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Bottom Dollar

J Bradford DeLongJ Bradford DeLong is Professor of Economics at the University of California at Berkeley and a former Assistant US Treasury Secretary. His last piece in Webdiary was Fiscal apocalypse now.

by J Bradford DeLong

As more time passes with neither the value of the dollar declining sharply nor market forces beginning to shrink America’s current-account deficit – which may well reach $1 trillion this year – two diametrically opposed reactions are emerging. Most international finance economists are becoming increasingly frightened that a major international financial crisis could erupt. Indeed, they fear that the scale of that potential crisis is becoming larger and larger.

Others – especially managers of financial assets – are becoming increasingly convinced that economists don’t know very much, and that what they do know is of no use to traders like themselves. They see little reason to believe that current asset values and trade flows are not sustainable.

After all, they (or some of them) argue, the real GDP of the United States is growing by $400 billion per year, with about $270 billion going to labor and $130 billion to capital. Even after depreciation, that $130 billion of extra annual income is capitalized at about $1.5 trillion of wealth, so the current-account deficit, even at $1 trillion, is not overwhelmingly large. We Americans can sell off two-thirds of the increment to our wealth to finance imports and still be $500 billion better off this year than we were last year.

Moreover, the annual interest charged on the extra $1 trillion per year that Americans borrow from the rest of the world is about $50 billion – just one-eighth of annual economic growth, while the trade deficit is financed out of the growth of the value of capital. So what’s unsustainable? Why can’t the US current-account deficit remain at its 2006 value indefinitely?

The counterargument hinges on the difference between the current-account deficit and the trade deficit. The current-account deficit is equal to the trade deficit plus the cost of servicing the net international asset position: the net rent, interest, and dividends owed to foreigners who have invested their capital in the US. As time passes, deficits accumulate. As deficits accumulate, the cost of servicing the net international asset position grows.

Thus, in order to keep the current-account deficit stable, the trade deficit must shrink. And the only way for the trade deficit to shrink substantially is for net imports to fall, which requires either a relatively sharp decline in the value of the dollar, thereby raising import prices, or a depression in the US. Both outcomes would weaken demand for foreign goods by making Americans feel that they are too poor to buy them.

As a result, holders of dollar-denominated assets should be looking forward to two alternative scenarios. In one, the value of the dollar will be low; in the other, the US will be in a depression. In neither scenario does it make sense to hold huge amounts of dollar-denominated assets today. Therefore, foreign speculators should, any day now, dump their dollar-denominated assets onto the market, and so bring about the dollar decline that they so fear.

But foreign-currency speculators and international investors are not looking forward to either of these scenarios. They continue to hold very large positions in dollar-denominated assets, which they would not do if they thought the US faced a choice between a cheap dollar and a deep depression.

So, what alternative does the market see? And why is it so different from the possible scenarios that international financial economists see?

The answer appears to be that there is nobody in the financial centers of New York, London, Tokyo, Frankfurt, and Hong Kong who thinks it is their business to bet on a future flight from the dollar. Especially in times of crisis – and a sharp fall in US imports would imply a much more severe crisis for Asian and European exporters than it would for the US – the dollar is a currency that you run to, not from.

George Soros can bet on a run on the British pound. Thai import-export firms can bet on a run on the baht by accelerating their dollar receipts and delaying their dollar payouts. Everyone can bet on a run on the Argentine peso – a favorite sport of international financial speculators for a century and a half. But not the dollar. Not yet.

In other words, the market is betting that the dollar will fall gradually in the next five years, and that the US current-account deficit will narrow without a financial crisis. That is what happened in the late 1980’s, and in the late 1970’s, too. After all, God, it is said, protects children, fools, dogs, and the United States of America. But the odds on a soft landing are lengthening with each passing day.

Copyright: Project Syndicate, 2006.

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Howard's false economy.

Let's have a reality check and a lot of reasoning. WHY reduce the incomes of Australian workers while the Business community are making obscene profits? (Is he admitting that his false economy will soon go into recession?) WHY, with Costello's "robust" economy do we have 49 continuous dificits in our Trade - which is now at an all time record of 500 Billion? WHY does Howard and Andrews still lie about the draconian IR legislation being for the benefit of Australian workers when they allow business to bring in foreign labor?

Is this to put pressure on our countrymen and women to accept "gratefully" that he is allowing them a job at all? WHY does he crow "any job is better than no job at all"? Has he ever worked for mines, building, digging roads by hand, in extremely dangerous situations - without even a reasonable living wage? Has he ever worked at all?

But, he says - let's MOVE ON! Move on while these IR laws take us back 150 years? His TV HD system is being forced on us while all comparable Countries are phasing it out - moving on? His intended Nuclear Power and Waste plans (for George Bush) are being decided at a time when the entire western world is directing it's attention to the control of CO2 ommissions so that the Coal firing can continue rather than nuclear waste proliferation - and this when we have enormous coal deposits for export - moving on?

And with all of this, he pushes our workers towards the typical "White Coolie" slave labour! After all doesn't he pontificate that the Chinese Coolies (especially miners) whose employment has been slatted by him as Crimes against humanity - what is the difference? ANY JOB IS BETTER THAN NO JOB AT ALL - isn't it? There is no truth - just the powers that be!

Let's not let Howard dictate the issues.

Just a quick comment on Costello's diversion regarding his false economy.  Like the fascist he is, he wants to give complete control to the Federal Government and the States to become "sub-Committees". Does this mean that HE acknowledges that the economy HE claims is booming because of him, is really because of the economic management of the Labor States?  Or is HE preparing to blame the States when Australians wake up to his false plastic card economy?  Do you believe that Costello and Howard would really create a totalitarian regime in a true Democracy IF they believed that they could lose that power?  Don't you see that their behaviour is not that of a confident Party but, the attitude of a group who, somehow, KNOW THAT THEY WILL WIN? While the States become servants to THEM and not the PEOPLE?  Howard has an unaccountable fascist-minded government now - make sure that he doesn't take over the States to increase that corruptible power.  And remember that, while they have not asked you for that mandate - they will claim they have it because Costello "mentioned" it now. Wake up Australia.

The biggest media protected con of all.

