This Is Bernanke’s Minimum-Wage „Recovery“ In Facts And Figures

A suddenly seemingly hawkish Ben Bernanke may be giving the impression he is preparing to taper because he feels confident enough about the recovery (just don't ask him about sudden dramatic rises in yields: that "puzzles" him). Yet as those who have been reading Zero Hedge for the past three years know, this jobs "recovery" is purely quantitative (not to mention seasonally adjusted): the quality of jobs regained is, in a word, abysmal, with the bulk of new job creation benefiting part-time and minimum-wage jobs. If anything, this loss of saving power, is the backdrop not for a recovery, but for a depression far more acute than the current "sugar-high" one when the Fed finally pulls the training wheels off, and when the US consumer realizes that all purchasing power is gone, all gone, and in exchange the only valuable and competitive job skills gained have been, well, absolutely none.

Here are the facts from the NELP:

During the recession, employment losses occurred throughout the economy, but were concentrated in mid-wage occupations. By contrast, during the recovery, employment gains have been concentrated in lower-wage occupations, which grew 2.7 times as fast as mid-wage and higher-wage occupations. Specifically:

  • Lower-wage occupations were 21 percent of recession losses, but 58 percent of recovery growth.
  • Mid-wage occupations were 60 percent of recession losses, but only 22 percent of recovery growth.
  • Higher-wage occupations were 19 percent of recession job losses, and 20 percent of recovery growth.

2 The lower-wage occupations that grew the most during the recovery include retail salespersons, food preparation workers, laborers and freight workers, waiters and waitresses, personal and home care aides, and office clerks and customer representatives.

3 The unbalanced recession and recovery have meant that the long-term rise in inequality in the U.S. continues. The good jobs deficit is now deeper than it was at the start of the 21st century:

  • Since the first quarter of 2001, employment has grown by 8.7 percent in lower-wage occupations and by 6.6 percent in higher-wage occupations.
  • By contrast, employment in mid-wage occupations has fallen by 7.3.

In addition, the wages paid by these occupations has changed. Between the first quarters of 2001 and 2012, median real wages for lower-wage and mid-wage occupations declined (by 2.1 and 0.2 percent, respectively), but increased for higher-wage occupations (by 4.1 percent).

4 Industry dynamics are playing an important role in shaping the unbalanced recovery. We find that three low-wage industries (food services, retail, and employment services) added 1.7 million jobs over the past two years, fully 43 percent of net employment growth. At the same time, better-paying industries (like construction; manufacturing; finance, insurance and real estate; and information) did not grow, or did not grow enough to make up for recession losses. Other better-paying industries (like professional and technical services) saw solid growth, but not in their mid-wage occupations. And steep cuts in state and local government have hit mid- and higher-wage occupations the hardest.

In short, America’s good jobs deficit continues. Policymakers have understandably been focused on the urgent goal of getting U.S. employment back to where it was before the recession (we are still missing nearly 10 million jobs), but the above findings underscore that job quality is rapidly emerging as a second front in the struggling recovery.

* * *

And while the Fed is finally thinking about the labor force participation rate as a factor in explaining the unemployment rate (after ignoring it for the entire period it was helping to push the unemployment rate lower), the smartest economists in the room have glaringly forgotten that not all jobs are created equal and that a part-time WalMart greeter "job" is just a little less equal than a Goldman Sachs CEO "job."

Of course, if the Fed wasn't blatantly ignorant of the smallest and most obvious details, it wouldn't have to monetize $2.5 trillion in securities just to undo the mistakes of its previous failed attempt at central planning.

Argentina: A Textbook Case Of Government Gone Mad

Submitted by David Galland via,

Nick Giambruno: Joining me now is David Galland, the managing director of Casey Research. His internationalization story, which involved moving his life and his family from the US to Argentina, was recently featured in Internationalize Your Assets, a free online video from Casey Research. He is perfectly suited to help us better understand some of the important lessons in internationalization that Argentina offers. Welcome, David.

David Galland: Nice to be here.

Nick: First, why don't you give us a little background about the Argentine people and how they have learned to deal with their government and recurring financial crises?

David: A good way to think about Argentina is that it is an immigrant society, very much like the US, except that the dominating culture emerging from the melting pot was Italian. This is why Argentines tend to be famous for their dark good looks, vibrant culture, and excellent food. Unfortunately, they also inherited "Italian style" politics. I think that's a useful context for understanding the consistent dysfunctioning of the Argentine government.

This at least partially explains Argentina's long love affair with the Peróns. The country had one of the most successful economies in the world until Juan Perón came into power and destroyed it. And, with some rare bright spots, it's gone through long periods of financial crisis ever since. Despite that, the Perónistas are still very much in charge.

If you look at the history of financial crises in Argentina, you will see there is almost no 10-year period when there isn't a financial crisis. As a result, the population has become extremely resilient in the face of financial crises. When you mention the faltering state of the economy, every Argentine you talk to will shrug and make a comment along the lines of, "No problem; this is Argentina, we're used to it." In other words, they have become fatalistic about such things.

But that doesn't mean they are complacent, because thanks to their long experiences with financial crises Argentines have become masters at dealing with things like inflation and ridiculous government policies. For the most part, the government is highly ineffective, and so the Argentines just ignore it. Reasonably intelligent people always figure out ways to work around whatever the latest decree the government comes up with, then they tell their family members and friends. The word spreads so that in no time at all, the populace at large has figured out how to deal with the government's latest misstep, as often as not turning it to their personal advantage. As a consequence, there is a very robust underground economy; if people can do business off the books, they do. Argentines pride themselves on their ability to outsmart the government.

Nick: How can the actions of the Argentine government give us insight into what a desperate government is capable of and what might be in store for the United States?

David: The current Argentine government is dominated by true believers – young people who have that idealistic notion of equality for all, and who believe that government mandates can fix anything that ails. They are hardcore socialists, leaning towards communism. But, as is the case in the United States, they really don't know what they are doing and so pursue policies that are incredibly shortsighted. They are uninformed as far as history and economics are concerned and blunder from one harebrained policy to another. There is literally nothing that they will not try.

It is like a textbook case in government gone mad.

They have stolen the retirement accounts, devalued the currency, and put capital controls in place. There are trade controls so that people can't import necessities into the country, but instead, have to manufacture them locally, with the government giving monopolies to their friends. They have price controls, which force the local supermarkets to not raise their prices. This will ultimately lead to shortages. And there are already shortages of certain items. They didn't like an opposition newspaper, so they nationalized the newsprint manufacturing industry. In fact, just about every single thing that you could do to screw up a country, they have done. It is comical to see the extremes they have gone to. For example, in Argentina, if you publish an inflation statistic that differs from of the official government numbers, you could be hit with a $100,000 fine. I had never heard of this anywhere else – except maybe in communist Russia. They are really completely out of control and the country is spinning off into la-la-land. Frankly, I love living right in the midst of all of it.

There is a lesson to be learned from all of this, and I think it is a very important one. When it comes right down to it, any government – not just the Argentine government, but the US government as well – will simply do whatever it thinks it needs to do to keep the status quo intact, with no moral or ethical considerations.

In the case of Argentina, and the United States as well, it is a testament to the legacy strengths of the country – minerals, an educated population, agricultural land in abundance, energy resources – that despite a history of bad governance, the economy is still remarkably robust. People living outside of the country would be forgiven, based on the media reporting, for thinking the place is a basket case – but, against all odds, it isn't. To a large extent that is because the government's policies have chased much of the economic activity underground.

Nick: I think something that exemplifies some of the points you've just made was the recent debacle with the minister of the economy. During an interview he was asked a very straightforward question on the Argentine inflation rate. He uncomfortably stumbled through his answer and cut the interview short [Editor's note: You can read more about that here]. How was that received in the country?

David: It was widely reported. At this point, the Argentines have a great sense of humor about their government, as in the majority of them think it's a joke. That said, people are fed up too. In the seven months that we have lived down here, there have been two massive, countrywide protests totaling around two million people. That's about 5% of the country's population. In most countries that would be enough to send a dictator and the government scrambling for their private jets to get out of town.

The Kirchner government, however, has basically said, "Let the people protest. We don't care; it's just a bunch of noise." To a certain extent, that is true. But it's getting to the point where one of these days it's going to boil over. In addition to the middle class, the unions – which have traditionally been a bastion of support for the Perónistas – are starting to show up in the streets as well. If the government's purported friends are starting to protest against them, then you have to wonder how much longer the current regime can last.

