I’ve had a fair amount of luck fending off fears of high inflation in recent years (see here) and getting the inflation trend right (at least directionally during the last few years of the deflation, inflation, disinflation, inflation sea-saw).  Understanding the balance sheet recession and its impacts on the monetary system have been key to this outlook.  If you understood the deleveraging story and the fact that banks don’t lend reserves then you knew that the QE’s  were not going to be inflationary.  You further understood that the massive deficit was merely masking the underlying turmoil occurring at the consumer level.

Late last year I put together a timeline for QE3 (see here) and why I believe there is a high probability of QE3 coming this summer at the June FOMC meeting.  My thinking is simple – the Fed doesn’t want to introduce new “stimulative” policy while the rate of inflation remains above their 2% target so we’re unlikely to see further policy action until inflation resides a bit.  I think there’s the potential for this to happen in H1 this year.

To understand my thinking we need to start with the various types of inflation – demand-pull inflation and cost-push inflation.  As of now, demand-pull inflation appears like a low probability event.  Although recent data has shown economic improvement there are still high levels of spare capacity, relatively low capacity utilization rates and generally tepid demand for goods (aggregate demand is still very weak).  The large budget deficit is contributing to the demand pull story by helping consumers to continue spending while also deleveraging, but the two combine to equal a modest positive for the economy as a whole.

The cost push inflation debate can be answered in one story – jobs.  The majority of cost-push inflation is generally due to labor (although oil prices are a growing risk as discussed below).  As of now, labor remains weak  and the unemployment rate is only slowly declining.  The SF Fed sees unemployment remaining above 8% this year.  The consumer earnings story is pretty uniform across the economy.  Hourly earnings are nearing their lows and real disposable income continues to decline so core inflation is likely to remain depressed:


If you’re looking for a big rebound in these data sets (and much higher inflation) you should probably own a leveraged portfolio of stocks because that would likely be accompanied by a sizable economic boom.  While the labor market is picking up steam the signs are tepid at best given the maturity of this recovery.

The most important component in headline inflation in recent years has been motor fuel.  I’ve highlighted this on several occasions noting the discrepancy in headline and core inflation.  You can see the close correlation between headline and motor fuel prices:


The story here is an interesting one.   Last year’s oil scare from the Middle East uprisings caused a huge spike in fuel prices.  Gasoline prices peaked near $3.40 before falling to $2.50 later in the year.  The latest price of $2.75 means prices would have to rally 24% in the next 3 months just to create a 0% YoY climb in fuel prices in April.   I’m not saying that’s impossible and I’ve previously stated my bullish stance on oil in general (as a hedge against exactly this), but for the inflation story the picture is clear.  The YoY rate of fuel prices is going to decline between now and April unless turmoil causes a huge rally.  That means headline inflation is highly likely to experience a brief bout of disinflation between now and the May data set.

I think that could set the table for increasing QE3 talk at the June meeting as the economy is likely to remain weak and fears of a slowing global economy and tepid labor market provoke Fed action.

In sum – prepare for a brief bout of disinflation likely taking the headline rate below 3% before stabilizing just when the Fed thinks it needs to intervene.  The major risk to this outlook is further turmoil in the Middle East in which case fuel prices could rally enormously leaving my theory dead in the water.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • CharlesH

    Nice. Thanks CR.

  • Junkie

    So assuming you were to trade your expectation (ie, lower inflation for H1, moving into QE3 for H2), what would you do?

    If you think inflation is dropping then the key beneficiary of that is fixed income as real rates go up. Treasuries, however, are already trading close to their all-time highs (primarily on the back of European fears I suspect). So, do you buy treasuries, or other fixed income?

    Obviously, in Q2 you would start selling fixed income and building a stock portfolio, in preparation for QE3.

    And what to do about oil in the meantime? You’ve said to hedge this but if you’re expecting oil prices to drop then, if you’re right, this will eat into your profits. So how do you hedge this – with options, ie a volatility hedge?

    You’ve got a pretty specific/clear market view here. I just wish I knew enough to know how one would actually express that view in the markets, if one wanted to do so.

    ps, your algo recently triggered a sale. That looked very prescient for the next 48 hours or so – however, in the last 24 hours, risk seems to be back on. eg, S&P500 futures cracking 1,300. How often is your algo updated? Does it only signal medium/long-term moves, or does it cover shorter-term stuff as well?

  • http://jerrykhachoyan.com TheArmoTrader

    Cullen, I know having deflation is generally bad in the long term, but speaking short term, won’t it be better to have lower prices in goods (and a stable dollar) in a time of deleveraging?
    Especially since consumption is > 2/3rds of GDP.
    Won’t that help US consumer? I’m not saying we should have negative or 0% inflation, but I think keeping it keeping it in the 1-2% range sounds reasonable. Won’t that technically “put more money into the pockets” of Consumers, thus speeding up the deleveraging process?
    This is one of the reason’s I am against QE3 (besides the fact that it wont do anything), because it will uselessly bid up commodity prices.

    What do you think?

  • Jenkins

    Where is Cullen’s algo?

  • Brick

    Interesting ideas and from a monetary policy point of view, I would largely agree, but would have some quibbles around some ideas.