Howard's false economy!  Let's get real.  Take note that the highest taxing government in Australia's history (GST in NSW alone last year was 15 BILLION) pays enormous sums of our money to the media for comment and advertising - that's out of our pocket.  With the "wealthy" charade coming apart (despite the commodities boom) note the amount of expensive "junk" mail you are getting?  They are all tax deductible - that's out of our pocket.  Take the "good deals" that the Corporations are are offering - no interest - no payments for years - 70% off etc!!!  Is that the normal benevolent behaviour of the "Caveat Emptor" Corporations? Look at the advertising becoming our every hour, every day, every avenue which pushes Howard and his incompetent government.  Check the numbers of diversions that he throws in our faces to continue to "moving target" theories of Karl Rove.  IF our young people can only be influenced by money - look at the financial sharks who are now feasting on late mortgages and plastic card debt - look for the foreclosures and re-possessing by these kind hearted Corporations.  Wake up Australia - the last thing we need is Howard's Corporations government.  NE OUBLIE.

Howard's false "plastic card" economy.

Howard's false economy is beginning to collapse and, though the media tries to continue to hide it - truth is surfacing all over the country.  A Lady from the ABS did a survey with the typical Howard narrow "terms of reference".  She reported that wages had increased an average of 3% each year for Howard's ten years.  What she did not have the authority to report was that those rises were won in the Australian Industrial Commission by the ACTU and each and every one was contested by Howard!!!  Now they claim the result is due to their management.  Fair dinkum.  In addition, the it was factually reported that Australians were the hardest workers in the Western World and that the average wage was achieved with upt to 60 hours per week.  And the overtime tax was up to 70% - so let's get real.  Access Economics has reported that the wealthiest people in Australia consist of one fifth (20%) of our population - and they control 60% of our resources!  Conversely, one fifth (20%) of our poorest citizens control only one percent (1%) of our resources.  Using 21 million as an estimated population at this time, that report means that 60% of our wealth has been channeled to 4.2 million people over the Howard 10 years and the opposite end of the spectrum means that 4.2 million have "control" of 1%.  I am in Queensland at the moment in a shopping mall where at least 25% of the shops have closed since last September.  This is happening due to Howard's mismanagement of our nation by railroading us into Globilisation.  It is only common sense to acknowledge that this goal will only favour the Corporations and the "powers that be" as amalgamations, mergers, take-overs and the inability to compete with the mega-moguls will see the smaller business people gobbled up.  Yet they still believe that Howard is concerned about their future!!!  Fair dinkum.

Here's one for EWG

G'day Ernest W.

Sorry about the delay. The acronym CGT stands for capital gains tax. I'm presuming it was introduced by a Labor govt (Hawke/Keating?) but I'm not too well briefed on this period, having been other-where engaged around those times.

But: our CGT rate was halved by Costello, in 1999, an action which, if one had wished to prompt an asset-bubble, could not have been better designed - or so I read somewhere (reference lost).

Web Results 1-78 of about 290 English pages over the past 3 months for CGT rate halved Costello site:.au (0.27 secs).

1st 'hit': Howard's crackpot capital gains tax reforms fail - News - www.smh ... Howard liked Ralph's extraordinary recommendations so much that he halved the CGT rate to a maximum of 24.25 per cent for individuals who held their assets ... [SMH ]

Just read the article.

But talking about a debt-ridden economy, get more from a horse's mouth here:

Posted: 21:14 AEST
Labor must take on Govt over interest rates, private debt: Keating
Former prime minister Paul Keating has called on the Federal Opposition to take on the Government over interest rates and Australia's private debt overseas." [AusBC]

Keating: "So why didn't we take him on on interest rates because we were too stupid that's why, too gutless...

IMHO, it's all because the AL-bloody-P has sold out to the 'big end of town'; abandoning us, we the people. If so, how can they ever expect to get elected?

We need a choice. Not a better choice - as it stands, we have none.

Keating, the man with guts.

G'day Phil. I chased up your quote of Paul Keating in the ABC Online. A breath of courage, wisdom, fresh air and a true course for the Labor Party, IF indeed it does have the courage.

Mr Keating was one of the best handlers of the"big end of town" interviewers that I ever had the pleasure of watching. The way that the Corporation media - yes the Liberal media - falsely portrayed the economic comparisons between his policies and those of the Howard led Opposition, has been a disgrace at the last four elections.

Even I, with the help of the ABS, easily discovered that when Howard was Treasurer for Fraser he produced only four budgets and ALL IN DEFICIT. His personally nurtured Australian record Bank interest rates hit 21 per cent in 1982!! When the Fraser government was defeated it was Howard who left the Labor Party with a "huge recession and 11 per cent inflation". Labor handled it by bringing it down with high interest rates to ONE - yes ONE PER CENT inflation!!

"How did he get away with it," Mark Latham had queried so many times while the media attacked him from every direction, including an act of defending his luggage from a foreign Taxi driver - and even after he had been crucified and left in a sorry state, they kept after him and even interferred with his childrens' privacy. What truly Australian those two acts were - and - what no good bastards the media are.

Look at the circus they made out of the tragedy and the heroism of the AUSTRALIAN WORKERS UNION Miners in Tasmania? The typical lies and misinformation to make a story was rampant. Kim Beasley quite rightly pointed out the connection between the existence of the Union there to protect the Miners and Howard's anti-Union, anti Workers "let's sack 'em legislation".

Now Haw Haw Costello, protected by the Corporate media, lays down a budget which, with already minimum scrutiny, gives tax cuts grossly favouring those earning $100,000 or more - now that will help the middle earners won't it? How does Howard get away with it? The media - and some fool asked what I have against the media - fair dinkum?


Ernest, Paul Keating, A breath of courage, wisdom, fresh air and a true course for the Labor Party, I recall him saying that the Labor Party was "bloody stupid". He was only saying what most people already know.

As for Beazley's fiasco during the Beaconsfield disaster, both he and the Bill Shorten milked it for everything they could. I wonder how much quicker those men would have got out if the Union would have foregone their time in front of the cameras.

As for Latham defending his luggage, the man was a hothead and it was not the first time he had hit someone. As for the press crucifying him, he was a basket case from the start but Beazley and Co put him forward as the best thing since sliced bread. Now we have the Labor Party saying, "they are all behind Beazley," he would be better off if they were in front of him where he can see them.

Howard's personal media representatives.

We note that where ever Howard goes, the media follows him to give him maximum coverage ad nauseum.  Even the Liberals recognise that this little narcissist "Deputy Sheriff" is over the top in his desire to be seen as a dictator subservient only to the Bush Administration.  Even though it is obvious to everyone that he has no real national need to take these world trips other than to promote himself as a gift to the U.S.  And that he is. 

