Deflation American Style
By Mike Mish Shedlock Jan 18, 2008 3:45 pm
The pent-up deflationary forces in the US are such that deflation American-style figures to be far worse than deflation Japanese-style.
Prof. Kevin Depew was writing about Deflation American Style in point Number 4 of Thursday's Five Things:
We continue to get feedback noting the sharp contrast between the way Japan's banks handled deflation and the way U.S. banks are handing the credit crunch here in the U.S. Indeed, banks today are quickly writing off bad debt in comparison to Japan's banks during that country's banking crisis.
Again, the real key here is that while the amount of writedowns by U.S. banks are enormous, they are not the driver of this crisis, but a symptom of it. Even worse, the writedowns by U.S. banks are only symptomatic of the sickness affecting loans that have already been made. From that vantage point, the sickness is merely a pre-condition to a far more serious disease where the demand for new credit by consumers shuts down.
Ah yes, what to reflate? Unless reflation creates jobs, attempts to reflate will only provide the fuel to destroy still more capital. Rising oil prices, rising gold prices, or rising wheat prices will only make problems worse for cash-strapped consumers. Even if reflation did create jobs, it would not accomplish much other than to postpone the day of reckoning.
Furthermore, as professor Depew implies, it is the debt load of consumers in the US that makes US problems much worse than what happened in Japan.
Differences Between Japan and the US
- Look for steeply rising unemployment in the US. One of the consequences of those debt writedowns in the US is that US corporations will be forced to cut expenses. The biggest expense for many companies is employees. Japan had far more loyalty to its employees than US corporations ever will.
- Enormous consumer debt makes the problem the US faces far more severe than the problem Japan faced. Consumer debt that that cannot be repaid will be defaulted on. Rising unemployment will further exacerbate mortgage-related problems and credit card-related problems.
- Consumption continued in Japan because of savings. The US will be forced to cut back on consumption and increase savings.
- Global wage arbitrage is a far bigger economic force now than during the bulk of Japan's deflationary years.
- Japan had the benefit of a global Internet boom followed by a global housing boom to help the economy. The US is facing a global contraction of the housing boom.
- Most people in the US "own" their own home. The skew of those deep in debt is huge. 1/3 of Americans owe nothing on their homes. The debt is carried by those who can least afford to carry that debt in an economic downturn.
- Japan had a huge valuation problem in real estate. The US not only has a huge valuation problem, commercial real estate is also woefully overbuilt.
Those who argue "it's different in Japan" need to weigh the impact of those differences. The pent-up deflationary forces in the US are such that Deflation American Style figures to be far worse than Deflation Japanese Style.
Here is one similarity: Fiscal stimulus failed in Japan. Fiscal "Stimulus" Is Doomed To Fail in the US. The consequences to the US will be severe.
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2008-01-18 15:58:09
"forced to increase savings"
Of what? Pray tell...
Everyone's past production has been converted to gas guzzling vehicles and a boatload of sheetrock-covered farmland. Few know what a shovel is anymore, and ADM isn't going to feed the world if the farmers can't buy fertilizer or fuel to run Old MacDonald's Factory Farm.
"Fiscal Stimulus" Doomed? Heck, as Mogambo would say, "We're ALL freakin' doomed!!"
Everyone's past production has been converted to gas guzzling vehicles and a boatload of sheetrock-covered farmland. Few know what a shovel is anymore, and ADM isn't going to feed the world if the farmers can't buy fertilizer or fuel to run Old MacDonald's Factory Farm.
"Fiscal Stimulus" Doomed? Heck, as Mogambo would say, "We're ALL freakin' doomed!!"
2008-01-19 03:37:19
Deflation, Yes, but Inflation, Too
My general comment would be that in its prediction of general deflation, the article seems to overlook the offsetting inflationary effects of the dollars presently held overseas as a result of the trade deficit.