    First up would be which direction oil prices will go. There is an argument that a downturn in Europe will allow oil prices to drop and perhaps some speculation will leave the oil markets. This is most likely true but I think there are other competing factors as well. For instance the partial shutdowns in oil production in Nigeria. My other query would be around the effects of price capping of final distilates (gas) in certain countries. We know that as oil prices rise on demand in India for example that it becomes uneconomic for refiners to refine and they stop. This suppresses availability and consumption with the end result that final distilate prices cap tend to rise to keep the economy growing. That tends to cause the oil price floor to rise and a bump in consumption. Combining all these factors is difficult, but I would point to two trends which have me worried, one anecdotal in that the oil industry hiring has slowed to a crawl and the other that the EIA has been reporting a decline in oil stocks at cushing since mid way through 2011. Essentially your graph for motor fuel price indexes does not contain the last few months data and extrapolating without that data might be risky.Not that I think it makes much difference to headline inflation over the short term as you correctly point out, but since cpi is strongly linked to oil prices, I am not so sure about further out.

    Next up is the question surrounding whether QE is inflationary or not. My personal guess is that it is both inflationary and deflationary, but in different areas. The key I think is not whether it is an expansion of the monetary base but how it affects the velocity in certain assets. Buying a sizable chunk of any asset probably means some are out of circulation and the velocity of that asset reduces. Contrastingly that asset may not have been very liquid and buying it enables investment into more liquid assets, increasing velocity in the alternative asset until it becomes scarce. The net effect on inflation is minimal but it alters investment preferences away from the real economy into commodities, sovereign debt and agency debt.

    The next round of QE will most likely be structured differently and assuming the net inflationary effect will be zero seems unlikely to me. I would expect them to target house prices and rents, which will impact deflationary forces but be negative for disposable income.

    Ask yourself some difficult question based on those graphs
    1) Why is disposable income dropping as gas prices drop recently.
    2) Why is disposable income not linked to inflation very well.
    3) Why are hourly earnings not linked to disposable income over the last year .

    You might come up with the idea that using inflation and GDP to measure the state of the real economy might have questionable usefullness. You might also question whether altering liquidity in selective parts of the economy might not be detrimental to the part of the economy most of us live in. Perhaps more interesting will be what happens to Inflation when the Fed has to finally exit accomodative policy.

  • http://howfiatdies.blogspot.com Vincent Cate

    Do you think there has been any example of “cost push” or “demand pull” inflation where there was not a bunch of new money created in the previous 3 years? Friedman did studies and it really seems inflation comes from new money creation.

  • Darial

    Does population growth also factor into the inflation rate?

  • Alberto

    CR thanks for this great post…

    But what will happen if oil goes to 55$ ?

    Absurd ? Absolutely not. An extremely interesting paper by Chris Cook former compliance and market supervision director of the International Petroleum Exchange goes deep in one of the greatest and most opaque market in the world. This is the incipit:

    “All is not as it appears in the global oil markets, which in my view have become entirely dysfunctional and no longer fit for its purpose. I believe that the market price is about to collapse as it did in 2008 and that this will mark the end of an era in which the market has been run by and on behalf of trading and financial intermediaries…”

    And this is the link:


    This is another extremely interesting one on the same argument:


    MUST READ, food for brains.

  • wh10

    Vincent, how many years until you’re willing to say your hyperinflation call was wrong?

  • http://howfiatdies.blogspot.com Vincent Cate

    Gold is up 100% in a bit over 2 years. Inflation is 3.5%. Are you getting 0.5% on Treasuries and thinking you are right? You understand the real value of such Treasuries is going down 3% each year? More if you calculate inflation rates on the things we really buy. A guaranteed loss is a bad investment. Really.

    I think the US dollar will get hyperinflation in the next 3 years, but I will still feel right if it takes 4 or 5.

  • http://www.pragcap.com Cullen Roche

    Tsys were up 35% last year….

  • wh10

    That’s fine. I really was just asking the time frame you had in mind.

    BTW, we’ve gone through several extended periods of real negative rates on US debt in the past without hyperinflation.

  • http://howfiatdies.blogspot.com Vincent Cate

    Cullen, are you in long term Treasuries?

  • http://howfiatdies.blogspot.com Vincent Cate

    The only time before that we had debt and deficit levels that were near the danger levels was during WW2. But as soon as the war ended and they cut the military the deficit was gone. Without a deficit even the current debt level would not be dangerous. So you have to go back to the hyperinflations of the Revolutionary War or Civil War to see these kinds of levels.

  • http://howfiatdies.blogspot.com Vincent Cate

    The current inflation rate is not a predictor of hyperinflation. You often have deflation right before hyperinflation. I think it is like the tide going out before a tsunami hits. To make a really big wave it helps to start out moving the other direction.

    I don’t think negative real interest rates are a predictor for hyperinflation but I am not sure.

    The main predictor for hyperinflation is debt over 80% of GNP and deficits over 40% of spending.

  • http://howfiatdies.blogspot.com Vincent Cate

    Central bankers and government economists always try to shift the blame for inflation away from the creation of new money. So they like to say things like “cost push inflation” and “demand pull inflation”. But I thought the MMT position was that the “monopoly issuer of a currency is responsible for its value”. Don’t MMT people take the view that if inflation is getting too high the government needs to cut back spending or increase taxes?

  • wh10

    Why are you resistant to the concept of comparing deficits to productive capacity? Do you not think there is a difference if we’re running massive deficits at 10% unemployment vs full employment?

    What do you mean by “40% of spending?”

    Mosler said some interesting things here: http://moslereconomics.com/2011/11/14/it-must-be-impossible-for-the-fed-to-create-inflation/

    “Turns out it was those pesky war reparations that caused government deficit spending to soar to something like 50% of GDP annually, with most of that whopping deficit spending used to sell the German currency and buy foreign currency to pay their war reparations.”

    “Applying this to the US to replicate the Wiemar inflation Congress would have to increase the deficit to about $8 trillion a year and then sell those dollars continuously in the market place, using them to buy the likes of yen, euro, and pounds. And replicating Zimbabwe would mean some kind of disaster that wiped out 80% of our real productive capacity and then continuing to spend federal dollars as if that never happened.”

