the subject, for different countries. In some, we consider high (or worse) inflation a serious prospect. In others the opposite is true. There is no one size fits all. And of course our best estimates today are based solely on the facts as we know them – if the facts change, so will our opinions. When we wrote this chapter late last year, it was not obvious that the Fed would purchase 100% of the US debt. We currently assume that will stop. If it does not, then the lessons of this chapter are more important than we would like them to be. Inflation and hyperinflation are choices made by humans. That means there is an element of uncertainty, when logic would dictate there should not be. And also, we start off the chapter a little tongue in cheek (we are NOT really recommending inflation as an answer to debt!).

Endgame got up to #2 on Amazon yesterday (#1 non-fiction). Thanks to all you faithful readers who bought the book, whether there or at your local bookstores. Maybe this weekend, those of you who procrastinated will help us get to #1! And if you are going to buy some extra books for clients, family, or friends go ahead and do it now! No more procrastination! Go to www.Amazon.com/endgame and get clicking!

I just bought the book myself (really!) on Kindle. I need it on my IPad for reference. It works great! And we are #1 on Kindle! OK, I will only be this aggressive for another month or so, then it’s back into regular e-letter mode, but cut me some slack – books are a big deal for my generation. And I think this one adds some important insights to the national conversations that must be had around the world. Now, let’s jump into the chapter on inflation.

 

Inflation and Hyperinflation

In the previous chapter, we looked at deflation. Now let’s look at the opposite: inflation and even hyperinflation. Hyperinflation is an extreme case of inflation and a nightmare for anyone living it.
We know that the world is drowning in too much debt, and it is unlikely that households and governments everywhere will be able to pay down that debt. Doing so in some cases is impossible, and in other cases it will condemn people to many hard years of labor to be debt-free. Inflation, by comparison, appears to be the easy way out for many policy makers.
Companies and households typically deal with excessive debt by defaulting; countries overwhelmingly usually deal with excessive debt by inflating it away. While debt is fixed, prices and wages can go up, making the total debt burden smaller. People can’t increase prices and wages through inflation, but governments can create inflation, and they’ve been pretty good at it over the years. Inflation, debt monetization, and currency debasement are not new. They have been used for the past few thousand years as means to get rid of debt. In fact, they work pretty well.

The average person thinks that inflation comes from printing money. There is some truth to this, and indeed the most vivid images of hyperinflation are of printed German reichsmarks being burned for heat in the 1920s or Hungarian pengös being swept up in the streets in 1945.

You don’t even have to go that far back to see hyperinflation and how brilliantly it works at eliminating debt. Let’s look at the example of Brazil, which is one of the world’s most recent examples of hyperinflation. This happened within our lifetimes. In the late 1980s and 1990s, it very successfully got rid of most of its debt.
Today, Brazil has very little debt, as it has all been inflated away. Its economy is booming, people trust the central bank, and the country is a success story. Much like the United States had high inflation in the 1970s and then got a diligent central banker like Paul Volcker, in Brazil a new government came in, beat inflation, produced strong real GDP growth, and set the stage for one of the greatest economic success stories of the past two decades. Indeed, the same could be said of other countries like Turkey that had hyperinflation, devaluation, and then found monetary and fiscal rectitude.

In 1993, Brazilian inflation was roughly 2,000 percent. Only four years later, in 1997 it was 7 percent. Almost as if by magic, the debt disappeared. Imagine if the United States increased its money supply, which is currently $900 billion, by a factor of 10,000 times, as Brazil did between 1991 and 1996. We would have 9 quadrillion U.S. dollars on the Fed’s balance sheet. That is a lot of zeros. It would also mean that our current debt of 13 trillion would be chump change. A critic of this strategy for getting rid of our debt could point out that no one would lend to us again if we did that. Hardly. Investors, sadly, have very short memories. Markets always forgive default and inflation. Just look at Brazil, Bolivia, and Russia today. Foreigners are delighted to invest in these countries.

Endgame is not complicated under inflation and hyperinflation. Deflation is not inevitable. Money printing and monetization of government debt work when real growth fails. It has worked in countless emerging market economies (Zimbabwe, Ukraine, Tajikistan, Taiwan, Brazil, etc.). We could even use it in the United States to get rid of all our debts. It would take a few years, and then we could get a new central banker like Volcker to kill inflation. We could then be a real success story like Brazil.

Honestly, recommending hyperinflation is tongue in cheek. But now even serious economists are recommending inflation as a solution. Given the powerful deflationary forces in the world, inflation will stay low in the near term. This gives some comfort to mainstream economists who think we can create inflation to solve the debt problem in the short run. The International Monetary Fund’s top economist, Olivier Blanchard, has argued that central banks should target a higher inflation rate than they do at present to avoid the possibility of deflation. Economists like Paul Krugman, a Nobel Prize winner, and Blanchard argue that central banks should raise their inflation targets to as high as 4 percent. Paul McCulley argues that central banks should be “responsibly irresponsible.” There are, however, problems with inflation as a policy tool.

In this chapter, we’ll examine inflation and hyperinflation, what they are, how they’re different, and how hyperinflation ends. As a quick aside, that is why we expect the current attempts by the Fed at quantitative easing 2 to be probably ineffective: $600 billion is not all that much in the grand scheme of things. Now, if they start talking $6 trillion, that would get our attention.

 

A Dose of Inflation

In the previous chapter, we discussed why the current crisis presents the real risk of deflation if monetary velocity falls and does not rise. However, there are many reasons to believe that we will not see deflation. The major mistake that deflationists now make is their focus on spare capacity. Central bankers and most economists assume that because of the huge deleveraging we’re seeing, governments can print money and borrow like crazy without provoking inflation because of slack in productive capacity created by the recession.

The severity of the recession means that they are wrong. During a normal downturn, production slows, but spare capacity isn’t destroyed, and it is able to create extra supply when demand returns. A severe credit squeeze, though, does lasting structural damage, as the evaporation of bank lending destroys firms’ longer-term ability to produce at given levels. People who think inflation isn’t possible point to high unemployment in the United States, the United Kingdom, and Europe. But as we’ve shown earlier in this book, many of the unemployed in the developed world are unskilled or will be unemployed long enough that their skills will be totally rusty and, hence, they will be unemployable. The slack, in other word is imaginary.

According to a major study by Athanasios Orphanides, now central banker in Cyprus, the “ex-post revisions of the output gap are of the same order of magnitude as the output gap itself, that these ex post revisions are highly persistent and that real-time estimates tend to be severely biased around business cycle turning points, when the cost of policy induced errors due to incorrect measurement is at its greatest. . . . The bulk of the problem is due to the pervasive unreliability of end-of-sample estimates of the trend in output.”