Nick: Given the situation you just described, what's it like for you personally to be living on the ground in a country that is going through all this? Does the inflation work to your advantage if your money is not denominated in pesos and not located in the country?

David: Yes, absolutely. Argentina is really two different countries. First, there is Buenos Aires [BA], which is a big city and contains by far the largest percentage of the country's population. In BA there is a bit of crime, and in certain parts of the city you are going to have more crime, but generally speaking, you would be surprised to know that you were in the beating heart of a crisis. Restaurants are full; the stores are open and full of very nice stuff. Second, there are the provinces, which are mostly rural and agriculturally oriented. Here the central government's authority is weak, and the people are relaxed. The quality of life is tremendous. This is not just the case for Americans, or people who are non-peso based; it's pretty much for everyone. Food in a place like Cafayate, where we live, is so cheap it's almost free. You can walk out of a store with a huge bag of fresh produce and it's going to set you back only a few bucks. A kilo of fine tenderloin will cost you maybe five dollars. Back here in the US a couple of days ago I paid $22 for less than a pound of steak. Then there's the cost of labor. In Argentina, we have an extremely competent maid who comes in for five hours a day, five days a week and does all the cleaning and laundry – drudge work that people in the Western world have learned to view as an unavoidable part of life – and the cost is all of about $40 a week.

So, despite the overarching reality that the government is dysfunctional and that this is currently being evidenced in the inflation, the quality of life in Argentina for anyone with a few bucks is very, very high.

When I first arrived in the country, I was expressing bewilderment about how screwed up the government was and all of their stupid policies to a friend of mine who owns a local café. After listening patiently, my friend looked at me and said, "David, is the sun not shining, is the wine not plentiful, and is the food not good? So what are you worried about?" It's a fatalism, but it's also a realism that the people don't worry about the government. And because the government is so inefficient, people can, for the most part, ignore it with impunity. That's not the case in the Western countries where the government has become very adept at using the latest technologies to keep an eye on the populace.

Another friend of mine, a retired successful businessman said, "You know, Argentina is the best country in the world. We just need a little better government." And I looked at him and I said, "Just a little better?" And he said, "Yeah, just a little better. We don't want them to become too efficient, then we wouldn't be able to get away with everything we are able to get away with."

That said, there are obviously middle-class and lower-class people who are struggling under the inflation. Again, this is especially the case in the big city where the social safety net of friends and family is not quite as tightly knit, and where ready access to the straight-from-the-farm produce is not as easy.

For anyone whose net worth isn't tied up in pesos and who keeps most of their money out of the country, the current inflation has been a real boon.

You can go to the best restaurant in town and your entrée is going to cost you five to seven dollars, and this is a very good restaurant. A bottle of wine that would cost you $40, $50, $60 in the States, costs you maybe $5-6. The quality of life is incredible. A lot of that has to do with the exchange rate, which has been as much as ten pesos to the dollar recently. When we first started coming down here, it was like three and a half. In short, the inflation is a real benefit if you don't have your savings and income tied up in the peso.

Nick: From what it sounds like, despite having capital controls, those measures are mostly aimed at people trying to take so-called hard currency, like US dollars, out of the country. For those bringing them into the country, it doesn't appear that there is much of a problem. Is that the case?

David: You would think they would want more US dollars to flow into the country, but the government policy is so balled up they have put up some barriers to bringing money into the country. That said, there are simple mechanisms you can use to get around the restrictions that are completely legal. One of which involves buying Argentine bonds on the international market and selling them back in Argentina. As for the Argentines who want to get their money out of the country, they have to be extra clever, but they are very good at this kind of stuff. For me, dealing with this situation has been a great experience. Unlike in the US, where everything is straightforward and the rules generally make sense, in Argentina it's a very fluid situation. I love the fact that I feel like I'm getting a degree in economic crises and how to operate in one.

Nick: Do Argentines favor gold? What about getting gold in and out of the country and buying or selling it in the country?

David: This is a very interesting question. I've asked that question in the context of economic crises around the world and throughout history. Gold only comes in as sort of the asset of last resort. We did a crisis panel at one of our conferences a couple of years ago, and we had people who had been through the hyperinflation in Zimbabwe and Serbia, and we also had someone from Argentina. I was moderating the panel and asked them all what factor gold played in preserving their wealth. Everyone said it was not a factor. Instead, they all used whatever strong currency they could get their hands on. In the case of Serbia it was the deutschemark. In the case of the Zimbabwe it was the South African rand, and in the case of Argentina it was, and still is, the US dollar.

In Argentina, the whole country revolves around US dollars; it's their medium of exchange and how they preserve their cash. For now at least, the US dollar is king in Argentina. Personally, I exchange my dollars in a coffee shop where I slip behind the cashier's counter and this very cute girl does the exchange from stacks of pesos and thousands of dollars. At some point, if the dollar starts to really collapse and there isn't a suitable regional or local currency to take its place, I think you will see more transactions in gold.

As far as gold transactions in the country, there are dealers in Salta City, which is the nearest big city to us. Private transactions can also be arranged. In Buenos Aires, of course, you can buy and sell gold easier, but it's just not part of the culture at this time.

Nick: Turning to real estate, there are many people who are potentially interested in Argentine real estate as we approach what appears to be the bottom of the current crisis. What are your thoughts?

David: I'm a big fan. We own a lot of real estate in Argentina, most of bought when it was a lot cheaper. If you are a dollar-based investor and you can get your money into the country at a good exchange rate, then the real estate prices are very reasonable. That said, I would add that the biggest market for Argentine real estate currently is for Argentinians, because they have to find a place to put their currency before its purchasing power erodes further. Right now it is depreciating probably at 30% to 45% a year. My general sense is that people who have their money outside of the country aren't in a rush to bring it into Argentina. I can't fault them for that.

As far as I'm concerned, if you can afford to live in La Estancia de Cafayate and you don't, you are a fool. But that's a lifestyle decision, not a pure investment decision. Cafayate is a really beautiful place, with all the amenities and a great community of people. It's like the Napa Valley 80 years ago. Most people who are looking to make a pure investment right now should probably wait a bit longer. I don't think the current crisis is over yet.

Nick: Last year the government made it illegal for people to use US dollars in real estate transactions. Now, as you mentioned, not everybody follows these types of rules. Is this something that's adhered to? It could actually work to your significant advantage, if you are foreign investor or someone who is looking to make a lifestyle decision to buy property in Argentina, if there is a further significant decline in the peso and you are forced to use pesos in real estate transactions.

David: Absolutely. Provided you can get your money into the country and get a good exchange rate, which you can, using that bond trade method I mentioned previously. Cafayate is a small valley with a limited amount of real estate available. It is very much on the upswing, and prices are definitely going higher in dollar as well as peso terms. In terms of putting your money into a pure investment or real estate speculation, I don't think you could go wrong buying in Cafayate at this point, especially if you get in at the right exchange rate. You have to have the right mentality though, as it is not a traditional investment.

Nick: What is the endgame with this current crisis? Do you think there will be devaluation of the official exchange rate or some other wealth-confiscation measures? What do you think will signal that we're at the bottom?

David: I don't think you are going to see wealth confiscation. The foreign percentage of ownership of the Argentine economy is pretty small, so I don't think they would go after wealthy foreigners. Could they go after the wealthy Argentines? It's possible, but Argentina is not a big country and everybody knows each other. Most of these government officials have managed to steal themselves enough money to become part of the elite they would potentially be targeting. So I don't see wealth confiscation coming. I think the endgame will come when you get three or four million people in the streets and the government realizes it has to do something. Maybe they would give into the pressure for a devaluation of the peso.

Regardless, in the next election this October, I think there is a good chance the current government will get voted out. If the new government isn't completely stupid, then I think you could end up with a real economic boom. That's the history of Argentina, a crisis followed by a boom. I don't think we are at the bottom of the current crisis yet, but I think we are getting there.

Nick: All right David, thanks for your time and insight into the situation. There are indeed many lessons that Argentina can teach for those wise enough to absorb them.

David: My pleasure.