Regarding Kim Beasley doing the right thing and travelling to Tasmania to support the Union members in their heroic efforts to save two of the three men trapped in the Mine.  It is typical of the idiots who vote for any contemporary Liberal or National candidate, that they have the duplicity to criticise him for his seconds of time in un-orchestrated appearances.  Do we remember what the media did to Mark Latham when, while he was extremely sick in Hospital, and did not "comment" on the Indian Ocean sub quake?

There are of course, unlimited examples of this grandstanding which is awash with our taxpayer's money - as are all of Howard's much-publicised world trips.  Look at your local Federal candidate and write to him/her, no matter what party is involved, and ask what they think of Howard's grovelling to Bush and the media's bias?  Let's concentrate on them, not "I know nothing" Howard or any of his lying Ministers.  After all, if we put the blow-torch to the local Liberal/Nationals, more people will be able to understand the incompetence of this government of depraved indifference.  There is no truth - just the "powers that be"!

Dummy spit

Ernest William ..." Do we remember what the media did to Mark Latham when, while he was extremely sick in Hospital, and did not "comment" on the Indian Ocean sub quake?"

 I thought he was on holiday on the Central Coast when he spat the dummy on the sub-quake.

Come on, Beazley went to Tasmania to cash in on the disaster and try and take some of the gloss off Bill Shorten.

What interest rise?

Isn't it amazing that the subject of interest rises, which was falsely used by Howard and his venal media to succeed in the last election, suddenly seems hardly worth a mention. We are told that all of these factors which hurt (and will continue to hurt), the middle to lower class of Australians, are definitely not caused by the Howard government's false debt-ridden economy? Because at the same time the mainly foreign shareholders are reaping obscene profits - as are the Corporations. Shades of the AWB! Let's have a reality check on Howard's claim that he can do nothing about Oil prices or the cost at the bowser.

Firstly, remember the Petrol price hike in the First Gulf War? It rose to 80c per litre. We were told that it was because of that war affecting Oil production in Iraq, at that time claimed to be the second biggest producer after Saudi Arabia. The wisdom of Bush senior in not invading Iraq itself has proved to have been correct.

Then there was the food-for-oil system which began when the Howard government was actually in control of the AWB - and we now know what happened then and after.

So, look back at the slow but constant rises in Oil prices since March 2003, the time of the illegal invasion of Iraq and the "citizens" burning oil to prevent the occupiers enjoying the fruits of their crime? We have had all the excuses we can handle from Refinery shutdowns in America to a democratic election in South America.

However, the rises never drop when all of those "problems" are resolved - WHY? The U.S. has the highest stockpile of oil since WW II - WHY? Now how about Howard and his heralded surplus of eleven billion dollars - and he cannot do anything about the cost of fuel??? Currently, with his TAKE of the CAKE per litre is approximately 42% due to the EXCISE and the Meg Lees' GST. Down south NSW we are paying $147.9 per litre!! That means that the "wallowing in wealth Howard government" receives in the region of 62c for each litre! Now that wouldn't offer a way to ease the pain - would it? And now we see the corporation's reply to Treasurer Mr. Costello's plea - NOT to increase their prices!!

Fair dinkum. Many ordinary people like myself, have been warning for two years at least, that the LABOR established boom has only been maintained by a conspiracy between the Howard government and the Banks to lend "plastic" money for ridiculous amounts - and like the pied piper who has to be paid - the banks and financial institutions will now reap the benefits by picking up hundreds of almost new homes of "Howard battlers" who were conned into over-borrowing.

Add to the mix of - higher interest rates; record domestic debt; massive increases in "part time" employment; and higher costs of child minding for Mothers to work - Howard's' "move forward to 150 years in the PAST" Industrial Relations easy to sack legislation - and see if the Howard media STILL CALLS THAT A BOOMING ECONOMY!!

Graphics from The Economist

The most dramatic slowdown has been in Australia where, according to official figures, the 12-month rate of increase in house prices fell to only 2.7% in the fourth quarter of 2004, down from nearly 19% at the end of 2003.

While America's housing market is still red hot, others - in Britain, Australia and the Netherlands - have already cooled

irrational exuberance; 'printing money' & grisly greed

G'day Ernest, and yes I do remember you from the late ( and more or less) lamented CT-HYS.

You ask me to explain: "how our Foreign debt is a massive $500 billion and yet the Treasurer claims a 'debt free' day. Apparently because, while 'private enterprise' borrowing has created this worrisome amount, the Government borrowing has been reduced? In my thinking, the latter may be due to the fact that the Howard government is selling our assets and resources at an alarming rate," then for an opinion re same from me.

First of all, I wouldn't attempt to explain any of the Howard/Costello policy-cum-obfuscations; I doubt if even the principals (or their confounded lackeys) could explain some/all of them. I have heard that a Fed Govt without debt could cause problems on the bond market - i.e. no bonds for trading with - but who cares, obviously not Howard&Co.

I would propose a bit of caution; I don't believe all our troubles are due to Howard&Co, remember that the AL-bloody-P (thanks, P.Adams) also sold and continues to sell our 'family silver.' I don't know which is worse, selling Medibank Private (Fed-Lib) or the Snowy (58% NSW-ALP), but I consider selling either or both to be the filthiest treachery and toadally un-Australian to boot. But that's really just a sign of the times; rampant, possibly wrong and/or unjustifiable ideology rampant - and that often the same from both sides; we are given no choice. Also, that although a majority of the MSM (incl. big bits of the AusBC) may be corrupt, their masters are not directly the politicians. Indeed, it is more likely that the politicians are the dupes and puppets of 'the big end of town'. How else could one explain the craven cowardice of our so-called opposition parties?

Excessive borrowing o/s is a problem I addressed at 'inflation' above, where I asserted that inflation (house prices, stock markets) was being driven by printed money. But you don't have to take my word for it, try this: "What about global markets? They have been driven up by the rising world economy, low inflation and easy money, pumped out by central banks after the equity bubble burst in 2000." [Alan Wood, theAus]

Similarly, you don't need to take my word for house price inflation, try these (found after a tip from John Henry Calvinist in 'Fiscal apocalypse now'):



[Graphics from The Economist]

Looks like the worst may be over for us - but for how long?