The English translation is: Economists and central bankers are very, very bad at estimating output gaps. No surprise there!

The output gap is often subject to considerable measurement error, and it is often revised because of revisions to real GDP and to estimates of the economy’s underlying rate of productivity growth. So output gap estimates and capacity utilization estimates are almost worthless in real time. Not only are they worthless but also revisions turn out to be bigger even than the output gap itself. (As we’ve written before, anyone can make mistakes, but it takes an expert with a computer to really foul things up.)

Even Federal Reserve governors understand the problem. As Charles Plosser of the Philadelphia Federal Reserve has noted, “The data uncertainties are not just theoretical curiosities. They have caused actual problems when policy has been based on mis-measured gaps, resulting in unnecessary economic instability. A particularly poignant example is the Great Inflation of the 1970s in the U.S. [emphasis added].”

I have written before that when you become a Federal Reserve Bank governor, you are taken into a back room and are given a DNA transplant that makes you viscerally and at all times opposed to deflation. Modern central bankers are much happier with inflation. They’re pretty good at producing it, in fact.

Figure 8.1 shows U.S. inflation historically, going back to the late 1600s. (How economic historians know what prices were centuries ago always amazes us, but that is the story for another fascinating book.) As you can see from Figure 8.1, when the United States and the rest of the world used a gold standard, periods of inflation alternated with periods of deflation. On average, the price level didn’t go anywhere. One year’s inflation was usually canceled out by the next year’s deflation. But if you look to the right on the chart, you see that suddenly we don’t get deflation anymore. After the Bretton Woods Agreement in 1948, when the world moved to a dollar standard only nominally backed by gold,

and then after 1971, when the United States no longer made the dollar exchangeable for gold, something happened: We only got inflation. Figure 8.1 shows that inflation is the norm in a world of paper currencies. Central banks and governments have an inflationary bias. They can regulate monetary policy much more easily when interest rates are positive, so they prefer always to have some inflation in the system. In fact, there are very, very few examples of deflation after 1948 or 1971.

In the previous chapter, we looked at the elements of deflation. Deflation can happen right after banking crises and property busts. It happened, for example, after the Japanese bubble burst and as the Japanese banks started going bust. It also happened after the housing bubble burst in Hong Kong in 1997, the banking bust in Ireland in 2008, and the Baltics after their housing bust in 2008. These examples are the only examples we know of deflation after 1971. Almost all of these cases happened because the countries had given up control of their monetary policy. Hong Kong, Ireland, and the Baltics did not control their own money supply. They operated pegs that fixed their exchange rate to the U.S. dollar or the euro (in Ireland’s case, it was in fact already inside the euro). Japan is the one and only case of deflation in a country that is not pegged to another currency or in a currency union.

As Reinhart and Rogoff have shown us, the typical pattern is for banking crises to lead to sovereign defaults and for sovereign defaults to lead to inflation.

BANKING CRISIS (leads to) DEFAULT (which leads to) INFLATION

The simple explanation is that banking crises unleash powerful deflationary forces of deleveraging and falling monetary velocity. In this environment, people, corporations, and eventually governments are unable to pay their debts and default. Government defaults typically lead foreigners to sell the local currency, and you get a currency devaluation. A devaluation makes prices for imported goods more expensive and leads to inflation. At the same time, governments and central banks fight the downturn with more expansive monetary policies, which leads to higher inflation.

The previous paragraph is a highly simplified (or if you’re an economist, it is a highly stylized) version of what typically happens. But it is accurate. Figure 8.2, by Reinhart and Rogoff, captures very well how inflation typically follows external defaults, which typically follow banking crises.

It is easy to see why this is the case. Every week, you can read a very respectable professor recommending monetizing deficits and having a free lunch. If only the world worked that way. The following was written by Ricardo Caballero, a brilliant professor at MIT:

“What we need is a fiscal expansion (e.g. a temporary and large cut of sales taxes) that does not raise public debt in equal amount. This can be done with a ‘helicopter drop’ targeted at the Treasury. That is, a monetary gift from the Fed to the Treasury.

“Critics may argue that this is simply voodoo accounting, as it is still the case that the consolidated balance sheet of the government, which includes the Fed, has incurred a liability. But this argument misses the point that the economy is in liquidity-trap range, and once this happens the system becomes willing to absorb unlimited amounts of money. In this context, by changing the composition of the liabilities of the consolidated public sector in the direction of money, the government gets a sort of ‘free lunch.’”

Of course, in Professor Caballero’s defense, he argues that we should have a mechanism to drain this liquidity from the system, but realistically, would the Treasury or the Fed have the wisdom to do it? Inflation doesn’t work as a policy response for many reasons. The reason inflation only makes things worse is probably best shown by looking at extreme examples, where the ravages of inflation are clearest and most evident. We will look at hyperinflations, which is a lot of fun for the reader, but not much fun if you’ve lived through hyperinflation.

 

The Characteristics of Hyperinflations

Just as Reinhart and Rogoff wrote the book on banking and debt crises, there is one book that is the bible on hyperinflations. Professor Peter Bernholz, from the University of Basel, has written Monetary Regimes and Inflation, which provides an overview of every inflationary episode that has ever happened, and he explains the origins and characteristics of hyperinflation. It is well worth your time if you are interested in the mechanics of hyperinflation.

As Professor Bernholz points out, you can get inflationary episodes without printing money. Under the Greeks and Romans, rulers often made gold and silver coins smaller or put bad coins into circulation to debase their currency. However, true hyperinflation only happens with paper currencies.5 As you can see from Table 8.1, almost all hyperinflations have happened in the twentieth century. (Note: he wrote the book before the episode in Zimbabwe.) The only hyperinflation prior to the twentieth century was during the French Revolution, when the French monetary regime, too, was based on the paper money standard. We don’t have very long-term inflation data for most countries, but as you can see in the case of the United Kingdom, where we have

historical data, inflation was relatively stable for about 600 years. It was only after the United Kingdom moved toward paper money that inflation has really taken off. Unfortunately, this is true of every country with a paper currency (see Figure 8.3). Interestingly, after countries abandoned the gold standard, there are more cases of hyperinflation than deflation. Figure 8.3 shows inflation, but we need to distinguish between inflation and hyperinflation. Many countries have high inflation, but hyperinflation is a very special case in which money grows greater than 50 percent from one month to the next. When money starts growing that quickly, the numbers become truly astronomical. To give you a sense of just how crazy inflation can get once it gets going, Figure 8.4 shows inflation in Weimar Germany. You can see that toward the end of 1923, inflation was growing at 16 million percent per year.

