|
|
Before I start I wish to say that I highly respect David Rosenberg at Gluskin Sheff, one of the few mainstream economists to call the crash, and whose observations about the markets are always worth reading.
This morning he came out with a long-term analysis of inflation which I don’t think is right. I urge you to read his commentary, below, but in general he sees one to two years of continuing “deflationary” pressure that favors the bond market and he says “inflation” will be at zero. He then see the beginning of “inflation” as the result of war and the need of government to fund it. The result, he says, will be high inflation and perhaps hyperinflation.
While you would think as a fellow doom and gloomer I would hop on his bandwagon, but for the most part I think Rosenberg’s analysis of the forces behind inflation and deflation are wrong. He uses historical analysis to prove his point, but he doesn’t explain the underlying factors that cause inflation or deflation, which, as I have discussed before, have to do with increases and decreases of money supply by the Fed.
He assumes that Boomers will cut back on consumption and increase savings. I agree and I went into detail on that in my Megatrends and other articles. He says that will result in “deflation.” But deflation is a monetary phenomenon, not a savings problem or lack of consumption problem. We will see deflation because money supply is declining, and it has been declining since late last year. … Continue reading The Problem With Rosie On Inflation
I’ve noticed more articles expressing concern about deflation. In addition to this article today from the Wall Street Journal (Deflation Defies Expectations—and Solutions), there was another one today from the L.A. Times. The Journal piece was written by a good reporter, Jon Hilsenrath, but it demonstrates no real understanding of what deflation is. In fact this is the premise of the article that “economists” don’t really understand deflation:
The old bogeyman of deflation has re-emerged as a worry for the U.S. economy. Here’s something else to fret about: After studying more than a decade of deflation in Japan, economists have slowly realized they have no idea how it works. …
Economists don’t have good answers. “We don’t know how deflation works,” says Adam Posen, a member of the Bank of England’s monetary policy committee who has been studying Japan since 1997. “We don’t have a way of rationalizing steady, several-year flat deflation,” he says.
Actually some economists do understand deflation. Keynesian economists don’t understand business cycles in general, inflation or deflation. Inflation and deflation are monetary phenomenon. If money supply increases, that is inflation. The ensuing and inevitable rise in prices is one of the results of inflation, not the cause. Inflation decreases the value of the currency which most people see as rising prices. It does a lot of other bad things as well.
Deflation is the opposite: it is a decline in money supply. The result is that the purchasing power of the currency goes up. In a deflation, creditors are at an advantage as loan payments don’t go down, but the debtor has to pay in dollars that are more valuable, leaving him in a worse position; in inflation debtors are favored because they can pay creditors with cheaper dollars.
Hilsenrath brings up the quandary of the Phillips Curve which says you can’t have inflation with excess industrial capacity: until industrial capacity is near full utilization, manufacturers can’t raise prices. The only problem is that this isn’t true. Stagflation in the 1970s showed that you could have excess capacity and inflation. This is because it doesn’t have anything to do with prices, but rather money supply. … Continue reading Economists ‘Don’t Understand Deflation’
This link will allow you to download a PDF version of the complete article, “Will We Have Inflation, Deflation, or Hyperinflation?” This may be more convenient for readers who which to take in the article as a whole. If you have problems with the download, please let me know. You are free to distribute [...]
This is is the final part of my four part article that deals with what I feel is the primary question investors must now answer: is our future to be inflation or deflation? The answer has vast implications to our investment planning and decisions for the near term, and possibly for our long term. It is a very complex question with a lot of moving parts involving economics and politics.
Like it or not, it is economic theory that is driving macroeconomic policies and political decisions that determine whether we will have inflation or deflation. Since not all of my readers are sophisticated traders I have tried to present the issues in a direct and hopefully understandable way. To those sophisticated readers, please bear with me.
Part 4 of 4
What is Money Supply Doing Now?
Money supply will tell you if we are headed for inflation or deflation. If we look at the rates of change of M1 or Austrian True Money Supply (TMS), they are declining. In fact, M1 and TMS appears to have peaked in 2009 and have been declining on a year-over-year basis ever since. On an absolute basis, as shown previously, M1 growth is flattening. These two charts below show the year-over-year percentage change in money supply.
 Courtesy Michael Pollaro Michael Pollaro at TrueSlant.com
What Will the Fed’s Options be in a Double-Dip Economic Decline?
This is the main point. If, as I have been saying, the economy declines in the second half of 2010, what will the Fed do?
Let me paint a scenario. In any scenario with declining economic growth, unemployment will rise. If unemployment at the narrowest measure is now 9.7% and at the broadest measures (U-6) is 16.9%, rising unemployment will become politically unacceptable to the Obama Administration.