  • http://www.pragcap.com Cullen Roche

    Oh Vincent. Still betting on hyperinflation?

  • http://www.pragcap.com Cullen Roche

    Not anymore. But I was for most of last year….And I’ll likely be a buyer when yields move a bit higher….

  • http://www.pragcap.com Cullen Roche

    I’ll have a read. Thanks.

  • Willy2

    I agree. Deflation could precede Hyper-Inflation.
    I agree, the higher the debtload the higher the probability of Hyper-Inflation. But first we need to see the destruction of A LOT OF credit instruments. Because Deflation equals “”Credit destruction””. And when A LOT OF credit has been destroyed then the FED could decide to literally print banknotes, in an attempt to facilitate financial transactions. And then and only then Hyper-Inflation could take hold.

    Sources: Robert Prechter, Hugh Hendry, Bob Hoye.

  • Willy2

    QE3 won’t work with China, Europe, the US in “”recession””, a USD rising and stock- and commodity markets falling. QE3 will only work when one or more asset classes are rising or remaining flat. Like it failed in the second half of 2008. Bazooka of no Bazooka. MMT or no MMT.

    A source I highly respect predicts that in the US the bond vigilantes will show up in 2012. He expects the TNX and the TYX futures to drop (at least) 20 points in 2012. If that happens then I expect to “”break all hell loose””. And foreigners could/will dump their long term US debt if they see such a rise in yields. But this won’t be as a result of (Hyper-)inflation. Like I have said before , it’s one way of credit destruction (=deflation).

  • http://howfiatdies.blogspot.com Vincent Cate

    Yes Cullen. I still think the US dollar is headed for hyperinflation. To be fair, I also think the Yen and the Pound probably will also get hyperinflation. The Euro I am not so sure about either way.

  • http://howfiatdies.blogspot.com Vincent Cate

    War reparations were only 11.8% of the German governments budget in 1921. After they destroyed their economy with hyperinflation then it was worse.


    The Bernholz numbers are debt over 80% of GNP and deficit over 40% of government spending. If it were 50% it would mean they had to borrow or print half of what they spend. Another way to look at it is they spend nearly twice what the collect in taxes.

  • Pierce Inverarity

    We aren’t on the gold standard any longer, Vincent. Besides, the government “debt” you talk about isn’t the same kind of debt that you or I have. It’s a private sector savings instrument.

  • http://howfiatdies.blogspot.com Vincent Cate

    Cullen. I want to try again. :-)

    Imagine a first case where the US government collects $1 trillion from selling 10 year bonds and then 10 years later pays that back. We agree that the bonds are not used to fund the government. So conceptually they could burn the $1 trillion collected and then print a new $1 trillion 10 years later.

    Now imagine a second case where the government puts in some special temporary taxes that collect $1 trillion and then 10 years later gives out $1 trillion in stimulus checks.

    In this second case you would agree that taxes reduce aggregate demand and so lower inflationary pressures. And after the $1 trillion stimulus checks there would be an increase in inflationary pressure.

    As far as the impact on money in circulation and inflationary pressure why don’t you agree that the two cases are equivalent?

  • jswede

    Cullen, Mish has a good post on inflation / money supply as of this AM. He gets started completely on the wrong foot, but from there it’s a pretty good post – as far as non-(post)MMT goes, anyhow.


  • Pierce Inverarity

    The Fed does not print the banknotes. That’s the Treasury’s job.

  • wh10

    Would you like to comment on my point about spending relative to productivity?

  • Ben Wolf

    Not to answer for Cullen, but deflation means a contraction of the money supply and an increase in the purchasing power of the remaining dollars. Assuming someone owes a mortgage debt of $250,000, this would mean downward pressure on that person’s salary or wages. So they have fewer dollars available to repay their mortgage which slows the deleveraging process. Inflation on the other hand means more dollars available and upward pressure on salaries and wages. That the purchasing power of each dollar falls is irrelevant to the debtor because his debt is fixed at $250,000 and the number of dollars he receives for his work is increasing. It’s more complicated than what I’ve just described but the basic principles old.

    If we really wanted to assist deleveraging in aggregate we’d be stimulating inflation further by increasing the money supply through additional government spending.

  • Geoff


    Calling for hyperinflation in the US, UK and Japan is pretty aggressive considering none of those countries have any foreign denominated debt.

  • http://www.pragcap.com Cullen Roche

    Are you arguing that a man with $1MM in tsy bonds has lower buying power than a man with $1MM in cash?

  • Octavio Richetta

    “My algo generally covers a 6-8 week trade. It’s equities specific so no commodities, bonds or other instruments. And I don’t really detail investment options because I have clients who rely on me to keep my cards near my chest so they benefit. Sorry.”

    Makes sense. Have you looked into the Ivy portfolio? I found out about it via D. short. According to him, from all the stuff he looks at they seem to have something going.

  • http://www.pragcap.com Cullen Roche

    Yeah, I’m not really fully sold on the Ivy Portfolio. I like the idea as a fairly passive approach (for those who don’t have time to monitor the markets daily), but I am not sure it’s the alpha generator that it’s advertised to be….

