http://www.mises.org - cover story on inflation - what you see and what you dont see - web link to story above

thanks

Financial assets inflation is what we’re observing all around the world at the moment. Information technology has enabled us to conquer drastic reductions in the costs of transacting financial assets, most notably stocks. With lower transaction costs, and consequent increase in traded volume (turnover in US equity markets has quadrupled since 1980), stocks have become an effective alternate to sovereign money as a means of exchange. We get paid in company stock; what could be a clearer sign?

With higher liquidity, stocks trade at a lower discount. This means their prices go up. However, this is an illusion; an inflationary illusion. The illiquidity discount in stocks is in effect a liquidity premium on money. Prices are all relative, so what’s the difference? The difference is that money is effectively worth less in consumption units; it looses purchasing power. The shadow price for the constraints on trading adds a premium to the purchasing power of more liquid assets (including sovereign money), but leaves the purchasing power of the less liquid assets unchanged. The reason for this is that liquid assets are traded first in the interest of risk sharing. Once all liquid assets have been traded, all remaining unbalanced assets are equally illiquid, and hence no liquidity differential is created.

If sovereign money has lost its purchasing power, we should observe a rise in consumption goods. The reason why we don’t is that the progress in information and transportation technologies has allowed us to tap into the excess capacity in offshore labour markets, as Tom points out.

So what does this mean? This means

1. The end of Equity Premium Puzzle – as the liquidity portion of stock returns has been realised at present value in the last decades;

2. Significant devaluation of OECD money against consumption goods - as the excess capacity in offshore labour markets are dried up (and we are already starting to see some of that in China);

3. Sharp decline in demand for consumption, especially in those countries with the lowest saving rates (i.e. the US);

4. Substitution of US consumption for consumption in China - as the lifting of the masses above the poverty line allows consumption to climb the exponential curve of wealth distribution;

5. China stops rolling over its stake at the US debt (currently $1.2 trillion) – as it no longer sees the need to finance its main client;

6. Oil producing countries also sell off their US Treasury assets (currently valued at $1.3 trillion);

7. Japan may remain loyal to the US, as their protectors and benefactors, but only to their own detriment, as a broke nation will be unlikely to defend them against China;

8. Devaluation of the USD against other currencies – as US interest rates go through the roof (this is the foreign exchange inflation Tom pointed out);

9. Further substitution of the US for China as the global trade partner, especially for commodity and energy producing countries (i.e. Brazil, Australia, Venezuela, and countries in Africa and the Middle East) as well as service providers;

10. Major shift in geopolitical power. What happens to Japan and Israel?