Due to the inflationary effects of those foreign-held dollars, my own best guess would be that even as some things fall in price (due to dropping domestic demand), other things will rise in price (due to increasing demand from abroad), and since that foreign demand may increase for long-term purchases once the dollar bottoms out, some things that are falling now may be rising later. So, it may be that we'll have deflation in some areas, and inflation in others, in a shifting pattern, and the net effect upon any given person will depend upon the mix of things that she wants to buy, and when she wants or needs to buy them.
A second driver of domestic inflation will be dollar devaluation, which increases the cost of imports. This will join the aforesaid uptick in foreign demand (decreasing the availability, to US, of goods produced domestically).
The effect of dollar depreciation on import costs, and therefore on domestic inflation, should be obvious. But that's only half of the story. Thanks to the U.S. trade deficit, nearly seven trillion dollars have accumulated in the central banks of creditor nations such as China. Until not very long ago, the Chinese and others very nicely kept most of that money invested in U.S. Treasuries and other things that did not require the delivery of actual goods from the U.S. to those nations. But now, with the weakened dollar, certain items are rushing out of the country at an accelerating rate. Especially in demand is the now-inexpensive U.S. grain and other foodstuffs; a recent report indicates that in at least one Western U.S. port, grain exports have quadrupled. This is creating a very tangible inflationary effect domestically, as anyone visiting her local food market can tell you first-hand.
And if you live near any tourist destinations, you'd better be carrying Euros, because prices have been driven way up by foreign tourists spending exchanged dollars as if they were quarters.
The spending of these trillions on U.S. goods is guaranteed to have an inflationary effect on anything that can be consumed immediately, even as many U.S. workers experience reduced or no income due to the domestic recession/depression.
So long as the dollar continues to fall (as it has been for years, with minor interruptions), inflation of more long-term investments, such as houses, commercial real estate, factories, companies (and their stocks), and so on, should be limited, because foreign investors (with their trillions of dollars) will be reluctant to buy and hold with the dollar continuing to tank, devaluing their investments day after day. So, during the immediate period ahead, my guess would be that we will have inflation in consumables like grain, but deflation in real estate, factories, company valuations (i.e., the stock market), etc. The net effect on you might be neutral if you don't own a home and happen to have the cash or credit to buy when real estate (or the stock market) bottoms out, but for most U.S. residents, food, clothing, oil, and so on will a far greater percentage of total purchases, and so the net effect for most of US will be inflationary, not deflationary. Or, more precisely, STAGflationary.
Furthermore, once the dollar bottoms out, get ready for the other shoe to drop, because the rest of those foreign trillions will rush in to buy houses, commercial real estate, and factories at dirt-cheap prices, and we'll all be paying rent to landlords with addresses in Hong Kong or Berlin. This will bring up the depressed prices in these long-term investment areas somewhat from their lows, although probably nowhere near their present values. But of course that will eliminate some of the offsetting deflationary effect of the long-term items vs. the inflated consumables, resulting in even more net inflation.
Now, there may be some consumables that are produced exclusively domestically, with domestic labor, and domestic materials, that nobody overseas wants to buy, and in that case, yes, domestic demand will be determining and those goods will deflate in value (unless, of course, a lot of the manufacturers have to shut down due to liquidity problems plus said lack of demand, in which case even those goods may be scarce and expensive). But this probably will not affect you, unless you are planning to buy a U.S. flag, and last time I checked those, too, were being made in China.
Due to the inflationary effects of those foreign-held dollars, my own best guess would be that even as some things fall in price (due to dropping domestic demand), other things will rise in price (due to increasing demand from abroad), and since that foreign demand may increase for long-term purchases once the dollar bottoms out, some things that are falling now may be rising later. So, it may be that we'll have deflation in some areas, and inflation in others, in a shifting pattern, and the net effect upon any given person will depend upon the mix of things that she wants to buy, and when she wants or needs to buy them.
A second driver of domestic inflation will be dollar devaluation, which increases the cost of imports. This will join the aforesaid uptick in foreign demand (decreasing the availability, to US, of goods produced domestically).
