How The Bubble Bursts
By Mr Practical Jul 02, 2008 11:00 am
Understanding inflation and deflation.
Now that we’ve seen the beginning stages of deflation, it’s becoming clearer what’s going on and what’s important: to conserve capital. To save.
So let’s review what inflation and deflation really are.
The traditional definition of inflation (rising prices) and deflation (falling prices) don’t make sense in today’s world. That’s why people are confused. Ironically, the Fed wants you to be this confused, because it’s actually they who create inflation - which plants the seeds for eventual deflation.
Inflation’s just the expansion of the money supply, almost always through the expansion of debt. This is what the Fed does: They create debt out of thin air and pass that debt on to the banking system by extending credit; banks then extend it to consumers.
From 1993 to 2006 the Fed created massive inflation by creating massive debt, keeping real interest rates negative and supplying plenty of credit to keep them there. This was particularly true from 2001 to 2006; in 2006 alone the Fed expanded the money supply by creating $4 trillion in new debt.
Click to enlarge
People who had no business borrowing took money from people who had no business lending. This drove the prices of the cars and house they bought with that money up, while the debt drove the value of the currency down. This doubles the pressure on the prices of things we get from other countries - like oil.
So it isn’t hard to convince people that inflation means rising prices, because rising prices almost always occur when the money supply’s inflated with debt.
In 2007, we reached a point where there was just too much debt; no one could take on any more. This is where the Fed’s inflation machine breaks down: If no one can borrow or lend on the credit they offer the banking system, the money supply stops expanding. In fact, as people try to pay off all that debt (retire it) or default on it (destroy it), the money supply, bloated with debt, begins to shrink. Hence deflation.
What does the Fed do then? Why, they buy that debt themselves, to try to keep the money supply from deflating. This leads to those TAF (term auction facility) auctions you’ve heard about, where the Fed exchanges new capital (t-bills) for bad debts with banks.
Despite these efforts, the money supply has probably deflated by the amount of write-offs -- by now, approximately $400 billion -- that banks have incurred. Strict measures of money supply, like M3, haven’t fallen - but that doesn’t include the most important broad sources of new money, like derivatives and securitized loans. As the money supply deflates, people borrow less and spending goes down. The deflation thus feeds on itself, because lower spending means lower income and debt becomes even harder to support. Prices in stocks begin to fall as the money supply dwindles.
Central banks are powerless to stop the money supply from deflating unless they take on the debt themselves. If not, it will be systematically destroyed by defaulting, and the money supply will shrink even more.
As central banks fight this by taking on debt (as in TAFs and the Bear Stearns bailout), taxpayers will be called upon to make up the losses. Ironically, the Fed’s attempts to keep the money supply inflated are much worse for the average person, who suffers from a declining dollar and higher taxes in the long run.
Why doesn’t this happen all the time, you ask? It does - it just usually happens in smaller increments. What’s happening now is different only in terms of magnitude: The money supply has been so debt-inflated for so long that the reversal is very significant. Over the years, it just adds up: Few realize just how much debt’s still out there.
When a bank takes a write-off, debt gets smaller - but we still have a long way to go. How long? Well, the level of debt’s currently four to five times greater than is normal for our economy; the natural level of income and savings aren’t enough to support the debt. Debt will get destroyed -- and the money supply will deflate -- until debt and actual savings are more balanced.
If you understand inflation and deflation in this way, our current crisis makes more sense. Now we’re seeing deflation (a shrinking money supply and lost liquidity), which is causing havoc in markets.
We’re still seeing prices rise on certain scarce commodities as various competing forces work their way through the system; but that’s to be expected, because those rising prices are caused by more debt, which will eventually make the debt untenable as income goes down.
We’re seeing formerly powerful financial institutions destroyed by even these first stages of deflation. That’s because their only power came from franchise - from being able to take out high-risk spreads. So they actually had very little capital to support vast amounts of debt when things began to sour.
High risk has been rewarded in the past by government (easy monetary policy), legislation (the repeal of Glass-Steagall, now clearly a mistake), and the markets (the Wall Street marketing machine). Those rewards fall away quickly when you see that you have built your house built on sand.
For decades, but especially over the last seven years, central banks have “solved” any and all market dips, slowing economies, and financial problems by creating debt. If the stock market declines, just make it easy to borrow, so people can buy stocks. If the economy slows, just make it easy to borrow, so people can consume more. This methodology may work on occasion, but doing it systematically leads to crisis.
Central banks can’t fix this problem: They can only create more banking debt or transfer its risks onto taxpayers via TAF auctions or nationalization - which will only stabilize the banking system long enough for banks to dilute themselves massively by suckering investors into buying stock. More debt isn’t the solution.
So stay the course. Stay out of the way. Bottom feeders keep coming up empty. There will be rallies in stocks. Some will be quite vicious, but that doesn’t mean we’re in a bull market. The GDP’s going to go way down, but will eventually come back when debt is wiped out to a point where those with savings want to lend or invest again.
We have a long way to go, though - and risk is high.
No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2009 Minyanville Media, Inc. All Rights Reserved.
Copyright 2009 Minyanville Media, Inc. All Rights Reserved.
(68)
Reply
2008-07-02 11:24:49
Another Gem by Mr. P
Succinctly put and understandable by anybody who can read.
Obviously there are people in power who prefer that the masses don't understand the mechanics of inflation / deflation as they would be rightly joining the ranks of the unemployed.
Obviously there are people in power who prefer that the masses don't understand the mechanics of inflation / deflation as they would be rightly joining the ranks of the unemployed.
2008-07-02 11:25:57
So true about the Fed
Great artcile and I wrote about a similar topic with matching viewpoints recently at : http://www.savingtoinvest.com/
The Fed and other world central banks can only try and reduce the pain, not stop it.
The Fed and other world central banks can only try and reduce the pain, not stop it.
2008-07-02 11:58:07
Good work.
Thank you.
Next up: The Popping of the Perception of Perpetual Growth.
Next up: The Popping of the Perception of Perpetual Growth.
2008-07-02 12:05:42
Ways to Inflate
I enjoyed this interesting and informative article, but it seemed like its pessimism required the premise that the solitary method of inflating the currency is to increase the volume of domestic debt.
Is it really the case that the only way the money supply can be increased is by increasing (domestic) debt? Can't the supply also be increased by, e.g., lowering taxes or shifting debt overseas? And doesn't the Fed. have a couple of additional tools at its disposal besides making loans cheaper?
Thanks for any additional info.
W
Is it really the case that the only way the money supply can be increased is by increasing (domestic) debt? Can't the supply also be increased by, e.g., lowering taxes or shifting debt overseas? And doesn't the Fed. have a couple of additional tools at its disposal besides making loans cheaper?
Thanks for any additional info.
W
2008-07-02 12:47:30
Mr. Practical, I believe your analysis is upside down
To Bob
Changing the definition of a word doesn't make it so.
Mr. P does give the correct definition of inflation/deflation (of the money+credit supply) which generally manifests itself to the public as the layman's definition of rising/falling prices.
Your version of "inflation" - more demand for dollars by foreigners, would actually manifest itself as layman's "deflation" to members of dollar denomination exchanges, as the price of things in dollars would decrease relative to competing currencies who suddenly preferred dollars.
Changing the definition of a word doesn't make it so.
Mr. P does give the correct definition of inflation/deflation (of the money+credit supply) which generally manifests itself to the public as the layman's definition of rising/falling prices.
Your version of "inflation" - more demand for dollars by foreigners, would actually manifest itself as layman's "deflation" to members of dollar denomination exchanges, as the price of things in dollars would decrease relative to competing currencies who suddenly preferred dollars.
2008-07-02 13:03:29
Middle Ground
Seems to me pessimism is high. This can feed on itself and create the situation by which deflation and long term suffering become widespread.
This isn't to say optimism itself will save the day. However, while there is massive debt that needs to be washed out of the system, a great portion already has been washed out. Is there more to go?
Of course. Debt is the engine that drives every economy...debt is what we borrow against the belief that this borrowing will yield a greater return in the long run.
If that debt becomes too great, the yield won't materialize. That is the situation some of these individuals/firms led themselves to reach.
But, at some point, that yield WILL materialize for many who have longer views and/or took out debt earlier (or have been good at paying it off). At that point, other distressed properties begin to look very, very good again.
The Fed is not an evil conspirator in a game of beggaring the population. That is not its goal, whether you choose to believe it or not. It certainly does not have unlimited tools to prevent all manner of crises, either (neither does a gold-based currency, either, by the way).
However, the REAL problem that leads to deflation is expectations. It is the guy next to you who sees the market decline 10% in a week and he feels that he has to get out before it goes further. If he's the only one who does so, then he more than likely will lose out on the rally that follows.
If there are 20 of him, and they have alot invested, then they create further declines because their expectations fell.
If, on the other hand, most of these investors choose to hold, or at least leave slowly in bits and pieces, then the declines will be less severe and eventually things will even out.
