Devaluation is the only way out - W.C. Varones

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Devaluation is the only way out

At the risk of validating Fed researcher Kartik Athreya's argument that bloggers are stupid and have no business opining on economics, I've been intending for a while to write more about why I think inflation/devaluation is inevitable.

First, a few assumptions. These are unambiguously true in my view, but if you disagree with any of them, you'll likely disagree with the rest of the argument.

1) This is not a typical cyclical recession but a huge bust created by the bursting of the Mother of All Bubbles.

2) We have huge structural, not cyclical, job losses. No vast new labor-intensive industries will soon spring up to replace the millions of construction workers, realtors, and mortgage brokers who have lost jobs or suffered greatly reduced incomes in the housing bust, nor the retail and related jobs created by home equity withdrawals.

3) Fiscal stimulus has been a complete failure. We've wasted a trillion dollars on political pork and paying people to stay unemployed for 99 weeks. We are running huge deficits of 10%+ of GDP, and getting only 3% GDP growth from it. Since government spending translates directly into GDP mathematically no matter how badly it is wasted, 3% GDP growth during 10% deficit spending indicates that the non-government economy is in a severe depression.

4) Without government and/or Fed intervention, housing prices will return to historically normal price/rent and price/income levels. Indeed, signs of another leg down are already occurring after the recent expiration of the house buyer tax credits.

The fourth point is the nightmare scenario. Another big drop in house prices would cause a huge new vicious cycle of strategic defaults and foreclosures, would wipe out the net worth of millions of households, and would bankrupt the entire banking system and dump hundreds of billions or trillions more losses on the taxpayers via Fannie, Freddie, and FHA. Then of course all of the cities, counties, and states would have their budgets destroyed by reduced property values and reduced economic activity. And then all the pension funds that own bank debt and equity would take a huge hit and be unable to ever pay their promised benefits. In short, the Mother of All Depression Spirals.

The primary obstacle to economic recovery is widespread insolvency among households and banks (meaning liabilities exceed assets). A consumer who is broke cannot spend, and a bank that is broke cannot lend. Devaluing the dollar would reduce the real value of the debt (increase the nominal value of the assets), rendering millions of households and most banks instantly solvent. A simple example: a family has a $200,000 mortgage on a house now worth just $150,000, and they also carry some credit card debt and are underwater on an auto loan. A 50% devaluation of the dollar would mean a doubling of general price levels, making the house worth $300,000 and allowing the family to sell or refinance the house and/or car, pay off the credit card debts, and go from a negative net worth to a substantial positive net worth.

A secondary benefit to devaluation would be improvement in American labor competitiveness. Currently labor costs are too high in the U.S. relative to the rest of the world, leading to both automation and overseas outsourcing. If the U.S. devalues the dollar faster than other countries devalue their currencies, American manufacturing and exporting will become more viable.

If inflation is the only way out, how best to achieve that inflation? As I've pointed out before, Bernanke's current mechanisms are not working. Zero interest rates and buying assets from the banks serves only to bail out Wall Street and create asset bubbles that benefit asset owners, but this doesn't get money to the broad mass of consumers. The misguided theory seems to be that if the banks are made healthy, they'll eventually start lending to the little people. But people don't need more debt. Too much debt is what got them here in the first place, and more debt will only make things worse. What people need is cash to pay down the debt. If Ben Bernanke really wanted to solve the problem, he'd stop giving money to the banks and follow through on his "helicopter drop" threat to get the money where it's needed, to the people. One mechanism would be a printing-financed tax refund: give everybody a refund of all the federal income taxes they've paid for the last three years. Cap the amount for the rich and give some to the non-taxpaying poor to get the money where it will help.

It gives me no pleasure to call for debasing the currency. I hate what the Dirty Fed has done to our dollar and our country. But by blowing bigger and bigger bubbles to try to prevent normal, healthy recessions from occurring, the Fed has painted itself into a corner.

Obviously there are great risks to devaluation/inflation, with Weimar Germany and Zimbabwe being cautionary examples. Is it possible to pull off a one-time devaluation followed by a sound money regime? I don't know, but I don't see any option but to try.

I'm still formulating my thoughts on the subject. I'd love to hear your thoughts.

UPDATE: How much would have to be printed for the helicopter drop? The government collects around $1 trillion per year in individual income taxes. And the top 1%, 5%, and 10% of the rich recently paid 40%, 61%, and 71% respectively of all income taxes. So you could cap tax refunds for the rich somewhere in that range and give everybody else a full refund of the past three years' income taxes paid for around $1 trillion to $1.5 trillion. That's on the same scale as what Zimbabwe Ben has already printed to bail out Wall Street, and it's not too much more than Obama has stolen from our children for his $800 billion porkulus.