The effect of dollar depreciation on import costs, and therefore on domestic inflation, should be obvious. But that's only half of the story. Thanks to the U.S. trade deficit, nearly seven trillion dollars have accumulated in the central banks of creditor nations such as China. Until not very long ago, the Chinese and others very nicely kept most of that money invested in U.S. Treasuries and other things that did not require the delivery of actual goods from the U.S. to those nations. But now, with the weakened dollar, certain items are rushing out of the country at an accelerating rate. Especially in demand is the now-inexpensive U.S. grain and other foodstuffs; a recent report indicates that in at least one Western U.S. port, grain exports have quadrupled. This is creating a very tangible inflationary effect domestically, as anyone visiting her local food market can tell you first-hand.
And if you live near any tourist destinations, you'd better be carrying Euros, because prices have been driven way up by foreign tourists spending exchanged dollars as if they were quarters.
The spending of these trillions on U.S. goods is guaranteed to have an inflationary effect on anything that can be consumed immediately, even as many U.S. workers experience reduced or no income due to the domestic recession/depression.
So long as the dollar continues to fall (as it has been for years, with minor interruptions), inflation of more long-term investments, such as houses, commercial real estate, factories, companies (and their stocks), and so on, should be limited, because foreign investors (with their trillions of dollars) will be reluctant to buy and hold with the dollar continuing to tank, devaluing their investments day after day. So, during the immediate period ahead, my guess would be that we will have inflation in consumables like grain, but deflation in real estate, factories, company valuations (i.e., the stock market), etc. The net effect on you might be neutral if you don't own a home and happen to have the cash or credit to buy when real estate (or the stock market) bottoms out, but for most U.S. residents, food, clothing, oil, and so on will a far greater percentage of total purchases, and so the net effect for most of US will be inflationary, not deflationary. Or, more precisely, STAGflationary.
Furthermore, once the dollar bottoms out, get ready for the other shoe to drop, because the rest of those foreign trillions will rush in to buy houses, commercial real estate, and factories at dirt-cheap prices, and we'll all be paying rent to landlords with addresses in Hong Kong or Berlin. This will bring up the depressed prices in these long-term investment areas somewhat from their lows, although probably nowhere near their present values. But of course that will eliminate some of the offsetting deflationary effect of the long-term items vs. the inflated consumables, resulting in even more net inflation.
Now, there may be some consumables that are produced exclusively domestically, with domestic labor, and domestic materials, that nobody overseas wants to buy, and in that case, yes, domestic demand will be determining and those goods will deflate in value (unless, of course, a lot of the manufacturers have to shut down due to liquidity problems plus said lack of demand, in which case even those goods may be scarce and expensive). But this probably will not affect you, unless you are planning to buy a U.S. flag, and last time I checked those, too, were being made in China.
2008-01-19 11:08:27
What is the point?
Mish,
I think there is some confusion here. Probably most people like me feel that your opinion is that deflation (contraction in credit) will lead to falling prices in commodities? I disagree if that is the case.
That is where I disagree and where virtually everyone in the anti-deflation camp disagrees. Will reflation 'save' the US economy? No, from my point of view very few in the inflation camp believe that reflation will save the US economy.
The point from an investment perspective is how will deflation in (housing, stocks and bonds) impact our investment decisions.
My argument is that you cannot expect that the prices of commodities will decrease. The monetary inflation pent up in the system from the last 25 years which has remained in stocks, bonds and housing has clearly been transferring to commodities. Too much money chasing too few goods. On top of this inflation created demand you have legitimate demand from Asia. Asian consumers set the prices of raw materials. The last time middle class creation set the price of commodities was between 1946-60 when the U.S., Canda and Japan brought 55 million people into the middle class. Today we are seeing 40 million people PER year brought into the middle class thereby straining supplies of energy, metals and food.
So, the question from an investment point of view is will asset deflation in the US particularly infect the global demand for commodities? I highly doubt it. I do believe there is a MASSIVE deflation (in financial assets) risk out there in credit derivatives toppling in a dominoe effect since too much debt is used as collateral. There could be far more deflation coming in structured products than anyone expects. And you are right this is a global problem, however its nucleus is in the US financial system.