I believe the politicians will first take Paul Krugman’s advice and extend existing stimulus programs and create new ones to spur spending. All the talk about fiscal sanity and deficit warnings will be forgotten as politicians on both sides of the aisle panic. Look for further extensions of the home buyer tax credit program, and other programs that politicians believe will help businesses in their districts. Cash for [Your Industry Here] will be the byword. It will add to an already huge federal debt and will result in more wasteful spending and non-viable short-term results.
On top of all this, the politicians will hammer Bernanke to create jobs, which is one of the Fed’s mandates. But how can he do that? He will try to inflate.
The Fed has limited options in such a case. They can’t reduce the Fed Funds rate any further and they can’t force banks to lend. It is likely that banks will further restrict credit as the economy declines.
I think their only viable option is to use Open Market Operations (OMO) to inject new money into the economy. The next question is: what will they buy? … Continue reading Will We Have Inflation, Deflation, or Hyperinflation? Part 4 (Final)
This is Part 3 of a four part article that deals with what I feel is the primary question investors must now answer: is our future to be inflation or deflation? The answer has vast implications to our investment planning and decisions for the near term, and possibly for our long term. It is a very complex question with a lot of moving parts involving economics and politics.
Like it or not, it is economic theory that is driving macroeconomic policies and political decisions that determine whether we will have inflation or deflation. Since not all of my readers are sophisticated traders I have tried to present the issues in a direct and hopefully understandable way. To those sophisticated readers, please bear with me.
Part 3
What Factors Will Drive the Economy?
This is the point where we need to look at some long-term trends in the economy to see how they will impact a recovery.
If our economy is based on consumer spending (70% of GDP) then GDP will see a decline in the second half of 2010.
In my article, Economic Megatrends That Will Drive Our Future, I point our seven megatrends that will impact our economy for the long term:
- The culture of consumption is broken and won’t return to former levels. This is the key to everything.
- Consumers will continue to increase savings to prepare for retirement.
- Declining U.S. consumer demand will continue to negatively impact the world economy.
- Deflation (deleveraging) will continue for some time.
- Home ownership rates will decline to more historical levels of, say, around 66%, down from the high of 69% during the boom, which will keep a lid on home prices.
- Government stimulus and recovery programs only delay recovery and deepen the pain for workers.
- Massive federal deficits will double the national debt, result in higher taxes, and will act as a permanent drag on the economy.
I wrote this article in September, 2009, and it still stands. The significant things to note are No. 1 and No.2. Consumers are over-indebted and are doing their best to pay down debt. This article from the Wall Street Journal defines the issue:
After years of bingeing on debt, U.S. households are paring back. Those not doing so by choice are often being forced, because lending standards remain tight.
[T]he household sector’s debt level, which includes both consumer credit and mortgage loans, remained at about 20% of total assets in the first quarter.
In the mid-1990s that ratio was around 15%, compared with a peak in the first quarter of 2009 of about 22.5%.
Just getting debt down to 18% would require households to shed an additional $1.4 trillion of debt. … Continue reading Will We Have Inflation, Deflation, or Hyperinflation? Part 3
This is Part 2 of a four part article that deals with what I feel is the primary question investors must now answer: is our future to be inflation or deflation? The answer has vast implications to our investment planning and decisions for the near term, and possibly for our long term. It is a very complex question with a lot of moving parts involving economics and politics.
Like it or not, it is economic theory that is driving macroeconomic policies and political decisions that determine whether we will have inflation or deflation. Since not all of my readers are sophisticated traders I have tried to present the issues in a direct and hopefully understandable way. To those sophisticated readers, please bear with me.
Part 2
The Inflation Argument
The argument for inflation rests on the money supply charts. The inflationists show various measures of money supply increasing, including the version used by Austrian theory economists, called True Money Supply (TMS)[1]:
Note: The M1 chart shown in Part 1 more clearly shows the trend in the M1 money supply increase.
Again, the YoY percentage change is more revealing:
The inflationists also point to the Consumer Price Index (CPI) which shows price increases:
The YoY rate of change of the CPI clearer:
As the chart reveals, prices have been rising since mid-2009. Even the measure of Core CPI (CPI less energy and food, CPILFENS) appears to be rising:
The inflationists would say that this effect of inflation, rising prices, is a classic measure that proves new money is hitting the economy and that has caused, among other things, prices to rise. … Continue reading Will We Have Inflation, Deflation, or Hyperinflation? Part 2
This article is presented in four parts. It deals with what I feel is the primary question investors must now answer: is our future to be inflation or deflation? The answer has vast implications to our investment planning and decisions for the near term, and possibly for our long term. It is a very complex question with a lot of moving parts involving economics and politics.
