Tesla - the company starts a new future for the planet

It's amazing how limited in a imagination some people in finance are. Elon Musk has imagination and ambition for the planet.  Tesla's stock price has almost no limit. Certainly the man is someone to whom the trite addege "no limits" applies in more fullness than anyone else I can think of. With the Model S he is advancing a sea change in technology as significant as the Model T Ford. Not just cars will be able to use this technology. The same principles can apply to any thing that uses an internal combustion engine. The technology can be used equally well in boats, planes, motorbikes and mowers.

Can Tesla license the technology to other manufacturers? Of Course!

Infation or Deflation: that is the question.

The whole deflation inflation debate is terrible interesting. Simplistically it is astounding that the debate is about two apparently opposite outcomes. One sort of simplistic argument that I have not heard made often goes like this… In a world where the majority of new money is conjured up by bankers when they make loans how can central bankers engineer inflation when the value of the assets backing the loans are falling in value? The reason this question is interesting is that when banks loan money into existence they do so at a leverage of 10 times. This means the banks are wiped out when the assets backing their loans fall by 10% plus whatever the borrowers initial equity was. When the loans are written off it creates a huge deflationary force.

To me the force seems assymetric to the downside. I could give reasons why but it would be very boring. Marc Faber who predicts hyper inflation uses the argument that you can have inflation in a weak economy just look at Zimbabwe. There are of course many differences between Zimbabwe and advanced western nations. Among them being the level of indebtedness. I imagine the average Zimbabwian did not have a mortgage on his house or massive credit card debt. These things don’t exist in poorer nations. Weimar Germany likewise probably was not a society of highly indebted people. My guess is it is much easier to generate inflationary pressures in a low Debt society than in a high Debt society.

what-the-pboc-cannot-do-with-its-reserves

Very interesting and important post from Micheal Pettis.

What is Excess Liquidity Good For?

Here is a weird thing about the carry trade. When central banks provide more liquidity than is need to supply the domestic market with its need for a medium of exchange, (thats liquidity right? the medium of exchange), the remainder can be used to purchase foreign goods or make investments on foreign shores.

That's the origin of the term carry trade. It used to be gold that had been freed up by the advent of fractional reserve baking that was used. After all who would trust paper from a foreign state?

So theoretically all this excess liquidity gets used by the banks to speculate in foreign markets. They just don't need it domestically. Now these are the too big to fail banks that when their speculations land them in the crapper get bailed out by the government effecting a transfer of wealth form the citizens who save to the naughty banks who speculate.

If I were a Japanese saver, and they are renown for it, I would be hopping mad.

Whats Next?

Finance is so weird. The massive imbalances are obvious to everyone and yet there is huge debate about how they will resolve.

I will try to give my 2 cents worth.

The root cause of the problem are the huge foreign reserves built up by over productive undervalued currencies, and for arguments sake I will lump China and Japan together in this even though their bubbles have occurred many years apart. Both China and Japan have beaten American manurfactures successively on the head. What has kept the American economy going is the steadily lowering of interest rates which I think somehow replaces labor with capital although I don’t understand this. Anyway what is easily understood is that GDP and employment have been kept up in America by using other peoples money (Japan and China) to consume and build. This was enabled by lowering interest rates and facilitated by the creditor nations through their willingness to lend at those rates.

Now it looks like this process is coming to an end and I think that we should not look to the past twenty years as a guide to what will happen now because there are too many differences. Globalization is now pretty mature. Accordingly and to make my argument as simple as possible the world should be considered as a single economic unit and now I’m heading in the direction of Reinhart and Roghoff sp? although I have not read their book. But consider this. The savers of the world the Chinese and Japanese have nice looking credits on their investment statements. BUT the statements ultimately represent loans made to their governments. In the case of Japan much of the loans made by the people to the government were spent by the government in Japan to prop up the economy for the past decade or so. In the case of China the loans made to the government have been used by the Peoples Bank of China to buy US treasuries in order to maintain their currency peg.

So globally what we have is a situation where vast amounts of private savings have been entrusted with domestic or foreign sovereign debt programmes and probably all somehow leveraged 10x. Well! you might say what is so unusual about that! And I would say nothing except that the debts are so large and are sustainable only at low low interest rates. I would ask what happens if there is a crises of confidence in sovereign debt?