What kinds of prices does 16 million percent inflation give you? The highest-value banknote issued by the Weimar government’s Reichsbank had a face value of 100 trillion marks (100,000,000,000,000; 100 billion on the log scale).6 At the height of the inflation, one U.S. dollar was worth 4 trillion German marks. One of the firms printing these notes submitted an invoice for the work to the Reichsbank for 32,776,899,763,734,490,417.05 (3.28 x 1019, or 33 quintillion) marks.


What causes such a spectacular increase in prices? Bernholz has explained the process very elegantly. He argues that governments have a bias toward inflation. The evidence doesn’t disagree with him. The only thing that limits a government’s desire for inflation is an independent central bank. After looking at inflation across all countries and analyzing all hyperinflationary episodes, the lessons are the following:

*Metallic standards like gold or silver show no or a much smaller inflationary tendency than discretionary paper money standards.

*Paper money standards with central banks independent of political authorities are less inflation-based than those with dependent central banks.

*Currencies based on discretionary paper standards and bound by a regime of a fixed exchange rate to currencies, which either enjoy a metallic standard or, with a discretionary paper money standard, an independent central bank, show also a smaller tendency toward inflation, whether their central banks are independent or not.

Bernholz examined 12 of the 29 hyperinflationary episodes where significant data exist. Every hyperinflation looked the same. “Hyperinflations are always caused by public budget deficits which are largely financed by money creation.” But even more interestingly, Bernholz identified the level at which hyperinflations can start. He concluded that “the figures demonstrate clearly that deficits amounting to 40 percent or more of expenditures cannot be maintained. They lead to high inflation and hyperinflations. . . .” Interestingly, even lower levels of government deficits can cause inflation. For example, 20 percent deficits were behind all but four cases of hyperinflation.

Stay with us here, because this is an important point. Most analysts quote government deficits as a percentage of GDP. They’ll say, “The United States has a government deficit of 10 percent of GDP.” While this measure makes some sense, it doesn’t tell you how big the deficit is relative to expenditures. The deficit may be 10 percent of the size of the U.S. economy; currently the U.S. deficit is over 30 percent of all government spending. That is a big difference.

Figure 8.5 shows the level of deficits relative to expenditures before hyperinflationary periods.

Interestingly, currently Japan and the United States are not far from levels that have preceded hyperinflations. The big difference between Japan or the United States and countries that have experienced hyperinflations is that the central banks are not monetizing most of the deficit. If they were to do that, then we would be one step away from paying quadrillions of dollars for a stamp or a sandwich (see Figure 8.6). It is extremely important to note Bernholz’s conclusion. Hyperinflations are not caused by aggressive central banks. They are caused by


irresponsible and profligate legislatures that spend far beyond their means and by accommodative central banks that lend a helping hand to governments.

What are the implications for the present day? Fiscal liabilities are the real threat that will lead to higher inflation, if central banks continue to monetize government liabilities. In the case of a monetization, governments with independently authorized central banks disavow the overly convenient slippery slope option of paying their bills by printing new currency. A government must pay down its liabilities with currency already in circulation or else finance deficits by issuing new bonds and selling them to the public or to their central bank to acquire the necessary money. For the bonds to end up in the central bank, it must conduct an open market purchase. This action increases the monetary base through the money creation process. This process of financing government spending is called monetizing the debt. Monetizing debt is thus a two-step process where the government issues debt to finance its spending and the central bank purchases the debt from the public. The public is left with an increased supply of base money.

Although now with quantitative easing (QE2), some would argue that the United States is on such a path. Mohamed El-Erian writes:

“The unfortunate conclusion is that QE2 will be of limited success in sustaining high growth and job creation in the US, and will complicate life for many other countries. With domestic outcomes again falling short of policy expectations, it is just a matter of time until the Fed will be expected to do even more. And this means Wednesday’s QE2 announcement is unlikely to be the end of unusual Fed policy activism.”

Do we think the Fed will abandon its responsibility to control inflation and resort to total monetization of U.S. debt? No. But in the attempt to get mild inflation, it is possible the controlled fire they hope to kindle could get out of control, forcing them to act to take back the excess reserves and bring about a recession, as did Volcker. Let’s hope it does not come to that.

If inflation is the cure for too much debt, as we suggested earlier in our tongue-in-cheek example of Brazil, why is it that high inflation and eventually hyperinflation made things worse? Governments have to spend money all year round, but typically they collect tax revenues at the end of the year. So the value of the government’s revenue in real terms is constantly diminished until the money is spent. Indeed, plugging a hole with inflation merely makes the hole bigger. Digging yourself deeper in an inflationary situation is what economists call the Tanzi effect, after the economist who discovered it.

Hyperinflations are all very similar. At first, bad money drives out the good. Under the Greeks and Romans, when gold coins were debased, few people were dumb enough to want to exchange their old coins that had high gold content for newer ones that had low gold content, so older good coins disappeared as people hid them. This is called Gresham’s law: Bad money drives out good money.

In modern hyperinflations where gold coins don’t exist, people begin to barter and exchange goods and services to avoid having to use devalued paper. Then, if they can get their hands on a foreign currency that is perceived to be hard and unlikely to lose its value, like dollars or deutschmarks, they will start to use the foreign currency. At first, they’ll use the foreign currency as a unit of account to settle wages and price negotiations, then as a means of exchange, and finally as a store of value. Once enough people use the hard currency, Gresham’s law reverses itself and hyperinflations come full circle. The good foreign money drives out the bad, and the inflating currency becomes totally worthless. This is called Their’s law.

This happened in Argentina. If you are buying a home, you literally come to the closing with large bags of physical U.S. dollars. One side counts the cash while the other checks the paperwork.

The consequences to this pattern are dreadful. Hyperinflation completely destroys the purchasing power of private and public savings. No one wants to hold paper money, so it leads to excessive consumption and the hoarding of real assets. Investors face uncertainty and refuse to invest, unemployment skyrockets, and savings flee the country. The best-performing stock market in 2008 was Zimbabwe, which offered people a way to hedge their currency risks, even as their economy plummeted.

 

The Problems of Inflation

It’s tempting to think that highly indebted countries can inflate their way out of their fiscal problems. Inflation would erode the real value of debt. Debts are fixed, while workers, companies, and governments could earn higher income as wages and prices could be indexed to inflation. The main drawback of high inflation or hyperinflation is that most people become poorer through reduced real income. If we look at the real incomes, we can see that periods of high inflation, for example in the late seventies and in the last few years, have led to negative real wages. On the other hand, periods of disinflation and deflation have led to periods of positive real wage growth. Simply put, prices go up faster than wages, so the things you need to buy tend to go up faster in price than your salary (see Figure 8.7).