Marc Faber: „People With Financial Assets Are All Doomed“

As Barron's notes in this recent interview, Marc Faber view the world with a skeptical eye, and never hesitates to speak his mind when things don't look quite right. In other words, he would be the first in a crowd to tell you the emperor has no clothes, and has done so early, often, and aptly in the case of numerous investment bubbles. With even the world's bankers now concerned at 'unsustainable bubbles', it is therefore unsurprising that in the discussion below, Faber explains, among other things, the fallacy of the Fed's help "the problem is the money doesn't flow into the system evenly, how with money-printing "the majority loses, and the minority wins," and how, thanks to the further misallocation of capital, "people with assets are all doomed, because prices are grossly inflated globally for stocks and bonds." Faber says he buys gold every month, adding that "I want to have some assets that aren't in the banking system. When the asset bubble bursts, financial assets will be particularly vulnerable."

Excerpted from Barron's:

On the error of the Fed's ways:

The Fed has been flooding the system with money. The problem is the money doesn't flow into the system evenly. It doesn't increase economic activity and asset prices in concert. Instead, it creates dangerous excesses in countries and asset classes. Money-printing fueled the colossal stock-market bubble of 1999-2000, when the Nasdaq more than doubled, becoming disconnected from economic reality. It fueled the housing bubble, which burst in 2008, and the commodities bubble. Now money is flowing into the high-end asset market - things like stocks, bonds, art, wine, jewelry, and luxury real estate.


Money-printing boosts the economy of the people closest to the money flow. But it doesn't help the worker in Detroit, or the vast majority of the middle class. It leads to a widening wealth gap. The majority loses, and the minority wins.




The neo-Keynesians would argue that if the Fed hadn't flooded the system with money, things would have been much worse. That might be true, but they would have been worse for a shorter period of time.

On the Bubble:

I am suggesting that in the fourth year of an economic expansion, near-zero interest rates will lead to a further misallocation of capital. I thought the U.S. market would have a 20% correction last fall, but it didn't happen. I also said the market might explode to the upside before the correction occurred. We might be in the final acceleration phase now. The Standard & Poor's 500 is at 1650. It could rally to 1750 or even 2000 in the next month or two before collapsing. People with assets are all doomed, because prices are grossly inflated globally for stocks, bonds, and collectibles.

On China:

There has been a huge credit bubble in China, and it isn't going to end well. Its economy officially grew 7.7% in the first quarter. In reality, it is growing 4% a year, at best. Figures on Chinese exports to Taiwan, South Korea, Hong Kong, and Singapore don't agree with the import figures of those countries. In each case, reported exports are much larger than reported imports.

On wealth divides and Social Unrest:

Again, the economy of the rich is booming. There has been huge wealth accumulation in Asia in recent years. But the middle class has experienced diminishing purchasing power. Throughout history, growing wealth inequality has been corrected either peacefully, through taxation and wealth redistribution, or by revolution, as in Russia.  I am not sure we will have a revolution in the Western world, but I can see European voters turning against the arrogance of the bureaucracy.

On Europe:

Investors don't fully comprehend what happened in Cyprus. In the event of future bailouts, bank depositors will lose a percentage of their money. Money in the bank isn't 100% safe anymore.

On Gold:

Gold is down 30% from its 2011 peak of $1,921, but has far outperformed financial assets since 1999. A correction was overdue. I have about a 25% allocation to gold and buy some every month. I want to have some assets that aren't in the banking system. When the asset bubble bursts, financial assets will be particularly vulnerable.


Gold is easier to carry than a Lamborghini.


Most of my gold is in a safe-deposit box in Switzerland, but I am shifting it to Asia.

Guest Post: The Microeconomics Of Inflation (Or How We Know This Ends In Tears)

Submitted by Martin Sibileau of A View From The Trenches blog,

A week later and everyone is a bit more nervous, with the speculation that US sovereign debt purchases by the Federal Reserve will wind down and with the Bank of Japan completely cornered.

In anticipation to the debate on the Fed’s bond purchase tapering, on April 28th (see here) I wrote why the Federal Reserve cannot exit Quantitative Easing: Any tightening must be preceded by a change in policy that addresses fiscal deficits. It has absolutely nothing to do with unemployment or activity levels. Furthermore, it will require international coordination. This is also not possible. The Bank of Japan is helplessly facing the collapse of the country’s sovereign debt, the European Monetary Union is anything but what its name indicates, with one of its members under capital controls, and China is improvising as its credit bubble bursts.

In light of this, we are now beginning to see research that incorporates the problem of future higher inflation to the valuation of different asset classes. One example of this, in the corporate credit space was Morgan Stanley’s “Credit Continuum: Debt Cost and the Real Deal” published on May 17th, 2013. Upon reading it, I was uncomfortable with the notion that inflation is the simple reflection of the change in a price index, which implies the thesis of the neutrality of money. For instance, the said research note discusses how standard financial metrics compare vis-à-vis a rate of inflation.

Why is this relevant? The gap between current valuations in the capital markets (both debt and credit) and the weak activity data releases could mistakenly be interpreted as a reflection of the collective expectation of an imminent recovery. The question therefore is: Can inflation bring a recovery? Can inflation positively affect valuations?

I am not going to comment on others’ views or recommendations, but on the underlying method. A price index is a mental tool that has no relation to reality. In the real world, we trade driven by relative prices. To infer economic behaviour off changes in a price index is a mistake. The impact of inflation is more complex. For this reason and in anticipation of future debates on this topic, I offer you today a microeconomic analysis of such impact, on value.


I suggest that a good way (but certainly not the only one) to assess the impact of inflation on the valuation of a firm is to think of the same within the typical free-cash flow approach. After all, what matters is not how inflation can affect a certain component of its capital structure, but how the entire value of a firm is impacted, before the same can be shared among the different contributors to the said capital structure (i.e. equity, debt holders, etc.)

Simplifying, as far as I can recall from the times when I worked in the area of Private Equity,  the way to calculate the free cash flow of a firm for a determined period is to obtain its operating margin, add to it depreciation & amortization costs and subtract capital expenditures, changes in net working capital and taxes. I show the formula below:


– Operating Costs

Operating margin


+ Depreciation & Amortization

- Capital Expenditures

- Change in net working capital

- Operating tax

Free Cash flow



What follows is a discussion on the impact of inflation on each of the components of the valuation formula above:

Revenues (= unit price x volume sold)

Under inflation, only those firms that have pricing power can defend the value of their production. At the same time and because inflation brings unemployment and the destruction of purchasing power, in general (not for all firms, of course), sales volume drops too. This backdrop encourages consolidation, where big players get bigger and small ones disappear. With it, the bigger firms obtain oligopolistic to monopolistic pricing power which assures two things: The currency zone where this development takes place loses in innovation and prices become less flexible. This inflexibility, when fully unfolded, directly leads to indexation, which is the stepping stone for any hyperinflationary process. If the consolidating firms are public, it is likely that during the consolidation process they become private via leveraged deals, as long as credit is still available.

Operating costs (=unit cost x volume bought + factors)

With regards to direct inputs, the same pricing problem described above arises. There are those firms that have leverage with their suppliers and can force these to delay price increases (i.e. margin contraction) and those that can’t. Consolidation therefore pays off on this front too, carrying the same consequences mentioned above. From an accounting perspective, when inflation is high, firms can’t even measure the cost of their inputs and are forced to take a Schrodinger approach, with either Last in-First Out (LIFO) or First in – First Out (FIFO) accounting.

With regards to indirect inputs, these can be segmented into labour and capital. Labour intensive firms will struggle with a unionizing work force and inflation always nourishes the growth of unions, to renegotiate labour contracts. All things equal, this context simultaneously encourages higher unemployment and illegal immigration, because while credit is available at negative real rates (i.e. the nominal interest rate is lower than the inflation rate), firms will find more convenient to replace labour with capital. This takes place during the lower stages of an inflationary process. In later stages, credit disappears and the higher interest rates make refinancing debts unfeasible, bankrupting those firms that dared to invest in capital expenditures.

Where the required labour is low skilled but expensive due to social security legislation, firms will also replace it with illegal immigration, whenever possible.


The impact of inflation on operating margins (i.e. revenues – operating costs) is to drive consolidation, the replacement of labour by capital, indexation, price rigidity and the loss of competitiveness. The loss of competitiveness is the natural result of an environment that favours oligopolistic/monopolistic structures and short-term investment opportunities. It is very common to blame entrepreneurs or management for this outcome. However, the conditions that drive firms to adopt these survival strategies are the exclusive responsibility of politicians.

Depreciation & Amortization

“…Both depreciation and amortization (as well as depletion) are methods used to prorate the cost of a specific type of asset to the asset’s life…these methods are calculated by subtracting the asset’s salvage value from its original cost…” (Investopedia)

It is clear that any attempt to accurately portray the value and life cycle of fixed or intangible assets under inflation becomes irrelevant. What if due to high inflation the salvage value of an asset is higher than its original cost?