Note that a change of over 100% for Aus means that house prices more than doubled. The graph shows when the bubble started here: just about when Costello reduced the CGT. Coincidence? That the bubbles are pretty-well world wide means too much dough is sloshing around, everywhere, possibly just all monkey-see, monkey-do after the US. And remember, fiat currencies are managed, do we think the bubbles are planned? Grisly greedy people taking advantage of plentiful, freshly printed money; the fat cats getting ever more obscenely fatter, while the 'great unwashed' with their wages indexed by a CPI which ignores asset bubbles have to go and live under bridges, eating Pal?

Thanks Phil.

I understand the gist of what you are saying. I have been forming a strong reasoning opinion from as much variable information I can access. Without belaboring the subject - I believe that we have had a false economy of encouraged debt, roughly since 1999. Many could dispute this but I try to figure out WHY so many people borrowed so much money (on plastic cards) over such a long period.

When I was young (under Menzies' "never-never" Hire Purchase) to obtain a loan from the Banks, you had to prove that your circumstances (including permanent full-time employment) showed that you didn't need it. Yet, youngsters are still being  taken in by the "PINOCCHIO GIFT" of Howard's thousands of our dollars to promote the building industry.  There is no means test so the wealthy can "get in the act" without fear of losing their "investment" as they can indeed, with the so-called "stay at home Wife" con and Abbott's Medicare "safety net".

So I digress - just one more point Phil - what does the acronym CGT mean?

Median wage

JHC, I agree that the median wage is likely to be of greater relevance to your average wage earner than the mean. The ABS produces of masses of data on weekly earnings including figures for median earnings. Download the EEBTUM for August 2005, it shows that for weekly full-time earnings (before tax) the median was $846 and the mean $983.

I also agree with you that the HES (Household expenditure survey) data that drives CPI does not reflect the typical expenditure of a person below the poverty line. That is not the purpose of CPI. CPI is trying to measure inflation relevant to the expenditure of all households, not a small group of them.

It is not the fault of the ABS (or BLS, ILO etc) that underemployment statistics are ignored, both unemployment and underemployment numbers are reported. Maybe most media and finance commentators don’t consider underemployment to be very significant.

Housing costs are included in CPI

Phil Kendall, you may recall this.

Phil, ok here are two facts. Annual inflation in the US measured by CPI for the 12 months ending in Feb 06 was 3.6%. The rate for core inflation (ie excluding food and energy) was 2.1%. These figures were sourced from the Bureau of Labour Statistics.

Phil if you don’t agree with these numbers, rather than supplying more interesting but irrelevant links like your previous one, I suggest you supply an alternative figure for US inflation and a legitimate source to back it. The ‘Financial Sense Online’ link you provided does indeed claim that “inflation is here loud and clear”, however the site does not back this with any comprehensive price data. It merely lists a series of graphs for the market price of Oil, Silver, Copper and a Commodity Index for the period 2001 to present. Does this mean the “real” rate of inflation can be discerned by viewing metal and commodity market prices alone?

You assert that inflation is not measured correctly both in the US and Australia and that the resulting CPI numbers are wrong. For US evidence you provided changes in the price of Coffee in Afghanistan, houses in Phoenix, Copper, Silver, Oil etc.

Maybe you could answer my question first. If the methodology for measuring CPI is flawed, maybe you could outline an alternative. If the reported rates of inflation are incorrect perhaps you could give us an idea what they should be.

Re your question Phil, the ABS CPI figures do include house price inflation. This is covered in the group called housing. Follow the links I provided before for an explanation of this works.

Some Thoughts re Averages and Indexation

Gareth Eastwood, thanks for supplying the relevant breakdown - and, alright, "ludicrous" was hyperbole on my part, I'll confess. Still, I'm certainly not convinced by the AP&SF and ACOSS arguments, since they appear to pay more attention to those beneficiaries in much more comfortable circumstances, rather than attempting to push for a hybrid approach to indexing that would actually attempt to account for the differentials.

Another, more general point well-worthing making is that a switch to median - rather mean - methods re many (most/all?) general money-denominated averages would clearly be fully justified in light of our skewed wealth distribution... since, in that situation, medians invariably supply a more accurate average than means. This is usually considered orthodox amongst scientists using statistics, from whence I sourced this argument, but medians are rarely (if ever?) used in the preparation of official statistics... one reason for my distrust of same.

Now, re indexation. Looking at the breakdown supplied, I'd have to say that it has very little in common with the expenditures of the poor. Housing, food, electricity, and telephone charges make up well over 80% of my costs, for example, with housing taking about half that, alone. So, while ACOSS may not be in favour of a more complex indexing system, that would seriously try to offset the stronger effects of inflation on the poorest, I certainly am! Now, I'm no statistician, so I'll decline your invitation to come up with my own model.

However, I really can't see why we don't have a median - rather than mean - average wage, for example - nor can I see why poor people strongly dependent upon indexed incomes should not have these indexed in line with the type of expenditures they actually have to make, rather than via some national average which only poorly reflects these. Similarly, I can't see why unemployment figures exclude underemployment - a latter statistic is issued, but virtually never receives much attention - in a labour market like ours where part-time and casual work is arguably dominant amongst those at the poorer end of the wealth distribution.

And so, it isn't at all unreasonable, given such considerations, for people to have less than full faith in the type of statistics the ABS produces... and, even more, in the uses made of them by governments.

All the best.


Until the 'Bretton Woods' system (having been debased by massive US deficit caused inflation) was 'terminated' by Nixon on 15 Aug 71, 'money' was more or less 'tied' to gold. Not any more (and no further correspondence on gold will or needs to be entered into); we now have 'fiat' currencies[2].

As I pointed out on Bob Wall's 'values' thread, if house prices increase at 14.87% they will exactly double every 5 years; and if wages (indexed to a CPI which largely excludes house price inflation) are allowed to grow at 3.714% in the same time, they will increase by a total of only 20%.

This situation approximately describes our own experiences in the last few years (both here in Australia and in the US) where house price increases have often exceeded 14.87% while CPI figures have generally been less than 3%. (Also similar vis-à-vis stocks'n share prices.)

A major result is that house affordability declines; the 'great Aussie dream' of owning one's own home is denied to ever more people. This is confirmed by the movement of a greater proportion of the housing stock into the 'investment' sphere.

Any argument? Hardly likely.

