United States: Technical Deflation - The Changing Face of Global Finance

Many international bankers, lawyers, accountants, and investors have been rather dazed and confused by the global meltdown of all classes of paper assets. The Japanese economy is continuing its deflationary monetary policies, while attempting to deal with over 500 billion in dollar terms of bad loans held by the banking system.

The global monetary system is being effected not as much by the policies and practices of governments, but by the massive explosion of information that is available freely to more people than at any time in history. A single human being has the potential power to communicate with over 500 million people with the single click of a mouse, provided those people have access to the internet and the sender has a large enough network to pass on the information through a method of distribution which duplicates exactly the original communication.

Inflation is caused by an increase in global money supply in excess of global production. The opposite occurs, deflation, when the amount of products, goods and services increases beyond the growth rates in money supply, or the perception of the general investing and consuming public is changed, where the value of saving and investing in income producing assets, or assets which will retain their value, is greater than the value of borrowing and being indebted.

Historically speaking, Japan was once the leader in electronic and information technology, both in production and developments. Japan, despite borrowing rates as close to zero as you could possibly set, overproduced to such an extent that they had to resort to investing their surpluses in dollar denominated assets to protect themselves from their own inevitable deflation, despite maintaining the Yen in a range of 80 to 140 during the past three decades. In the long run, when productivity reached capacity, and machines took the place of humans in exceeding production quotas, deflation was inevitable as technology had advanced automation beyond the ability of the central bank to maintain the balance between expanding production and money supplies.

This same phenomenon has begun in Europe and the United States. In Europe, the number of currencies in circulation was reduced from twelve to one vis a vis the Euro. Total global debt reached a peak some time late in 2001 at approximately 700 trillion in dollar terms. A major shift in perception began in the mid 90's when the internet took hold and growing numbers of sophisticated knowledge seekers began to study the global impact of technological innovation that increased productivity 100 fold in all areas of global commerce. The technical shift in values occured when savvy investors realized that borrowing yen at .01%, selling the Yen short, and reinvesting the proceeds in U.S. treasuries and agency securities a la mortgage backed securities, could easily garner a 400% return per annum. Many hedge funds and international private wealthy individuals began flowing money into such mechanisms until recently when the spread between US bonds has narrowed.

The cause of this narrowing can be attributed more to the calculations and perception of the global investing public through the educational processes available through our information age. Fifty years ago it would have been impossible for 500 million people to understand how the global economy worked. The time involved in the education process required many years in college or university. The Internet changed all that. Today, financial information available to leading edge investors, is delivered in time measured in seconds, rather than months or years. Statistics are gathered at rates unimaginable heretofore, and verifications of those statistics occur quickly enough to cause governments and public companies to constantly restate published information.

Consumers and investors, who saw the dollar rising in value against most foreign currencies, save some oil rich countries, began to understand that if long term borrowing costs were 6% in dollar terms, and the dollar rose 50% relative to purchasing power in foreign lands, the true cost of the borrowing during the past decade would be 56%, since the borrowed funds would need to be paid back in appreciating dollars, not depreciating foreign currencies. When this information began to circulate among the general investing public, the savings rates in the United states made a shift from being the lowest in the world.

By the end of 1999, perhaps as part of the millennium scare, or by way of a greater knowledge of economics, the general public in the United States was saving money at a faster rate than at any time in the previous fifty years. A national penny shortage actually developed, requiring the the U.S. Mint to increase penny production by 33% during the last few months of the century. The savings rate has continued to increase to the point that investors that saw the bubble in the U.S. began to pull out of the stock market. Companies which did not reflect growth histories and true book values relative to their market prices saw their equity value begin to shrink. This massive outflow of capital out of equities into long term bonds drove interest rates further down, with US treasuries and their agencies today trading at record low levels. The trend is continuing. 27 of the 30 DOW components still trade above 2 times their net present tangible book value. Few of these companies will add that much to book value during the coming business cycle. Savvy investors who short on the way down, and cover on the upticking short term rallies are faring very well.

Zero interest teaser rates on credit cards, zero interest auto loans are precedent to the issuance of zero interest mortgage paper and the consolidation of the global banking industry. Technologically, humanity is now in a position to establish a globally automated banking system, reduce the total number of financial institutions issuing credit and debt instruments, and reduce the number of currencies so as to establish stable global monetary operations and policies.

Proponents of a singular global currency, and a singular global central bank, are gaining favor with many disgruntled investors who were not given advance knowledge of the technical indicators which brought about the current global deflationary environment. Such organizations as the Soros Open Society Fund are going to great lengths to make the entire global financial system more transparent through such policy recommendations as requiring the largest oil companies to disclose a breakdown of their total royalty payments to foreign governments in the financial statements. Global policy makers are planning to adopt sovereign bankruptcy laws which will allow entire nations to file bankruptcy and wipe out or completely restructure their debts. Such a policy will accelerate the natural process of deflation which comes when production continues to compound at an accelerating automated rate in the most advanced countries, while less developed countries play catch up, but are blocked from doing so because of the massive debts and interest they must bear without relief.

Other broadly supported organizations, such as the International Bank Activities Reform Commisson, are educating the public about the long term benefits of changing tax laws in various countries which induces greater savings, and discourages being in debt. In the United States, a Washington D.C. lobbying group is raising $5 million to introduce a bill in the Senate and House to repeal the mortgage interest deduction on single family owner occupied housing and replace it with a tax credit for principal reduction. Such a policy would increase taxes in the short term, which the group says should go to paying off the national debt of 6 trillion, while at the same time create long term real wealth for 70 million homeowners.

The Free and Clear Society supports this lobbying effort and has developed the intellectual capital to implement a global zero interest mortgage program which will benefit 1 billion families. This product has been in development for the past decade and now with interest rates on 10 year US treasuries being below 4.0%, the product can be a very stable and higher yielding instrument than conventional agency issues. With greater education comes greater understanding. With greater understanding comes greater freedom. With greater freedom comes greater responsibility. As the world gains greater access to information, the interest bearing debt systems that have operated in a disequilibrium in global capital markets will gradually be replaced with a more equitable and just system of economics. The work that was begun almost a decade ago will be completed within the next decade. And the world will be a freer and clearer place.