  • wh10

    I’d want Cullen and Fullwiler to take a crack at this, but here’s my take-

    1) The tax is a forced reduction in private sector NFA whereas the bond sale is not
    2) Bond sales do not require a reduction in deposit accounts like you’re imagining (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1825303) and can be funded from credit created out of thin air rather than drawing down upon existing financial assets in a zero-sum fashion. Arbitrage b/w short term rates and long term rates using forward markets to fix debt rollover costs will ensure this; this is what primary dealers and hedge funds run by smarties like Warren Mosler do.
    3) From Fullwiler (http://neweconomicperspectives.blogspot.com/2011/08/coin-seignorage-and-inflation.html):

    “Furthermore, while non-bank sellers of the Treasury securities would now be holding deposits instead of securities, this is also not inflationary. Again, from my previous post:

    “First, sellers of bonds were always able to sell their securities for deposits with or without the Treasury’s intervention given that there are around 20 dealers posting bids at all times. Anyone holding a Treasury Security and desiring to sell it in order to spend more out of current income can do so easily; holders of Treasury Securities are never constrained in spending by the fact that they hold the security instead of a deposit. Further, dealers finance purchases of securities from both the private sector and the Treasury by borrowing in the repo market—that is, via credit creation using securities as collateral. This means there is no ‘taking money from one person to give it to another’ zero sum game when bonds are issued (banks can similarly purchase securities by taking an overdraft in reserve accounts and clearing it at the end of the day in the federal funds market), as what in fact happens is that the existence of the security actually enables more credit creation and is known to regularly facilitate credit creation in money markets that are a multiple of face value. Removing the security from circulation eliminates the ability for it to be leveraged many times over in money markets.”

    “Second, the seller of the security now holding a deposit is earning less interest and can convert the deposit to an interest earning balance. Just as one holding a Treasury can easily sell, one holding a deposit can easily find interest earning alternatives. Some make the argument that the security can decline in value and so this is not the same as holding a deposit, but this unwittingly supports my point that holders of deposits aren’t necessarily doing so to spend. Deposits don’t spend themselves, after all.”

    “Third, these operations by the Treasury create no new net financial assets for the non-government sector (and can in fact reduce its net saving by reducing interest paid on the national debt as bonds are replaced by reserve balances earning 0.25%). Any increase in aggregate spending would thereby require the private sector to spend more out of existing income, or to dis-save, as opposed to doing additional spending out of additional income. The commonly held view that ‘more money’ necessarily creates spending confuses ‘more money’ with ‘more income.’ QE—whether ‘Fed style’ or ‘Treasury style’—creates the former via an asset swap; on the other hand, a true helicopter drop would create the latter as it raises the net financial assets of the private sector. Again, ‘money’ doesn’t spend itself. By definition, spending more out of existing income is a re-leveraging of private sector balance sheets. This is highly unlikely in the current balance-sheet recession, aside from the fact that QE again does nothing to facilitate more spending or credit creation beyond what is already possible without QE. The exception is that QE may reduce interest rates, particularly if the Fed or (in this case) the Treasury sets a fixed bid and offers to purchase all bonds offered for sale at that price—though this again may not lead to more credit creation in a balance-sheet recession and has the negative effect of reducing the net interest income of the private sector. (As an aside, a key difficulty neoclassical economists are having at the moment is they do not recognize the difference between a balance-sheet recession and their own flawed understanding of Keynes’s liquidity trap.)”

  • http://howfiatdies.blogspot.com Vincent Cate

    America has had hyperinflation twice before without debt in a foreign currency. They had hyperinflation in the Revolutionary War, remember “not worth a Continental” and then also in the Civil War. MMT people make the claim that you need foreign debt but that is not correct. Foreign debt is the easiest to default on. No voters care. Unless, as in the case of Germany, the French invade if you don’t pay. But that is not the normal situation at all.

  • Octavio Richetta

    It would really be great (or frustrating??? After all the work one puts in in trying to make a buck) if investing boiled-down to looking at 10-month (about 200 trading days) moving averages and getting in/out whenever the investment class, whatever it is, crosses the moving average line.

    They make their in-out move/rebalance at the beginning of the month and calculate the 10-month monthly moving average based on the closing price for the last trade day of the month. They also rebalance at the beginning of the month.

    I read the paper. The strategy looks pretty robust since the 70s. It is just a version of momentum investing do it lags in solid bull markets such as we had in the 80s/90s.


  • Willy2

    Whatever. The overall story remains the same.

  • http://howfiatdies.blogspot.com Vincent Cate

    Really the $1 mil in sty bonds goes up and down in value and is like any other asset but it is not money. A guy with $1 mil in tsy bonds can not spend them at the grocery store. He has to sell them to someone else (like a hot potato in hyperinflation) who can then not buy things at the grocery store. He might be able to borrow against them, but in that case there is someone else who has given up their cash. But this is like a house or any other asset, you must first sell it or borrow against it to get money, then you can spend.

    I am arguing that MMT people all ignore the impact of bonds on demand / inflation. A bond temporarily reduces demand just like a tax and then later a stimulus check. I am asking, what difference as far as money supply or inflation is there in the 2 cases I described? If MMT people understood this then hyperinflation is easy to understand.

  • Willy2

    Ah, another error. The problem is not that the world is not drowning in money but drowning in debt/credit. Compare the amount new credit with the amount of credit/debt. Only the FED can “”print””/create money. Credit can be created by the private sector as well.

  • wh10

    “He might be able to borrow against them, but in that case there is someone else who has given up their cash.”

    100% false in this case of loans from banks. Banks DO NOT lend someone else’s cash, reducing someone else’s spending power. They create the loan deposit out of thin air. If they need to back it with reserves, then they borrow in the interbank market, which the Fed always makes sure has enough reserves to meet demand at their target interest rate. Banks can also borrow if need be from the discount window, which again creates reserves out of thin air. In the medium/longer run, banks reduce borrowing costs by attracting more depositors.