Asset prices growing at a faster rate than 'general' inflation are called 'bubbles', and are inflationary in their own right. Such bubbles occur when too much money is chasing too few assets.

Any argument? Hardly likely.

Sooo, Q: where does the (excess!) money come from?

A: Quite simply, it's printed. Note: 'printed' is a metaphor; nobody actually uses banknotes for anything except trivial transactions. In a 'closed' economy (ie. no external transactions), any printing can only be done by the 'central bank' entity (which also sets interest rates). In an 'open' economy, printing may occur off-shore. Again: 'printing' is a metaphor; money is created by fiat but enters the economy by way of (usually interest bearing) loans. Interest rates are the 'cost' of borrowing. Q: What happens when interest rates are (artificially) below the true inflation rate? A: Asset bubbles (among other bad things, like wages dropping behind, lower house affordability and more people eating Pal).
As an aside, borrowing overseas differs from domestic borrowing in three ways; 1) the 'owner' of the mortgage is not your local bank but some foreigner, 2) any interest on such borrowing goes o/s instead'a staying home and 3) one now has an exchange-rate exposure. Q: What happens when you borrow a foreign currency (Filthy Lucre, say) at such'n such an interest rate, then the exchange rate goes up? A: A double whammy; you now owe more interest on an increased capital sum, in local currency terms. I recall hearing something about this, some time ago? Lots'a farmers losing their land? Hmmm.

My point is simply this: fiat currencies are managed currencies; if inflation occurs it is a sign of mismanagement.

And we've got (asset) inflation in spades, implying massive mismanagement.


It has been suggested, that fiat currencies are being handled by a 'free market'; that this market shows some sort'a 'value' of the currencies; people (like China, say) wouldn't hold onto massive amounts of $US (Oh, about $US800bio), if they were truly worthless. But look here; thanks John Henry Calvinist: "In the full span of modern history, most free markets have been in profound disequilibrium most of the time - often dangerous and destructive disequilibrium."

I suggested to Gareth Eastwood also on 'values' that he might explain just why a CPI which largely excludes house price inflation might be useful in the setting of wages. During my preparation of this post, this: 'CPI methodology' Submitted by Gareth Eastwood on April 27, 2006 - 10:32pm. Note that of the two objections he quotes both don't like the CPI much, and then talk of house mortgage interest rates. Which is not directly the problem, but house price inflation definitely is. My question to Gareth is still unanswered.



[1] inflation n. 1 inflating. 2 Econ. a general increase in prices. b increase in the supply of money regarded as causing this.  inflationary adj. [POD]

[2] Fiat money or fiat currency, usually paper money, is a type of currency whose only value is that a government made a fiat (ie decreed) that the money is a legal method of exchange. Unlike commodity money or representative money it is not based in another commodity such as gold or silver and is not covered by a special reserve. Fiat money holds its value so long as holders of the currency feel that they can find an exchange partner for it at some later time. ... [en.wikipedia.org/wiki/Fiat_currency]

[3] "The Bretton Woods system was finally undone by the most destructive venture of the Pax Americana, its criminal war in Indochina. The Kennedy, Johnson and Nixon administrations were all determined both to have that war, and the rest of the Cold War military establishment, and domestic expansion, particularly in election years. Demand, in other words, was stimulated by government purchases of both guns and butter, and the result was inflation. This could have been controlled either by raising interest rates or increasing unemployment, but neither was politically acceptable. But the fact that American inflation was significantly higher than that of (in particular) Germany made dollars relatively less attractive than deutsche marks. Under the Bretton Woods system, this probably qualified as a fundamental disequilibrium, and should have been resolved by moving the pegs, lowering the dollar price of marks (and other allied currencies). This, too, was unacceptable to the US, so in the early 1970s there were a series of speculative attacks on the dollar, and unsuccessful attempts to patch up the Bretton Woods system without addressing the fundamental problems. The end came early in that ominous year, 1973[4], when by unspoken but common consent pegs were abandoned and currencies left to float as they would." From a review by Cosma Shalizi of Globalizing Capital, A History of the International Monetary System by Barry Eichengreen [cscs.umich.edu]

[4] Actually, I think it it was more like 71: "On August 15, 1971, President Nixon announced his New Economic Policy, which suspended the convertibility of the dollar to gold, imposed a 10 percent tax on imports; and reduced foreign assistance expenditures by 10 percent. ... The cessation of dollar-gold convertibility and sudden floating of the dollar, ie, devaluation, had special impact on U.S. foreign relations." [US State Dept]

Note that Reagan turned the US from the world's greatest creditor into the greatest debtor, and now GWBush is running up even greater deficits...

Phil - As usual your posts are excellent.

I don't know if you remember me as a co-contributor to Have Your Say? But I certainly remember you. I feel that I am more able to see the big picture than to debate with confidence the actual pros and cons of the economy. All I can discern with common sense seems to indicate that the figures which the Howard/Costello government come up with appear to be contradictory to my perception of what is really going on.

Bear with me, Phil - I believe that the economy of our nation has been depreciating since at least 1999, when the Howard government achieved another record - the highest bankruptcy rate in Australia's history. And, remembering that when the 17% interest rates under Paul Keating only required 50% of the average household disposal income to service, we now have 5.5% which requires, according to the figures, 150% of household disposal income.

In layman's terms, could you explain to me how our Foreign debt is a massive $500 billion and yet the Treasurer claims a "debt free" day. Apparently because, while "private enterprise" borrowing has created this worrisome amount, the Government borrowing has been reduced? In my thinking, the latter may be due to the fact that the Howard government is selling our assets and resources at an alarming rate. If you have the time, Phil, I would appreciate your opinion.


Ernest William, you are right you cannot debate the pros and cons of the economy, because you are thinking along Labor lines. Please explain how you can service a mortgage with 150% of your disposable income.

CPI methodology

JHC, according to the ABS. (using these links, onetwothree)

"The reference population for the Australian CPI is all private households in the eight capital cities. It represents approximately 64% of Australian private households. Ideally the CPI population group should encompass all Australian households, but this is not feasible due to the substantial additional resources that would be required to collect prices outside the capital cities."

"The 15th series CPI basket is divided into 11 major groups, each representing a specific set of commodities: Food, Alcohol and tobacco, Clothing and footwear, Housing, Household contents & services, Health, Transportation, Communication, Recreation, Education and Financial &Insurance services."