Markets move on the back of many different bits of information and inputs. Lowering interest rates tends to drive up stock prices, but the opposited occurred in the 90's, when raising interest rates coincided with a rising market....so sometimes other factors come into play.
Right now, there are many factors in play. But the largest, and most distressing, is the doom and gloom factor of expectations.
I have had conversations with many friends who are absolutely in fear of the "bad times ahead". I have pointed out to them that times are only bad if you choose to let them be, and are unprepared. Just saying they are going to be bad will make them bad, it doesn't prepare you.
I, on the other hand, remain cautiously optimistic. I am not going to be investing, but I'm not selling either. I will take my lumps if a downturn arrives, because the upside that follows will be significant and wonderful, and I won't have to worry about timing it.
I am prepared for bad times, but being prepared for them doesn't mean I have to expect them or even act like they will be bad.
It's all about attitude. I've survived before, I'll do it again. Any of you who, like me, lived through the 70's know what I'm talking about. Will this be worse? I doubt it. Could be if the doom and gloomers take over, though.
I choose not to let them. In the end, pessimists lose, pollyannas lose, but optimists win.
This isn't to say optimism itself will save the day. However, while there is massive debt that needs to be washed out of the system, a great portion already has been washed out. Is there more to go?
Of course. Debt is the engine that drives every economy...debt is what we borrow against the belief that this borrowing will yield a greater return in the long run.
If that debt becomes too great, the yield won't materialize. That is the situation some of these individuals/firms led themselves to reach.
But, at some point, that yield WILL materialize for many who have longer views and/or took out debt earlier (or have been good at paying it off). At that point, other distressed properties begin to look very, very good again.
The Fed is not an evil conspirator in a game of beggaring the population. That is not its goal, whether you choose to believe it or not. It certainly does not have unlimited tools to prevent all manner of crises, either (neither does a gold-based currency, either, by the way).
However, the REAL problem that leads to deflation is expectations. It is the guy next to you who sees the market decline 10% in a week and he feels that he has to get out before it goes further. If he's the only one who does so, then he more than likely will lose out on the rally that follows.
If there are 20 of him, and they have alot invested, then they create further declines because their expectations fell.
If, on the other hand, most of these investors choose to hold, or at least leave slowly in bits and pieces, then the declines will be less severe and eventually things will even out.
Markets move on the back of many different bits of information and inputs. Lowering interest rates tends to drive up stock prices, but the opposited occurred in the 90's, when raising interest rates coincided with a rising market....so sometimes other factors come into play.
Right now, there are many factors in play. But the largest, and most distressing, is the doom and gloom factor of expectations.
I have had conversations with many friends who are absolutely in fear of the "bad times ahead". I have pointed out to them that times are only bad if you choose to let them be, and are unprepared. Just saying they are going to be bad will make them bad, it doesn't prepare you.
I, on the other hand, remain cautiously optimistic. I am not going to be investing, but I'm not selling either. I will take my lumps if a downturn arrives, because the upside that follows will be significant and wonderful, and I won't have to worry about timing it.
I am prepared for bad times, but being prepared for them doesn't mean I have to expect them or even act like they will be bad.
It's all about attitude. I've survived before, I'll do it again. Any of you who, like me, lived through the 70's know what I'm talking about. Will this be worse? I doubt it. Could be if the doom and gloomers take over, though.
I choose not to let them. In the end, pessimists lose, pollyannas lose, but optimists win.
2008-07-02 13:23:52
slow strangulation
as these forces squeeze the individual, city state and federal goevernment are going to be hit hard with increased expenditures and falling revenues...the last debt to be writtten off will eventually be the national debt; t-bills secure?...how could a risk magager rate the federal government anything but totally incapable of paying back its debt? When it is all over we will be spending Ameros instead of dollars...
2008-07-02 13:27:27
Mr. Practical, I believe your analysis is upside down
It is a pleasure to see that someone is finally thinking outside the box in terms of the current state of inflationary and deflationary pressures. Mr. Practical, your points are well thought out but I believe your logic is faulty.
Capitalism 101: When the number of widgets being produced outstrips the demand for widgets, the price of widgets fall. Over the years, consider the money widget. As money supply increased (the supply of widgets), the price of the money (borrowing rates) decreased. If you happened to own widgets (cash in the bank) during the past 8 years, the price you got for selling your widgets (lending money) also dwindled. Finally, consider the international market for the US dollar widget; i.e., how much has the world wanted to pay for the US dollar in recent years? Well, we all know the answer to that one.
The decreasing prices of widgets over time is the essence of deflation.
So, my contention is that we have been in the throes of deflation for several years. No way, you say. The price of cars or apples or computers or clothes hasn't fallen since, say, Y2K. Well, actually, they have. That is, when you talk about the purchase power of the dollar in absolute terms, they have.
If an apple costs one dollar on January 1 and one dollar on December 31, there was no inflation or deflation, right? Well, not necessarily. If the cost of the widget used to purchase the apple (the dollar) has decreased from January 1 to December 31, then the price of the apple has effectively decreased. That's deflation.
Mr. Practical contends that the drying up of the availability of money widgets will be a deflationary factor. I say the opposite. When the supply of money is reduced, the price of money will go up. When the price of money goes up, borrowing and lending rates will go up. Europeans will see that the price of the US dollar widget is rising which will make them buy more, which will, in turn, put even more upward pressure on the price of the US dollar. As the availability of dollars decreases, the farmer who needed to borrow money to buy the trucks to collect his apples will go up. The price of apples will go up. And so on.
That, folks, is the essence of inflation.
Capitalism 101: When the number of widgets being produced outstrips the demand for widgets, the price of widgets fall. Over the years, consider the money widget. As money supply increased (the supply of widgets), the price of the money (borrowing rates) decreased. If you happened to own widgets (cash in the bank) during the past 8 years, the price you got for selling your widgets (lending money) also dwindled. Finally, consider the international market for the US dollar widget; i.e., how much has the world wanted to pay for the US dollar in recent years? Well, we all know the answer to that one.
The decreasing prices of widgets over time is the essence of deflation.
So, my contention is that we have been in the throes of deflation for several years. No way, you say. The price of cars or apples or computers or clothes hasn't fallen since, say, Y2K. Well, actually, they have. That is, when you talk about the purchase power of the dollar in absolute terms, they have.
If an apple costs one dollar on January 1 and one dollar on December 31, there was no inflation or deflation, right? Well, not necessarily. If the cost of the widget used to purchase the apple (the dollar) has decreased from January 1 to December 31, then the price of the apple has effectively decreased. That's deflation.
Mr. Practical contends that the drying up of the availability of money widgets will be a deflationary factor. I say the opposite. When the supply of money is reduced, the price of money will go up. When the price of money goes up, borrowing and lending rates will go up. Europeans will see that the price of the US dollar widget is rising which will make them buy more, which will, in turn, put even more upward pressure on the price of the US dollar. As the availability of dollars decreases, the farmer who needed to borrow money to buy the trucks to collect his apples will go up. The price of apples will go up. And so on.
That, folks, is the essence of inflation.
2008-07-02 13:28:29
Middle Ground
I cannot tell a lie says George. But the Bear says I can and I will. Bush says I can and I will. So does the analist, Banker, Broker, Preacher and the Judge. Thus a wave of pessimism, fear, disbeleif and distrust. Look for Wa-mu to downgrade someone in the near future. Its typical of a rabid dog to try and bite something before it croakes.
JPM
JPM
2008-07-02 13:48:59
Glass-Steagall Act
It is nice to know that there is at least one other person out there that recognizes how foolish policy makers were to repeal the Glass-Steagall Act. I noted how it was contributing to earlier scandals (e.g., Enron) in talks I gave at that time. I really didn't think anyone else would recognize the importance of keeping investment banking and commercial banking regulatorily separate. Oh, to have not had the "free market" fools run monetary and microeconomic policy these past twenty-five years!
2008-07-02 13:50:18
once again, mr. practical cuts through the nonsense and the noise.
please, mr. p, never stop writing!
please, mr. p, never stop writing!
2008-07-02 13:54:07
Excellent Article. But not all debt is bad debt
This is an excellent article.
As you mention, the potential for a debt spiral is very real. I argue that one way out of this is for us to do a "Manhattan Project" and develop alternatives to oil. This will create new industries, and hence growth.
This massive investment in new industries, technologies, and infrastructure could help mitigate the pain of a debt spiral, and just give us a slow contraction. It would require deficit spending, but in this case it would be an investment in future growth, not just will nilly debt.
As you mention, the potential for a debt spiral is very real. I argue that one way out of this is for us to do a "Manhattan Project" and develop alternatives to oil. This will create new industries, and hence growth.
This massive investment in new industries, technologies, and infrastructure could help mitigate the pain of a debt spiral, and just give us a slow contraction. It would require deficit spending, but in this case it would be an investment in future growth, not just will nilly debt.