Remember how subprime was going to be so easy to contain? Lets hope that the emerging sovereign debt crises in member countries of the EU IS contained! The possibility of a global sovereign debt crises is to horrible too imagine. We won’t be merely worried about capital gains or losses on our bonds. Return of funds in a stable currency may be of a greater concern. Crikey now I’ve got myself all worried again.

Feel free to correct criticise or enlarge.

China's Foreign Reserves

Right let's see if I can get this straight as it seems like a very important concept to understand. China's foreign reserves are netted out on it's central bank balance sheet by a corresponding debt. How has this happened?

First thing that happens is China produces widgets that America likes and sells them profitably to. In return the widget maker is given US dollars which he sells and purchases Yaun with. The important point here is that because the widget which was created by labor has been made profitably it results in a net increase in demand for Yaun which would normally cause the Yaun to rise and assuming the US does not do better in it's trade with any other countries the $US dollar would be inclined to fall.

The China central bank notices from it's elevated perch that the profitable manufacturers are driving up the value of the Yaun putting the breaks on it's economic growth. In order to prevent the Yaun from rising it sells Yaun and buys US dollars. But since it did not make anything in a profitable way it must create a corresponding debt on the other side of the ledger or print money to purchase the $US.

There you have it. I think.

Of course there are other processes occurring at the same time. Such as money formation at the regional banks in the form of debts and credits to fund the manufacturers expanding factories. Artificially low interest rates to tax effectively tax savers and help capitalize banks. And using similar methods to the federal reserve to expand it's balance sheet and encourage lending as part of it's fiscal stimulus measures.


Here is a better explaination fo China's foreign reserves by Hua Qiao from

http://mpettis.com/2010/02/never-short-a-country-with-2-trillion-in-reserves/#comment-4827

Chinese exporters sell to US consumers for dollars. China, through the PBOC and SAFE (State Agency of Foreign Exchange), controls the Yuan by being the only market agent for that exchange, currently pegging the Yuan at 6.83 for every dollar. So for every $1 tendered, the exporter gets 6.83 RMB deposited into his bank account.

PBOC takes the dollars, transfers them to CIC or some other investment entity, and invests them back into vehicles in the west, typically treasuries. They could sell the dollars in the world market for some other currency. They could buy physical assets with the US dollars. But China has to date, bought principally US Government debt.

Back home in China, the PBOC must effectively print more RMB to cover the deposit, increasing the money supply. If they want to offset the inflationary effects of that increase, they issue sterilization bonds which they require the banks to buy. They were pretty much doing so up until 2008 when they stopped.

So, are these foreign exchange assets wealth? Probably not the right question to ask. Clearly, the reserves are an asset that China, as a country, can use to project its influence on the international stage. But that asset comes at the expense of improving Chinese citizen’s lot at home. If the increase in RMB supply is not sterilized, then inflation will eat away at the value of those deposits the exporters and hardworking laborers have stuck at the banks. If the sterilization bonds are issued, then the government is essentially directly borrowing those deposits from their citizens to “invest” overseas.

FX reserves are an asset, just like anything else. However, they represent a redistribution of income/wealth. China is sort of rearranging its national balance sheet. So the Chinese consumer cannot enjoy the fruits of his labor as much as he should because his cash is stuck in low yielding deposits and some of the foreign goods he would like to buy are prohibitively expensive because of the undervalued RMB and also the import duties on foreign goods. Try to buy a REAL set of Ping golf clubs, or a foreign produced car, or imported perfume, foreign vitamins, or foreign makeup or foreign wine here.

As long as you have a pliant population, who you can feed a constant flow of propaganda that their country is well off, the government is working hard for them and tomorrow will be better than today, then they tolerate the hidden costs and the forced savings.

The New Normal....not good

It all boils down to the fact that if a lot of people are getting rich and are not producing anything then the production economy MUST be paying some how. Lets count the ways.. no lets not there are too many.

This is the failure of capitalism. It has put the ability to destroy productivity and get rich at the same time into the hands of the finance industry. Is this good? not really. What can be done? I don't know. But if someone comes up with a way to defeat them and improve the lot of the productive sector they will deserve to get very rich indeed.