“The overall CPI is compiled by weighting price movements between the base and current period by their shares of total household expenditure in the base period.” “The 15th series CPI was introduced in the September quarter 2005 using expenditure weights from the 2003-04 HES (Household Expenditure Survey).” A new series is produced every 5 years.

The actual ABS weightings can be downloaded into Excel here.

The weightings are as follows (I’ve added the annual increases from the previous link to illustrate what is driving the +3% CPI figure).

Food 15.44
Alcohol & Tobacco 6.79
Clothing & Footwear 3.91
Housing 19.53
Household contents & services 9.61
Health 4.7
Transportation 13.11
Communication 3.31
Recreation 11.55
Education 2.73
Financial & insurance services 9.31
new (-0.6 for the qtr)

JHC, this whole process looks pretty reasonable to me. But rather than listen to me, try these alternate views.

From the Australian Pensioners and Superannuants Federation (AP&SF): “AP&SF is aware of the significant debate occurring amongst older people about the relevance of the CPI to their circumstances, though for a number of reasons, is not willing to support the application of a special index for older people. A major factor is that there are significant variations within the retiree population and one 'pensioner' or 'retiree' index would not represent all older people's consumption patterns. Some older people will still do better or worse than the average from time to time. However, on balance, the current CPI-based approach to price movements is better than any alternative proposed so far. AP&SF, however, is concerned about a growing lack of confidence in the CPI amongst its constituency and supports actions by the ABS to restore this confidence.”

Another view from the Australian Council of Social Service (ACOSS): “ACOSS considers that the CPI should reflect changes in household living costs in a timely manner and should be valid and credible. ACOSS leans towards an outlays approach as it is more credible in the eyes of the average household. ACOSS is not sure if the acquisition approach would achieve the Reserve Bank of Australia (RBA) objective of reducing inflationary expectations in boom times if the measure did not correspond to the commonsense perceptions of households with mortgage interest costs. ACOSS accepts that there are problems in including housing interest rates because of their volatility but supports publication of the current index and one excluding mortgage interest charges. ACOSS is reluctant to have separate indexes for pensioners or other income support recipients. Recipients are a diverse group. ACOSS would like to explore the suitability of a measure excluding housing interest rates for income support households, but if this is different to the CPI it would not be credible to use it to index income support payments. ACOSS believes that more research should be conducted in order to better understand changes in the cost of living among different recipient groups.”

JHC do you still consider the CPI figure to be “ludicrous”? If so, perhaps you could suggest an alternative method pf measuring changes in household living standards and inflation.

Methodology, please?

Gareth ... fair enough, they DO include those factors. However, I note that you didn't consider doing what I actually asked - which is provide a proper breakdown of how the figures were calculated. As I clearly stated, I wasn't at all sure that these factors were not included ... but I was sure that the methodology was seriously misleading re the actual cost of living rises for most of us. And I stand by that.

Re such figures as the CPI, I happen to think it is simply ludicrous to use an aggregate figure like this - from a society with huge wealth disparities - to index the income of some people at the bottom of the income distribution, whose outgoings are necessarily strongly biased toward the basics. And, I'd definitely like to see exactly how you could possibly defend this?

Also had a quick look at the site you linked to and I couldn't find what I was looking for - the relative weighting of each factor in producing the aggregate figure. Personally, I think I'm right to be suspicious of any statistical artifact whose composition I don't know - and, as I said, it's many years since I saw a breakdown of how the figure was calculated. Perhaps, since you seem to know this area, you might be so good as to fill us all in here? Properly informed debate, after all, is what some of us are looking for...

Australian CPI +3%pa as per ABS

JHC, I think the only factually correct statement you made in your two paragraphs about inflation was this one “Now, I could be wrong about this.”

I don’t why so much time is spent on Webdiary debating the accuracy and relevance of basic statistics produced by the ABS (or BLS). Anyway here’s a breakdown of the latest CPI release, showing +0.9% for the quarter and +3.0% annually. It specifically mentions rent, fuel and electricity.

JHC, if you don’t agree with a statistic produced by the ABS (or BLS), perhaps you could provide an alternative number supported by a substantial source and logical explanation.

Some Pointers re Inflation and Crises

, very pleased to see to see you back here, since I was concerned that you may have abandoned this forum after the recent mess - which I definitely contributed to! Anyway, I'm (certainly) no expert here, but - as far as I remember, from the reading I've done in this area in the past - our current official "measures" of inflation are, by any sensible standard, ridiculously circumscribed re what they actually count...

For example, I'm pretty sure - off the top of my head, mind you (still, I do have a pretty decent head) - that they don't include the price of energy (ie oil and electricity), nor do they include housing... such as rent and real estate. Now, I could be wrong about this, but if I am, in a genuinely large forum like this I fully expect that I'll be rapidly corrected by those who've got an accurate picture of this measure? The one thing I'm absolutely certain of, however, is that when I did read a piece accurately detailing exactly what was counted in our current inflation figures - and how - I clearly developed the understanding that they were seriously misleading for anyone bar the most affluent members of of the Australian community...

Anyone who wishes to challenge this conclusion... please, go right ahead! But, remember, we'll expect you to provide a proper breakdown of how the figures are calculated.

Back to your (very astute) point, Will. To be sure, the operation of leverage is a crucial amplifier here, both in bubbles, and in crashes. By the way, for those not familiar with the terminology, leverage is the method via which speculators (and all banks, by the way) borrow against the assets they actually own (and, the borrowings are much, much larger than the assets), to invest elsewhere... This mechanism, in a fractional reserve banking system such as we have, means that - in any serious and sustained crash - the entire system is put at risk! Just thought you'd like to know.

But, the reason I was focusing upon the shift to speculation is that, to my mind, this is a much, much deeper malaise than the current extent of leverage, since - all going well - the latter could (relatively) easily be corrected by a mild downturn/stagnation that flushed-out the excesses here... as has happened many times since the last Great Depression. What disturbs me to a much greater extent, however, is the gradual overall shift towards purely financial speculation in the entire system over the last twenty to thirty years, since much/most of that is purely parasitic/destabilising re the "real" productive world economy, as many leading economists have noted, with increasing dismay over time. This, as far as I can gather, also amplifies systemic shocks, but is a much more resilient feature of our current situation - to the extent that any sudden reduction of same (unlike leverage) is liable to prove disastrous. In short, we’re much more dependent on it, and it’s - like a junkies’ fix - growing all the time.