2008-07-02 14:20:31
slow strangulation
actually if you read the prospectus on the T bills, etc. you will see disclaimer after disclaimer that there is NO GUARANTEE what so ever that the govt will have the means to repay its debt.
Like any fiat currency it is completely reliant on TRUST.
Look at Zimbabwe - NO TRUST and currency is completely worthless.
Could/Will this happen to US currency - It's deflated over 97% since WWII so you tell me???
Again it is the Feds job to deflate currency little by little so as to not cause panic and have the ability to repay debt with cheaper dollars.
True deflation will cause problems we haven't even thought of yet.
Like any fiat currency it is completely reliant on TRUST.
Look at Zimbabwe - NO TRUST and currency is completely worthless.
Could/Will this happen to US currency - It's deflated over 97% since WWII so you tell me???
Again it is the Feds job to deflate currency little by little so as to not cause panic and have the ability to repay debt with cheaper dollars.
True deflation will cause problems we haven't even thought of yet.
2008-07-02 14:22:33
Mr. Practical, I believe your analysis is upside down
Given a basket of goods of fixed size.:
When the supply of money is reduced, a smaller quantity of money represents the basket of goods. Hence each unit of money can buy more of that basket. Each unit is worth more. <Deflation>
If we increase the supply of money, i.e. print and make more of it, then each unit of money can buy less of that basket. Hence we need more units of money to buy what we previously could. <Inflation>
The danger with deflation is that if you are in debt, you must service and pay that debt. As the deflation takes hold, the value of your basket of debt is increasing in time, while your income is not. The more deflation you have, the more of a burden that debt basket will be. This can be a crushing spiral.
With inflation, the value of your debt basket goes down as the inflation increases. Your income is also usually adjusted with inflation, and hence being in debt over time is good. Some of my neighbors paid $50K for their houses many, many years ago.
When the supply of money is reduced, a smaller quantity of money represents the basket of goods. Hence each unit of money can buy more of that basket. Each unit is worth more. <Deflation>
If we increase the supply of money, i.e. print and make more of it, then each unit of money can buy less of that basket. Hence we need more units of money to buy what we previously could. <Inflation>
The danger with deflation is that if you are in debt, you must service and pay that debt. As the deflation takes hold, the value of your basket of debt is increasing in time, while your income is not. The more deflation you have, the more of a burden that debt basket will be. This can be a crushing spiral.
With inflation, the value of your debt basket goes down as the inflation increases. Your income is also usually adjusted with inflation, and hence being in debt over time is good. Some of my neighbors paid $50K for their houses many, many years ago.
2008-07-02 14:36:04
Middle Ground
Lies are the essence of fear. Fear is driven by lies.
I don't want to discuss politics because all politicians lie, regardless of whether it's Bush, McCain, Obama, or Clinton. None really know what drives markets, nor do they care. They are interested in getting elected and making policies that have their name on it, without worrying about the effects of those policies.
What I DO worry about is why so many people spend so much time trying to scare us?
I prefer cautious optimism. It preaches caution at ALL times, even around the rabid dog that you happen to run into as you are walking on Easy Street. Just because the dog's there, doesn't mean it's going to bite you.
But the guy yelling from the safety of his window "hey, that dog WILL bite you" to everyone on the street gets them all in panic mode.
WAMU get downgraded? Big deal, most financials have already gotten downgraded, what's one more downgrade mean?
Now if WAMU shutters the teller's window...THAT'S a story.
I don't want to discuss politics because all politicians lie, regardless of whether it's Bush, McCain, Obama, or Clinton. None really know what drives markets, nor do they care. They are interested in getting elected and making policies that have their name on it, without worrying about the effects of those policies.
What I DO worry about is why so many people spend so much time trying to scare us?
I prefer cautious optimism. It preaches caution at ALL times, even around the rabid dog that you happen to run into as you are walking on Easy Street. Just because the dog's there, doesn't mean it's going to bite you.
But the guy yelling from the safety of his window "hey, that dog WILL bite you" to everyone on the street gets them all in panic mode.
WAMU get downgraded? Big deal, most financials have already gotten downgraded, what's one more downgrade mean?
Now if WAMU shutters the teller's window...THAT'S a story.
2008-07-02 14:51:19
The greenspan put
All things monetary?
To me it seems that the deflation we face today is a result excess capacity which was the result of an excess in the money supply which was fostered by low interest.
Interest rates were too low for too long because our esteemed "Greenspan" tried to operate outside his skill set.
Much like that "genus" 10 year-old we all know, the one that gets on your nerves at his parents party. . . . we humor him even when we really don't understand him because we don't want to discourage creative thinking. We know the naïvety of his science experiment will be followed by experience and eventually he'll become a great doctor, engineer or architect. Meanwhile he continues to believe in himself and . . . he is after all only 10 yeas old.
When the "maestro" performed for Congress you could see his audience sit in aww . . . gears turning . . . slowly . . . . eventually succumbing to his brilliance! You could see that everyone truly believed they were in the presence of a genus. You could see that ten year old "genus" . . . . only this experiment was real with real consequences.
To me it seems that the deflation we face today is a result excess capacity which was the result of an excess in the money supply which was fostered by low interest.
Interest rates were too low for too long because our esteemed "Greenspan" tried to operate outside his skill set.
Much like that "genus" 10 year-old we all know, the one that gets on your nerves at his parents party. . . . we humor him even when we really don't understand him because we don't want to discourage creative thinking. We know the naïvety of his science experiment will be followed by experience and eventually he'll become a great doctor, engineer or architect. Meanwhile he continues to believe in himself and . . . he is after all only 10 yeas old.
When the "maestro" performed for Congress you could see his audience sit in aww . . . gears turning . . . slowly . . . . eventually succumbing to his brilliance! You could see that everyone truly believed they were in the presence of a genus. You could see that ten year old "genus" . . . . only this experiment was real with real consequences.
2008-07-02 15:10:52
Prices are rising on more than "certain scarce commodities".
A general rise in the price of "stuff" continues to occur.
Could you discuss why Mr. P. ?
A general rise in the price of "stuff" continues to occur.
Could you discuss why Mr. P. ?
2008-07-02 15:39:59
The greenspan put
Yeah...it was all one guy's fault.
This is precisely the problem. We're seeking to place blame. Greenspan wasn't that bad, and money wasn't that loose in the 90's.
The excess capacity you refer to has more to do with the loss of manufacturing and other productive output to more competitive shores. This had NOTHING to do with money supply.
The issue at hand is WHAT CAN BE DONE if all the horrible things come to pass that the pessimists claim will happen. After all, a stopped watch is right twice a day...it's quite possible the pessimists will fulfill their destiny and eventually be correct.
So if they are - what is the strategy? I've seen many articles about how bad it's going to be. Very little about concrete strategies in either policy or personal decision making. Aside from the occasional "sit tight, sit on the sidelines, save" there are other things people can do.
In fact, there are things they can do to STIMULATE the economy, beyond simply spending their tax rebate.
They can seek to reduce their exposure to foreign oil (forget the global warming religion BS, think simple economics). For example, add a solar panel or a vertically aligned wind generator.
Or get a motor scooter.
Or ride the bus/train.
Stop placing blame and looking for boogeymen around the corner. Be practical, not conspiratorial.
This is precisely the problem. We're seeking to place blame. Greenspan wasn't that bad, and money wasn't that loose in the 90's.
The excess capacity you refer to has more to do with the loss of manufacturing and other productive output to more competitive shores. This had NOTHING to do with money supply.
The issue at hand is WHAT CAN BE DONE if all the horrible things come to pass that the pessimists claim will happen. After all, a stopped watch is right twice a day...it's quite possible the pessimists will fulfill their destiny and eventually be correct.
So if they are - what is the strategy? I've seen many articles about how bad it's going to be. Very little about concrete strategies in either policy or personal decision making. Aside from the occasional "sit tight, sit on the sidelines, save" there are other things people can do.
In fact, there are things they can do to STIMULATE the economy, beyond simply spending their tax rebate.
They can seek to reduce their exposure to foreign oil (forget the global warming religion BS, think simple economics). For example, add a solar panel or a vertically aligned wind generator.
Or get a motor scooter.
Or ride the bus/train.
Stop placing blame and looking for boogeymen around the corner. Be practical, not conspiratorial.
2008-07-02 15:55:46
The greenspan put
Just for fun you might bring up a chart of the fed funds rate to . . say . . . 1990.
2008-07-02 16:04:42
Mr. Practical, I believe your analysis is upside down
With all due respect, you and Mr. Practical are using cliches rather than reason in analyzing the economic horizon.
For example, you say "If we increase the supply of money, i.e. print and make more of it,..." as if "printing more money" has an automatic correlation to "making more of it". It doesn't. In the last eight years, the government has printed more money that any previous eight year spread in history. Have wages increased proportionately?
The false axiom that says "printing money causes inflation" implies that printing more money somehow magically raises wages and prices, the the two antagonists for inflation. This rote thinking is the metaphorical wool covering most people's eyes.
