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Five Things You Need to Know: Vanished, Deflation Is Good... Until it Isn't, Dear Prudence, Sounds Like a Plan... A Very Bad Plan, Who Needs Dollars Anyway?


What you need to know (and what it means)!


Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Vanished

The Labor Department reported that consumer prices were unchanged last month, below expectations of the 0.2 percent rise economists had been expecting.

  • Inflation has vanished.
  • Recall that last month the CPI fell 0.5%.
  • Oh, and it fell 0.5% in September too.
  • Yeah, but that's due to the sharp declines since the summer in energy, right?
  • Well, core inflation, which excludes food and energy, was also unchanged in November, the lowest reading since June 2005.
  • Fortunately, all this consumer price data is seasonally adjusted.
  • Otherwise, we would see that the core rate, which the Fed prefers to focus on showed an outright decline of 0.1% last month.

2. Deflation Is Good... Until it Isn't

What do you call a persistent decline in an aggregate indicator of price movements? Oh yeah, deflation.

  • So why are stocks reacting positively to news that deflation may be upon us?
  • Because right now the consensus (at least as shown by the increase in stock prices) is that this is a benign bout of supply-driven deflation, not the collapse in aggregate demand that Fed policymakers fear so deeply.
  • Structural deflation is not, in and of itself, something the market fears, and that is one reason the Fed has implemented policy in a manner that most market participants find difficult to understand.
  • In a true bout of secular inflation the actions of the U.S. central bank, ratcheting up the Fed Funds rate over time even as credit expands and bond yields "fail to respond" - the Greenspan conundrum - would indeed seem impossible to understand.
  • But, as we have argued, this is no true bout of secular inflation we have experienced. Rather, it was a bout of cyclical inflation within a structural deflationary environment.
  • The disconnect now, the view least shared by market participants, is that the structural deflationary environment we are in is poised to suffer from a potential collapse in aggregate demand.
  • Remember, Japan's bout with deflation was viewed as benign deflation for many years.
  • Be that as it may, the most important thing to take away from the movement of stock prices is not that the stock market is saying, "Hey, there is no deflation." It's that stocks are saying, "Hey, there may be deflation, but it's still ok."
  • Unfortunately, by the time good deflation turns bad, it will be too late. And stock prices, all asset prices, will move accordingly.

3. Dear Prudence

European central bankers on Thursday appealed to investors to be more prudent in the region's leveraged finance sector, where activity has exploded this year amid cheap borrowing conditions, the Financial Times reported.

  • The European Central Bank warned in its monthly bulletin that increased leverage multiples and the easing of loan conditions were now "a cause for concern."
  • European leveraged loan issuance has now exceeded levels seen in the late-1990s telecoms boom, the ECB said.
  • This week, Standard & Poor's said that there was now "extreme credit risk" in the leveraged finance world, because of rising debt levels.
  • Meanwhile, Sir John Gieve, deputy governor of the Bank of England, urged financial players to remember that "financial markets are liable to overshoot", the FT reported.
  • The value of leveraged buy-out deals reached nearly $105 billion year-to-date ending the third quarter of 2006.
  • The sun is up, the sky is blue, it's beautiful and so are you. Dear Prudence, won't you open up your eyes.

4. Sounds Like a Plan... A Very Bad Plan

More than half of recently surveyed British mortgage brokers said their clients admit to buying property to supplement poor retirement savings, according to the Telegraph.

  • A lack of confidence in the stock market is fueling increased investment in rental properties despite the fact the income from the properties in many cases fails to cover interest and management costs, the Telegraph said.
  • Borrowing by so-called "buy-to-let "investors will rise more quickly than borrowing by home owners and will account for 13% of gross lending in 2007 and 14%in 2008, up from 11% in 2006, according to the Council of Mortgage Lenders.
  • The phrase "buy-to-let" is simply the British vernacular for buying a residential property to lease for a profit and the particular category of mortgage loans used to purchase the property for leasing.
  • A survey published this week shows eight in 10 mortgage brokers expect to see an increase in buy-to-let lending in 2007 from today's already record levels.
  • Claire Burston, at financial consultancy Penrose which commissioned the study, told the Telegraph: "People are becoming increasingly aware of the need to supplement their existing savings prior to retirement and this will result in a boom in the buy-to-let market."
  • Meanwhile, two weeks ago UCB Homeloans announced it was relaxing buy-to-let lending criteria.
  • So, let's see if we got this right. What we have here is people who haven't saved enough money for retirement buying property they can't afford (thanks to relaxed lending standards) and renting the property for less than the cost of carry to other people who apparently can't afford to buy a home either.
  • If we hated money this is exactly what we would do to get rid of it.

5. Who Needs Dollars Anyway?

A town in Massachusetts is experimenting with its own local currency backed by federal dollars, according to the Hartford Courant.

  • This spring, the town of Great Barrington Massachusetts printed a local currency backed by federal dollars to encourage people to shop locally and boost the local economy.
  • For every $90 in U.S. money, buyers come away with 100 BerkShares, which have purchasing power equal to the full $100 with participating merchants, the Hartford Courant said.
  • About 3,000 people have exchanged their federal dollars for 350,000 BerkShares and have spent an estimated 130,000 of the B's at 188 stores, law firms, auto repair shops and other businesses that pledged to accept them.
  • Merchants can restrict how the BerkShares are used - some take them for small items but not big-ticket purchases - but when they take them, the merchants allow a 10 percent discount, the article said.
  • "It's the consumers' fault that we haven't banded together. Instead of complaining about the global economy, and the goods produced under that situation - here's how to promote local production," Susan Witt, who initiated the program, told the newspaper.
  • There's no law saying consumers have to pay for goods or services with federal reserve notes - although a local currency system can't preclude the use of U.S. dollars, a Federal Reserve spokeswoman said.

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