On to your last point, Will. The question you ask, here, is precisely in line with the thinking which has led to the current exclusion of energy costs from inflation figures. What it (crucially) leaves out, however, is the differential costs of energy within the economy. Say I run an aluminium smelter - which I don't, by the way! When energy costs rise, I - undoubtedly - feel these much, much more than does, say, an internet service provider. No question. Unfortunately, the economic modeling that delivers our so-called "inflation figures" fails to take such things into account, and (again, from memory) assumes that the universals - such as energy and shelter - impact equally.

Well, as anyone can see... they don't! And, in any situation where the differential is particularly strong - and rapidly changing - such as, say, the collapse of a housing bubble (or the rapid rise in oil prices), they'll undoubtedly have a major destabilising effect on the economic system as a whole. Not only that, but - by excluding two of the three factors which maximally impact on the poorest (shelter and energy) - such changes undoubtedly mean that in any real crisis period, the sheer inadequacy of inflation indexing is liable to mobilise EXACTLY those people (including me, by the way, since - according to the experts - I am currently unemployable!) who feel themselves least served by the current economic order! This, to put it mildly, is not very sensible.

But - to be sure - if such changes had an equal effect upon all, the result would probably be mildly inflationary (in the case of a fall) or mildly deflationary (in the case of a rise). But, sadly, this ideal model doesn't at at resemble the real world. So, what we get, instead, is systemic shock - and the results are unpredictable... In fact, the ONLY predictable outcome, to my mind, is delivered by the sheer inadequacy of the very system (inflation indexation) which is supposedly "designed" to cushion such changes re those least able to cope with them. As I said, not very sensible, at all!

This, unfortunately, brings us back to your first. Because, in a situation where our market design (and, there are no "free" markets whatsoever - merely better or worse designed ones) strongly favours speculation - such as ours - and is open to unrestrained leverage (thus amplifying both booms and busts), we are particularly vulnerable to such systemic shocks, for obvious reasons. And such vulnerability - sans major redesign - clearly grows as the system ages...

Given that the powers that be are heavily dependent upon those who benefit from the system as is, I - unlike many/most here - have basically little interest in trying to substantially modify it today, since I'm well aware that history proves this a futile endeavour. On the other hand, I do devote a lot of my time to trying to understand how productive/innovative capitalism could well work much better - since I can see how that could easily be useful once out-of-control speculation causes the next crash. All I can say is, let's just hope it's not too brutal, because "economic man" gets damnably irrational at times!

All the best.

A Quick One...

Scott...glad to hear I've been useful! Now, a quick run through, as I have to get offline asap, as I'm expecting a call (and can't afford broadband). Yeah...the Fischer is very interesting, isn't it (on the big picture, at least)? - and, it does show us that, repeatedly, that our "elites" do come a cropper once their greed gets too greedy, and a genuine downturn eventuates. Methinks, as does Fischer, sometime soon?

And, re money supply...no, we aren't seeing a tight one yet, by any stretch of the imagination. But, what we ARE seeing - and have been for quite a while, now, is the diversion of increasing amounts of same into purely speculative, as opposed to productive, investment. This is, quite frankly, a veritable cancer on the wellsprings of the capitalist system - and, it'll certainly (unless ACTIVELY constrained by government - fat chance!) drive the entire system into crisis at some point in the very near future. Until then, however, we can expect the monetary system to simply keep on keeping on...

Finally...re my "back flip" - well, to my mind, I've explained it in the relevant post...since I think that those accusing him (including, of course, JHC) almost certainly underestimated Jay's ability to use different rhetorical strategies (as well as careful revision and a spell-check when he wanted to be read straight). That's not at all to say that he's a skilful user of such rhetorical strategies - merely that, on balance, I'm sure that my prima facie case for multiple authorship is NOT a viable one... I certainly didn't enjoy making this public, mind you...but, I definitely did feel that it was both necessary and important to do so...

all the best

Energy and inflation

John Henry Calvinist writes: "re money supply...no, we aren't seeing a tight one yet, by any stretch of the imagination. But, what we ARE seeing - and have been for quite a while, now, is the diversion of increasing amounts of same into purely speculative, as opposed to productive, investment."

Two questions:

1) Isn't the vulnerability now, as in 1929, the degree to which investors are leveraged in their holdings (e.g holding shares on margin and/or having little real equity in properties)? Granted there are mechanisms in place now to limit the damage from "crashes" in property, securities, and banking, but aren't we still vulnerable to that leverage (which can work both ways)?

2) Why are rising energy costs thought of as inflationary? I would have thought diversion of greater amounts of money into energy costs would be neutral or even deflationary.

On the Great Depression

Scott...while I certainly can't pretend to Brad's expertise, I can recommend to you three very good books. Barry Eichengreen's Globalizing Captial is a very astute historical analysis of the history of international finance, and has some very sharp things to say about the Depression. Cosma Shalizi's review, which alerted me to the book, is here - and provides a very good summary.

On the Depression itself, though, the classic account is still John Kenneth Galbraith's The Great Crash 1929 which, although it concentrates on the initial stage, also provides a very good account of how that then locked-in, for a variety of reasons, into a low-equilibrium trap that was extremely difficult to break. I'll get to the third book later...

Short answer is that a long-term bubble - as now - ended up fueling MUCH more speculation than productive investment...eventually drawing in much of the savings of the middle classes. So, when it crashed, the infrastructure and real demand were still there, but effective demand, in a mass consumer economy, was not - due to the disappearance of broad-based savings/monetary shrinkage. Actions of governments and bankers - acting on neo-liberal orthodoxy - accentuated the shrinkage, since if banks don't lend in a fractional reserve system, the actual amount of money in circulation goes down tremendously. And, governments, of course, also tightened the purse-strings...as well as erecting protectionist barriers in an overall system whose health was now quite strongly dependent on international trade. A thoroughgoing mess, in other words...

What'll probably happen soon, however, won't simply replicate this, by any stretch of the imagination. After all, the main driving force of middle-class consumption today may be speculation, but it's now on housing, not shares and financial instruments. And, as any honest economist could tell you, housing (somewhat like labour) markets are inherently "sticky"...so they never behave much like the abstract analyses of markets, whatever the situation. Combine that with the rising price of energy (not to mention the much greater scale and scope of globalisation today) and, I suspect, our forthcoming mess'll be quite a different thing. For a long-term pattern that will probably play itself out in the political aftermath, however, let me recommend David Hackett Fischer's The Great Wave - my review here  - albeit you'll have to consider how the energy issue may well modify this, since it's not some simple cycle he proposes, but a genuinely complex understanding of long-term change.