However, an immediate contraction in credit most probably will not lead to an immediate decrease in demand. We know this from stagflation in the 70s. We know that pent up inflation in assets always transfers to prices. Since the 1500s food and fuel inflation has portended general price inflation. David Hackett Fischer has proved that.
In light of massive forthcoming deflation central banks will attempt to inflate. Yes, you both are right - inflate what? There is nothing left to inflate. Absolutely. However, that does not mean they will not try and clearly that inflation they create will now go straight into commodities. A dollar weakening leads to domestic inflation....we could create a carry trade where investment money borrows cheaply in a depreciating currency and invests abroad,....manufacturers in the US and global companies borrow to increase their share they are acquiring through a cheap dollar. Will it save the US economy? No, I don't think so. But I don't care because all I care about is that commodities stay high from an investment point of view.
It seems unlikely that this deflation event in the US will knock Asian growth all the way down from double digits and decrease demand. Rather the printing of money (not even yet done yet) will most likely fuel at a minimum borrowing to invest in commodity related assets. I know you think this is unlikely. The same day you posted your blog post saying it was difficult to see banks doing this, I actually saw an article about how banks are gobbling up commodity traders with fury as they seek to recover their losses by investing where the growth has been - commodities.
I remain unconvinced that a deflation in asset prices leads immediately to a deflation in price levels globally. This has not been the case for the five or so years that you have been looking for it. A contraction in credit does not mean that prices will collapse anytime soon.
disclosure: I am invested mainly in precious metals companies.
I think there is some confusion here. Probably most people like me feel that your opinion is that deflation (contraction in credit) will lead to falling prices in commodities? I disagree if that is the case.
That is where I disagree and where virtually everyone in the anti-deflation camp disagrees. Will reflation 'save' the US economy? No, from my point of view very few in the inflation camp believe that reflation will save the US economy.
The point from an investment perspective is how will deflation in (housing, stocks and bonds) impact our investment decisions.
My argument is that you cannot expect that the prices of commodities will decrease. The monetary inflation pent up in the system from the last 25 years which has remained in stocks, bonds and housing has clearly been transferring to commodities. Too much money chasing too few goods. On top of this inflation created demand you have legitimate demand from Asia. Asian consumers set the prices of raw materials. The last time middle class creation set the price of commodities was between 1946-60 when the U.S., Canda and Japan brought 55 million people into the middle class. Today we are seeing 40 million people PER year brought into the middle class thereby straining supplies of energy, metals and food.
So, the question from an investment point of view is will asset deflation in the US particularly infect the global demand for commodities? I highly doubt it. I do believe there is a MASSIVE deflation (in financial assets) risk out there in credit derivatives toppling in a dominoe effect since too much debt is used as collateral. There could be far more deflation coming in structured products than anyone expects. And you are right this is a global problem, however its nucleus is in the US financial system.
However, an immediate contraction in credit most probably will not lead to an immediate decrease in demand. We know this from stagflation in the 70s. We know that pent up inflation in assets always transfers to prices. Since the 1500s food and fuel inflation has portended general price inflation. David Hackett Fischer has proved that.
In light of massive forthcoming deflation central banks will attempt to inflate. Yes, you both are right - inflate what? There is nothing left to inflate. Absolutely. However, that does not mean they will not try and clearly that inflation they create will now go straight into commodities. A dollar weakening leads to domestic inflation....we could create a carry trade where investment money borrows cheaply in a depreciating currency and invests abroad,....manufacturers in the US and global companies borrow to increase their share they are acquiring through a cheap dollar. Will it save the US economy? No, I don't think so. But I don't care because all I care about is that commodities stay high from an investment point of view.
It seems unlikely that this deflation event in the US will knock Asian growth all the way down from double digits and decrease demand. Rather the printing of money (not even yet done yet) will most likely fuel at a minimum borrowing to invest in commodity related assets. I know you think this is unlikely. The same day you posted your blog post saying it was difficult to see banks doing this, I actually saw an article about how banks are gobbling up commodity traders with fury as they seek to recover their losses by investing where the growth has been - commodities.