    Also, see what I already posted, from Fullwiler:

    “Further, dealers finance purchases of securities from both the private sector and the Treasury by borrowing in the repo market—that is, via credit creation using securities as collateral. This means there is no ‘taking money from one person to give it to another’ zero sum game when bonds are issued (banks can similarly purchase securities by taking an overdraft in reserve accounts and clearing it at the end of the day in the federal funds market), as what in fact happens is that the existence of the security actually enables more credit creation and is known to regularly facilitate credit creation in money markets that are a multiple of face value. Removing the security from circulation eliminates the ability for it to be leveraged many times over in money markets.”

  • wh10

    Vincent, MMTers understand this quite well. From the MMT perspective, you’re the one messing up the accounting on how taxes vs bond sales affect various measures of the money supply as well as what the ramifications of these changes might be. I posted a large comment with a paper and quotes from Fullwiler for you to consider.

  • Pierce Inverarity

    When you don’t get the facts straight, it makes it harder to believe you actually understand the workings of the American monetary system.

  • Pierce Inverarity

    You are correct, Vincent, but in both those cases we’re talking about war on U.S. soil. They were incredibly disruptive and called into question the legitimacy of their respective governments. If that happens again, yes, we’ll see hyperinflation, which has always been Cullen’s argument. Hyperinflation is NOT a monetary event. It is a loss of faith in a currency, which is co-substantial with a loss of faith in the government.

  • Willy2

    Hyper-Inflation in the UK, US, Japan is quite possible. When (not if) their (domestic) credit markets in those countries have imploded. And Vincent Cate is right whe he points to the Revolutionary War and the Civil War.

    I would like to point to France in the late 1700s. They hadn’t foreign denominated debt either. Yet they experienced hyper-inflation as well. I would say the US is most likely to experience Hyper-Inflation somewhere within the next say 5 to 10 years.

    The foundations for Hyper-Inflation are “”Implosion of credit markets””.

  • jt26

    Remember looking at this a while back and when you look at different time constants (other than 10 month), you can sometimes get very similar performance. Sounds a bit like data snooping, which is a weakness of a lot of the backtest+fitting timing models. Maybe if T=10 mo came out of some power spectrum analysis of industrial production curves or 2s-10s or ….

  • Pierce Inverarity

    Good luck with that bet.

  • Junkie

    … and presumably only US equities, right?

    I wasn’t expecting you to divulge your actual trades, Cullen – but was hoping other PragCap readers might translate for the less experienced among us.

  • SS

    Cullen, I am really psyched to see where you’re headed with Monetary Realism. I always thought you brought the most rational MMT perspective to the table so it will be nice to see you expand your thoughts without constraint from their politics.

  • LRM

    The Ivy portfolio guy, Mebene Faber has a strategic asset allocation fund that did not have a great year but he does have some additional info at his site.

  • http://howfiatdies.blogspot.com Vincent Cate

    I also think Cullen is the most rational of the MMT folks. Some seem rather dogmatic. I really feel Cullen is trying to understand and describe reality. I would rather debate him than others. :-)

  • http://howfiatdies.blogspot.com Vincent Cate

    The hyperinflations in the Revolutionary War and Civil War were with paper money, not a gold standard. All hyperinflations are with paper money. Gold has been money for 5000+ years and has no chance of hyperinflation this year. Most paper money does not last 50 years without hyperinflation destroying the value.

  • Brian

    That or we get 0% interest rates for several decades. With high debt-GDP levels, 0% interest is the only stable equilibrium.

  • Andrew P

    Even if there is a crash in oil prices, the prices will rebound quickly. OPEC is in the driver’s seat and the total supply of exportable oil worldwide can only decrease from now on.

  • Willy2

    Currently I am a deflationist. IF (NOT WHEN) the US starts to literally print LOTS of money (i.e. banknotes) after the upcoming credit market collapse then the US WILL experience Hyper-Inflation.

    But Weimar Germany provides an answer how to stop Hyper-Inflation as well.. And it’s extremely simple. In november 1923 the newly appointed director of the german central bank (Hjalmar Schacht) ordered that the printing presses (which churned out the banknotes) must be stopped. And they presses stopped printing money. And within one or two weeks Hyper-Inflation ended.

  • Willy2

    Deflation is destruction of credit. And that implies rising interest rates (even in the US). MMT or no MMT.

    And foreigners already have started selling their US T-bonds. And that means that the US will be forced to finance its budget deficits domestically.

  • http://howfiatdies.blogspot.com Vincent Cate

    In the Revolutionary War people did not lose faith in George Washington or the revolution. A currency where the government is spending far more than it is taxing can go down in value without the government falling. If anything, the government not being able to spend valuable money causes the government to fall, not the falling government causing the money to fall.

    I think over 1/3rd of the hyperinflations do not involve either war or foreign debt and MMT folks ignore these.

  • http://howfiatdies.blogspot.com Vincent Cate

    While it is true that banks can borrow from the Fed and buy Treasuries and in that case there is no net change in the money outside government, that is not the case I want to look at.

    The historical problem comes when people stop buying bonds and all get cash as the bonds come due. Then you get hyperinflation. Really. History is very clear, if you monetize a debt that is over 80% of GNP you get hyperinflation. But MMT theory does not match experimental results. I think I understand why. They count bonds as money so think there is no difference when the government monetizes the debt. But in reality there is. Bonds need to be viewed as an asset but not money. So when the government sells bonds it temporarily reduces the money supply. Then MMT makes understanding hyperinflation very easy. If lots of short term bonds come due it releases a lot of demand all at once.

  • http://howfiatdies.blogspot.com Vincent Cate

    If the bond buyer did not borrow money from the Fed then there is a reduction in money.

    MMT sees bonds as just a way to control interest rates. But really they also impact the money supply and demand/inflation.

    This is a major problem for MMT accurately matching reality. Cullen seems interested in matching reality.