Under inflation there is uncertainty on the true cost of maintaining the fixed resources involved in the operation of a business. This uncertainty forces firms to cut back on capital expenditures. Investment demand and economic growth therefore collapse

Capital expenditures

Because nothing can be reasonably forecasted under inflation and growth and efficiencies are better served via consolidation and without innovation, capital expenditures can only be of a very short nature, if any.

Change in net working capital

This item is perhaps the most neglected and yet, most relevant, in my view. For valuation purposes, an increase in net working capital means that a higher amount of capital is tied to the operations of a firm. Therefore, a lower amount of cash is available to the contributors of capital to the firm (i.e. debt and equity holders). For this reason, the change in net working capital is subtracted in the valuation formula above.

What is net working capital? In simple terms:

Accounts receivable

+ Inventory

-  Accounts payable

Net working capital

If from one period to another the time necessary to collect on accounts receivable increase and/or the inventory turnover necessary to run an operation decreases, the value of the firm falls, as less cash is available to the contributors of capital. Alternatively, if the firm manages to increase the time necessary to honor accounts payable –all things equal- more cash is available.

What is the impact of inflation on net working capital? Complete! Under inflation, firms seek to delay any cash outflow. The higher their accounts payable, the more debt they dilute. At the same time, bank lending quickly shrinks. At high inflation levels, even working capital lending disappears. At this stage, vendor financing is key and only those companies that demonstrate a steady commitment to their suppliers can obtain credit from them. Suppliers, on the other side, often go bankrupt precisely because they cannot collect on their receivables. One of the painful ironies of inflation is that under it, liquidity evaporates!

With regards to inventory, this is counter intuitive, but firms will try to maximize its amount, as long as they can get vendor financing. The accumulation of inventory allows firms to lock in a cost of production that would otherwise be uncertain. This is very inefficient. Just-in-time production models become totally unfeasible. The accumulation of 

inventory is more understandable when one realizes that inflation is the destruction of the medium of indirect exchange, which forces us to barter. Under barter, inventory is not a burden.

Just as much as firms seek to delay cash outflows, they will want to collect as quickly as possible. Those firms that operate at the end of the distribution chain and can sell to a granular, cash-paying public will be at an advantage over those that operate at earlier links of the chain (and have a concentrated customer base which demands vendor financing). Inflation therefore leads to consolidation on this basis too, towards the end of a distribution chain.

An example of a firm that would fit this profile, benefitting from an inflationary context would be Costco Wholesale Corp. (and no, this is not an investment recommendation, but a hypothetical example). As Costco sells in bulk, its customer base would grow, since the public that seeks to escape from a devaluing currency and lock the price of necessary staples would see an advantage in purchasing the same in quantities, at a discount. Simultaneously, the company would be in a privileged position to exert pricing power over its suppliers and grow via acquisitions. As an extreme (but illustrative) example, I recall that during the ‘80s in Argentina, when employees were paid their salaries, many took the day off (and parents left their kids with nannies) to go shopping. They were simply ensuring that not one day would pass with them holding depreciating currency, which had to be exchanged as fast as possible for all the goods that were going to be consumed until the next wage payment. They set off in a hurry and bought, when possible, in bulk!


Operating tax

Tax payments are simply one more cash outflow. Even without inflation, one tries to minimize and delay this outflow. Under high inflation, delaying its payment is a matter of survival and represents and additional source of financing. Because all hyperinflations took place before the internet era, we don’t know how easy it will be to delay tax payments when the next hyperinflation arrives. I imagine it will be much harder in the digital era.


The inflationary policies carried out globally today, if successful will have a considerably negative impact on economic growth. The microeconomic impact described above brings the following unintended and unnecessary macroeconomic consequences:

-Oligopolistic/ Monopolistic structures

-Loss of innovation, competitiveness

-Indexation, price rigidities

-Unionization of labour force and higher unemployment

-Illegal migratory flows

-Destruction of public capital markets

-Higher fiscal deficits

If this analysis is correct, the record asset values we see today cannot be interpreted as the omen of an imminent recovery. I am not saying that these nominal values are not justified. What I am saying is that they should not be interpreted as an indication that economic growth is on the way

Guest Post: The Fed’s Real Worry – A Pick Up In Deflation

Submitted by Lance Roberts of Street Talk Live blog,

Four Signs That We’re Back In Dangerous Bubble Territory

Submitted by Chris Martenson of Peak Prosperity blog,

As the global equity and bond markets grind ever higher, abundant signs exist that we are once again living through an asset bubble or rather a whole series of bubbles in a variety of markets. This makes this period quite interesting, but also quite dangerous.

With equity and bond markets at or near all-time record highs, with all financial assets consistently shrugging off bad or worse news as the riskiest of assets continue to find consistent upward bids, we find ourselves in familiar and bubbly territory.

I can summarize my thoughts in one sentence:  How could this be happening again so soon?

In times past, it took one or more generations between bubbles for people to financially recover and forget the painful lessons before they would consider doing it all again. Yet here we are, working our way through our third set of bubbles in less than two decades, which must be some sort of world record.

I will confess to my biases right up front: I have always been deeply skeptical of both the practice of running up debts at a faster pace than income (the common practice of the entire developed world over the past several decades) and the idea that the solution to too much debt is more debt, enabled by cheaper money courtesy of thin-air money printing.

In short, instead of seeing central banks as sophisticated stewards of intricate monetary policies, I view them as serial bubble-blowers and reckless debt-enablers whose only response, when confronted with the inevitable consequences of their actions, is to serve up more thin-air money at an even cheaper rate. And when that doesn't work, then they simply try even more of the same, but in larger quantities.

While I think central banks are populated by earnest people with impressive credentials who have rationalized their actions as being necessary and in service of the greater good, I also think that the biggest ones hold an entrenched set of institutional views that are dogmatic, fail to incorporate the idea of economic and resource limits, and are seemingly immune to healthy introspection.

Somewhere along the way, I would have hoped they might have noted that each new crisis is larger than the one before necessitating an even larger response that begets an even larger crisis next time, etc., and so on. A corporate bond hiccup in 1994 led to monetary loosening that enabled the development of the Long Term Capital Management (LTCM) fiasco of 1998, which was followed by the tech bubble, and then the housing bubble, and here we are with a now global equity and bond bubble that is larger than all the prior bubbles combined. Much larger.

It was famously said that the market can remain irrational longer than you can remain solvent. And if the trading maxim, don't fight the Fed, is worth heeding, then surely one should absolutely not take on all of the central banks at once, either. So, the risk I run here in seeing things through my 'common sense' filter is that perhaps this time the Fed, et al., have got it right, and a true and lasting recovery is at hand.

With that caveat, in this report I lay out the five most worrisome signs that horrific market losses await the unwary, the careless, the reckless and those who possess all three characteristics (i.e., your average central bank).

These are not normal times. The degree of separation between reality and today's financial markets is extreme, which means they have a tremendous degree of potential energy stored up that could erupt in a downward cascade at any time.

While we can’t predict the exact time or trigger of a market avalanche back down to reasonable levels, I can definitely advise that you do not want to be standing in the valley when it happens.

Four Signs That We're Bubbling

Here are the four things that convince me that we are in truly bubbly territory:

Sign #1: Junk Bond Prices at Record Highs

The Fed, et al., have been buying up all of the 'safe' bonds, with the twin intents of driving down interest rates and chasing investors into riskier assets. With lower yields comes (hopefully) more borrowing; and when investors move towards riskier assets, this drives up the equity markets which, as the thinking goes, will paint a rosier picture of the economy plus boost consumer confidence and spending.

Along with this, however, we find speculators and investors, starved for yield, chasing the junkiest of the junk.

Indeed, the prices of these "assets" have recently been driven to all-time record highs, which means that their yields have hit record lows.

And not just "low" prices, but a brand new record low in all of financial history.

Sign #2: Junk Sovereign Debt Being Chased to New Highs

It was just over a year ago when Greece ten-year debt was yielding a whopping 30%, reflecting the poor economic fundamentals of the country and concern that the European Central Bank (ECB) might stop loaning Greece the principal and interest payments needed to prevent another default.

Oh yes, and let's not forget that just a year prior, more than $130 billion had been lost by Greek bond investors, which created a ripple effect across Europe, including recently crippling Cyprus' key banks.

