Mish's Global Economic Trend Analysis

BRICs Under Attack: S&P Cuts Brazil's Credit Rating to One Notch Above Speculative
Will Prices Rise Significantly When Velocity of Money Picks Up?
Stupidity is Logical and Understandable; So, How Stupid Will Things Get?
Monetary Perspective on QE and Tapering
China Output Contracts at Quickest Pace in 18 Months

BRICs Under Attack: S&P Cuts Brazil's Credit Rating to One Notch Above Speculative

Posted: 24 Mar 2014 10:24 PM PDT

BRICs (Brazil, Russia, India, and China) cannot seem to get much love lately. Today, it's Brazil's turn to say "show me the love".

Reuters reports S&P Cuts Brazil Credit Rating.

Standard & Poor's cut Brazil's sovereign debt rating closer to speculative territory on Monday in a blow to President Dilma Rousseff, whose efforts to stir the economy from a years-long slump have eroded the country's finances.

Brazil had its long-term debt rating downgraded to BBB minus, the agency's lowest investment-grade rating. S&P changed its outlook to stable from negative, meaning further downgrades are unlikely for now, which will come as a relief for both politicians in Brasilia and financial markets.

The move was widely expected but the timing surprised some investors.

"The downgrade reflects the combination of fiscal slippage, the prospect that fiscal execution will remain weak amid subdued growth in the coming years, a constrained ability to adjust policy ahead of the October presidential elections, and some weakening in Brazil's external accounts," S&P said.

The agency said that fiscal credibility had been "systematically weakened" following cuts in the government's main budget target, and that loans by state-run banks had "undermined policy credibility and transparency."

The Brazilian finance ministry rejected S&P's arguments and said the downgrade contradicted Brazil's solid economic fundamentals and healthy standing compared with other major economies.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Will Prices Rise Significantly When Velocity of Money Picks Up?

Posted: 24 Mar 2014 12:18 PM PDT

Several people have written recently telling me that price inflation is under control only because the velocity of money (the alleged rate at which money circulates) is falling.

Reader Mark pinged me with this statement "Falling velocity is deflationary. It indicates people are saving their cash." Others have expressed similar opinions, typically in reference to this chart by the Fed.

Velocity

Discussion of Ratios

That chart looks ominous. Is it?

First, please note the chart says velocity is a "ratio". A ratio of what?

Velocity = Value of Transactions/Supply of Money.
The value of transactions = Price * Transactions.
In other words
V = (P)(T/M) where where V stands for velocity, P stands for average prices, T stands for volume of transactions, and M stands for the money supply.

Multiplying both sides by M yields the frequently cited equation: M(V) = P(T).

Economists use real GDP as a measure of P(T).
Thus M(V) = GDP. And of course V = GDP/M

The ratio in the above chart is Real GDP/M2. Clearly velocity is falling.

Velocity Theory

The widely presented theory is "prices will rapidly rise if velocity increases." One problem with making such assumptions is in regards to measurement.

What is Money? Is it M1, M2, M3 (discontinued), MZM, TMS1, or TMS2? Each one will give you a different measure of velocity. The Fed provides Three Measures of Velocity.

And what about GDP? Recall that government spending, no matter how useless, adds to GDP. If the government paid people to spit at the moon it would add to GDP by definition. And as stupid as that sounds, it would have been less destructive than bombing Iraq to smithereens, making enemies in the process, and reducing the supply of oil at the same time.

If GDP is debatable and money is debatable, and prices cannot be precisely measured in the first place, can velocity mean much?

Three Important Statements Regarding Velocity

Velocity is falling because money supply is rising faster than GDP.
If the Fed stops printing (more precisely if money supply is constant) and GDP goes up, velocity will go up automatically. Prices could actually drop with rising velocity if the volume of transactions goes up enough to make up for it!
As an implied result of statements one and two, we can correctly deduce that rising or falling velocity will not cause anything in particular to happen to prices.

Is Velocity Like Magic?

Also consider some similar observations made by Frank Shostak in the Mises Daily article Is Velocity Like Magic?

Velocity Has Nothing To Do With the Purchasing Power of Money

Does velocity have anything to do with prices of goods? Prices are the outcome of individuals' purposeful actions. Thus John the baker believes that he will raise his living standard by exchanging his ten loaves of bread for $10, which will enable him to purchase 5kg of potatoes from Bob the potato farmer. Likewise, Bob has concluded that by means of $10 he will be able to secure the purchase of 10kg of sugar, which he believes will raise his living standard.