Mutnodjmet said...

W.C.: What is your thought on this piece of analysis --

Dow Repeats Great Depression Pattern: Charts

Frankly, with so much of the bad news preceded with the adjective "unexpected", I have come to rely on the wisdom of you and other Internet econo-pundits much more.

qs said...

Ponzi scheme

T-Dub said...

I think that the bond market respectfully (strongly) disagrees with your viewpoint. This is not to say that markets are always right, but the bond market is signaling "fail".

I would be curious to know if *any* society using a fiat currency has ever been able to pull off a "soft landing" after hyperinflation. I think that the bigger consequence of money dropping from helicopters is that people lose complete faith in the currency and we temporarily become a barter society until some new credible currency is established. A loss of faith in the currency certainly won't create jobs either.

I don't think that a one time money drop works either. Once your credibility with lenders is gone, it will take decades to repair. You can't just commit one murder and tell the jurors that it was a one time event.

One other thing that I am struggling with is Japan. Why haven't they been able to create inflation? Are Japan's central bankers just plain stupid? This argument is pretty similar to that of today's Keynsians: the widely held view is that if we had only tried harder during the depression we could have stopped it dead in it's tracks in the early '30s.

Bottom line: the invisible hand is much stronger than most believe. For every new scheme that they concoct, market participants will react in a rational, rent seeking way. The only real solution is abstinence from fiat currency.

darkcloud said...

Solid article, WC, with some great points and merit.

Won't happen though, because the Power Elite doesn't give a rat's ass for doing what's best for the greater good. They only care about widening the chasm between the haves - themselves and theirs - and the have-nots.

And Congress works for them now, as seems obvious. So there's little or no hope for us there, either.

W.C. Varones said...


I don't generally put a lot of faith in charts, but I do appreciate history rhyming if not repeating. That's at least an eerie coincidence, and it aligns with my fundamental view that nothing has been fixed and we still have a lot of pain ahead.


I'm surprised people haven't lost faith in the currency already. The dollar has lost 95%+ of its value in the less than 100 years that the Dirty Fed has been around. And in the last few years the Fed has broken both law and precedent with increasingly radical and illegal policy actions (e.g. Maiden Lane SPV to buy Bear Stearns' toxic waste). Further debasement would be another step on a continuum more than a significant departure from what the Fed is already doing.

Japan haunts me too. Perhaps the difference is that the BOJ wasn't as reckless as Greenspan and didn't let households get as up-to-their-eyeballs in debt with no savings. By not painting themselves as far into a corner, the Japanese may not be as tempted/forced to go for the nuclear option.

Angryfutureexpat said...

Wow. This must have been a painful post for you to write. It's tough to look at the world and realize that the utterly awful and unthinkable is actually the least bad outcome - I've been there.

Welcome to my world my friend

Negocios Loucos said...

Angryfutureexpat, starvation is not a least painful outcome. And that's probably not the only pain involved as with hyperinflation, like in Germany, greater tyranny can come to power. Zerohedge continually predicts that war will be the outcome. What's worse than that?

W.C. Varones said...


Perhaps there's a way to do a one-time devaluation without causing hyperinflation.

Say, abolish the Dirty Fed and go back on the gold standard at $5000 per ounce.

SarahB said...

You on right on the money (no pun intended). It's not a matter of if, but of when. Sadly. But people had better get real about this and prepare.

B-Daddy said...

I generally agree with you, but not this time. While it is true that this is the mother of all bubble bursts, that is normally salutary as it allows the economy to redeploy resources more efficiently. I also agree that federal fiscal stimulus will continue to be a complete failure.

You wrote: "The primary obstacle to economic recovery is widespread insolvency among households and banks (meaning liabilities exceed assets)." This is where I disagree. The primary obstacle is that businesses in America are not investing because this administration is the most anti-business I can remember. The results of Obamacare and the recently enacted "fiscal reforms" are not fully understood. Adding to the uncertainty are the issues of what carbon policy will be legislated or imposed, what will really happen with marginal tax rates, will a form of card check be imposed, and how will the "doctor fix" be solved in November. Because of the massive uncertainty, private sector businesses are sitting on piles of cash that is not going to work in the economy. When it becomes clear that Obama will be a one term President and the Democrats current reign of terror will be brought to a halt, then businesses will start to invest and the economy will take off. In the meantime, we may have to suffer a double dip recession, but the long term outlook is good, in my opinion. The Economist has an article about cash holdings.

wcv said...