Printing money has a direct correlation with deflation and here it is:
Printing money creates an creates a larger money supply which creates a glut of money to lend thus lowering the "cost of money"; i.e., lowering borrowing rates to lenders. Businesses, the makers of your 'baskets of goods' are now the beneficiaries of cheaper money, borrowing money at lower rates. Hence, the cost of doing business goes down. As the cost of doing business goes down, the cost of the 'basket of goods' that the business produces goes down. The business becomes more competitive by passing on the lowered cost to the consumer, lowering the price of their "basket of goods". <deflation>
For example, you say "If we increase the supply of money, i.e. print and make more of it,..." as if "printing more money" has an automatic correlation to "making more of it". It doesn't. In the last eight years, the government has printed more money that any previous eight year spread in history. Have wages increased proportionately?
The false axiom that says "printing money causes inflation" implies that printing more money somehow magically raises wages and prices, the the two antagonists for inflation. This rote thinking is the metaphorical wool covering most people's eyes.
Printing money has a direct correlation with deflation and here it is:
Printing money creates an creates a larger money supply which creates a glut of money to lend thus lowering the "cost of money"; i.e., lowering borrowing rates to lenders. Businesses, the makers of your 'baskets of goods' are now the beneficiaries of cheaper money, borrowing money at lower rates. Hence, the cost of doing business goes down. As the cost of doing business goes down, the cost of the 'basket of goods' that the business produces goes down. The business becomes more competitive by passing on the lowered cost to the consumer, lowering the price of their "basket of goods". <deflation>
2008-07-02 16:15:37
So are we headed for the Gary Shilling scenario ("good" deflation, 1920s, Japan-in-1990s, great for bonds/money markets/gold) or are we headed for the Robert Prechtor scenario ("bad" deflation, 1930s, bad for everything but cash, historically bad social mood)?
2008-07-02 16:19:49
Excellent Article. But not all debt is bad debt
I meant to say deflationary spiral, not debt spiral.
One important point not to gloss over: A deflationary spiral is very, very bad, and will make everyone very, very poor. Especially those who have personal debt now.
This is why I recommend the "Manhattan Project" government program, to get us off of imported oil. Invest in the country, and try to generate new growth industries. This would be good debt.
So I am advocating generating this new debt in this new area to feed future growth, to slow the rate of debt reduction down, and generate growth, which will ultimately be needed to service any remaining debt.
People forget that Japan was deeply in the hole for at least a decade. The Great Depression lasted until WWII, and all the spending built up US industries, which after the war went into producing the worlds best goods.
A deflationary spiral is no joke. Sitting it out is like watching your house burn. It must be avoided at all costs. If it can't be avoided, it's effects must mitigated.
I personally believe oil will try to ignite inflation, while this debt contraction will be taking place. This all equals a lower standard of living. The only way out is with major growth initiatives.
So I hope we get the required leadership.
P.S.
I hope some policy makers are not going to try and start another conflict (with the worlds third largest oil reserve), to increase spending and secure our oil supply. I don't think this is the way out.
One important point not to gloss over: A deflationary spiral is very, very bad, and will make everyone very, very poor. Especially those who have personal debt now.
This is why I recommend the "Manhattan Project" government program, to get us off of imported oil. Invest in the country, and try to generate new growth industries. This would be good debt.
So I am advocating generating this new debt in this new area to feed future growth, to slow the rate of debt reduction down, and generate growth, which will ultimately be needed to service any remaining debt.
People forget that Japan was deeply in the hole for at least a decade. The Great Depression lasted until WWII, and all the spending built up US industries, which after the war went into producing the worlds best goods.
A deflationary spiral is no joke. Sitting it out is like watching your house burn. It must be avoided at all costs. If it can't be avoided, it's effects must mitigated.
I personally believe oil will try to ignite inflation, while this debt contraction will be taking place. This all equals a lower standard of living. The only way out is with major growth initiatives.
So I hope we get the required leadership.
P.S.
I hope some policy makers are not going to try and start another conflict (with the worlds third largest oil reserve), to increase spending and secure our oil supply. I don't think this is the way out.
2008-07-02 16:47:21
It is interesting that this fed chairman and administration gets to suffer the sins of the past since I doubt that all this occured only in the last 8 years. After the debt is destroyed, whoever is the next president will come up smelling like a rose.
2008-07-02 17:00:13
Commodity Inflation
Hi all, I have a question regarding commodity prices and how they are affected by foreign buyers, namely China & India. It has been said that India and China will suffer INFLATION as we in the USA suffer DEFLATION. Does that mean that commodity prices continue to rise due to the inflationary problems in those two countries and their overall increased demand for oil, uranium, copper, etc? Or does US Deflation trump China & India's Inflation? Thanks in advance for any answers.
2008-07-02 17:15:49
Mr. Practical, I believe your analysis is upside down
Ok,
Let me ask you the following questions:
If we have an economy with 100 barbells and 100 dollars in it.
1. How much will you pay for a barbell, and at what interest rate can I lone you a dollar at? What is the value of your money?
2. Now I decide to print 100 more dollars. So we have 100 barbells and 200 dollars in the economy.
How much will you pay for a barbell, and at what interest rate can I lone you a dollar at? Have you been inflated or deflated? What is the value of your money?
3. Say you owe me $10 in case #2, and we decide to put the economy back to case #1 (and salaries in the barbell world are decreasing)
What will happen? Are you beetter off? What is the value of your money? What is the value of the debt?
Believe me, I have been asking myself all of these questions.
Let me ask you the following questions:
If we have an economy with 100 barbells and 100 dollars in it.
1. How much will you pay for a barbell, and at what interest rate can I lone you a dollar at? What is the value of your money?
2. Now I decide to print 100 more dollars. So we have 100 barbells and 200 dollars in the economy.
How much will you pay for a barbell, and at what interest rate can I lone you a dollar at? Have you been inflated or deflated? What is the value of your money?
3. Say you owe me $10 in case #2, and we decide to put the economy back to case #1 (and salaries in the barbell world are decreasing)
What will happen? Are you beetter off? What is the value of your money? What is the value of the debt?
Believe me, I have been asking myself all of these questions.
2008-07-02 18:02:31
Mr. Practical, I believe your analysis is upside down
Shannon - The layman's definition of inflation may be prosaic but it's the only one consumers care about - The purchasing power of their dollars diminishing as prices climb.
The more demand for dollars that I speak of is a result of, not a cause of, inflation that I assert will be fueled by the contracting money supply of which Mr. Practical speaks.
As to your comment: "Your version of "inflation" - more demand for dollars by foreigners, would actually manifest itself as layman's "deflation" to members of dollar denomination exchanges, as the price of things in dollars would decrease relative to competing currencies who suddenly preferred dollars."
-- yes your are absolutely correct: if (layman's) inflation runs rampant in the US, the relative view that "members of the dollar denominated exchanges" would have is exactly as you describe. But that doesn't belie my assertion that the constriction of the money supply is going exert (counter-intuitively) inflationary pressure on the US economy - albeit the "layman's" kind.
The bottom line is the price of capital. As it rises, the price of doing business rises and so will the price of goods. If the curve is smooth, wages will follow. However, just as stomping on an accelerator can red-line a motor, an extraordinary acceleration of the cost of money could indeed red-line the economy and send us in the direction that Mr. Practical foresees.
See my response to Mr. Bacan regarding the counter-intuitive effect that the printing of money can have - as it has the last 8 years.
The more demand for dollars that I speak of is a result of, not a cause of, inflation that I assert will be fueled by the contracting money supply of which Mr. Practical speaks.
As to your comment: "Your version of "inflation" - more demand for dollars by foreigners, would actually manifest itself as layman's "deflation" to members of dollar denomination exchanges, as the price of things in dollars would decrease relative to competing currencies who suddenly preferred dollars."
-- yes your are absolutely correct: if (layman's) inflation runs rampant in the US, the relative view that "members of the dollar denominated exchanges" would have is exactly as you describe. But that doesn't belie my assertion that the constriction of the money supply is going exert (counter-intuitively) inflationary pressure on the US economy - albeit the "layman's" kind.
The bottom line is the price of capital. As it rises, the price of doing business rises and so will the price of goods. If the curve is smooth, wages will follow. However, just as stomping on an accelerator can red-line a motor, an extraordinary acceleration of the cost of money could indeed red-line the economy and send us in the direction that Mr. Practical foresees.
See my response to Mr. Bacan regarding the counter-intuitive effect that the printing of money can have - as it has the last 8 years.
2008-07-02 18:43:01
Mr. Practical, I believe your analysis is upside down
I do not know how to answer your questions and this is why:
Let's say that you have 100 barbells and I have 100 dollars. You and I can pick some arbitrary price for the barbell and a borrowing rate. But let's add that the government also has 100 dollars.