By entering an exchange, both John and Bob are able to realize their goals and thus promote their respective well-being. In other words, John had agreed that it is a good deal to exchange ten loaves of bread for $10, for it will enable him to procure 5kg of potatoes. Likewise, Bob had concluded that $10 for his 5kg of potatoes is a good price for it will enable him to secure 10kg of sugar. Observe that price is the outcome of different ends, hence the different importance that both parties to a trade assign to means.

In short, it is individuals' purposeful actions that determine the prices of goods and not some mythical notion of velocity.

Consequently, the fact that so-called velocity is "3" or any other number has nothing to do with average prices and the average purchasing power of money as such. Moreover, the average purchasing power of money cannot even be established. For instance, in a transaction, the price of $1 was established as one loaf of bread. In another transaction, the price of $1 was established as 0.5kg of potatoes, while in the third transaction the price is 1kg of sugar. Observe that, since bread, potatoes, and sugar are not commensurable, no average price of money can be established.

Now, if the average price of money can't be established, it means that the average price of goods can't be established either. Consequently, the entire equation of exchange falls apart. In short, conceptually, the whole thing is not a tenable proposition, and covering a fallacy in mathematical clothing cannot make it less fallacious.

Velocity Does Not Have an Independent Existence

Contrary to mainstream economics, velocity does not have a "life of its own." It is not an independent entity--it is always value of transactions P(T) divided into money M, i.e., P(T/M). On this Rothbard wrote: "But it is absurd to dignify any quantity with a place in an equation unless it can be defined independently of the other terms in the equation." (Man, Economy, and State, p. 735)

Since V is P(T/M), it follows that the equation of exchange is reduced to M(PxT)/M = P(T), which is reduced to P(T) = P(T), and this is not a very interesting truism. It is like stating that $10=$10, and this tautology conveys no new knowledge of economic facts.

Conclusion

Most of the discussion to date regarding the velocity of money has been ridiculous.

Velocity can rise when prices are going up
Velocity can fall when prices are going up
Velocity can rise when prices are falling
Velocity can fall when prices are falling

Given GDP = P(T), you can repeat the above four statements substituting GDP for prices. Doing so, please note that rising prices with falling GDP would be the dreaded stagflation scenario, something Keynesian theory once suggested was "impossible".

In short, it may very well be that prices rise with rising velocity, but they may also rise with falling velocity. Thus ...

Velocity is an essentially meaningless result in an essentially meaningless equation. Rising or falling velocity will not cause anything to happen.

Yet, the debate over the importance of velocity rages on.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Stupidity is Logical and Understandable; So, How Stupid Will Things Get?

Posted: 24 Mar 2014 11:10 AM PDT

As president Obama arrives in Europe to meet German chancellor Angela Merkel, Pressure mounts on Merkel Over Sanctions in Ukraine Crisis.

When Angela Merkel, the German chancellor, meets Barack Obama, US president, at The Hague nuclear security summit on Monday, she will come under pressure to back economic sanctions against Russia.

Meanwhile, in Germany, belief is growing among top policy makers that economic penalties might soon come. Norbert Röttgen, chairman of the Bundestag's foreign affairs committee and a leading member of Ms Merkel's CDU party, said in a newspaper interview on Sunday that "further western sanctions, including economic sanctions" were "inevitable".

Günther Oettinger, German EU energy commissioner, late last week called for the imposition of economic sanctions on Russia in response to the annexation of Crimea, even without waiting for further aggression from Moscow.

"I consider sanctions, which hit economic relations, involving exports, imports and investment, as logical and understandable," the senior CDU politician told Die Welt newspaper.

But those doing business with Russia have not given up the fight. Eckhard Cordes, the head of the Eastern Committee, the powerful Russia-oriented business lobby, argued, in an interview on Friday with Handelsblatt, the business daily, that sanctions on Russia would not work.

"We have a strategic partnership . . . to bring our peoples together," Mr Cordes said. "And now we want to cover ourselves with sanctions? I find that difficult to imagine."

Stupidity is Never Difficult to Imagine

Cordes finds sanctions "difficult to imagine" but Merkel's CDU party chief says further sanctions are "inevitable".

Upping the ante, German EU energy commissioner, Oettinger, a ranking CDU politician wants increased sanctions without waiting for further aggression from Moscow. Oettinger says sanctions, which hit economic relations, involving exports, imports and investment are "logical and understandable"

Since sanctions won't work and are a sure-fire Negative Sum Game, this is what Oettinger is really saying: "Stupidity is Logical and Understandable".