  • Andrew P

    I could see possible scenarios for either hyperinflation case. Both illustrate the importance of military power in maintaining US currency value.

    (1)If the price of oil went well north of $1000/barrel due to actual global shortage, or a concerted international effort to break the US, the USA could easily be printing $10 trillion a year to pay for imported oil, and that would be enough to drive the dollar down, down, down. This is especially true if oil is denominated in something other than dollars, and could be the fundamental reason the USA goes so hard after any regime that dares to price oil exports in other currencies. It is also one fundamental reason that Iran wants nukes, and why we want to deny them that privilege.

    (2) A nuclear war could eliminate 80% of productive capacity while causing spending to rise dramatically. Especially if the enemy is strategic in their use of EMP – in which case only a few multimegaton bombs exploded in space could do the trick.

  • Andrew P

    I think Vincent is arguing for what happens during a time of rising interest rates. We don’t see this now because rates have been falling for 31 years. Bonds have been an asset that produces only positive returns. But if I have a 10 year bond at 2% and rates jumped to 8%, I can only spend that cash in the grocery store by selling that bond for much less than I paid for it. The only way I can get my nominal money back is to hold it to maturity. If there is a rapidly rising rate environment I may not want to hold it to maturity. If interest rates are zero across the whole yield curve than bonds and cash are exactly equivalent. But in a rising rate environment they are very inequivalent. Also, in a time of rapidly rising rates, the only bonds that are in demand are inflation indexed ones.

    At some point the US will enter another period of rising rates, and based on the past, that era will probably last for 30-40 years. The big question is how long do we have before the direction of rates turns around? My best guess from history is that the turnaround is at most 15 years away, and probably no less than 5 years away.

    So, what could force rates to rise without commensurate economic growth? The Fed will keep rates low unless we get growth or unless it is overwhelmed by an irresistible force. I would bet on the same thing that did it in the 1970s – a massive oil shock.

  • Andrew P

    I think the UK is a much more likely candidate for hyperinflation than Japan. Japan is a very productive exporting country, but the UK is not. The UK also has a massively overleveraged financial sector, an enormous housing bubble that hasn’t fully burst, and a public that is under increasingly severe financial pressure. The UK might also break up with the secession of Scotland soon. The BOE is already doing QE forever, and if there is another financial crash combined with a massive oil shock, the BOE could put those printing presses into high gear just to keep the government afloat and services running. Severe political unrest is also very possible here.

    Btw, France in the late 1700s had a very bloody revolution. Political unrest can destroy productive capacity and lead to hyperinflation.

  • Andrew P

    Brian is right that 0% rates is the only stable equilibrium with high debt/GDP ratios. The Fed could keep interest rates at zero forever, unless an oil shock intervened and forced inflation rates up. I think such an oil shock will probably happen within this decade, and is absolutely certain within 2 decades.

  • Andrew P

    Yes they stopped the presses, but they also stopped paying war reparations.

  • http://howfiatdies.blogspot.com Vincent Cate

    I don’t think people will keep buying bonds if interest rates seem like they will be going up for the next 31 years. As they go up people lose money on bonds. If people stop buying the either the interest rates shoot up till they are a good investment or the Fed buys like crazy which will cause more inflation and more reluctance to buy bonds. It is the kind of situation where you get a bond crash.

    As for 5 or 10 more years till rates start going up, I doubt that very much. Rates are basically at 0% now and can’t go down from here. Once things can’t go down further they usually start going up.

    When the dollar disconnected from gold in 1971 it reduced the real value of the dollar. So oil prices went up in terms of dollars but not in terms of gold. When they print more than a trillion new dollars per year the last few years it will eventually reduce the value of the dollar and oil will go up. But when people blame the Arabs that will not be right.

    Having a big army can be a liability when your problem is that you are spending twice what you get in taxes and your currency is in danger. Obama is trying to make big cuts in the military.

  • Andrew P

    I think 2012 is way too early for a forced run up in US rates. The Fed can buy all T-bond issue this year with no trouble. Even if there is war with Iran, oil supplies are still too plentiful for the sustained price shock that would be required. And I don’t think Iran has the capacity to do a successful EMP attack on the US, but they could probably nuke a US city or two (though I really don’t know). The only think that makes 2012 rising rate scenarios have any credence at all is that Bill Gross has started betting on continued declines in US rates, and he has been consistently wrong of late.

  • Andrew P

    I don’t think that scenario is quite right. Congress could make a political decision to massively increase spending if there was a total credit collapse and soaring unemployment. Congress also controls the total amount of banknotes in circulation. So yes, if there is a complete credit collapse, and unemployment goes to 50%, I could see Congress putting most of the population on the dole, and not caring at all about inflation.

  • http://howfiatdies.blogspot.com Vincent Cate

    Hyperinflation also leads to political unrest. The US Federal government gets the states to pass all kinds of laws by paying them money to do so. If the dollar gets hyperinflation and the Fed does not have the ability to spend twice what it gets in taxes it will not have nearly so much ability to control the states. The constitution does not give it the current level of power. It is just the Fed that has given it so much power. I think there is a real chance that like Scotland leaving England we could see Texas leaving the USA, or other states. If the Federal government is totally broke it may not be in a position to protest. It could be like the USSR and just fall apart.

  • Willy2

    Iran has stopped the development of a nuclear weapon in 2003. It was meant to be a counterweight to the Iraqi nuclear program of the 1980s & 1990s. But that’s something the mainstream propaganda medium (in the US, UK or anywhere else) doesn’t know or doesn’t want you to know.
    The worst scenario for the US is a rising USD and as a result falling commodity prices ( Keywords: Shrinking or Collapsing Trade Deficit.) in combination with rising US deficits.