There are three main problems with trying to use inflation to get rid of the value of real debt. Investors would recognize even a stealth inflation policy and quickly push up yields. Many governments around the world have tied pensions and salaries to inflation measures, so increases in government spending would rise with inflation. Nearly half of federal outlays are linked to inflation, so higher inflation means higher deficits. Social Security, which represents about 25 percent of federal spending outlays, is officially indexed, and Medicare and Medicaid are unofficially indexed. Indeed, over the period 2009 to 2020, the Congressional Budget Office (CBO) estimates that these three programs will account for 72 percent of the growth in total federal outlays and about the same share of the growth in debt. If anything, CBO’s assumptions may be conservative, as they are required under current law to assume a sharp cutback in physician reimbursement payments under the Medicare program. Those cuts have been delayed every year since 2003. Any increase in inflation will erode the value of existing debt, but it will make deficits much larger going forward and even possibly increase the real burden of debt as a percentage of GDP. The CBO estimates that if inflation is 1 percentage point higher over the next decade than the rate CBO has projected, budget deficits during those years would be roughly $700 billion larger.

 

Hyperinflation in the United States?

Congress likes spending more than a drunken sailor on shore leave, and the Federal Reserve sees the answer to any problem as providing more liquidity. Given this unfortunate dynamic, what is the likelihood that the United States will suffer from higher inflation and hyperinflation? Who better to answer the question than the world’s foremost expert on hyperinflation? Given all the fiscal problems and the monetary response, Bernholz sees many potential problems, but he currently sees no danger in the United States:

“But does this mean that inflation may evolve into a hyperinflation in the United States? I believe not. Though it is true that budget deficits with government expenditures covered by 40 percent or more through credits have historically led to hyperinflation, it has been stressed in Monetary Regimes and Inflation that it is not only the size of these credits but also their composition that is important. This is noted in the book, thus:

“‘It will be demonstrated by looking at 12 hyperinflations that they have all been caused by the financing of huge budget deficits through money creation” [emphasis added]. This expresses the fact that only credit extended directly or indirectly by the monetary authorities to the government leads to the creation of money, that is, an increase of the monetary base. This is not true for borrowings taken up in the capital markets if they are not resold to the Fed. Looking from this perspective at the U.S. deficit, by far not all of the credits borrowed by the government were financed by the Fed.

‘According to preliminary and rough estimates, not 40 percent but “only” about 13 percent of U.S. expenditures are presently financed this way. Moreover, in discussing this problem it has to be taken into account that about two-thirds of dollar bills are estimated to circulate abroad. This—together with the fact that incredibly huge holdings of dollar assets are owned especially by the central banks of China, India, and the Gulf States—may pose other and later dangers. But these dangers will be, except for a return of the dollar bills and a purchase of foreign-owned dollar assets by the Fed, of a different nature. Inflation may rise more or less strongly during the next years, but there is presently no danger of a hyperinflation in the United States.’”

Bernholz is likely being far too generous to the Fed and Congress. He is not counting more than $700 billion worth of mortgage bonds by Fannie and Freddie that the Fed bought with money it printed. Arguably, if other central banks had not been dumping their mortgage-backed securities, the Fed would have monetized 100 percent of the U.S. deficit through Treasury purchases. Interestingly, the only country in the world that currently fits the bill for hyperinflation is the United Kingdom, where 100 percent of the budget deficit was monetized by the central bank. Unsurprisingly, ever since, inflation in the United Kingdom has consistently overshot the Bank of England’s own forecasts. Apparently, they don’t see a connection.

While it is unlikely that the United States, Japan, or any other country will soon enter hyperinflation, the situation could change in the future if any of the central banks were to lose their independence or continue to coordinate their actions with their treasuries. Central banks have lost a lot of independence through quantitative easing. They may say they are keeping an arm’s length from the legislature and the Treasury, but few are fooled. Central banks in the United Kingdom, Europe, and the United States are now effectively working alongside the Treasury to pump money into the economy, so far with limited results due to the massive deleveraging in the private sector. They may continue to try this on a greater scale, and the larger the scale, the greater the need for coordination and the less the independence. If we go into a downturn, we hope central banks will be wise enough not to monetize government debt in any fiscal crisis. Sadly, they probably will. The Federal Reserve has made spectacular mistakes over the past few decades. Under Alan Greenspan, the Fed’s only solution to any problem was to provide more liquidity. To a man who only has a hammer, everything looks like a nail. Under Bernanke, the Federal Reserve effectively monetized government debt and monetized mortgage bonds held by quasi-government entities like Fannie Mae and Freddie Mac.

If we go into another downturn, will the Fed use its hammer again and provide more liquidity by monetizing even greater quantities of government liabilities? We hope not. Debt deflation is a terrible thing, but hyperinflation is even worse. We must remain vigilant that central banks maintain their independence.

13-year High for Acres

By: Roger Bernard

Expect to see more corn, soybeans, wheat, upland cotton, rice, sorghum, barley and oats planted this year. A whopping 9.8 million more acres is the latest estimate, the largest year-over-year 

increase in planted acreage to the eight major crops since 1998, said USDA Chief Economist Joe Glauber at the department’s annual Outlook Forum in late February. The grand total for the eight crops is 255 million acres. 

Here’s how Glauber’s tallies stack up in the primary commodities:

Corn. USDA assumes a national average yield of 161.7 bu. per acre, putting production from 92 million acres at 13.73 billion bushels—a new record. Usage is forecast at 13.56 billion bushels, as exports and corn used for ethanol are expected to increase as well. 

"Feed and residual use is anticipated to fall slightly in 2011/12 as high feed costs limit expansion in the pork and poultry sectors and beef feeding declines with tighter feeder cattle supplies," Glauber said.

Ending stocks for the 2011/12 marketing year are estimated at 865 million bushels, up 190 million bushels from the February forecast for 2010/11 ending stocks. USDA expects corn prices to average $5.06 per bushel, which is 20¢ more than the February 2010/11 forecast. 

In order to push carryover above 1.1 billion bushels, corn yields would need to reach 2009’s record of 164.7 bu. per acre. "That assumes no increase usage for feeding, ethanol or exports, an unlikely scenario," Glauber added. 

China was a frequent topic of discussion at the Outlook Forum. USDA analysts said "China’s potential to import corn remains unknown. It will be dependent on domestic production, relative prices and internal policies."

Soybeans. Planted acreage is forecast at 78 million acres due to strong prices and an increase in double cropping. Assuming a trendline yield for soybeans, total production should be 3.345 billion bushels. Domestic use is estimated at 1.765 billion bushels, unchanged from 2010/11, while exports are tallied at 1.575 billion bushels. 

