Morning after note: This post is a good example of why booze and blogging shouldn’t mix.

I’m a bit drunk. I’m supposed to be working, but my wife is a tease, she’s plying me with red wine, telling me, “Go! Take your laptop and work! You know I can’t help but distract you if you’re here!” She promises to take back the wine. The wine is still here, next to my keyboard. Well, half of it is still here.

Maybe it’s just the wine, my space-time continuum starts to go all lava-lampy when I read stuff like this Bloomberg article.

Pound Rallies Above $2 for First Time Since 1992 on Inflation

By Aaron Pan and Agnes Lovasz

April 17 (Bloomberg) — The pound leapt above $2 for the first time in 15 years as a U.K. report showed inflation unexpectedly quickened, prompting traders to bet the Bank of England will raise interest rates twice more this year.

…

Now, back when I was studying this stuff, I learned that, ceteris paribus (as the big dogs say), high inflation means a weak currency. After all, the cost of peanuts must be the same everywhere. If the price of peanuts in Liverpudlian pounds doubles, but the price in dollars stays the same, that means a dollar is worth twice as many pounds, no? Sure the “arb” (as the fast dogs whine) in peanuts is less than liquid, transaction costs are high with all that moisture and aflatoxin on the high seas. But still. Remember hyperinflationary currencies? They were never the rage with the FX and cocaine crowd.

But, truly, this is the new millennium. Inflation, it seems is the best thing ever that could happen to a currency. Now I’m not complaining. I own a few Liverpudlians meself, thank-yuh-very-much. Can I buy you a drink?

But let’s think this through, shall we? Here inside the rabbit hole high inflation provokes a rise in the nominal exchange rate. Now maybe this is old-think, but I used to learn that inflation, if not accompanied by an expected depreciation in nominal FX, amounts all on its own to an increase in the real exchange rate. Inflation plus nominal appreciation, that’s like a double whammy, coffee-grounds and meth snorted through a likeness of the Queen, from a real-exchange rate perspective. Not that I’d know. Anyway. The real value of a Brit’s salary has shot to levels formerly associated with Russian businessman. I heard on the radio that beggars from Kings Cross were hopping “the pond” on a week’s score of spare change just for the unforgettable, if unprofitable, experience of panhandling Park Avenue.

That’s all well and good. I like visitors, and their accents are charming. But, I’d like to be rich too. That’s why I’m asking Ben Bernanke to SIN. That is, “Surge Inflation Now!” Since the value of a dollar now increases with inflation, dat’s like mintin’ free money for the people!

Okay. I know. If Big Ben were to drop rates, the Carry Traders of Wonderland would flee. No, he’d have to be more subtle. Manufacture inflation by purchasing long bonds, hold the FF rate high by selling short-duration debt. No one cares about an inverted yield curve no more anyway. Ben’s a smart guy. He can make inflation and high interest rates all at once. Dr. Helicopter, or how I learned to love stagflation. He could just enlist GWB to spend more cash on “domestic initiatives”, while the man clucks sternly and “tightens”. Loose fiscal, tight monetary. That’d work too. It’s so orthodox.

Sure. Okay. There’d be no investment here. It’d be rough for business with those high rates and all. But we don’t need no stinking investment. We can buy stuff really cheap from “emerging markets”. What a wonderful world!

Now this sweet Kentucky wine may not be as good as I’d hoped. Because I’m already beginning to think about the hangover. If inflation rates and nominal exchange rates are now mutually reinforcing (thanks to our modern, sophisticated central banks, envy of the world), what would happen if we really did, you know, get inflation under control? The Fed would drop rates, our carry trade friends would sell our money, start using the greenback (or the pound) for funding rather than carry. We’d look just like Japan. Except they still know how to manufacture and sell stuff, so that even when their money is worthless, they can earn a lot of other peoples’ money. We Americans (#1, yo), and you Brits too, we won’t have that luxury. All we make is paper, the glossy kind, ‘cuz we stuck a tariff on China. So there.

But that’s tomorrow, and my bottle isn’t empty. A hangover is just bad science fiction until you actually wake up. In the meantime, god bless the carry trade! Let’s have more inflation! More sticky nominal rates (viz the countries that actually make stuff). More free money seeking yield! Let’s light it all on fire and suck it through a straw. Purchasing power parity is an urban myth, a wives tale told by fuddyduddies just to keep us from having fun. Be a scientist. Run a regression. In this new millennium, a peanut in Peoria can purchase a peasant in Patpong, that’s just how it is, learn to live with it, learn to love it, have a good time. They be some funky peasants in Patpong. Just get into that. Sanctimoious cant about sustainability, or justice, that stuff is just a downer. I hate thinking about that stuff.

My wife just poured me another glass. Sweet, cheap, Kentucky wine. I tried to say no. Really I did. Oh well.

This entry was posted on Thursday, April 19th, 2007 at 9:45 pm PDT.
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