Hope you find this useful!

all the best

Thanks, JHC

Thank you for that, JHC, it was most informative. I found The Great Wave interesting from a philosophical rather than economic angle; change and our powerlessness to prevent it. The old adage "Those that do not learn from history" etc is all well and good but it requires an intellectual capacity unlikely to be found in mainstream politics. Indeed a defining feature of most political animals is their anti-intellectualism. Still I don't think it would make any difference: "the only unchanging thing in the universe is the nature of change."

On the subject of money supply, I recognised instantly the possibility of the impracticality and consequences of the world's best treasurer's ideologically driven move to divest government of as much of its social responsibilities as possible with his super scheme.

It must have, I thought, the same impact on money supply as has been detailed. Further, it must also have an inflationary effect on investment products; super funds awash with money scratching their heads trying to find places for it. It would be better invested in infrastructure of all descriptions that would enable following generations to finance social requirements.

I remember reading somewhere that those holding stock at the point of the crash of '29 would have had to wait for twenty-seven years before the stock recovered the price. So much for super.

One thing puzzles me, however. Is there any sign of a contracting money supply? We seem to be bombarded with offers of credit although they don't seem to be quite so frequent of late. Is this a case of financial institutions lending what they don't have or borrowing to lend and pocketing the margin?

Thanks once again: it's a relief to see WD functioning as it was designed to. I certainly don't want to re-open this wound but remain quizzical about your apparent back flip. This only to let you know I'm thinking.

(Hamish, mate, where's that bloody message board? The last doesn't belong here.)

America going down, which is why gold is rising?

I have been following the rise and rise of gold for some time now. With a few sharp falls, no doubt due to gold cartel interference, its rise has been steady against ALL currencies.

Does anyone know of a nation which is not in financial trouble right now?

There is an interesting website called GATA (www.gata.org) which has been around for a few years now. They believe gold has been fixed for a long time, and the gold cartel are still trying to do this even now, but that they are fighting a losing battle.

Another good site is Le Metropole Cafe. They also have predicted a very strong bull market in gold. I have read articles by them off and on, but have now joined for a two week trial.

Many Americans (well, the ones I communicate with) believe it is inevitable that America will crash, and that countries like China and Japan are getting at least some of their money out of the dollar before the fall. Some are even stacking away non-perishable foodstuffs. They simply can't see how their country can be so deeply in debt and survive without either a severe depression or an outright crash.

And importantly, and back to my original point, many are stocking up on real gold.

If there is truth in this, and I believe there could well be, I wonder how it will affect the rest of the world.


Daphne, I'm certainly not arguing but what on earth is the point of anyone hoarding gold? They can't eat or trade it if everything goes belly up. I have no grounding in economics whatsoever. I have never read The Wealth of Nations but (outside of Adam Smith's social views) understand the principles of his economic philosophy; no more than stating the bleeding obvious by my reckoning.

Economics, as with any other subject, can be as simple or complex and esoteric as human imagination will shape it, derivatives, futures, options, hedge funds etc. Money after all does not exist as an entity in the real world; it is a medium only but in the words of the sixties guru, Marshall MacLuhan, the medium has become the message or in this case the commodity.

All the supposed increase of personal "wealth" that has been created in the last few decades has been built on the back of cheap energy. This is coming to an end.

We had a debate on the old SMH Webdiary; two articles: "Peak Oil" and "Horse Dung Up To Our Ears" in which this was debated. It is not that we are about to run out of energy but that it will no longer be cheap; ie economic expansion will be slowed. In the meantime a bubble has been created and all indications that I have seen point to a collapse in the near future. By near, I mean anything between tomorrow and five years hence or whatever.

You know, the funny thing is, I have never come across (not that I have looked) a definitive work on the causes of the great depression of the thirties. What had fundamentally changed? After all, the infrastructure was in place, the demand and supply were there but patently the mechanism of exchange of goods and services experienced a hiatus. Perhaps Mr De Long with his considerable expertise could apply himself to answering my question.

So Howard/Costello have a "debt free day"?

What a cynical and arrogant person is the failed Industrial Barrister Mr. Costello! While record foreign and domestic debt continues to rise and the Banks and other lending institutions begin to "pull in" the inevitableY "sacked" and money-strapped Mortgagees, this Government of depraved indifference can smirk and lie at the same time. Mr. Costello said that he had honoured the $96 billion HE CLAIMS was inherited from Labor - well the Australian Bureau of Statistics better duck because, according the AUSSTATS our debt is almost $A500 billion as of December 2005. And don't be carried away by America leading from financial strength - their foreign debt is in the trillions.

I quote ABS 5302.0 from December 2005 as to the FOREIGN OWNERSHIP OF AUSTRALIAN ENTERPRISE GROUPS BY SECTOR.  Analysis of results:  Table F1 shows that the value of equity on issue by Australian enterprise groups at 30 June 2005 stood at $1,540.1 billion. Of this total, 63% related to SHARES or similar equity interest issued by non-financial CORPORATIONS. Other financial sub-sectors, including life and other insurance corporations and central borrowing authorities accounted for 19%; banks accounted for a further 15% of total equity issued; while lesser amounts were issued by 'non-bank deposit taking institutions' (3%); and the Central Bank (1%).  (Emphasis added).  Where are the Australian citizen "Mums and Dads"? Where is the "drowning in wealth" of the middle to low income families?

As of Dec. 2005, the current foreign debt of the Howard government is almost $500 BILLION. The venal media has tricked the Australian people in 2001 and 2004 - for Australia's future, for goodness sake don't ever let it happen again. NE OUBLIE.

A Very Astute Analysis

Yet another insightful piece from Brad DeLong. For those of you who also watch the international press for potential tipping points, here's yet another, from a recent issue of the Asia Times Online - and, while we can't predict in complex systems, we need to remember that every such shift which reduces the number of sources of easy credit for the US renders its financial system more and more fragile...

Eventually, this will probably start to seriously panic the short-term horse traders that Brad refers to... and, then - watch out! Because such people trade in packs - and, they're the ones who deliver the crashes.

All the best.

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