USDA expects soybean carryover for 2011/12 will end up at 160 million bushels, the highest since 2007/08. "Given the increased use since 2007/08, the stocks-to-use ratio is still estimated to be below 5%, indicating a tight market," Glauber added.

As for prices, USDA expects soybean producers will receive a record $13 per bushel.

Wheat. Despite an increase in wheat plantings to 57 million acres, total wheat production is expected to fall to 2.08 billion bushels because higher abandonment rates in the Southern Plains will reduce harvested acreage to levels comparable with this past year (47.5 million acres). A return to trend yields (43.8 bu. per acre) would mean wheat production levels will fall about 6% from this past year.

Global wheat production is expected to increase, which will translate into lower U.S. wheat exports—down 12%. Carryover is pegged at 663 million bushels and the average farm price at $7.50 per bushel.

Cotton. With cotton acreage at 12.8 million and yields at 810 lb. per acre, the U.S. should produce 19.5 million bales of cotton in 2011. Add in usage assumptions and cotton carryover should climb to 2.9 million bales. The cotton average price is forecast at $1.10 per pound, exceeding the 2010/11 price by 35%.

Livestock. Total U.S. production of meat and poultry is forecast to remain overall flat in 2011, with slight growth in pork and poultry supplies but reduced supplies of beef. Stable production, increased exports and some recovery in domestic demand should help maintain livestock prices near 2010’s historic highs.

The price-to-feed cost ratios in January for cattle, broilers, hogs and milk, as reported by the National Agricultural Statistics Service, were all well below year-ago levels. "While livestock prices are expected to remain strong and further improvement in milk prices is likely in the months ahead, higher feed costs could lead to below-average margins for livestock and dairy producers in 2011," Glauber said.

Has Corn Demand Peaked?

By: Greg Vincent

A significant liquidation all week was justified with Thursday’s WASDE (World Agriculture Supply and Demand) report from USDA.

Money left the market throughout the week ahead of the report that showed no significant positive news. That lack of anything bullish sent commodity prices tumbling on Thursday and Friday as the March corn contract fell nearly 64 cents for the week. Soybean and wheat prices followed suit.

"The excuses from the floor, and they usually come up with something after there is liquidation, was that funds were getting out. And in particular about the agriculture outlook was that there was nothing negative, but there wasn’t anything positive either," says Jerry Gulke, president of the Gulke Group.

"The trade viewed the fact that we didn’t increase feed or ethanol usage as a signal that we’ve peaked demand," he says. "Of course, we still have the supply side to figure out, but right away the thought was that if we’ve peaked the demand side, we may have a lot more later on."

Now the attention is turning to the March 31 acreage report. Gulke says many in the trade believe the numbers will come in around 92 million corn acres, but they also believe it could reach as high as 94 million with the June report. 

Friday’s earthquake in northern Japan also added to the market tension. Japan is the largest export market for U.S. corn and the trade is questioning how much that demand will be upset by the earthquake and the following tsunami. 

"Will they need any corn to feed their hogs? There’s just a lot of uncertainty and people just got out of the way."

Despite the significant downturn in prices this week, the bull market isn’t necessarily over. The low-side resistance levels still remain from a technical trader’s perspective.  It’s also not new to this marketing year, he says.

Lows were tested in September. After testing the low-side of the trend line, the market rebounded and moved significantly higher. "We’ve tested it numerous times and violated it several times in November. You can never say never, but you can’t say for sure this party is over unless you look at that trend line. Today in December corn we managed to close above that trendline."

However, to move to new contract highs in this market, Gulke believes we will need to some significant production challenges this growing season.

Japan Tsunami: Trying to make sense of the market crash

By Sreekumar Raghavan

The Japanese tsunami that hit the coastal areas causing severe devastation on Friday caused market crashes in commodities and stocks and there is panic everywhere. I was a bit skeptical in commenting about the impact of tsunami on commodities when I was asked to do so by a leading Malayalam TV channel, Manorama News.

A major disaster in one nation cannot have a severe impact across the globe because what is more important is the fundamentals and ofcourse the investor interest or panic in a particular commodity or stock and therefore in my response to the TV anchor's questions I maintained a cautious approach harping back to the fundamentals although these days it is not just fundamentals that drive the commodities but huge investments that happen with hedge funds or ETFs that cause volatilities in the market.

Yesterday, evening I got an analysis from The Steel Index (TSI) pointing out that if five major Japan steel mills have been closed and if they remain closed for six months then that would wipe out 2.2 mn tonnes of iron ore demand from the market causing the iron prices to crash in the coming months. Ofcourse, I posted the report and it did get good readership from the panic striken investors but at heart the conclusions are hypothetical and speculative.

 The several news items that have appeared on the market crashes have also not been able to point out why the crash has really occured apart from a panic reaction from investors. When Dhirubhai Ambani, the Chairman of Reliance Industries Ltd died, it lead to a crash in prices of RIL although there was nothing going to happen to the fundamentals of the company in the long run.

The Platts reported that the International coal markets were mixed on news of Friday's catastrophic earthquake in Japan, even as many participants tried to assess the potential effects of the disaster and resulting tsunamis.Japan imported about 165 million short tons of coal in 2009, making it the largest importer of both steam and metallurgical coal, according to estimates by the International Energy Agency. The quake comes at a time when Pacific coal markets have been particularly sensitive because of flooding and a recent typhoon that has curtailed Australian exports. "Coal market participants in the US and abroad said Friday that it was simply too soon to know how the earthquake might affect the country's coal-importing and coal-burning infrastructure."

A report in The Washington Post said that coal, natural gas prices may zoom as Japan shuts its nuclear reactors thereby forcing utilities there to use other fuel options to generate power while the closing down of refineries would mean import of fuel from nearby Asian refineries to make up for the deficit thereby giving support to an otherwise falling crude oil.

Coal accounted for 22% of the country's total energy consumption in 2007, ranking it second behind oil, according to the US Energy Information Administration. Japanese steel producers said that at least one plant had been unaffected by the quake; while others had been closed, were operating at reduced rates or could not be reached by telephone. Lower steel production could mean that coking coal is redirected to other countries, though reconstruction efforts would eventually increase the amount of domestic consumption, market sources said. The country is second only to China in both pig iron and crude steel production, according to Platts.

"That steel production will have to resurface elsewhere around the world and the coking coal demand that would have been taken by Japan would be supplemented by other countries," according to Ted O'Brien quoted in the Platts news analysis.

"European paraxylene traders said Friday it was still unclear what impact the 8.9 magnitude earthquake that struck Japan earlier in the day would have on the Northwest European paraxylene market.In Asia, market reaction was swift. Asian PX prices surged $51.50 Friday, ending the week at $1,651.50/mt FOB South Korea and $1,671.50/mt CFR Taiwan/China after the earthquake was reported," another Platts analysis said.