All true of course. I just see the Obama-created problems being on top of the underlying structural problem.

I would be shocked if we have a healthy economy in 5 years (unemployment < 6%, real GDP growth > 2%, deficit spending on a real downward trajectory) unless we address all of the above -- devalue the dollar and dump Obama, ObamaCare, and Obamunism.

Negocios Loucos said...


"Perhaps there's a way to do a one-time devaluation without causing hyperinflation.

Say, abolish the Dirty Fed and go back on the gold standard at $5000 per ounce."

That would mean the Executive, Legislative, and Judicial branches would have to take over as rulers of the country. The horror.....

symbolicalhead said...

The problem is that there is no such thing as _the_ price level. If you doubled the in-circulation amount of money via helicopter drop, some prices might go up by 100%, but others might go up by 500% and yet others by 2%.

Good luck predicting which ones did what. You may not succeed in raising the prices (and therefore the effective equity) on the items that current debts are issued against to the extent you needed.

If you really want to devalue debt effectively, I think you'd need to attack it directly or else absolutely trash the currency (ie, Zimbabwe-style). I don't think there is any in between

To attack debt directly, rather than indirectly, you'd need to:

(A) Redenominate the currency without adjusting debt contracts.

(B) Reset the principal on all loans.

Either one is an absolute slap in the face to contract law, and would destroy the loan markets for years. It is also much trickier than it sounds, as many complicated debt instruments exist.

W.C. Varones said...


Agreed. Devaluation is far from perfect, but I think it's the path of least resistance from here.

I'm positioning myself appropriately, in equities, real estate, gold, and lead.

Anonymous said...

I agree with your article, premise, and reasoning.

Question: the lead.
:-) Cartridges or pipes?

Anonymous said...

You know, I like the blog but sometimes you go off the reservation, way off. Let's just consider one of the more obvious flaws in your argument:

"A 50% devaluation of the dollar would mean a doubling of general price levels, making the house worth $300,000 and allowing the family to sell or refinance the house and/or car, pay off the credit card debts, and go from a negative net worth to a substantial positive net worth."

You have just cut all savings in half. The person who had saved a down payment to buy this house now no longer has enough for a down payment. Oh, wait, our happy home owners will just do a 28% APR fixed. Hope they didn't have an ARM before the devaluation because they will immediately be bankrupt. Pay off the credit card debts? With what, their reduced savings? Not to mention that credit cards don't have fixed rates. Do you think their employer is going to magically double their pay because of your little devaluation? Right, the employer will be dancing in the street as a result of massive wage cuts. Meanwhile, our house seller/refinancer must now pay double (or more, no reason to think this will be a linear adjustment) for the necessities of life on half pay.

Money for nothing and your chicks for free only works for rock stars. Money is a medium of exchange and, to a lesser extent, a store of value. That's all it is. Please note the Paul Krugman agrees with you wholeheartedly and the best real life example to support his thesis (by his own admission) is...wait for it...Argentina.

Anonymous said...

Oh, and here is a far better and more relevant Argentina link.

This is what you are advocating!

Anonymous said...

You can have a nanny state like, say, a Soviet Union or you can take responsibility for your own actions. Ostensibly, this blog favors the latter. Except here in this so-called "Greatest Hits" type article. Such cognitive dissonance is all too reminiscent of current republican rhetoric.

You see a problem and your solution is more central planning. WC, if you want a nanny state, then come right out and proclaim for one. Otherwise, the "problem" is only in your head and this problem as you see it is already being solved, albeit slowly. Foolish persons who took on more debt than they could handle are being bankrupted. Companies that should never have existed, ditto. As they should be. If there is any problem, it is that the government is needlessly interfering in this natural process of a free society. It is the government driving up costs through the mechanisms of needless money supply expansion, making unservicable loans, protecting monopolies and oligarchies of all kinds, issuing restricted currencies like SNAP cards, etc.

W.C. Varones said...

All largely true, but:

1) We are a debtor nation. The median household has more debt than savings. So a voting majority would be better off under devaluation.

2) I'm not advocating it as much as saying it's inevitable. We have debt/GDP over 100% and we are still running deficits of 8% of GDP. No country has ever gotten out of that without inflation (i.e. devaluation). See post-WWII.

3) I'm only saying what Bernanke is thinking and doing. Screwing savers with 0% interest and significant food and energy inflation to bail out debtors is exactly his plan.

The die was cast when we let the Fed create the Mother of All Bubbles and when we let Barry O start running trillion-dollar deficits.

Now it's just a question of whether we drag out devaluation for decades or get it over with and get back to sound money.

I'm just sayin' its happening so position yourself accordingly.

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