Today? Greek ten-year debt is under 10%.

Greece Bulls Charge Into Corporate Bonds

May 15, 2013


Investors are returning to Greece, lured by receding fears that the troubled country will leave the euro and the high returns offered by many of its battered assets.


It is a remarkable turnaround. Only a year ago, Greece was toxic territory for investors. A debt restructuring had just wiped out more than €100 billion ($130 billion) in government bonds. The stock market stood at one-tenth its 2007 levels. A political earthquake had the country poised for a chaotic election.


But now the markets have turned. Months of relative calm in Europe and the pressure to go somewhere, anywhere, for yield in a low-interest-rate world—has investors taking another look. The Athens stock market has rallied more than 80% in the past 12 months, with the Athex Composite Index rising 0.8% on Tuesday. Greek government bonds have been on a tear since June.


The real story here, about speculators not ‘investors’ returning to Greece, is that the world is so utterly starved for yield that even Greek debt seems reasonable now. In Greece, even as the trend towards buying Greek debt was building, the country's economy (as measured by unemployment and GDP) deteriorated sharply.

As compared to 2008, Greek GDP in 2012 shrank by 20%, and current trends continue to show 5%-6% shrinkage in 2013:


In what sort of a world does serious economic contraction, spiking unemployment, extremely high levels of debt-to-GDP, and falling bond yields go together? A bubbly world, that's where.

Sign #3: It's Not Official Until It's Denied

The poster child for a bubble market has to be Japan, where the main stock index of the island nation, the Nikkei, is up an astonishing 70% in the past six months (!) in a vertical index rise that is well outside of our personal experience:

This isn't some penny stock, but the entire stock index for the world's third largest economy. Of course, the 'reason' for this rise centers on the actions the Bank of Japan is taking to debase its currency. The people of Japan are realizing that they cannot trust their cash and had better put it to use somewhere besides their bank accounts before its purchasing power is drained away.

After such an obviously unstable spike in the market, what's left to do but officially deny that it's in a bubble?

Stock Boom Isn't a Bubble, Says BOJ's Kuroda

May 15, 2013


TOKYO—The Bank of Japan's governor played down worries that the stock-market boom is a bubble and that a weak yen will stir cost-push inflation, signaling his resolve to press ahead with the bold monetary easing that has fueled stock prices and driven down the currency.


Grilled by lawmakers during a session of the upper-house budget committee, Haruhiko Kuroda flatly rejected an opposition-party member's argument that the recent rapid rise in the Tokyo stock market is out of line with Japan's real economy.

"At this moment I do not think they are in a bubble," Mr. Kuroda said.

Driving this bubble is the determined resolve of the BoJ to make the yen worth less, perhaps even someday worthless. For a major world currency, the chart below is quite startling.

If something is not official until it's denied, then the Japanese stock market is most definitely in a bubble. It should be noted that there are similar examples of stock indexes making new highs on bad news and weak fundamentals the world over, so we're not just picking on Japan alone here.

Sign #4: Making Up Crazy Excuses

My final sign of that we are in bubble territory is when the folks who consider it their job to make sense of the high and spiking prices offer up thin, sometimes stretched-to-the-breaking-point, rationalizations for why the current price action make sense.

In the late 1990s, when the third most recent Fed bubble was cooking along, stratospherically valued technology shares were justified with strange metrics such as 'impressions' and 'eyeballs' and other contorted valuations contained in no standard finance methodologies.

In the 2000s, when the second most recent Fed bubble was cooking along, housing prices were justified with trite slogans such as "they're not making any more land, you know" and bizarro claims that housing had never gone down in price over time which it most certainly had.

Today is no different. We're seeing the same sorts of 'explanations' to justify high prices fueled by central bank printing. Perhaps the central cheerleader for the benefits of perpetuating central banking policy errors is Paul Krugman, who recently swept aside arguments for an equity bubble by saying something that Irving Fisher might recognize:

O.K., what about stocks? Major stock indexes are now higher than they were at the end of the 1990s, which can sound ominous. It sounds a lot less ominous, however, when you learn that corporate profits— which are, after all, what stocks are shares in — are more than two-and-a-half times higher than they were when the 1990s bubble burst.


Also, with bond yields so low, you would expect investors to move into stocks, driving their prices higher.


This sounds reasonable until you consider the context of this argument about corporate profits, of which an economist like Krugman ought to be fully aware. Corporate profits are in very, very unusual territory (one could even say record territory), and to say that equities are fairly valued now because of their relationship to corporate profits is to argue that such profitability is a new and permanent feature of life.

The economist Irving Fisher somewhat famously and regrettably opined in 1929 (right before the stock market crashed) that a new corporate model and economic era was in play that had led to a "permanent plateau of prosperity." The rest is history.

In life and investing, there's nothing quite so powerful as reversion to the mean, which in the case of corporate profits is nearly 50% lower than where they currently are. By the time that economists are dismissing the notion of an equity bubble by pointing out heightened corporate profits, without providing any of the necessary context, we are in full-blown rationalization mode which is another bubble indicator.

Also, the fact that Mr. Krugman is citing "low bond yields" as a justification for moving into stocks rather delightfully skips over the reality that it is the central banks themselves that are responsible for those low bond yields. Krugman presents the information as if such intervention were a normal market condition to which investors were rationally reacting, rather than a completely fake circumstance engineered by central banks conducting the biggest monetary experiment in human history.

Next, we have this tidy explanation from Goldman Sachs, groping for reasons to explain why stocks always seem to go up no matter what:

"while equity prices respond more to dovish surprises than hawkish surprises, the results suggest that equity prices typically go up regardless of whether the Fed policy surprise is positive or negative (“good news is good for equities, and bad news is good for equities”). But it is not at all clear why the equity market should systematically buy into this pattern."


(Source - Zero Hedge)

This is at least as honest an appraisal of the situation as I can find. Goldman Sachs is basically waving its hands in the air and saying that it's somewhat puzzling why markets should be acting this way. An even more honest statement would continue by noting that such periods of irrational exuberance are quite often found during bubbles, and that bubbles have a bad habit of destroying wealth.

As is common in life, such justifications merely expose the 'human factor' of bubbles. Bubbles require a belief system to be installed in the beholder, and two things that beliefs are exceptionally good at are gathering supporting data and rejecting contradictory data (if such data is even seen in the first place).

The human mind does this all the time with respect to our own level of ability, our luck, our good looks, our children's performance you name it this is just part of our innate mental programming.

The really odd part in this story is that once upon a time, bubbles were separated by a generation or more, so that the lessons (and pain) of the prior one could be culturally forgotten before the next one could take hold. Yet here we are, working on our third bubble in a row larger than the prior two that just happened within the past 15 years. (Of course, with a wide enough lens, we might say that each bubble was just a subset of the largest credit bubble in all of history that began building some 40 years ago).

For some reason, we are forgetting the lessons of the past faster than ever before. Such willful ignorance invites a series of reality-based reversions more punishing than ever before, too.

My advice: Keep a journal. These are interesting times; possibly not to be repeated in many, many generations.

Conclusion to Part I

There are abundant signs that the world's equity and bond markets are ignoring risk and chasing yield to dangerous extremes. Various denials and justifications are being offered to rationalize these behaviors as sensible or prudent. Taken together, this tells me we are once again in bubble territory, and that, as with all bubbles, this one will end badly. Or rather, these bubbles (plural) will end badly together.

I'm sure that most market participants have it in their minds to dance as long as the music is playing and to be among the first to reach the exits when the music stops. However, everybody is thinking this, and given that only the most well-connected of market players have the opportunity to exit first (literally in the blink of an eye), very few will actually make it through the doorway unscathed.

As is always true in life, the point of a bubble is to separate the most people from the most wealth. The wealth doesn't actually vanish; it's just simply transferred from the last purchasers to those who sold before the bursting.

I truly have no idea how much longer all this craziness can continue. I suspect the answer is a lot longer than anybody suspects, myself included. But I also know that reversals tend to happen quite quickly, all on their own, with very little warning. This leads to my personal motto: I'd rather be a year early than a day late.

In Part II: Protect Your Wealth in Advance of the Bubble's Bursting, we detail our rationale that all this ends in a wrenching market crash (Phase I), which will be followed by even larger, more desperate, and unusual central bank actions (Phase II) that will initially set the stage for what seems like a recovery but ultimately terminates in the largest currency crisis of modern times, if not human history (Phase III).