The greatest impact of the Tsunami was seen in Rubber prices that crashed across nations as Tokyo Commodity Exchange's (TOCOM) rubber futures is a benchmark for global prices while Japan is the third largest oil consumer whose daily consumption of 4.4 mn barrels of oil is three times more than 1.6 mn barrels per day produced by Libya, the third largest producer of oil in North Africa. It will take a few more days for the markets and the analysts to get to grips with the impact of Tsunami until then it will be hypothetical and speculative moves that will drive the markets. One analysis pointed out that market crash occured as large investors moved cash out of the markets in response to the Tsunami. Invesotrs can only keep their fingers crossed and hope things would return to normaly based on fundamentals.

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Are crop investors learning from the wrong crisis?

by Mike Verdin

Are investors drawing lessons from the wrong crisis?
They have taken a heavy toll on agricultural commodities since mid-February, when the start of Libya's turmoil crystallised concerns that the region's unrest could put global economic recovery on the skids, before Japan's earthquake compounded concerns.
Sugar and wheat have fallen some 20%, reaching the level which many analysts use for a sell-off to qualify as a correction. Rubber is down by more than 25%. The falls are reminiscent of the sell-off after the 2007-08 rally.
It is certainly rational to think that consumption will take a hit as higher oil prices bite. But there are good reasons to think a rerun of 2008, when prices of main grains halved in less than six months, is not on the cards.
Spring not sprung 
One reason is in the timing. When investors ran scared from crop futures three years for fear of lower demand, northern hemisphere farmers had already got bumper harvests in the barn, and southern hemisphere producers got many of theirs' in the ground.
World wheat production jumped 12% in 2008-09, far faster than consumption, leading to a jump in stocks of more than one-third – and the depressant effect of ample supplies on prices.
This sell-off has happened before spring crops are sown in the likes of the US, Europe and Canada, or winter grains in Australia, giving farmers the option of pruning planting programmes plans rather than bringing less fertile or conservation land back into production.
Sure, the picture for sowing incentives in the US is clouded by insurance programmes.
But the message elsewhere is that with stocks of, especially, corn, soybeans and cotton at historically thin levels, markets need to persuade the farmer to get seeding big time - which they wouldn't by pricing in a 50% discount.
Inflation vs deflation
The second is the nature of the central shock which has got investors in such a stew.
An economic slowdown caused by higher oil prices would present the world with a different set of problems to those it faced in 2008, when a credit drought sent the globe into recession.
Inflation is one, as higher energy prices feed through the pricing chain, unlike the deflation threat posed by tight money which got central bankers worked up until lately.
The oil-induced inflation scenario, while hardly comforting, may not be such a setback to farm commodities as some other assets.
Shock resistance
Take the most famous hit by oil to the world economy, in 1973.
Chicago corn prices rose 73% that year, and a further 27% in 1974, while wheat prices more than doubled.
OK, failed Russian crops had a big impact that time, as they have in 2010-11 too. But in many other years when oil prices have spiked, such as 1979, 1991 and of course in 2007-08, crop prices have improved as well.
And correlations between grains and crude will only have been enhanced by greater use in making biofuels.
China factor
That's not to say investors can ignore Middle East instability.
For one thing, it would hit hard in China, such a huge importer of raw materials including cotton, rubber and soybeans. The country wasn't such an issue during previous oil shocks, before it became such an important global economic player.
But to think that we are about to witness 2008 again looks misguided too.

The Probability of More Quantitative Easing


It would be an understatement to say that I was flabbergasted to see that the monetary base jumped $130 billion dollars in two weeks!

Well, using an exclamation point as punctuation seems to confirm my suspicions that I was, indeed, flabbergasted, as the term seems, somehow, appropriate since I felt something more than the usual crushing pains in my chest, numbness running down my left arm, my guts heaving and sphincters tightening kind of reaction I get when I see horrifying, huge increases in money and credit created by the damnable Federal Reserve.

Perhaps it is customary for those who are "flabbergasted" but I am a screaming crybaby about the horror of the terrible inflations in consumer prices that all this excess money creates, how it is going to destroy the country by destroying the purchasing power of the dollar, and take down the rest of the world with it.

And, I shudder to say it, the Fed is still at it! Last week - in One Freaking Week (OFW)! - the Fed waved its little magic wand and pressed the magic button to increase Total Credit by a huge $13.3 billion, which turned into money when the Fed ran all of this new credit through the banks, which multiplied it by whatever bizarre fractional-reserve multiplier that the banks want to use, and then turned it into boatloads of new money when borrowed by financial-services middlemen so that the Fed could buy $14.7 billion of government and agency debt, plus a smattering of anything the Fed wants to buy, no matter what the cost, to bail out any of their slimy friends, for any reason that they can think of, whimsical or not, in case all those commissions and fees are not enough.

At this point, the probabilities are very good that I am going to go into a Screaming Mogambo Tirade Of Outrage (SMTOO) about all of this monetary insanity, particularly to fund all the fiscal insanity of the federal government.

And speaking of probabilities, I will probably end up telling you what an idiot you are for not buying gold, silver and oil Right Freaking Now (RFN), which, if you are, then you're not, but if you are not, then you are, if you know what I mean.

But probabilities or not, I will try not to "lose control" and end up screaming and crying and making death threats until my throat is sore and my head hurts and my stomach hurts and everyone is laughing at me, which is good, as I see that other pundits are already discussing other probabilities, namely the possibilities and probabilities of something more horrifying: More monetizing government debt by the Federal Reserve, already referred to as Quantitative Easing 3.

If you have any worries about this, let me put your mind at rest. Yes, the Federal Reserve will continue to monetize government debt, regardless of the staggering, unbelievable amounts of money it takes, for as long as they want, whether the dollar has any value or not, which it won't have ere long at this rate.

To be fair, the Federal Reserve has to do this horrible thing because the time when it could stop creating excess money without collapsing the economy was decades and decades ago. Now nothing can be done, and it is "damned if you do and damned if you don't," so, they figure, "Why not?"

The problem is inflation in food and energy prices, primarily caused by all of this new money increasingly created by the evil Federal Reserve since the '80s makes people grumpy when they can't afford food.
And with incomes virtually stagnant in nominal terms, and falling rapidly in real (inflation-adjusted) terms, raging price increases will cause massive suffering as real, inflation-adjusted incomes go down faster and faster.

And to show you how this works in real life, let us tune into Chris Martenson of ChrisMartenson.com interviewing John Williams of ShadowStats.com, who says, "If you look at the government's latest statistics - the poverty survey of 2009, which is the most recent release, with average and median household income adjusted for inflation, it shows that not only has household income been falling the last year or two, but it's below its near-term peak before the 2001 recession."