My problem is that you say that "you" print up more dollars - which is a case that I do not understand. I contemplate the case where the government prints more money. Imagine that the government decides to print up a hundred million more dollars. Common thinking is that somehow the price of those barbells will automatically rise. Common thinking is also that somehow yours and my wages will automatically rise. I don't see it. I don't see the logic in that thinking nor do I see the empirical evidence of it , at least not in the last decade.
My assertion is that one possible scenario is this: The government has so much cheap money available that ACME Barbell company decides to borrow some to make their plant more efficient. Consequently, their cost of making a barbell decreases. York Barbell is their main competitor but now ACME can sell them cheaper. So the price of all barbells actually decreases. Why? Because the government printed out cheap money.
Also, ACME, my employer, decides that to remain competitive, they are not going to give me a raise. Well, I'm ticked. But actually I'm not that ticked. Why? Because the price of barbells has gone down so much that I actually have more pocket money than I did before. On a micro-economic level, wages have remained "in check".
Let's say that you have 100 barbells and I have 100 dollars. You and I can pick some arbitrary price for the barbell and a borrowing rate. But let's add that the government also has 100 dollars.
My problem is that you say that "you" print up more dollars - which is a case that I do not understand. I contemplate the case where the government prints more money. Imagine that the government decides to print up a hundred million more dollars. Common thinking is that somehow the price of those barbells will automatically rise. Common thinking is also that somehow yours and my wages will automatically rise. I don't see it. I don't see the logic in that thinking nor do I see the empirical evidence of it , at least not in the last decade.
My assertion is that one possible scenario is this: The government has so much cheap money available that ACME Barbell company decides to borrow some to make their plant more efficient. Consequently, their cost of making a barbell decreases. York Barbell is their main competitor but now ACME can sell them cheaper. So the price of all barbells actually decreases. Why? Because the government printed out cheap money.
Also, ACME, my employer, decides that to remain competitive, they are not going to give me a raise. Well, I'm ticked. But actually I'm not that ticked. Why? Because the price of barbells has gone down so much that I actually have more pocket money than I did before. On a micro-economic level, wages have remained "in check".
2008-07-02 18:54:09
Mr. Practical, I believe your analysis is upside down
Let me quickly respond:
Interest rates respond to inflation or deflation. Not the other way around.
Debt held during periods of deflation, get "heavier" and can crush you. The servicing of the debt gets harder.
Debt held during periods of inflation get "lighter" and can make you wealthy. The servicing of the debt gets easier.
The economy is 2/3 consumer spending. Anything that reduces this will hurt the economy.
Deflation can not be allowed to ignite at a time when people have a lot of debt, or it at least must be slowed down as much as possible.
The only way out is growth.
Interest rates respond to inflation or deflation. Not the other way around.
Debt held during periods of deflation, get "heavier" and can crush you. The servicing of the debt gets harder.
Debt held during periods of inflation get "lighter" and can make you wealthy. The servicing of the debt gets easier.
The economy is 2/3 consumer spending. Anything that reduces this will hurt the economy.
Deflation can not be allowed to ignite at a time when people have a lot of debt, or it at least must be slowed down as much as possible.
The only way out is growth.
2008-07-02 22:24:13
deflation / inflation better understood
nicely put w/nice examples
maybe, to go with "when the bubble bursts" - continued articles ala: "as the bubble bursts"
more examples as we go through the process should help keep making things clearer and clearer to all of us, myself very much included :-)
thanks!
maybe, to go with "when the bubble bursts" - continued articles ala: "as the bubble bursts"
more examples as we go through the process should help keep making things clearer and clearer to all of us, myself very much included :-)
thanks!
2008-07-02 22:24:34
Inflation is not entirely the expansion of the money supply
Well put article, however, inflation is also created by price and labor demand, as well as, the Federal Government stimulating the economy by borrowing.
We should all know the price of a pair of tennis shoes that are made, next to nothing, then are sold with a huge mark up. This is said, to be the creation of wealth. It is for somebody, but in the long term, it is debt.
With no real value of measure, the creation of this short term wealth contributed to the over expansion of industry, and in some cases, supply, that has relied on the banks and federal government and foreign investment.
Recessions may be painful, but are needed for the control of costs and over expansion of business. When the banks are allowed to do their job, no matter the political costs, we would have a healthy economy. It is part of the nature of supply and demand. Over supply kills the market place, as well as the dollar.
And one more thing, when workers demand more money, it is also responsible for inflation. The price of labor is passed on to the consumers, increasing the prices of product.
We should all know the price of a pair of tennis shoes that are made, next to nothing, then are sold with a huge mark up. This is said, to be the creation of wealth. It is for somebody, but in the long term, it is debt.
With no real value of measure, the creation of this short term wealth contributed to the over expansion of industry, and in some cases, supply, that has relied on the banks and federal government and foreign investment.
Recessions may be painful, but are needed for the control of costs and over expansion of business. When the banks are allowed to do their job, no matter the political costs, we would have a healthy economy. It is part of the nature of supply and demand. Over supply kills the market place, as well as the dollar.
And one more thing, when workers demand more money, it is also responsible for inflation. The price of labor is passed on to the consumers, increasing the prices of product.
2008-07-02 23:19:45
what about gold
how do you think gold (and silver) will do in this kind of situation ?
2008-07-03 01:07:10
How The Bubble Bursts
The Minyanville readership is extraordinary. Here we have 31 comments about this interesting article and not one person has blamed the problem on the Jews. Maybe there is hope for civilization after all.
2008-07-03 04:13:27
Short-sighted saving is not the answer.
My wife relayed a story to me recently, I admit anecdotal at best, but possibly true so I will relay it as well. An individual known to my wife recently lost a high-6 figure house to foreclosue being many 6-figures underwater on it. This indidvidual, with all the freed up cash (not having to pay the p&i note you see) rushed out to lease an $80,000+ plus automobile. As Mr. Practical opines, this person needs to save.
But, do all in this ecomony fall under this mandate? If so, then I would cry too pessimistic as well. Stuffing mattresses until the day that we can release the flying monkeys (the chosen figurative image for our pent up stuffed dollars) to descend upon all that cheap stuff being regurgutated by the lemming transactors seems more of the same--more money changers changing money just at deflated prices now.
In fact, spending money, perhaps even sums that you do not have (god-forbid, borrowed $$) on further training and education, top-notch school for the kids, etc may be the only real way out of this mess. More Americans becoming more highly trained, researching more efficient ways of doing things = better public/private schools=a viscious cycle of Americans who grow in the ability to offer relavant services to a growing population of highly educated people needing same. This is more of a recipe for growth than a New Deal or Marshall Plan scheme. Don't stuff, go pay tuition. Borrow it and pay it. Improve yourselves, and the American sitting next to you will then need to raise his game to compete on his end.
I believe what Mr. Practical has said. I also believe that the optimists who have written are onto something. Our government representatives (including the non-elected types) seem to spend their days bumbling over mis-interprations and mis-quotes of what was actually said by themselves. No answers/leadership in that swamp.
Don't stuff, invest in yourself and you'll be fine.
But, do all in this ecomony fall under this mandate? If so, then I would cry too pessimistic as well. Stuffing mattresses until the day that we can release the flying monkeys (the chosen figurative image for our pent up stuffed dollars) to descend upon all that cheap stuff being regurgutated by the lemming transactors seems more of the same--more money changers changing money just at deflated prices now.
In fact, spending money, perhaps even sums that you do not have (god-forbid, borrowed $$) on further training and education, top-notch school for the kids, etc may be the only real way out of this mess. More Americans becoming more highly trained, researching more efficient ways of doing things = better public/private schools=a viscious cycle of Americans who grow in the ability to offer relavant services to a growing population of highly educated people needing same. This is more of a recipe for growth than a New Deal or Marshall Plan scheme. Don't stuff, go pay tuition. Borrow it and pay it. Improve yourselves, and the American sitting next to you will then need to raise his game to compete on his end.
I believe what Mr. Practical has said. I also believe that the optimists who have written are onto something. Our government representatives (including the non-elected types) seem to spend their days bumbling over mis-interprations and mis-quotes of what was actually said by themselves. No answers/leadership in that swamp.
Don't stuff, invest in yourself and you'll be fine.
2008-07-03 09:08:06
Glass-Steagall Act
It was not foolish of policy makers to repeal Glass- Steagall, they were well paid to do so. Citi's Robert Rubin chatted them up, handed them envelopes with (laundered) cash, and assured them nice directorships when they retired from the political trough.
It will again be profitable 30-40 years hence to be a politician and get paid to roll back the regulations to be enacted over the next few years.
It will again be profitable 30-40 years hence to be a politician and get paid to roll back the regulations to be enacted over the next few years.
2008-07-03 09:20:31
Japan= good deflation?
You might want to ask the Japanese if the 1990's Deflation was "good".
2008-07-03 12:09:58
Mr. Practical, I believe your analysis is upside down
no. your error is in the margin. agree...deflation, the supply of money goes down, pressure on i rates to rise, the dollar becomes dear. but the prices of apples wont go up. the farmer is getting squeezed. he cant even produce apples because he cant borrow money at the right price and the mkt cant pay higher because of lower supply of money.