The difficulty will be avoiding being whipsawed throughout, losing wealth at every step. After all, the primary outcome of every attempt at money printing in the past has been a massive wealth transfer from a very large proportion of the afflicted society to a much smaller one.

Click here to access Part II of this report (free executive summary; enrollment required for full access).

In the meantime, trade safe. My advice here is to use extreme caution whether investing or speculating, whichever you are involved in.

Diablo 3: A Case Of Virtual Hyperinflation

Submitted by Peter C. Earle via the Ludwig von Mises Institute,

As virtual fantasy worlds go, Blizzard Entertainment’s Diablo 3 is particularly foreboding. In this multiplayer online game played by millions, witch doctors, demon hunters, and other character types duke it out in a war between angels and demons in a dark world called Sanctuary. The world is reminiscent of Judeo-Christian notions of hell: fire and brimstone, with the added fantasy elements of supernatural combat waged with magic and divine weaponry. And within a fairly straightforward gaming framework, virtual “gold” is used as currency for purchasing weapons and repairing battle damage. Over time, virtual gold can be used to purchase ever-more resources for confronting ever-more dangerous foes.

But in the last few months, various outposts in that world — Silver City and New Tristram, to name two — have borne more in common with real world places like Harare, Zimbabwe in 2007 or Berlin in 1923 than with Dante’s Inferno. A culmination of a series of unanticipated circumstances — and, finally, a most unfortunate programming bug — has over the last few weeks produced a new and unforeseen dimension of hellishness within Diablo 3: hyperinflation.


Austrian Economics and Inflation

In casual use, the term “inflation” is used in conjunction with price increases. From the perspective of the Austrian School of economics, though, that phenomenon is a secondary effect of increases in the money supply. As Henry Hazlitt wrote,

When the supply of money increase[s], people have more money to offer for goods. … Each individual dollar becomes less valuable because there are more dollars. Therefore more of them will be offered against, say, a pair of shoes or a hundred bushels of wheat than before. A “price” is an exchange ratio between a dollar and a unit of goods. When people have more dollars … [goods] rise in price, not because [they] are scarcer than before, but because dollars are more abundant.[1]

Furthermore, inflation is not simply an increase in the supply of money within an economy; it is the increase in that portion (if any) not backed by a commensurate increase in specie: most common in history, market commodities like gold or silver. Thus fiat currencies are, unless tightly controlled as to the amounts being created versus being destroyed (with the latter typically only occurring due to wear), notably susceptible to inflation.

As virtual currencies are digitally-created and not commodity-backed — therefore, not particularly dissimilar from real world currencies in this day and age — those such as Diablo 3’s gold are de facto fiat currencies.

Sinks, Faucets, and Inflation

In virtual economies, the primary instruments used to control the money supply are “faucets” and “sinks.” Faucets are ways through which game currency is injected into the game. This generally involve players receiving currency from the game system itself, as opposed to other players. In such situations, the received currency is created anew. Sinks are ways through which game currency is removed from the game. This generally involve players paying currency into the game system itself, as opposed to other players. In such situations, the paid currency is destroyed.[2] Examples of faucets and sinks in Diablo 3 are included below:


  • Drops — When a player defeats a foe, they often receive a reward of virtual gold or a good saleable into virtual gold;

  • Rewards — The game involves the player undertaking “Acts,” and within each act are a number of “quests.” For completing these, players are typically awarded virtual gold;

  • Buyers — Players can sell items to “in-game” (computerized, non-human) buyers, receiving virtual gold.


  • Repairs — Over time, a player’s equipment will become damaged in combat and suffers wear-and-tear, requiring periodic restoration from an in-game craftsman in exchange for virtual gold;

  • Forging — Players pay virtual gold to an in-game blacksmith for weapons;

  • Rakes — Using the gold auction house costs players both a listing fee and a transaction fee, removing virtual gold from the economy;

  • Consumables — Players can purchase potions, scrolls, and other items from vendors for virtual gold.

Diablo 3 was rolled out in May 2012, and there seem to have been early concerns among players that gold sinks within the game were insufficient. One site noted,

[M]ost of us (probably including Blizzard) assumed that the Blacksmith would be widely used — he was, after all, the only major gold sink in the game … but dropped items alone selling in the [auction house] have been enough to satiate the appetite [of players] and crafting is … a waste of [gold] when one could easily buy an optimal item from the [auction house] rather than pumping 50 to 170K of gold into [a Blacksmith-crafted weapon.][3]

The establishment by Blizzard of a real money auction house (“RMAH”) alongside a virtual gold auction house in the game provided players with an incentive to both farm the game for real world profits and to pursue arbitrage opportunities. The RMAH was also created, at least in part, to disincentivize players from patronizing third party markets outside the game. Nevertheless, bots — automated game participants whose sole purpose is to farm the game world for items to sell — quickly emerged.

Although its anonymity may make it subject to skepticism, several weeks after the game’s debut a source claimed that there were at least 1,000 bots active 24/7 in the Diablo 3 game world, allegedly “harvesting” (producing) 4 million virtual gold per hour.[4] Most of the gold generated by the ruthlessly productive, rapidly adapting bots found its way to third party vendors in a black market which undercut the prices in the sanctioned, in-game auction houses.

The combined effect of heavy bot activity and insufficient sinks immediately impacted the gold markets, and inflationary pressures were soon apparent. An exasperated player complained in August 2012:

I purchased most of my gear for around 5 mil [gold] early on. I’ve been farming for awhile [and] have saved around 30 million gold [but now] I can’t upgrade the gear I have ... Where is all this money coming from? Why is everything so expensive?[5]

And as in real world economies, the price effects of money inflation often arise unevenly. With gold prices falling, prices began spiking in certain goods. Another player noted with curiosity:

[Y]esterday Fiery Brimstone was 150K, now almost 300K. Each time I hit refresh it seems to be going up a bit[.][6]

Gold Floors vs. Black Markets

The RMAH had minimum and maximum dollar amounts for in-game gold transactions: $0.25 minimum, $250 maximum. Market participants were also limited to dealing in increments of a certain size, called a “stack.” The “stack” was initially set to 100K gold. But as gold prices fell owing to rapidly building supply, the stack size was changed in August 2012 to 1 million. This practice, known as redenomination, is a fairly standard (if cosmetic) method of addressing inflation, but was viewed by some players as tacit devaluation.[7]

If you’re changing the [price] of gold from 0.25 per 100,000 to .25 per 1,000,000 I would like to cancel my gold auctions before you do that. You’re completely shifting the market in less than a day, and those of us that have auctions listed that will be affected by this change cannot cancel them until after the patch hits, which is potentially too late.[8]

To be clear, at the time at which the redenomination was introduced, gold was still trading above the floor rate. But being artificial, caps and floors not only prevent markets from clearing, but give black markets a target to undercut, to say nothing of offering players an opportunity to avoid the 15 percent fee — another intended gold sink — levied upon transactions within the auction house. Another player predicted,

[T]his [change] will likely have 2 effects … [it] could kill the private 3rd party market for gold and hopefully discourage botting … [but] because the real money price of gold is decreasing on the RMAH … [g]old will become cheaper as botters flood the market in an attempt to unload their massive surplus of gold before it becomes absolutely worthless. … This decision will further destabilize the economy [as in the gold auction house] prices shoot from 100,000 gold to 1,000,000 gold … [or] 10,000,000 gold to 100,000,000 gold. … The same would happen if the [Federal Reserve] decided to suddenly release a flood of currency into the U.S. economy[.][9]

By early 2013, the gold price had fallen to the exchange floor set by the game managers — $0.25/million — and players began to show signs of concern. One asked,

[Are] there any plans of lowering the floor of gold[?] … It has been at .25 for about 2 weeks now … should I sell my gold now before it gets lowered?[10]

A Delirium of Stacks

Hyperinflation is the economist’s equivalent of an astrophysicist’s quasar cluster or a marine biologist’s dolphin “stampede”: a rare exhibition of a unique set of circumstances which arise infrequently and are closely studied when they materialize. Such events are exotic enough that they become legendary: many individuals knowing little about monetary policy are aware of the recent outbreak in Zimbabwe, or familiar with the defining instance in the post-WWI Weimar Republic.

Economically, the tipping point in the transformation of inflation into hyperinflation is characterized by a profound drop in the outstanding demand for money: when holders of money expect the supply of money to increase — particularly without any sense of timing, bounds, or other guidance — monetary demand in the present drops in favor of surrendering money for vendibles.