Like it or not, it is economic theory that is driving macroeconomic policies and political decisions that determine whether we will have inflation or deflation. Since not all of my readers are sophisticated traders I have tried to present the issues in a direct and hopefully understandable way. To those sophisticated readers, please bear with me.
Part 1
The Problem
The economy is not acting according to plan. At least not the plan devised by the Fed or the Obama Administration. According to the plan we should have liquidity flowing through the economy and the credit crunch should be over. In fact we should have moderate inflation by now. Government likes inflation because it gives the false impression that things are doing better than they really are: people confuse rising prices and wages with economic gain. As well, debtors, especially the government, can pay down debt with newly minted dollars. But the signals from the economy are mixed: mild inflation yet we still have a credit crunch as credit has continues to contract. Initial enthusiasm for a “recovery” is now giving way to concerns about deflation.
So what is it to be: inflation or deflation?
The Dispute
There is a rather significant running argument going on in the Austrian economics theory community about whether we are experiencing inflation or deflation. Further there are the gold bugs who are predicting, as they have for many years, hyperinflation. The deflationists are led by Mike Shedlock, known as “Mish” who argues that we are seeing deflation and that it will continue for some time. The inflationists are a variety of folks, but the loudest voice and harshest critic of Mish is Gary North. The most credible inflationists are Bob Murphy, a well known Austrian school economist, and Frank Shostak, chief economist for MF Global, formerly the trading arm of Man Financial, the world’s largest hedge fund. They insist that we are seeing inflation now and that more is coming.
I will side with the inflationists but I think Mish makes some valid points and that his timing has been good. I would say that some inflationists have been excellent on theory, but less accurate on timing. I call my position Modified Inflationism. … Continue reading Will We Have Inflation, Deflation, or Hyperinflation?
Another unexpected event rocks the hallways of the Treasury, the Fed and Academia as the Bureau of Labor Statistics reported today that the consumer price index unexpectedly fell 0.1% in April, the first time since March, 2009. You may recall that Bernanke, Summers, Geithner, Christina Romer, and Krugman believe that modern economics can easily [...]
I just saw an offering of the famous Screaming Eagle 1997 cab for $52,000 for the case, or minimum 3-bottle offering at $13,000. Parker gave it 100 points. I passed. I don’t think anyone told the purveyors that the market has loosened up a bit. My guess is that the offering (32 cases–1996, 1997, 1999–of the Eagle) may have been sprung loose by the economy. Some hedge fund guy blew up and … Maybe Paulson and Kovner fought over it.
For the rest of us, the great unwashed, bargains are awaiting. Here’s an article from Bloomberg reciting a sad tale.
In California’s Napa Valley, producer of the most expensive U.S. wines, 2010 may be a vintage year for foreclosures as the industry is squeezed by falling land values and a consumer shift to cheaper brands.
As many as 10 wineries and vineyards in Napa will change hands in distressed sales or foreclosures this year and next, up from none in 2008, according to Silicon Valley Bank. In a bank survey of vintners, 7 percent called their finances “very weak” or “on life support.”
“We have 250 vintner clients saying this downturn is the worst in 20 years,”Bill Stevens, manager of the bank’s wine division in St. Helena, California, said in an interview. “Anybody who was late to the party won’t have staying power.”
Land values in Napa, home to about 400 producers, have fallen 15 percent from the 2007 peak, driven in part by slumping demand for high-end wine, said Robert Nicholson, principal at International Wine Associates, a consulting and financing firm in Healdsburg, California. The decline makes it harder for owners to refinance mortgages, especially if the property is worth less than the loan.
Napa winery and vineyard loan defaults rose fourfold to 18 in the year through January, according to San Diego-based research firm MDA DataQuick. In the survey by Silicon Valley Bank, whose clients are mostly high-end West Coast wineries, 71 percent of respondents said credit is harder to get.
The recession has set in motion a “secular change,” with budget-conscious consumers trading down to less expensive wines, said Peter Kaufman, managing partner at Pleasanton, California- based Bacchus Capital Management LLC, a private-equity fund that provides mezzanine financing to wineries.
Personally, as a consumer I think I like “secular change.” … Continue reading Napa Vineyards Tank
This was a big day for economic reports and the Case Shiller Q4 report, the Consumer Confidence Index, and the FDIC Q4 report came out with not-so-surprising results. Since I am occasionally accused of cherry-picking negative data, I wish to point out that the following is a report and analysis of the data as it is with hyperlinks to the sources if you wish to see the original data yourself and try to squeeze good news out of them.