2008-07-03 12:13:16
Glass-Steagall Act
right. monopoly is not free market. this is big part of reason we in the mess we are in. there are so many conflicts of interest at bank that does everything i don't know where to begin...research, trading, merchant banking...etc.
2008-07-03 12:17:09
Short-sighted saving is not the answer.
agree. but this cultural change if you want to call it that won't come from the government. they may try, but as always will mis allocate capital/resources. it will come from private sector after it realizes that govt cannot do the job. it will come from revolution of sorts, not a violent one. at the bottom, when it occurs, i will be phenomenally bullish on america if it learns the right lessons.
2008-07-03 12:18:59
Japan= good deflation?
its not good while going thru it. but deflation has erased many imbalances and bad practice that is bullish in future. it re-equates incomes and wipes out debt. it is not a fun process. it is a mrkt process that destroys the bad.
2008-07-03 12:26:26
The greenspan put
excess capacity a symptom of deflation. inflation creates teh excess capacity as we now see...everyone built everything with cheap money. now near my house we have three empty office buildings waiting for tenants.
2008-07-03 12:29:10
stuff we need is still rising as people cut back on that last. we are also competing with foreigners for those goods as their money supplies are still inflating. stuff we don't NEED here in u.s. is starting now to fall. we are still in the space of deflation forces fighting inflation forces. if fed had not doen taf deflation would be rapid now (money supply would be falling big).
2008-07-03 12:33:01
Commodity Inflation
well again we are confusing what inflation is. the u.s. has been lowering rates. as china tries to peg its currency to the dollar to keep exports from falling, they have to expand their money supply. this forces prices up there and squeezes margins. this is what people mean when they say the u.s. is exporting infaltion to china. so now their prices are sky high and putting pressure on their economy. the west and east i believe are linked more closely than some espouse.
2008-07-03 12:40:58
Mr. Practical, I believe your analysis is upside down
as money supply grows the cost of borrowing goes down for consumers as well as business. prices always rise. i said nothing about wages. over the last several years business has made record profits by not raising wages. so margins widened. but prices go up and now those margins are getting squeezed.
you are confusing deflation with productivity.
you are confusing deflation with productivity.
2008-07-03 12:43:25
Inflation is not entirely the expansion of the money supply
agree but would say that "prices are influenced by the price and demand for labor" not inflation. to me inflation is the money supply expanding (growing).
2008-07-03 13:11:16
Japan= good deflation?
I fully agree on the necessity for periodic cleansings, and that the Feds desperate attempts to prevent a normal recession in 2001 led to an even bigger bubble. But Japan certainly did all it could to prop up failing companies and banks, which surely prolonged their purging process. Also, I know Schiller considered the U.S. 1860's deflation a "good" deflation, I did not think he considered Japan's to be "good".
The scary thing is that Japan went into their lost decade with lots of savings and while the rest of the world was building bubbles and consuming their exports. Compare that to the U.S. position.
I do agree with you, and sadly, Americans are all soon to become experts on Deflation.
The scary thing is that Japan went into their lost decade with lots of savings and while the rest of the world was building bubbles and consuming their exports. Compare that to the U.S. position.
I do agree with you, and sadly, Americans are all soon to become experts on Deflation.
2008-07-03 13:29:47
Clarifying inflation with deflation
Your explanation of the inflation we are seeing amid the deflation was hard to follow. It seems to me the best way of looking at the situation is that immobile assets (and derivatives of them) are deflaing RELATIVE to mobile goods. They both can go down, both can go up (theoretically with a gargantuan enough stimulus), or immobile can go down while mobile goes up.
In the Great Depression, commodity prices collapsed, because producers were still making the same quantities, but trying to sell them to a populace with a reduced supply of money. Therefore, they had to keep dropping the price to sell the same amount, and in fact, expanded production on the premise that that was the only way to generate revenue to cover debt and expenses.
Galbraith adequately showed that the tight money supply by the Federal Reserve exacerbated the situation by limiting the re-supply of money. Now, Bernanke is avoiding that trap by keeping money cheap, although even he is showing effects of pressure about inflation.
It seems clear to me that not only the currency effects of cheap dollar interest rates are causing our inflation. Continuing demand for mobile goods is doing so, and it is a result of the fact that mobile goods are subject to world markets. As the value of immobile assets (and instruments based on their value) are falling, the best central bank policy must be one of cheap money, even at the certain cost of inflation in mobile goods. Immobile property is not subject to the global market in the same way as mobile goods are, which is why we can have deflation in one and inflation in the other.
The problem we will have will come as other central banks, i.e., today, the European raised rates, start raising rates to quell their own inflation. That will cut demand in their economies for our goods, which will limit the growth necessary for us to pull out of the spiral and stabilize immobile asset prices in this country. Those other countries' actions in their own short-term interests will have the same effect as our Fed's in the Great Depression. The only question will be which of the competing forces will be greater.
The battle will determine the ability of business to keep employment going, because the loss of jobs must be avoided at all costs. Full employment is more important than ever, because only by the work-a-day transactions of consumers in the general economy will the business sector be able to generate the business that the financial sector needs in order to pay off its capital losses and keep the whole scheme afloat. Making money more expensive is the wrong way to go.
So isn't the choice between general deflation combined with financial collapse and economic depression versus inflation in wage and commodity markets?
In the Great Depression, commodity prices collapsed, because producers were still making the same quantities, but trying to sell them to a populace with a reduced supply of money. Therefore, they had to keep dropping the price to sell the same amount, and in fact, expanded production on the premise that that was the only way to generate revenue to cover debt and expenses.
Galbraith adequately showed that the tight money supply by the Federal Reserve exacerbated the situation by limiting the re-supply of money. Now, Bernanke is avoiding that trap by keeping money cheap, although even he is showing effects of pressure about inflation.
It seems clear to me that not only the currency effects of cheap dollar interest rates are causing our inflation. Continuing demand for mobile goods is doing so, and it is a result of the fact that mobile goods are subject to world markets. As the value of immobile assets (and instruments based on their value) are falling, the best central bank policy must be one of cheap money, even at the certain cost of inflation in mobile goods. Immobile property is not subject to the global market in the same way as mobile goods are, which is why we can have deflation in one and inflation in the other.
The problem we will have will come as other central banks, i.e., today, the European raised rates, start raising rates to quell their own inflation. That will cut demand in their economies for our goods, which will limit the growth necessary for us to pull out of the spiral and stabilize immobile asset prices in this country. Those other countries' actions in their own short-term interests will have the same effect as our Fed's in the Great Depression. The only question will be which of the competing forces will be greater.
The battle will determine the ability of business to keep employment going, because the loss of jobs must be avoided at all costs. Full employment is more important than ever, because only by the work-a-day transactions of consumers in the general economy will the business sector be able to generate the business that the financial sector needs in order to pay off its capital losses and keep the whole scheme afloat. Making money more expensive is the wrong way to go.
So isn't the choice between general deflation combined with financial collapse and economic depression versus inflation in wage and commodity markets?
2008-07-03 13:56:23
what about gold
I've wondered the same thing. Without deep knowledge of the gold market, my sense has been that the gold market will be determined by the net effect of monetary policies around the globe. As in my other posting, there is now a war between central banks.
If the result is that the economy slows substantially (because the ill-conceived tight monetarists win out), they will cause demand for things like oil and corn and wheat to plateau and decline to some extent or another. The speculators in those markets will have nowhere else to go, given even greater declines in immobile assets, equities, and bonds (remember, during the Great Depression, treasuries were so overbought that they had a negative rate of interest, because the rich were so desparate to preserve capital!). Then, they will buy precious metals and we will have a massive bubble in those markets.
However, if the Bernankes of the world win out, we will have support for continued inflation in commodities generally, and precious metals will be merely one market among many. The wild card, however, is the effect of continued high prices for food commodities in much of the world--there have already been serious riots and unrest in a number of countries. And what do governments do to distract their populations from such things? Start wars, which of course would be very bullish for gold.
If the result is that the economy slows substantially (because the ill-conceived tight monetarists win out), they will cause demand for things like oil and corn and wheat to plateau and decline to some extent or another. The speculators in those markets will have nowhere else to go, given even greater declines in immobile assets, equities, and bonds (remember, during the Great Depression, treasuries were so overbought that they had a negative rate of interest, because the rich were so desparate to preserve capital!). Then, they will buy precious metals and we will have a massive bubble in those markets.
However, if the Bernankes of the world win out, we will have support for continued inflation in commodities generally, and precious metals will be merely one market among many. The wild card, however, is the effect of continued high prices for food commodities in much of the world--there have already been serious riots and unrest in a number of countries. And what do governments do to distract their populations from such things? Start wars, which of course would be very bullish for gold.