Real incomes are lower than they were 10 years ago, thanks to the inflation caused by the foul Federal Reserve constantly creating more and more money? Yikes! Monetary policy is not working too well, is it?ù

Well, hold onto your hats, as it gets worse, and using the CPI-U sub-index of the Consumer Price Index as a proxy of inflation, "household income today is below where it was in 1973."

And with silver costing a couple of bucks in 1973 and gold at less than $70 an ounce, even an idiot like me can see that over the long term, "Whee! This investing stuff is easy!"

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The Commodity Price Rollercoaster and the CRB Golden Ratio Failure

By David Knox Barker

Commodity prices have been on a rollercoaster ride as central banks have pumped trillions in liquidity into the global system, trying to prevent a deflationary long wave debt collapse from delivering the economic coup de gras, and driving the global economy into a natural Kondratieff (aka Kondratiev) long wave winter season bottom. Commodities are the ingredients of global economic production; they go into almost everything you buy. Investors in commodities, stocks, bonds and gold should all take note of the most powerful resistance line the CRB Index has encountered since the 2009 bottom.

The 362.38 price target in the CRB is the golden ratio of the entire 2001-2008 commodity price edifice. It is extremely important that Mr. Market’s golden ratio just repelled the liquidity driven assault sponsored by the central banks of the developed world. Commodities ultimately have an impact all global markets, including equities and bonds, so they will have a major impact on the global economy, for better or worse.
 RollerCoaster
The goal of the central banks is rather straightforward. They are trying to cajole the global economy and commodities away from the global debt driven deflationary abyss and into the arms of inflation. Their objective is to inflate away the value of the mountains of debt. Debt is an albatross hanging around the neck of the global economy. Excessive debt threatens the stability of national governments, states, municipalities, businesses and individuals that took on too much of it over the past few decades.

In recent months, it has appears as if the central bankers have succeeded with their inflationary objectives. Deflationists would be less than honest if they try to convince you that their deflationary convictions have not wavered a bit. The inflationary arguments are very convincing and the markets have been agreeing with higher prices. Commodity prices have surged, driving the cost of goods higher for producers and manufacturers world over.

However, after this weeks market action, the score is now the Fibonacci golden ratio 1, the central bankers zero. The commodity rally was turned back. Deflationists have been dining daily on humble pie as inflationists have taken the wheel of global markets, since the rally in commodities off the 2009 low at 200.16. From the 2001 intraday low at 181.83 to the 2008 intraday high at 473.97, global commodities have ridden wave after wave of central bank injected liquidity, but now the commodity rally suddenly looks fragile.
 CRB
Unfortunately, in all the central banker’s calculations, they forgot about supply and demand and the fact that labor supplies are abundant, food not so much, so inflation flowed into the food prices of the emerging markets where it can be least afforded by workers. Inflation is threatening to flow down the entire global economic food chain, except for labor rates and housing prices, and spill into your gas tank, cereal bowl, and even pop out of your toaster. A mouse jumped out of our toaster the other morning, but that is another story that comes with the joys of a hundred plus year old farmhouse, and a fat cat that is a slacker. The moral here must be that when fat cats are slackers troubling things can happen.   

Where the economic food chain is short, such as in most emerging countries, commodity price increases flow rapidly through the real food chain and onto dinner tables. In developed economies food processing and labor costs mute the affect of the rise in commodity prices. The anger resulting from the central bank’s inflationary objectives has now spilled into the streets. The central bankers have set the political world on fire.

It is rather odd that while hundreds of billions are being pumped by the central banks, everyone seems to need more money, but from street vendors in Egypt to the commodity pits in Chicago this week, money is increasingly in short supply. Even with central bank liquidity supposedly pouring into markets, the actual amount of money available appears to be shrinking. Global debt is a great sponge, soaking up all the liquidity the centrals banks can pump and more.

The stresses produced by the great commodity price boom engineered by central banks, and laid on the backs of hard working bread winners world over, threatens the very foundations of civilization. Of course, theory only goes so far, price is where the rubber hits the road and all the theory puts up or shuts up with prices paid, and the CRB golden ratio just sent a massive heads-up signal as the inflation vs. deflation battle rages around the globe. The central banks may be able to pump trillions more and breach the golden ratio in their battle against forces of debt deflation. If they do, inflation is back in the driver’s seat. Observing the CRB, investors and traders in commodities have a front row seat in the fight of the century. Mr. Market, on the advice of his manager the Kondratieff long wave, just landed a hard right to the inflationary policies of Chairman Bernanke.   

The inflationist’s arguments are brilliant. Money supply, multiplier affects, electronic printing presses, the death of the dollar, they all make so much sense. What I can’t seem to figure out is how after all that pumping, all the trillions, why did the CRB just recoil from the golden ratio like it had touched the third rail of inflation theory. The 2008 high is still miles away.

Just remember that Mr. Market has the last word and he speaks in the language of markets called price. Right now, he is standing on the Fibonacci golden ratio in the CRB and telling the central banks and inflationists to go ahead and make his day. Inflation may yet take Mr. Market down and leave him bleeding in the back alley of some emerging market, where struggling entrepreneurs are just trying to earn enough profit to feed their families. They are fighting against the fat cat slackers that are trying to take the easy way out and slowly make all the debts go away, but they just keep getting bigger. Just watch price, especially in the CRB, this is where all the theories of inflation and deflation meet reality.

Speaking of price, if you are not observing the Fibonacci grids in the market in which you invest and trade, along with time and sentiment, you are investing and trading blindfolded. You create Level 1 grids by identifying the most important high and low in any market or security. Drilling into those grids to the next level between any two adjacent Fibonacci grid targets and on down, you can observe a detailed roadmap of intraday market action. A reader recently recognized the drill-down Fibonacci grids are “the holy trading grail” for day traders. Long-term investors are more interested in the Level 1 and Level 2 moves, like that failure that just occurred in the CRB at the golden ratio. The CRB tried to break into the Frenzy range but failed.
 Level 1
Until the central banks can reload their QE canons, which is now questionable due to the rising political opposition expected at this stage in the long wave winter season, the inflationist better have a Plan B. A commodity price crash is not out of the question, since the attempted breach of the golden ratio has failed. A retest of the floor of the Normal range at 293.41 is now in the cards.  

Political revolts have begun sweeping the globe, freedom and liberty from central planning is the cry, including freedom from the failing market manipulation efforts of the central banks. The age of human design is ending. Human action is stepping up to the challenge and filling the void, creating order out of the chaos created by human design.

