Chingo De Dinero

This past week the Fed mentioned they would purchase 300 MUSD in Treasuries, big deal, can’t impact me much, right?  Not really, the first thing you have to understand is to buy the 300 MUSD in Treasuries the Fed needs to pay…how do they do this, they “make” the money.  Yeah, that’s right, they just make the money.  Can they do this, why not?  They are in charge of the money supply.

So, now that you know how the Treasuries are bought, what is the effect?  Well, now there are 300 MUSD more dollars out there.  This money trickless down to people and given the great consumers we are, it will be spent.  With more people spending, sellers of goods can raise price.  BAM, inflation.  Will 300 MUSD alone cause inflation, no, but coupled with a lot of other factors, we could be in for some trouble.

What really gets to me is how I interpret this response to help the economy…spend our way out of it.  This can work in the short term, if not abused, but when you do it over and over and over, people are going to smarten up and stop selling, because in the end they are never going to actually get their return.  The easiest way for this to happen is a depreciation in the dollar vs other countries, which keeping Dollar output constant will result in losing ground vs others.

Of course, other countries are doing the same stuff, so relative we may be better off, none the less I would like to take the pain now, adjust consumption to what we really value, a shift the economy to improve this type of production.  The market is amazing efficient at this, especially compared to the government.

If you have followed the Yen lately, you might have heard the reason for its appreciation is the unwinding of the carry trade.  The main idea for the carry trade on currencies is to borrow in one currency, transfer to another, invest, then in the future, transfer the funds back to pay off the loan, and you will have some left over.  The reason for the leftover is the higher interest rates in the currency you invest in over the one you borrow in.  This was popular with the Yen and Dollar because the Yen rates were so low, and the risk of default for the Dollar are so low.  This works, and is very profitable as long as the currency you borrow in does not appreciate vs the one you invest.  Since Japan wanted to keep their currency weak to help exporters, investors could get a big paycheck.

This has since changed a little since the Yen has appreciated greatly vs the Dollar.  This means that investors started to lose money, which resulted into them closing their position…ie sell Dollars to buy Yen, which resulted in more appreciation.  In the end, a plan that seemed safe and highly profitable turns into a big money loser.

The key to a good carry trade is to find a safe currency which should keep its strength and pays a good rate, and a currency which has a government who wishes to keep it from appreciating, and has a very low interest rate for borrowers.

What came first, the chicken or the egg?  The difference between Keynes and Say is about what same, what drive the economy supply or demand.  If you do not know these two guys, I recommend looking them up real quick, it will shed some light on what the government is trying to do now.

For the last few decades the Keynes argument has been followed, increase money supplier, increase demand, speed up the economy.  Or do the opposite to slow down the economy.  This is what the government does when it lowers or raises the interest rates (a certain interest rate).  It is also the goal of the increase in infustructure speeding which is being talked about now.  In the past this has worked pretty well to control changes in the business cycle.  Hopefully since it is clear that this is what the government will use now, lets hope it works in the future too.

The other way of thinking is from Say, which thinks that supply is the more important factor.  When the economy slows down, it is not due to a lack of demand, but a shift in what is supplied.  In other words, the wrong items are being supplied, and a shift is taking place to stop producing the current items, and produce the other items.  If this is true, we are pretty much at full employeement at all times, only have structural unemployement which involves moving to different jobs, with different skill sets.  It this correct, could be, there are lots of places hiring for the people with the right skills, even as unemployement grows.  You will end up getting in the descussion what is full-employement.  We all know it should not be 0%, there will always be some unemployeement, but I think it is agreed that it is not 10%.  Also, I would say the number is moving, at some times, the shift in production is low, at others, it is high, I think between 3 and 8 is a reasonable range.  If this is true, the government is doing the wrong thing, instead of working to increase demand in certain areas, let production shift naturally, and move towards equalibrium.  Shift production artificially will only result in additional production of goods where they market does not think they should be produced, which is really the will of the people in a free market.  This will result in a decrease in long-term prosperity, with prosperity being people having the maximum amount of utility.

Not to get to deep, it is important to know these two ways of thinking to better understand what the government is trying to do currently.  We many never know for sure if demand drives supply or if supply drives demand, but it is something good to think about so we can try to limit our impact on long-term productivity as much as possible.  By the way, I would also speculate that sometimes demand drives, and other times supply drives…it is a social science.

If you want to make a lot of money in the short term, bet against the Argentinian Peso.

Here is why….

• The country is pretty much socialistic in spite of the mass privatization wave recently.

• One of the main drivers of government revenue, tax on agriculture is going to get hurt very badly with the reduction in grain prices.

• The last default is hanging over their heads, so getting financing for the government is pretty much impossible.

• The government has been spending some of its accumulated reserves defending the currency so far.

All these added up show signs that something will have to happen over the medium term.  In the short, you can see the action to try to take over pension funds as a sign the government is getting desperate for funds.  If this does not work, when revenue from agriculture taxes do not come in, the government will have no choice but to default.  I hate this happens, but if you spend more than you make, eventually you will have to face up to the consequences.

The wildcard for me right now is Venezuela…they are closely aligned, but my guess is will falling oil prices, Venezuela has its own problems, and will have to let its friend fight for itself.

Also, will the IMF step in.  Many South American countries are not the happiest with the IMF, Argentina in particular after the privatization wave, but if they do not come in to help, I have no idea what will happen.

There has already been depreciation in the currency vs the dollar, although not as bad a Brazil, which leads me to think without government support, it would be much worse.  Once the government is not able to support the currency, get ready for a quick and far fall!!!