Case Shiller Housing Report
Here are typical news reports on housing:
From the WSJ:
For the fourth quarter, the S&P Case-Shiller U.S. National Home Price Index posted a 2.5% decrease from a year earlier, a significant easing from the 19%, 15% and 8.7% declines in the rest of 2009. It fell 1.1% sequentially but rose 0.3% adjusting for seasonal factors.
From Bloomberg:
Home prices in 20 U.S. cities rose in December for a seventh consecutive month, indicating the industry at the heart of the worst recession since the 1930s is stabilizing.
The S&P/Case-Shiller home-price index increased 0.3 percent from the prior month on a seasonally adjusted basis, more than anticipated and matching the gain in November, figures from the group showed today in New York. The gauge was down 3.1 percent from December 2008, the smallest decline since May 2007. …
“The rebound in the housing market since April seems to be related to” government efforts such as the homebuyer tax credit and the Fed’s purchase of mortgage-backed securities, Robert Shiller, who co-created the home-price index, said today in a Bloomberg Television interview. “A lot of people are coming in buying because they think the recession has just ended.”
Shiller’s comment makes a lot of sense. This is an artificially stimulated market to a great extent. While I believe that the prime driver is lower prices, when the government shuts down the home buyer tax incentives in April, the market will pick up the down trend for a while.
I was intrigued by a report from my co-reporter, Tyler Durden at Zero Hedge, who brilliantly noted a flattening in the improving rate of decline of housing prices … Continue reading It’s Supposed to Work Part II: Housing, Consumer Confidence, and Banks
The core Consumer Price Index fell for the first time since 1982–0.1%–in January. Economists are lauding this deflation as a good thing on the theory that it gives the Fed more flexibility: in keeping interest rates low, as they have been doing, they don’t have to worry about inflation. I’m not sure what they mean by that since it has been the policy of the Fed to try to create inflation as a way to get out of our recession. It hasn’t worked.
If I’m not mistaken, just a few months back economists were worried about a deflationary tailspin and a further decline in employment. It was felt that whenever the Fed needed to, it could, and should, gin up a little inflation and bail us out of a deflationary spiral. There has been no shortage of credit poured into the economy by the Fed, otherwise the Fed wouldn’t need an exit strategy, yet the very thing stimulus and easy money was supposed to prevent, deflation and unemployment, stubbornly refuse to disappear. The Fed points to green shoots (GDP Q4 gain of 5.7%) such as the increase in manufacturing activity, auto sales, and health care expenditures. But …
It is not a coincidence that WalMart experienced it first ever decline in its U.S. same store sales. WalMart, which accounts for about 10% of all retail sales in the U.S., noted that heavy discounting (deflation) in food and electronics lowered the overall value of its sales. The strong corporate profits we are seeing so far have resulted from efficiencies rather than increased sales for the most part, and this can’t continue much longer–you can only fire so many people, shorten work week and cut slack to a point and then sales have to kick in. As well, inventory restocking will only boost the economy so far until the consumer goes shopping again.
According to classic Monetary and Keynesian theory, flooding the economy with money stimulates the economy, causes prices to rise, and consumer spending and general economic activity resume. Why hasn’t the Fed’s inflationary policy worked? Why is credit continuing to dramatically contract? Why are prices falling? … Continue reading It’s Supposed to Work: The CPI and Further Adventures in Keynesian Policy
The FDIC is proposing new rules that will allow banks to lower underwriting standards and capital requirements in order to encourage them to rewrite commercial real estate loans. This will cause more deflation, stagnation, and tightening of credit and lengthen the recession/depression. [...]
Japan vs. U.S.: Compare and Contrast
By Jeff Harding.
Japan has been in decline, or at least stagnation, for 19 years. Their GDP has not grown, unless you consider 0.6% (avg.) robust annual growth. They have experienced a deflationary economy, and now, it’s happening once again. They now have the highest national debt as a percentage of GDP than any other major economy. It has been argued that the U.S. is catching this Japanese “disease” and that not only will we have continued deflation, but also stagnation.
I went back and read my background material on Japan’s economic history, starting with the Bank of Japan’s money pumping in 1986, and was startled to see the similarities between the policies of Japan to stimulate its economy and what we are now doing. My last major article on this topic, The Japanese Disease, was written in January, 2009, just as our government was ramping up their fiscal stimulus programs, and things have changed quite a bit since then.