It is only now coming into focus, but objective reason is winning the day. The Internet is triggering human action and spontaneous order is trumping the chaos of human design; you are observing the objectivation of the world unfold. The looters are on notice. Ayn Rand would recognize what is occurring, as the chaos in the cities is growing and darkness threatens. Unlike the novel Atlas Shrugged, the prime movers remain hard at work, they did not leave the scene of the looters crime and head for the mountains of Colorado. Atlas is refusing to shrug. He has dropped into the heart of the action and is fighting back.   

Listen to Mr. Market, who speaks the language of price, he can be manipulated, but he never lies. A modern day Jubilee has come to Wall Street. The unfolding global debt collapse will force the old order to pass away. The central banks want inflation, but their objective of global inflation has just failed a major test. A new economy will rise on the other side of the global debt disaster that looms.

Price convulsions indicate that major global change is in the wind. The central bankers are keeping their options open. They have stopped selling their gold. They are now gold buyers. Digital gold currency (DGC) is in its infancy and ascendency. The global economy is convulsing into something new. The Great Republic is dawning. All the world is the stage, enjoy the drama, and have a great weekend!
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Has The Tsunami In Japan Destroyed The Japanese Economy?

by The Economic Collapse

The entire world is in a state of mourning today as details regarding the horrific damage caused by the massive tsunami in Japan continue to trickle in.  The magnitude 8.9 earthquake that caused the tsunami was the largest earthquake that Japan has ever experienced in modern times.  Waves as high as 30 feet swept over northern Japan.  The tsunami waters reached as far as 6 miles inland, and authorities have already recovered hundreds of dead bodies.  Those of us that have seen footage of this disaster on television will never forget it.  But this nightmare is not over yet.  There have been dozens of aftershocks, and many of them have been quite large. 

In fact, there have been 19 earthquakes of at least magnitude 6.0 in the area over the last 24 hours.  So what is this disaster going to do to the 3rd largest economy in the world?  Japan already had a national debt that was well over 200 percent of GDP.  Could this be the "tipping point" that pushes the Japanese economy over the edge and into oblivion?

It is hard to assess the full scope of the damage to Japan at this point, but virtually everyone agrees that much of northern Japan is a complete and total disaster area at this point.  Many towns have essentially been destroyed.  Some are estimating that the economic damage from this disaster will be in the hundreds of billions of dollars.  Others believe that the final total will be in the trillions of dollars.

Fortunately, major cities such as Tokyo came through this event relatively unscathed and most of the major manufacturing facilities are not in the areas that were most directly affected by the earthquake and the tsunami.
But let there be no doubt, this was a nation-changing event.  Japan will never quite be the same again.
Also, it isn't just Japan that will be affected by this.  The truth is that economic ripples from this event will be felt all over the world.

An economist from High Frequency Economics, Carl Weinberg, told AFP the following about the economic consequences of this disaster....
"There is no way to assess even the direct damage to Japan's economy or to the global economy. This is a sad day for Japan, and economic aftershocks could affect the whole world's economy."
It is literally going to take months to figure out exactly how much damage has been done.  Let us just hope that we don't see any more major earthquakes in the area.

The Japanese are a very resilient people and the Bank of Japan is already vowing that it will be doing whatever is necessary to ensure the stability of the financial markets.  The Bank of Japan has announced that it is going to provide as much liquidity as necessary to keep the Japanese economy functioning normally.

But the truth is that the Bank of Japan has already been printing money like crazy....

Is a tsunami of new yen really going to solve the economic damage that has been done by the earthquake and the tsunami?

Of course not.

The truth is that the economy of Japan was already deeply struggling before this disaster.

The national debt of Japan is now well over 200% of GDP and there seems to be no doubt that they will need to borrow massive amounts of money to deal with the aftermath of this crisis.

Up until now the Japanese government has been able to borrow money at ultra-low interest rates of around 1.30 percent for 10-year bonds, drawing on a huge pool of savings from its own citizens.

But in light of what has just happened, will the citizens of Japan still have enough resources to continue to fund the rampant spending of the Japanese government?

At this point, it is estimated that this gigantic mountain of debt breaks down to 7.5 million yen for every single citizen of Japan.

Politicians in Japan have been pledging for years to do something about all of this debt, but nobody has been able to make much progress.

Even before this disaster, the major credit rating agencies were warning that they may have to downgrade Japanese government debt.  The earthquake and the tsunami are certainly not going to make the Japanese even more credit-worthy.

Hideo Kumano, the chief economist at Dai-ichi Life Research Institute, has said that a "tipping point" will come when world financial markets finally recognize that the government of Japan simply cannot afford to service its debt any longer....
"It's hard to predict when the bond market might collapse, but it would happen when the market judges that Japan's ability to finance its debt is not sustainable anymore."
Is the massive tsunami that just hit Japan such a tipping point?

Other countries such as Greece and Ireland would have already collapsed if it had not been for the massive international bailouts that they received.

So who is going to bail Japan out?

This could potentially be one of the greatest economic disasters that the world has seen since World War 2.
With the world already on the verge of a major financial collapse, this is the last thing that world financial markets needed.

In fact, much of the rest of the world had been hoping that an influx of capital from Japan would help to stabilize things.

For example, Japanese insurance companies had recently announced that they were planning on buying up lots of European sovereign debt, but now obviously those plans are on hold.  As a result of this disaster, Japanese insurance companies will be forced to sell off assets like crazy in order to pay settlements.  But as Zero Hedge is correctly pointing out, without Japanese financial institutions stepping in to soak up Eurozone bonds this is going to make the European sovereign debt crisis even worse.

But right now the focus in on the devastation in Japan.  At the moment it is unclear how much of the economic infrastructure of Japan has survived.

For example, as USA Today is reporting, some factories cannot even be reached by phone at this point....
Toyota's phone calls to its plants in affected areas were not being answered, said Shiori Hashimoto, a spokeswoman in Tokyo. The Toyota City-based carmaker began production at a new plant in Miyagi this year that makes Yaris compact cars and has capacity to make 120,000 vehicles a year.
What is clear is that the cost of recovering and rebuilding after this disaster is going to put extraordinary financial stress on the Japanese government.

Julian Jessop of Capital Economics certainly does not sound optimistic about what this is going to mean for the Japanese economy....
"Japan's economic recovery has lost momentum and a large part of the reconstruction costs will add to the government's significant debt burden."
Hopefully the full extent of the damage is not as bad as many are now fearing.

But the truth is that this is a huge, huge event for a world economy that was already on the verge of collapse.
May our thoughts and our prayers be with the Japanese people at this time.

This is truly one of the biggest disasters that any of us have ever seen, and Japan will never be the same again.

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