    When one includes the US mortgage giants Fannie Mae and Freddy Mac then the US debt burden is even larger. These two black holes has cost the US taxpayer already more than 200 billion. So, I am not so sure which country is more burdened with debt: the US or the UK.

    Steve Keen had a blogpost on the debtsituation in the UK in december or january.

  • Willy2

    In the CURRENT situation literally printing banknotes is actually EXTREMELY deflationary because consumers are shell shocked and don’t want to take on more debt. They would use those banknotes to pay down their debts instead (= destruction of credit = deflation). And that’s the force both Congress and the FED are up against. And this force is called “”Mr. Market””.

    GDP = Total Income + change in debt (Source: Steve Keen). US wages are falling and total private debt is contracting. So, GDP is contracting as well.

  • Happy Swede

    Quite plausible scenario, but remember that the gov also can control inflation through decreased spending/increased taxation

  • Pierce Inverarity

    Hyperinflation is CAUSED by political unrest. I swear neither you nor Willy have taken the time to read anything about hyperinflation or Fed operations readily available on this site.

  • wh10

    No Vincent… a bank that makes a loan does NOT take money from someone else that would have spent it. A loan creates a deposit. The Fed only comes into play if it needs to supply a small fraction of that amount in reserves to maintain the target interest rate, but that has no effect on spending power.

    And what do you mean that’s not the case you want to look at? That’s how it works in the real world…

    As far as the your making the assumption that markets will not continue to rollover the debt, Fullwiler has this to say:

    “First, there are these things called primary dealers, who can borrow at the repo rate and fix their costs for any maturity in forwards and buy any Tsy issue that goes above the borrowing costs. And the repo rate–created out of thin air with just a previously issued security as collateral–always arbitrages with the overnight target rate.

    Second, there are these things called hedge funds–like 100s of Warren Moslers–who can (and in the case of Mosler, have and will continue to) borrow at LIBOR and fix this rate at any maturity in swaps or forwards. And LIBOR arbitrages at the overnight target rate, while eurodollars are created out of thin air like any bank loan.

    Third, if the public doesn’t want to hold bonds, there are these things called banks that offer these things called time deposits, and the public can hold these and earn interest at virtually any maturity. And then the bank can hold a Tsy and earn a spread, or it can hold interest earning reserve balances and earn a spread.”

  • ReturnFreeRisk

    “the Fed doesn’t want to introduce new “stimulative” policy while the rate of inflation remains above their 2%”

    The Bernanke Fed (lets include the last few years of Greenspan as well because Bernanke was a BIG influence on it) – has clearly changed the interest rate setting environment for the Fed.
    1) THey do not care as much about inflation – the PCE core deflator was above 2% for 4 straight years and they kept the real rate historically low – leading to a LOT of bad investments.
    2) The FOMC is a LOT more dovish this year and the change in tone by FOMC members early in the year shows that QE3 timetable has moved up to early 2012.

  • Dunce Cap Aficionado


    Can you give these examples MMTers ignore?


  • Paul

    Lol, a $15 trillion economy, a quarter of the world’s output and you think all of a sudden people will lose faith in the dollar and hyperinflation will ensue? What fundamentals are you looking at to come to this conclusion?

  • vimothy


    So why in your view would a person hold cash and not treasuries? It seems like a no-brainer that someone would take the higher yield asset if it has no disadvantages relative to cash.

  • http://howfiatdies.blogspot.com Vincent Cate

    Here is my stuff on hyperinflation in MMT terms. The key difference seems to be that I don’t count a 30 year bond as money. If you currently think it is the same as money then put your money in a 30 year bond and see if it holds its value 5 years from now. I think a bond sale is like a tax and then a stimulus check as far as the impact on the money supply and demand. A bond is an asset not money.


  • http://howfiatdies.blogspot.com Vincent Cate

    Cullen, you seem to be saying you made a 35% profit on your long term bonds last year and also saying that bonds and money are the same thing. If a bond can go up 35% in one year, how can you say it is the same as money? In bond panics leading up to hyperinflation you can easily lose 90% or more of the value of the bond. How can you say it has the same buying power? In the first month of hyperinflation imagine the US has 5% inflation in that one month. The buying power of your dollars will go down 5%. The value of a 30 year bond will drop to about zero.

  • wh10

    When did I ever imply there are no disadvantages? The private sector has various motives for where they place there money. The point is, the system is set up such that there will always be buyers of govt debt at a certain price, and when the mkt perceives the govt to be default free, then interest rates will follow the Fed’s lead.

  • http://www.pragcap.com Cullen Roche

    I made more like 25%, but who’s keeping track. :-) I don’t reject the idea that money can lose or gain in value. Do you? You seem to be saying that cash cannot lose value or fluctuate. Is that right? Sorry if I’ve misinterpreted….

  • vimothy

    Well, it seemed like you were saying that it’s as easy for someone with treasuries to spend as it is for someone with cash. Perhaps I misread you–at times I find it hard to follow the nested comment thread over here–but it does seem like a view that is common to many MMTers, which is why some people think that there aren’t really any inflationary implications of holding the stock of NFA as cash as opposed to bonds.

    Do you disagree with this view? Why do people hold cash instead of bonds?

  • Pierce Inverarity

    Cullen put his money in bonds last year and made 25% in dollar denominated terms. Gold was up about 10% or so, denominated in USD. The USD spot index itself was up about 1.46%. Money’s a flexible thing, Vincent. It’s always a social construct that fluctuates in value depending upon people’s faith and acceptance.

  • rodney

    Vincent. Inflation is spending beyond the production capacity of the country. I can imagine that during the revolutionary war a good portion of the working population were employed in the army and not making stuff. Inflationary. The british were also counterfeiting and spending the continentals. As mentioned in the former, very inflationary. I also beleived taxes were payed in gold and as such the continentals probably traded at a discount.