The focus of possessors of money, therefore, devolves into an effort to capture known, present purchasing power against the likelihood of its decline in the near future. Saving, in any event, delaying consumption, is chastened; and if a cycle of declining purchasing power and rapidly rising prices ensues, ultimately the propensity to hold money declines precipitously and may fundamentally disappear.

This was demonstrated when, in a message board entry prefaced by stating “Sell Equipment before Patch 1.0.5 Hits!” (a patch is a piece of software added to an operational program or application as bugs are found, changes desired, or ways of improving performance discovered), a player warned that,

Blizzard just announced that the drop rates for [certain] items are going to be doubled … if you haven’t already, you should consider converting your current gear to cash … since real $ [are] the best hedge against gold devaluation[.][11]

If historical cases of hyperinflation — real, and now virtual — have one thing in common, it is the instinct among its victims to blame the symptoms rather than the disease. The Austrian economist Hans Sennholz noted that during the German hyperinflation, “intrigue and artifice” were believed to be at work.[12] Similarly, a handful of Diablo 3 players, frustrated about the decimation of their purchasing power, expressed increasing suspicion of manipulation and conspiracy theories.

[W]hy [are] certain items priced [s]o astronomically high? Many of them are not even that good yet cost 100’s of millions of gold. … I have about 45,000,000 gold saved up [and] check every few days to see if I can get any upgrades that are worth the gold, but … everything is vastly overpriced … clearly controlled by the gold sellers.[13]

And, predictably, any number of baleful remedies were proposed.[14]

While RMAH prices for virtual gold rallied occasionally, the prevailing direction of black market prices for virtual gold was inexorably lower as third party sellers undercut the in-game gold floor. In February 2013, Patch 1.0.7 was rolled out, introducing a range of new gold sinks intended to sop up ever-increasing virtual gold; they included new weapons and items not eligible for sale on the RMAH. One month later, with gold prices continuing to decline, a player made the following diagnosis:

[A]dditional gold sinks [are] unfortunately comparable to spitting on a fire ... [they] do nothing to limit the core issue which is that players are earning gold faster than they [want] to spend it. Repairing is not a … good gold sink as it works best [for] players who are [dying]. … Crafting is the same, works well on players who can get the items to craft with … but leaves players with limited gold supply out of the picture. … The amount of gold that drops … needs to be nerfed, and not softly.[15]

The effort appears to have been futile, as the growth of the virtual gold supply continued to grow.

Several competing definitions for hyperinflation exist, with the strictest — an increase of 50 percent in one month — defined by economist Philip Cagan in his 1956 book The Monetary Dynamics of Hyperinflation. By his definition, the Diablo 3 economy appears to have entered hyperinflation between February and March of 2013, when the black market price of gold fell from $0.20/million to $0.05/million — a decline of over 75 percent in a few weeks. At around that time, a player commented that he was

watching the markets collapse and gold become worthless. … So you feel rich that you have a billion or two in gold[?] … [W]ell guess what, you aren’t … there is nothing you can invest in to hold value. The only thing worth anything has become $$$.

With a sardonic irony that markets sometimes display, real world currencies had assumed the role of commodity gold, and virtual gold had gone the way of all flesh and fiat currencies.

This, however, was still only the penultimate stage. On May 7th 8th, 2013, Blizzard rolled out Patch 1.0.8, which contained the seeds of the last, hyperbolic surge of gold superabundance. One change was the altering of the gold stack size from 1 million to 10 million per $0.25: a simultaneous redenomination and 90 percent devaluation (sitting, as the price was, at the RMAH floor) of virtual gold, targeting black market rates of roughly 4 cents per 10 million. In addition, a bug within the patch allowed users to cancel transactions in the auction house before completion, essentially allowing them to double their gold on demand.

In just a few hours, the already gold-swamped economy saw trillions more created: a mammoth deluge of, by then, worthless virtual gold chasing finite goods, driving prices upward in leaps and bounds. It was, at last, the hyperbolic blow-off characteristic of real world hyperinflationary episodes. Some of the price increases (in Diablo 3 gold) are shown below:

  2013 avg price 1-6 May avg price 7-8 May price
radiant star amethyst 17.4M 41.2M 85.8M
radiant square ruby 187K 260K 337K
flawless square topaz 491 5,170 8,700
star emerald 764K 1.1M 1.6M
tome of jewelcrafting 694 3,400 3,100

And in a noteworthy departure from real world hyperinflation, rather than resorting to barter (which frequently takes the form of food for skilled labor), as runaway inflation became hyperinflation, many chat channels — through which some measure of trade was consummated — seem to have fallen empty: without a need to eat or clothe oneself in the virtual world, some players simply appear to have turned away


Blizzard quickly closed the in-game auction houses and audited transactions which took place during the blowout, banning players who took advantage of the bug and donating the proceeds of certain sales to charity. The gold stack size was also moved back from 10M to 1M. One week later, on May 15th, the above-cited items were quoted at the following, approximate virtual gold prices: radiant star amethyst, 26.1M; radiant square ruby, 375K; flawless square topaz, 8,600; star emerald, 797K; tome of jewelcrafting, 1,350.

In May of 2012, the price of virtual gold was approximately $30/100,000 or $0.0003/gold. As this article was completed — and bearing in mind that these prices may be erroneous, stale, or merely indications of interest — one site showed Diablo 3 gold being offered by four third party sellers at an average price of $1.09/20M, or $0.0000000545/gold: one ten-thousandth its market price one year earlier.In the RMAH, virtual gold was priced at $0.39/1M.

Remembering that game economies are private and players are voluntary members, there’s no explicit mandate to ensure rigid inflation control as one often sees (however rarely pursued) in public economies. That said, knowing that gaming experiences can be upended by economic missteps, there is a clear business interest for gaming firms in keeping virtual currencies and the greater economies as a whole stable.

Frequently, hyperinflationary episodes have ended by substituting a currency outside the political and central banking control of a nation for the sovereign currency. During the early 1990s, during Serbia’s hyperinflation,

[t]he authorities could not print enough cash to keep up. On Jan 6th, 1994, the dinar officially collapsed. The government declared the German mark legal tender … [which] end[ed] the hyperinflation.

Two obvious solutions for managers of virtual economies include more vigilant bot restrictions and close — indeed, real-time — monitoring of faucet output, sink absorption, prices, and user behaviors. More critically, though, whether structured as auctions or exchanges, markets must be allowed to operate freely, without caps, floors, or other artificialities. Unrestricted (real) cash auctions would for the most part preempt and obviate black markets.

One also surmises, considering the level of planning that goes into designing and maintaining virtual gaming environments, that some measure of statistical monitoring and/or econometric modeling must have been applied to Diablo 3’s game world. The Austrian School has long warned of the arrogance and naïveté intrinsic to applying rigid, quantitative measures to the deductive study of human actions. Indeed; if a small, straightforward economy generating detailed, timely economic data for its managers can careen so completely aslant in a matter of months, should anyone be surprised when the performance of central banks consistently breeds results which are either ineffective or destabilizing?

By no means does this analysis intend to equate the actions of virtual gaming firms with the policies of governments or central banks, or to malign their indisputably talented managers, designers, and programmers. While their actions may ultimately generate similar outcomes, central planners seek and wield power whereas the actions of commercial gaming interests are undertaken to compete with other online entertainment providers by delicately balancing opportunities for newer players with the need to continually challenge experienced players.

By all accounts Diablo 3 is a great game; one hopes that with this episode passed, it will reacquire its former glory. But while decision-makers at online gaming firms can and should be forgiven for not anticipating the perilous and unpredictable torsions of rapidly expanding money supplies, the events of the last week provide a stark reminder of the power and inescapability of the laws of economics.

Argentina Peso Gap Between Official And Black Market Rate Hits To 100%, BMWs Become Inflation Hedge

Despite efforts by the government to quell the black-market (or blue-dollar) for Argentina's foreign exchange, the unofficial rate surged yesterday to 10.45 Pesos per USD. This is now double the official rate of 5.22 Pesos per USD. This implicit 50% devaluation comes amid the growing realization that there is no savings option to maintain the purchasing power of the peso in the context of sustained high inflation (no matter what the officials say) and negative real interest rates. The government is not amused, suggesting the devaluation won't happen (just as Mexico did right up until the day before they devalued), "those who seek to make money at the expense of devaluations must wait for another government." Perhaps the government should be careful with their threats? And of course, this could never happen in the US or Japan, right?