It is easy to say that because we have adopted many of the same Keynesian policies that failed in Japan, not only will they fail here, but that the economic results will be identical. As I write this, I am not sure the economic results will not be the same, but I think there are several major differences between Japan and the U.S. that may lead us to somewhat different results. It depends what the government will do.
Here’s a quick summary of Japan’s experience (excerpted from my January article):
They started with a huge credit expansion. Their discount rate was cut from 4.4% to 2.5% in 1986-1987. The result:
- Real estate and equity prices soared.
- To counter the speculative boom, the discount rate was raised in 1989-1990 from 2.5% to 6% and their markets crashed.
- The Nikkei went from 40,000 in 1989 to 11,000 in 2005. Real estate values plummeted 80%.
- GDP grew at only 1.17% from 1992 to 2003.
- Unemployment went from 2.1% in 1991 to 4.7% by 2004 (a very high rate in Japan).
- Consumption and investment fell dramatically.
- Banks were not lending.
What was the response of the government to this crisis?
- In order to kick-start the economy, the government went on an infrastructure spending binge and cut taxes.
- From 1992 to 1995 they spent ¥65.5 trillion on projects and cut taxes.
- In 1998 they cut taxes ¥2 trillion.
- In 1998 they spent another ¥40.6 trillion on spending stimulus.
- In 1999 they spent another ¥18 trillion in fiscal stimulus.
- In 2000 they tried another ¥11 trillion spending package.
- They set up a ¥20 trillion fund to lend directly to businesses (the Financial Investment and Loan Program [FILP]).
- To try and push money into the system the Bank of Japan and Ministry of Finance bought more than half of existing government bonds from the private market at a cost of ¥2.22 trillion.
- Trying monetary policy, they lowered the discount rate from 4.5% in 1991, 3.5% in 1992, 1.75% 1993-1994, to 0.5% 1995-2003.
- They set up a $524 billion bailout fund in 1998 to buy stock in failing banks or nationalize them.
It is estimated that the Japanese spent about $1 trillion about (¥135 trillion) to cure their financial problems. But the problems lingered, banks remained weak, lending and investment was severely reduced, unemployment was high, government debt went to more than 150% of GDP [it's now 200%], and the yen devalued. Nothing seemed to work.
Remember some of the hallmarks of the Japanese experience? “Zombie Banks” were banks that the government allowed to keep their doors open although they were really insolvent. “Zombie Corporations” were the companies whose debt were held by zombie banks, but were allowed to stay in business because the zombie banks didn’t write off these loans. “Window sitters,” a term applied to workers of zombie companies who showed up for work every day for a paycheck, presumably gazing out the window all day with nothing to do.
The irony of it is that they are trying the same things again in this crisis, with the same results. The Bank of Japan just predicted two years more of deflation, and unemployment is up to 5.5%. Exports, the mainstay of their economy, are falling off a cliff (11 straight months of decline). It reminds me of a definition of insanity: expecting a different result to occur from the same input, over and over again.
Does the Japanese scenario sound familiar? It should since we are doing most of the same things as they did.
- The Fed reduced the Fed Funds rate to 0.25%.
- The government has hugely increased the base money supply in an attempt to create inflation.
- The government has spent or pledged about $2.7 trillion dollars in direct loans, bailouts, debt purchases, grants, and wasteful spending projects.
- The guarantees to Fannie, Freddie, Sallie, and the FHA, plus additional backstop guarantees by the Fed and the Treasury amount to almost $10 trillion.
- The Obama Administration expects the national debt is to increase by almost $10 trillion over the next 10 years (a very conservative number considering the new national health care plans). This will get us to a national debt of about 200% of GDP.
- Programs like Cash for Clunkers, Cash for Refrigerators, and Cash for Casas are trying to stimulate consumer spending and increase consumer debt.
- Like Japan, mark-to-market accounting requirements for banks have been partially suspended.
- The Fed has been directly financing corporations through its commercial paper lending window.
- TARP, TALF and the host of other programs were implemented to keep bankrupt institutions afloat.
- They have been buying stock in financial and commercial companies.
- They have been buying U.S. debt, effectively partially monetizing the deficit.
It is not surprising that these policies have led us to many of the same results as Japan experienced:
- Deflation.
- Collapsing real estate values.
- A shrinking money supply.
- Decreased bank lending.
- Falling consumer spending.
- Falling consumer credit.
- Increased federal debt.
- Falling GDP.
- High unemployment.
One might ask, with all this faith in Keynesian policies, why aren’t they working? Why are we still having these problems? And, why aren’t we doing something different than Japan? … Continue reading Will We Have a Lost Decade(s) Like Japan?
|
|