2008-07-03 14:19:03
Intelligent, but I respectfully disagree
Your red and green money supply picture is important and insightful. But as the ratio of red to green falls (less credit), the Fed is going to try to keep the overall money supply (red + green) roughly constant or growing.
The result: financial assets decline from less borrowing and goods prices as in the CPI rise. Financial assets adjusted for inflation get totally smoked.
If you're expecting price deflation in common goods, such as those in the CPI, then forget about it.
Just my two cents, but I think framing inflation and deflation in terms of the money supply is whack. Ultimately, do I really care about the money supply? Instead, I care about the relative relationship of goods (CPI) and financial markets.
2008-07-03 16:19:20
deflation / inflation better understood
symptoms of deflation: lower profit margins, especially cyclicals, consumer, and financial companies; stronger currency: as debt is destroyed the currency in which it is denominated will rise as the "dollars" available decrease; lower risk tolerance: people begin to err on the side of caution; higher volatility: the lower liquidity creates higher movement as people try to buy and sell stuff; lower NOMINAL prices in everything from houses to stocks. when enough or too much debt is destroyed it plants the seeds for inflation: savers begin to lend again and productivity begins to rise.
2008-07-03 16:30:38
Japan= good deflation?
japan were the biggest "inflationists" on the planet, especially in 80s which led to deflation in 90s. 80s they expanded money supply (debt) astonomically. then they compounded the situation by exchanging their weak currency for a strong one (dollar) just at the wrong time by buying u.s. real estate. when the dollar began going down in late 80s they lost double the wealth and sent them into their 90s depression. this actually did alot to save the u.s. from a real recession from 1987 stock crash. all their shenanigans showed was 1) the govt can't stop deflation when debt gets to certain magnitude and 2) gross savings don't matter....it is the balance of savings and debt that matters. japan still has huge govt debt.
2008-07-03 16:39:21
Clarifying inflation with deflation
then i failed. tell you what let's not even use the words inflation/deflation. the government (fed) has the ability (when consumers have the propenisty to borrow) to lower interest rates and create debt throught the banking system. as they do this people have more "money" (credit) to buy stuff. prices rise in varying degrees. once consumers cannot borrow anymore because they have too much debt the fed loses its power. it cannot expand the money supply anymore (unless as they have it takes on itself borrowing through credit risk). when money supply begins to shrink, prices begin to decline. commodity prices haven't collapsed yet because we are still inbetween...but they will. i agree with immobile assets vs mobile but that only creates discrepency in prices.
2008-07-03 16:43:08
Intelligent, but I respectfully disagree
stay tuned then. we'll talk in six months. "whack" is the wrong word.
2008-07-03 17:32:30
Mr. Practical, I believe your analysis is upside down
With all due respect, Bob, how does the price of raw materials benefit from the growth in money supply? Initially, profligate money-creation can have a deflationary effect, but that assumes that the principle source of production costs arise from borrowing costs, not raw materials costs. I would argue that product prices are more dependent upon physical inputs than costs of capital. The simplistic argument of "more money chasing the same goods begets higher prices" that you so quickly deride is accurate when viewed as the microcosm that it is. From a broader perspective, credit creation can have a myriad of intermediate influences on a range of prices, but ultimately, the new money that has entered the system avoids the mal-investment that was devouring it upon inception and heads for the real things that make all others possible: commodities. Credit creation is inflationary (by definition) and credit contraction is deflationary. Credit creation is, however, determined by an infinite number of factors above and beyond the impetus of low interest rates. The general propensity to borrow is the counter-balance that permits credit creation, whereas credit destruction arises from a mixture of insolvency, declining borrowing appetites, and declining appetites for lending risks.
Oh, and the automobile analogy was nice, but it could have gone in a different direction: the costs of manufacturing automobiles (outside of raw materials) have declined over the years due to technological advancements and off-shore outsourcing. I would note, however, that the increases in raw material costs and overall demand (largely a product of money creation) have kept prices relatively static (ignoring the bogus science of hedonics,) resisting the deflationary effects of improved production efficiency.
Oh, and the automobile analogy was nice, but it could have gone in a different direction: the costs of manufacturing automobiles (outside of raw materials) have declined over the years due to technological advancements and off-shore outsourcing. I would note, however, that the increases in raw material costs and overall demand (largely a product of money creation) have kept prices relatively static (ignoring the bogus science of hedonics,) resisting the deflationary effects of improved production efficiency.
2008-07-03 20:04:42
Regular guy asks Why not Stagflation?
http://en.wikipedia.org/wiki/Talk:Stagflation
This intellectual discussion is fun, but what does it really mean to me? The above reference is usefull, especially when you select the discussion tab.
I wonder what all this discussion can really mean when all consumer products I want or need are directly related to the price of oil. The price of oil has exponetially risen, which has affected my lifestyle. Don't tell me that consumer demand will control this (oil)inflationary pressure. There is too much competition for oil in the global economy.
Like the 1970's where my purchasing decisions were affected (granted there is a difference since there is no embargo yet, how many of you had to live through the even number-odd number license number fiasco?) I again am in the same situation. Granted, I am finacially better off now than then, but the rise in the cost of goods has only just begun. I think profit margins are going to shrink to the point where prices have to rise, even for most of the products manufactured outside of the USA. Look at what DOW has done this year!
Are there still any 10-12% bonds still out there? Remember when 12% CDs were the best investment going? I remember being happy with a 9% VA loan on my first house.
This was because the Fed raised interest rates, drastically. It put an end to stagflation, but it hurt in the short term and took a long time to resolve.
So I agree with Mr. P in that sitting on cash at the moment is a pretty good idea.
Look at the DOW chart in a long term view.
This intellectual discussion is fun, but what does it really mean to me? The above reference is usefull, especially when you select the discussion tab.
I wonder what all this discussion can really mean when all consumer products I want or need are directly related to the price of oil. The price of oil has exponetially risen, which has affected my lifestyle. Don't tell me that consumer demand will control this (oil)inflationary pressure. There is too much competition for oil in the global economy.
Like the 1970's where my purchasing decisions were affected (granted there is a difference since there is no embargo yet, how many of you had to live through the even number-odd number license number fiasco?) I again am in the same situation. Granted, I am finacially better off now than then, but the rise in the cost of goods has only just begun. I think profit margins are going to shrink to the point where prices have to rise, even for most of the products manufactured outside of the USA. Look at what DOW has done this year!
Are there still any 10-12% bonds still out there? Remember when 12% CDs were the best investment going? I remember being happy with a 9% VA loan on my first house.
This was because the Fed raised interest rates, drastically. It put an end to stagflation, but it hurt in the short term and took a long time to resolve.
So I agree with Mr. P in that sitting on cash at the moment is a pretty good idea.
Look at the DOW chart in a long term view.
2008-07-04 06:19:22
One more thought
Wow! This article is getting a lot of attention!
One more quick thought:
According to your chart of the money supply, the ratio of debt to savings has grown dramatically. Fine.
In the same spirit, if I look at the Fed money supply data (http://www.federalreserve.gov/releases/h6/current/), I see that the ratio of M2/M1 has actually been increasing all the way through May 2008.
Under your scenario, wouldn't you have expected the opposite? And wouldn't you have expected it to have happened by now?
Just a thought. Keep up the good work! I love reading your articles.
2008-07-04 07:16:16
Japan= good deflation?
Thank you for your insights. One thing that has baffled me for past few years has been the insistence that the fed could prevent deflation by money printing/zero Fed Funds rate, and that they would not repeat the mistakes of the 1930's. Bernanke himself said this. But this was/is being said while Japan is suffering for almost 20 years of recession/deflation while having near zero/negative real rates, printing trillions in Yen and receiving advice from our Fed. The excuse given, in the rare instance that Japan's situation is even acknowledged, is that their Finance Ministry did not slash rates quite quickly enough. The model for how deflation can occur in a "modern" economy is right in front of our eyes, but is unseen. The Fed did see it, and fear it;
it explains their desperate re-flation efforts in 2001-2003 and why they are terrified of having a normal recession- they know it will not be a recession, but a major Depression.
it explains their desperate re-flation efforts in 2001-2003 and why they are terrified of having a normal recession- they know it will not be a recession, but a major Depression.
2008-07-04 12:57:13
This is a great explanation
I think this is a wonderful explanation of the credit cycle and why debt levels in the US have been rising for 25 years. When George Soros talks about the super bubble, this is what he means.
I wrote a similar article on my blog as well from the point of view of the ECB decision to raise rates versus the Fed decision to continue with easy money at (Credit Writedowns).
In addition to that, I have read a great article from the blog immobilien blasen that shows former Fed Governor Poole confessing that the Fed does actually want inflation so it can chip away at that debt pile.
Pretty unbelievable.
I wrote a similar article on my blog as well from the point of view of the ECB decision to raise rates versus the Fed decision to continue with easy money at (Credit Writedowns).
In addition to that, I have read a great article from the blog immobilien blasen that shows former Fed Governor Poole confessing that the Fed does actually want inflation so it can chip away at that debt pile.