And in the meantime, looking to hedge their inflation risk while taking advantage of the massive FX rate differential, the local population has found a new and original inflation hedge: BMWs.

Argentines are buying more BMWs, Jaguars and other luxury cars as a store of value as inflation decimates their deposits and pummels the nation’s bonds.


Purchases of cars from Germany’s Bayerische Motoren Werke AG (BMW) and Jaguar Land Rover Automotive Plc, owned by India’s Tata Motors Ltd. (TTMT), jumped the most in April among brands sold in Argentina. The sales were part of a 30 percent surge in car sales from a year earlier that was the biggest increase in 20 months, according to the Argentine Car Producers Association. While used-car prices rose in line with inflation last year, or about 25 percent, peso bonds tied to consumer prices fell 13 percent. The drop was the biggest in emerging markets.


Car sales in Argentina increased by the most in almost two years last month as a ban on buying dollars made Argentines turn to vehicles to protect savings against the fastest inflation in the Western Hemisphere after Venezuela. Luxury models are becoming more attractive because they are imported at the official dollar rate, said Gonzalo Dalmasso, vehicle industry analyst at Buenos Aires research company Argentines with savings in dollars are able to purchase cars at half the cost by trading in the unofficial currency market.


“I’m seeing a lot of people buying high-end cars for the first time, trading Minis for middle of the market models,” Ignacio Monteserin, a salesman at BMW’s Mini Cooper dealership in Buenos Aires’s Libertador Avenue, said. “It’s become very convenient to own luxury cars in general because of the big gap in the exchange rates and you get to have a quality good that will preserve the value of your money with time.”

Argentina’s Modest Proposal: Buy Bonds Or Go To Jail

While Argentina's recent extraordinary attempts at central planning have been widely documented, ranging from freezing supermarket prices in a (failed) attempt to control inflation, to banning advertising in a (failed) attempt to weaken the private media, so far nothing has worked at stabilizing the economy and preventing the collapse in the domestic currency (if leading to such humorous viral videos as #mequieroir). Ironically, this is both good and bad news. It is good news because as we showed two days ago, even the ludicrous speed rise in the Nikkei has been a snail's pace compared to that other unknown "Nation 1." We can now reveal that while Japan is Nation 2, Nation 1 is that inflationary basket case Argentina, and specifically its Merval stock index.

Of course, the surge in the stock index is nothing more than a reflection of the ongoing collapse in the economy, which in turn is reflected not by the official, government controlled exchange of the ARS (just try buying dollars at the official rate) which closed the week at a rate of 5.24 to the dollar, then certainly the black market one, showing just how weak the currency is for those who actually want to buy dollars in Argentina, which just hit a record high of over 10. In fact, as the chart below shows, when one factors in the 80% collapse in the real, unofficial exchange rate over the same time period, the stock index has barely kept up.

Furthermore, it is merely a time before the runaway inflation pushes corporate input costs so high, that not even the rise in the stock market can preserve wealth.

Still think soaring stock prices in the New Normal are an indication of anything but a collapse in the economy manifested by either current, or discounted, plunges in the purchasing power of a sovereign's currency?

And just to make sure there is no confusion, the full context here is that while the rest of the G-0 world at least has each other's central banks to fund mutual debt purchases, Argentina has been locked out from the global community for a variety of reasons. And yet, like any other Keynesian follower, the nation is desperate to borrow from the future in order to grow government now. However, without access to capital markets how will the country with the imploding currency do this?


Argentina's president Kirchner, a keen observer of recent events in Cyprus, has figured out a way to kill two birds with one stone, namely attempt to put an end to tax evasion, and fund the capex of the recently nationalized state oil company YPF (now that its former owner, Spainish Repsol, is less than keen to keep investing in its former Argentine subsidiary). To do that she will present the local tax-evading population (pretty much anyone with any disposable income and savings) with a simple choice: buy a 4% bond to fund YPF "growth" or go to prison.

From Bloomberg:

President Cristina Fernandez de Kirchner wants tax evaders hiding about $160 billion in dollars to help finance Argentina’s oil-producing ambitions. Her offer: Buy a 4 percent bond or face the prospect of jail time.

The tax authority announced the plan May 7, highlighting its information-sharing agreements with 40 nations and warning Argentines who don’t use the three-month amnesty window that they risk fines or arrest. Evaders have two options for their cash and the only one paying interest will be a dollar bond due in 2016 to finance YPF SA (YPF), the state oil company. The 4 percent rate is a third the average 13.85 yield on Argentine debt and less than the 4.6 percent in emerging markets.

Speaking of YPF's growth, we made it very clear a year ago when we reported on the latest "banana republic" nationalization of formerly efficient and private assets, that it was only a matter of time before an overarching government's epic misallocation of resources, leads to epic inefficiencies, and a liquidity scramble. It is not rocket science: only hardcore socialists can harbor any hope that a government is efficient at allocating capital, especially when one nets out the 50% or so in corruption "externalities" that are incurred along the way, be it in Argentina or the US. Once again we were right:

A year after seizing YPF, Fernandez is funneling more money into the nation’s energy industry as the government struggles to boost production from the world’s third-biggest shale oil reserves. With Argentina already committed to pumping $2 billion of central bank reserves into a fund for energy investments and the highest borrowing costs in emerging markets keeping it from issuing debt abroad, the government is eyeing the billions of undeclared dollars that Argentines hold to help shore up reserves that have dwindled to a six-year low.


“The authorities need to take steps to open up external resources in the energy sector and to finance the Treasury and local governments,” said Sebastian Vargas, a New York-based analyst at Barclays Plc. “The amnesty is not negative for markets but it’s disappointing because they do little to solve balance-of-payment difficulties.”

There are some cynics who will say what Argentina is doing on a semi-voluntary basis is what that other bastion of wealth expropriation, the European Union, did to Cypriot savers. They will be right of course, if only for the simple reason that Argentina does not know precisely where all the "illegal" tax-evading, offshore (and onshore) capital is held.

Argentines have at least $160 billion of undeclared funds, equal to about 36 percent of the nation’s gross domestic product, and $40 billion are hidden inside the country, Vice Economy Minister Axel Kicillof said at the May 7 press conference where he and other senior officials presented the amnesty.


Many Argentines hide assets to avoid a 35 percent income tax and a levy of as much as 1.25 percent on their personal wealth. Undeclared assets are also beyond the reach of the government, which in 1989 seized bank certificates of deposit in exchange for bonds and in 2002 converted dollar deposits into pesos.

In other words, unlike in Europe, where Russia's 'tax-efficient' billionaires had a bright shining red light blinking over Cyprus saying "we are here" (a light that is now blinking over Luxembourg, Lichtenstein and of course, Switzerland, not to mention other global offshore tax havens), in Argentina the government first has to find the money. Which is why its initial recourse is the conventional one: simple threats.

Those joining the plan would be immune from prosecution and won’t be forced to pay past-due taxes, said Ricardo Echegaray, head of the tax agency. The search for evaders, which includes cross-checking information on income and personal wealth reports with purchases of real estate and cars, foreign travel and credit card purchases, will continue, Echegaray said.


“You better bring your dollars back because we will find you,” Echegaray said at the May 7 press conference. Last year, tax collection in South America’s second-largest economy rose to 37 percent of gross domestic product from 16.5 percent in 2002, according to Economy Ministry data.


Former Vice Economy Minister Roberto Feletti, who is now a congressman for Fernandez’s Victory Front alliance, said the government expects to attract at least $5 billion under the program.

Good luck with that - the only thing Argentina will succeed is in forcing tax evaders to hide their money even deeper into the global shadow economy.

The amnesty program will probably fail because its benefits don’t outweigh investors’ mistrust of the government’s ability to rein in inflation, cut spending, attract foreign investment and restore confidence in the currency, according to Moody’s Analytics Inc.


“The problem the government faces is lack of credibility and lack of confidence,” Juan Pablo Fuentes, an economist at Moody’s, said in a telephone interview from West Chester, Pennsylvania. “That money is potentially there, it could come back eventually, but there needs to be a lot of changes. These bonds are not going to have any real impact.”

And in the meantime YPF, which can't afford to wait on capital infusion, will have less and less cash with which to operate and grow, until finally it is mothballed, dimming the one bright light in Argentina's economy, and leading to an even faster economic contraction, even more rapid devaluation of the Peso, if only in the black market of course, and an ever faster surge in inflation.

But at least the stock market will be off the charts: sounds like a fair exchange for yet another economy sent to an early grave by central planners.

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