  • rodney

    weimar germany was trading marks in the fx market to pay reparations which destroyed the currency. Speculators looking for a quick profit didn’t help. The country had little productive capacity left after the war and the french annexing the ruhr.

  • http://exertia.wordpress.com exertia

    Cullen, I find it strange that you never talk about your investment firm on your blog or even basics on how people can get there if they wanted to. I took a long and complicated path that involved going thru your Linkedin profile to figure out the website for the hedge fund you run.

    But even that website does not have any details on the minimums or eligibility criteria for becoming an investor. Its almost like you don’t want any more business :-)

    Would help if you could shed some more light on your fund, I am sure there must be a few HNWI’s in your reader base. Or is it SEC regulations that prevent you from doing so?

  • wh10


    People can’t spend bonds. There, I said it. How does this meaningfully change my argument. Also, see Fullwiler’s quote in my comment at 2:26PM for more on this. BTW, I am not adverse to having my mind changed, but I would implore you to respond directly to my quotes. It will be more convincing, and it this point, I view my argument to be much more sophisticated, nuanced, and well thought out than the ‘hot potato’ theory. I realize the natural interest rate is a greater point of contention.

    More to the point, you have to explain how we get from point A (normal times) to point B (hyperinflation). Vincent disagrees with me since he thinks hyperinflation is coming (I think spending relative to productive capacity squashes his argument) and the mkt controls interest rates/ won’t rollover the debt (I’ve argued why that is false under current constraints and the perception that the US is the monopoly issuer of $).

  • http://howfiatdies.blogspot.com Vincent Cate

    It is not the same currency if it can go up 35% or down 90% relative to that currency. If a 30 year bond has big changes in value relative to dollars then it is not dollars. Now a 30 day bond is very close to being dollars, and in fact will turn into dollars in 30 days. But a 30 year bond at 3% will become worth far less dollars when interest rates get to 10%. So it is not just an accounting entry different than dollars.

    But my real point is that when the government sells $1 trillion in bonds it can burn the money it collects just like it could burn the money it collects from taxes. And when it pays off the bond it could print the money to do so just like it could print the money to give people some stimulus money. So the two situations have the same impact on money supply and inflation.

  • vimothy


    I’m not really talking about the “hot potato theory”. AFAIK, that’s a something which only has currency (yuck, yuck, yuck) in a particular part of the econ-geekosphere. I’m not even that interested in inflation.

    What I am interested in is understanding why anyone would want to hold cash instead of bonds. The implication of Scott Fullwiler’s argument, it seems to me, is that holding wealth in the form of bonds doesn’t make spending any more difficult, and so if the private sector holds a greater portion of its wealth in less liquid liabilities, that doesn’t really matter for things like inflation.

    But then I find the fact that people do hold money rather hard to explain. If I can hold higher yielding instruments that are just as convenient as money, then it seems like that’s the obvious thing to do. So although I think I understand the MMT explanation for why the mix of bonds vs money doesn’t necessarily have any implications for inflation and aggregate demand, I’m struggling to see why we would want to hold money if it were correct.

    Sorry, I realize that this is somewhat tangential to your discussion with Vincent.

  • http://howfiatdies.blogspot.com Vincent Cate

    They don’t have to decide to print like crazy, that is not how hyperinflation happens. The problem is that most of the $15 trillion in debt is short term now and they are spending nearly twice what they get in taxes. If people stop buying the bonds then both paying off the bonds (which could be trillions) and the funding of the deficit really comes from new money. Historically monetizing in such large amounts causes hyperinflation. But it is not that any democratic body every voted for hyperinflation. Circumstances just get out of control.

  • http://howfiatdies.blogspot.com Vincent Cate

    Wikipedia is closed today so one online list is not available. And I can’t seem to put my hands on my Bernholz book. I will try tomorrow to get a list of hyperinflations that don’t fit the standard MMT model for you.

  • http://howfiatdies.blogspot.com Vincent Cate

    0% interest rate is not sustainable. Inflation is higher than that, so anyone who can borrow from the Fed can make money just borrowing and buying commodities. The more people that borrow and buy the more inflation there will be. So the more attractive this borrowing and buying becomes. As long as the Fed holds interest rates at 0% the borrowing and inflation will increase. In fact, even holding interest rates below the inflation rate is not stable. If inflation is 10% and the Fed loans at 5% then it is trivial to borrow and make a profit by buying any inflation hedge. But again, the more people that do that the more inflation there will be. Eventually people will get upset at the inflation and you will need a Volker type that brings interest rates above the inflation rate.

  • http://howfiatdies.blogspot.com Vincent Cate

    But you can not say a 30 year bond is the same as dollars if the value relative to dollars goes up and down. This will be particularly dramatic if he start to get hyperinflation. The real value of the bonds will head toward zero much faster than the value of the dollar does. A 30 year bond has to look 30 years out and once hyperinflation starts it usually kills the currency in a couple years, so a 30 year bond will be basically worthless.

  • http://howfiatdies.blogspot.com Vincent Cate

    Inflation is an increase in the money supply which comes from the government spending more than it takes in from taxes and bond sales. Hyperinflation is where the government can’t stop making new money. If they are spending twice what they get in taxes and have borrowed so much that it becomes clear they have to print, then they may not be able to borrow more. At that point the choices get hard. To really stop printing they have to cut away half of the government budget but that is usually not possible. If they let interest rates go up to attract more bond buyers then the payments on debt over 80% of GNP get crazy bad. If they default then there will be no more bond buyers at all. They end up printing uncontrollably no matter what.