Pretty unbelievable.
2008-07-04 18:59:47
Japan= good deflation?
yes. there are many lucid thoughts on what we have been talking about that make a reasonable argument that central banks can "reflate" or "avoid deflation". here is why they are wrong: this is a special case merely because of the degree. we are not talking about a little too much debt. we are talking about years of inflation (growing debt) topped off by six years of absurd monetary policy that has kept real rates negative. this has found the most speculative participants that were willing to lend and borrow. it took geniuses to figure out ways to package and hide that debt from general view. if greenspan had just taken his foot off the gas for a while we may have been able to manage the debt down as in the past. not now. it is going to take more, much more of what we are seeing (the market destroy debt) to correct egregious imbalances.
2008-07-05 14:17:12
Japan= good deflation?
a central bank can only reflate when consumer/business has the propensity (desire and ability) to borrow. all a central bank can do is create low priced credit (by devaluing the dollar and creating debt); they must have a borrower to take it and spend/invest it to get it into the real economy. we can see that the fed no longer has the ability to reflate as such because of the private sector has too much debt. so required was taf where the fed takes the credit risk itself. this transfers the credit risk eventually to tax payer (public debt increases).
2008-07-06 11:12:36
Excellent Article. But not all debt is bad debt
agree not all debt is bad. in fact debt has crucial place in economy to allocate capital to productive resource. but again, we are talking about "100 ways too much debt". as far as manhattan project, i prefer to have oil price rise and private sector find solution; i have a huge distrust of govt ability to allocate capital properly. in this case maybe i am wrong...don't know.
2008-07-06 11:21:30
Middle Ground
agree psychology plays an important role. but it is matter of degree. this particular epsiode is severe. investors will not be able to hold onto their properties etc. and will be forced to sell. agree if have no debt ride it out (what else to do). i too am optimistic at the bottom but we do have much more debt to write off. believe you haven't really dug into the numbers enough to understand this. as far as fed, if you have a period long enough you eventually will have a govt body that will be self serving. that is what greenspan was. he willing to keep doing the wrong thing to keep things going under tenure. he should be admonished and not listened to. fed is not inherintly evil, it is simply self serving in the long run.
2008-07-06 16:12:50
Excellent Article. But not all debt is bad debt
In my opinion, we now have three rogue waves heading for our economic ship (a rogue wave is a wave that is over 90 feet high, and can do serious damage to ships)
1. We have the huge debt bubble that is deflating (as you mention), which is pushing deflation.
2. I now believe that we are at peak oil. Hirsch and Pickens have stated that world oil supply has plateaued in 2005. If this is true, it will push inflation. So several plateaus in oil supply over the next few years, then a 2-3% decline/yr in the supply. This is what happened when American oil production hit peak in 1970.
3. Our local city government has been warned, that starting in 2010 the city revenues will dramatically fall due to population demographics. The economist plotted spending versus age for people. He then plotted this against several stock indexes, with a high degree of correlation. In summary, the number of people doing the most spending (45-65 year olds) will decrease dramatically for the next 10-15 years.
So I think we have two choices in the near future. Either the government wakes up, and starts massive growth initiatives (I argue these problems are too large for the private sector to fix), or we will go into a Japan style deflation (as you point out). Unfortunately I also believe the government is going to be too slow. Uncle Ben must know what is going on, will he have the guts to talk straight-talk, versus FED speak?
These waves are on the radar, and heading towards the ship. It is best to hit them head-on, bow first. A sideways blow could roll the ship. Also, being hit by one or two would be far less damaging, than all three.
Either deflation or inflation will hit the market in a big way. Inflation is the less painful way, but it will require massive government action.
1. We have the huge debt bubble that is deflating (as you mention), which is pushing deflation.
2. I now believe that we are at peak oil. Hirsch and Pickens have stated that world oil supply has plateaued in 2005. If this is true, it will push inflation. So several plateaus in oil supply over the next few years, then a 2-3% decline/yr in the supply. This is what happened when American oil production hit peak in 1970.
3. Our local city government has been warned, that starting in 2010 the city revenues will dramatically fall due to population demographics. The economist plotted spending versus age for people. He then plotted this against several stock indexes, with a high degree of correlation. In summary, the number of people doing the most spending (45-65 year olds) will decrease dramatically for the next 10-15 years.
So I think we have two choices in the near future. Either the government wakes up, and starts massive growth initiatives (I argue these problems are too large for the private sector to fix), or we will go into a Japan style deflation (as you point out). Unfortunately I also believe the government is going to be too slow. Uncle Ben must know what is going on, will he have the guts to talk straight-talk, versus FED speak?
These waves are on the radar, and heading towards the ship. It is best to hit them head-on, bow first. A sideways blow could roll the ship. Also, being hit by one or two would be far less damaging, than all three.
Either deflation or inflation will hit the market in a big way. Inflation is the less painful way, but it will require massive government action.
2008-07-07 09:38:39
what is cash?
In his Random Thoughts of July 2nd, Prof Harrison covers this issue - I have cut-n-pasted it here for your convenience:
---
Minyan Mailbag!
Toddo,
You would be doing your Minyans an immeasurable service if were you to sketch out the available avenues for a 100% cash nest egg -- replete with measured precautionary tags, and in your inimitable fashion. Out here in the international lurking area, you've become a reference.
-Minyan L
ML,
Sure. My nest egg is in a money market account backed by T-bills. There's no commercial paper, as a few basis points of potential return isn't worth the "other side" of toxicity (if, in fact, it comes home to roost).
Cash is king when it comes to long-term savings—only trade with what you can afford to lose.
Best of luck,
Toddo
---
Minyan Mailbag!
Toddo,
You would be doing your Minyans an immeasurable service if were you to sketch out the available avenues for a 100% cash nest egg -- replete with measured precautionary tags, and in your inimitable fashion. Out here in the international lurking area, you've become a reference.
-Minyan L
ML,
Sure. My nest egg is in a money market account backed by T-bills. There's no commercial paper, as a few basis points of potential return isn't worth the "other side" of toxicity (if, in fact, it comes home to roost).
Cash is king when it comes to long-term savings—only trade with what you can afford to lose.
Best of luck,
Toddo
2008-07-11 15:16:19
Possible Manhattan Project outline
A possible Manhattan Project:
1.Major effort to build nuclear plants
2. Update the electric infrastructure of the country
3. Support wind and solar energy
4. Support electric cars and or plug-in hybrids with fuel economy standards
5. Grow and burn biofuels (not food crops) in existing coal fired plants (for example switch grass. This is actually cleaner than burning coal). Biofuels for hot water heat
6. Support cellulose ethanol research, production
7. Support more drilling in USA, mainly for natural gas, as most big oil fields have been found
8. Use natural gas for transportation (Pickens)
9. Major conservation efforts (insulate houses, etc.)
10. Build coal conversion plants to produce liquid fuels
11. Research into batteries, other biomass energies, more efficient solar cells, cheaper means of production
12. Sell the newly developed technologies world-wide
13. Replacement of plastic parts with bio alternatives. They already have spoons made from bio products.
14. Convert most lighting completely to LED lighting (skip CFLs)
15. Allow imported ethanol (without a tax) to jumpstart a #6 industry.
1.Major effort to build nuclear plants
2. Update the electric infrastructure of the country
3. Support wind and solar energy
4. Support electric cars and or plug-in hybrids with fuel economy standards
5. Grow and burn biofuels (not food crops) in existing coal fired plants (for example switch grass. This is actually cleaner than burning coal). Biofuels for hot water heat
6. Support cellulose ethanol research, production
7. Support more drilling in USA, mainly for natural gas, as most big oil fields have been found
8. Use natural gas for transportation (Pickens)
9. Major conservation efforts (insulate houses, etc.)
10. Build coal conversion plants to produce liquid fuels
11. Research into batteries, other biomass energies, more efficient solar cells, cheaper means of production
12. Sell the newly developed technologies world-wide
13. Replacement of plastic parts with bio alternatives. They already have spoons made from bio products.
14. Convert most lighting completely to LED lighting (skip CFLs)
15. Allow imported ethanol (without a tax) to jumpstart a #6 industry.
2009-11-23 21:00:14
fitch
People all over the world know the <a title="abercrombie and fitch" href="http://www.anfworld.com/" rel="dofollow"><strong>abercrombie and fitch</strong></a>,but not everyone really knows how fashion the abercrombie is,hollister is the Legend maker. Everybody wears the hollister clothing would be the abercrombie mensand the abercrombie womens, if you want know you can search the Ruehl No.925 or abercrombie outlet in the www.google.com .
Get real-time options trading ideas from Steve Smith, veteran options trader and newsletter author, plus let him show you the way to cut risk and boost your returns through the strategic use of options. Click here for a free 14 day trial to OptionSmith by Steve Smith.
Copyright 2009 Minyanville Media, Inc. All Rights Reserved