Russia Imposes Sanctions on 13 Canadians, Including MPs

While waiting for inevitable stupidity from Germany, the Globe and Mail reports Russia imposes sanctions on 13 Canadians, including MPs.

The Russian government has banned entry to 13 Canadian senior civil servants and politicians in retaliation for punitive actions that Ottawa levied on Moscow elite over the annexation of Crimea and the destabilization of Ukraine.

The largely symbolic sanctions, which do not target Prime Minister Stephen Harper or Foreign Affairs Minister John Baird, come hours before the Group of Seven is expected to suspend Russia from the G8 and cancel a planned summit in Sochi.

According to a statement circulated by the Russian Foreign Ministry, the list of targeted Canadians includes a handful of senior servants, a couple of senior ranking Conservatives, three Tory backbenchers and outspoken opposition critics.

Mr. Baird called Moscow's tit-for-tat action against Canadian lawmakers and officials a "badge of honour" for Canada in its campaign against the annexation of Crimea.

Stupidity Is ...

Logical
Understandable
Inevitable
A Badge of Honor

With all that going for stupidity, especially with major egos involved (see Buffoon Bluffery; What are Sanctions Really About?), no one can precisely answer the question "How stupid will things get?"

Here's one thing we do know for sure: Failure is Truly Success!

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Monetary Perspective on QE and Tapering

Posted: 24 Mar 2014 01:42 AM PDT

In Reflections on the Yellen Taper-Hike Announcement; What Does the Fed Know? I quoted the opinion of Saxo Bank Chief economist Steen Jakobsen.

Steen commented "Please, do not think for one minute that FOMC have any clue about the economy six months from and even less so looking into 2015."

I am certainly in agreement with Steen, and gave my own look into what the Fed knew or didn't in Hilarious Transcripts of Fed Minutes from 2008 Reveal Completely Clueless Fed.

Opinions aside, let's take a look at facts from a monetary point of view.

My friend "BC" pinged me with the following chart.

Monetary Base vs. Loans and Leases

click on any chart for sharper image

Note that the adjusted monetary base is playing catchup to loans and leases of all commercial banks.

When that happens, and I believe it will, taper or no taper, will base money be sufficient to cover all credit?

Not quite. Taking a lead from "BC", here is a chart I put together.

Credit Market Instruments Liability vs. Monetary Base

This is precisely what fractional reserve lending has wrought. Total credit liabilities approach $60 trillion. Those liabilities are backed up by about $4 trillion in base money supply.

Some people might object the above chart reflects money substitutes and not money. Fair enough. So how much base money covers checking and savings accounts?

Monetary Base vs. Checking Plus Savings Accounts

Some readers will recognize the above chart as True Money Supply "TMS2" vs. Base Money Supply.
TMS2 consists of currency plus all the individual components of checking and savings deposits.

In terms of how much base money covers savings and checking accounts, you can see about $6 trillion is missing. Loans and Leases are another matter as is Total Credit Liability.

So when the Fed says it will "taper", let me ask some simple questions:

In what timeframe?
For how long before the next monetary expansion happens?
What happens in the event of a recession or even a serious global slowdown?
What will other central banks do?

Bonus Question: What is this likely to mean for gold?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

China Output Contracts at Quickest Pace in 18 Months

Posted: 23 Mar 2014 11:58 PM PDT

The HSBC Flash China Manufacturing PMI shows Output Contracts at Quickest Pace in 18 Months. The overall PMI index, new orders, and production were all lower.

Key points

Flash China Manufacturing PMI™ at 48.1 in March (48.5 in February). Eight-month low.
Flash China Manufacturing Output Index at 47.3 in March (48.8 in February). Eighteen-month low.

Commenting on the Flash China Manufacturing PMI survey, Hongbin Qu, Chief Economist, China & Co - Head of Asian Economic Research at HSBC said: "The HSBC Flash China Manufacturing PMI reading for March suggests that China's growth momentum continued to slow down. Weakness is broadly-based with domestic demand softening further. We expect Beijing to launch a series of policy measures to stabilize growth. Likely options include lowering entry barriers for private investment, targeted spending on subways, air-cleaning and public housing, and guiding lending rates lower."

In the face of an explosion of credit, still growing imbalances, malinvestments, property and other bubbles, it is a mystery why anyone expects China to make efforts to "stabilize growth".

To stabilize growth implies more bad loans and more SOE malinvestment. Given China's massive housing vacancies, support for still more housing is ridiculous.

More malinvestment is possible of course, but the longer China attempts to keep the credit party going, the worse the ultimate implosion.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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Mish's Global Economic Trend Analysis

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