I remain unconvinced that a deflation in asset prices leads immediately to a deflation in price levels globally. This has not been the case for the five or so years that you have been looking for it. A contraction in credit does not mean that prices will collapse anytime soon.
disclosure: I am invested mainly in precious metals companies.
2008-01-20 13:00:21
Deflation - good or bad?
I'm not convinced we'll have a long deflationary episode, if we have one at all. The global demand that is currently burgeoning is going to require goods manufactured, goods for which supply is not readily available. This, combined with the dollar weakness, will have a positive effect on US manufacturing - a sore spot throughout the growth of the past 20 years.
The problems the US face are real, and some are credit based. But the real problem has been the consistent inflation over time that has allowed us to grow our economy by purchasing from abroad. Until a time came (now) that foreign economies inflated, this was a great thing for the US.
My friends who complained about outsourcing for years never understood my reply that "when we weren't outsourcing, we were being the recipients of outsourced jobs". In other words, for years the US grew because other nations couldn't grow as fast or easily as we could. Eventually that changed, and the trends surrounding it changed - we sent jobs abroad (but continued to create them here, too, in lower paying service sectors) and sent money abroad via imports.
The world economy is maturing, and the US has to change how it does things. This is a good thing. If we deal with it effectively, we will survive and flourish. If we follow previous examples of world dominance and decline (Britain), we will not.
One thing that will help cushion the current situation is business investment. Many businesses I have worked for, despite the technological revolution, are sadly outdated in terms of capital. The reasons jobs go overseas is because these companies cannot compete with the tools available. Businesses MUST reinvest and update, because the world WILL require more from them in the future. US auto plants are poorly placed for producing the cars needed as more people focus on fuel economy...strangely much as they were poorly placed for a similar problem 30 years ago. Does anybody in the US business sector pay attention to history?
Joseph Schumpeter once famously said that a Depression is like a cold shower (story from my professor Robert Heilbroner who was a student of Schumpeter's). It is sometimes needed, and it's not a bad thing.
What is bad is how you look at it and react to it. Our journalists today will make things worse with their gloom and doom forecasts, because they make things seem much, much worse than they are.
What should they be doing? Helping people prepare for the worst...if they say it's going to be SO BAD, what can we do to prepare? We see very little of this help.
Minyanville is geared toward investors, so the advice here usually is geared toward investment decisions. But investment can ONLY take place after savings and spending are in control. What steps can we take to prepare for potential downturns in THIS regard? Some investors will take severe hits during this period of decline and NOT be prepared to deal with the hard times that follow, but there are survival tactics. Let's hear them.
I am not invested at all today, aside from my 401(k)s. I recently went through a 6 month layoff and am rebuilding my savings. I have already seen what can happen firsthand, and survived once. I'm sure I can do it again.
The problems the US face are real, and some are credit based. But the real problem has been the consistent inflation over time that has allowed us to grow our economy by purchasing from abroad. Until a time came (now) that foreign economies inflated, this was a great thing for the US.
My friends who complained about outsourcing for years never understood my reply that "when we weren't outsourcing, we were being the recipients of outsourced jobs". In other words, for years the US grew because other nations couldn't grow as fast or easily as we could. Eventually that changed, and the trends surrounding it changed - we sent jobs abroad (but continued to create them here, too, in lower paying service sectors) and sent money abroad via imports.
The world economy is maturing, and the US has to change how it does things. This is a good thing. If we deal with it effectively, we will survive and flourish. If we follow previous examples of world dominance and decline (Britain), we will not.
One thing that will help cushion the current situation is business investment. Many businesses I have worked for, despite the technological revolution, are sadly outdated in terms of capital. The reasons jobs go overseas is because these companies cannot compete with the tools available. Businesses MUST reinvest and update, because the world WILL require more from them in the future. US auto plants are poorly placed for producing the cars needed as more people focus on fuel economy...strangely much as they were poorly placed for a similar problem 30 years ago. Does anybody in the US business sector pay attention to history?
Joseph Schumpeter once famously said that a Depression is like a cold shower (story from my professor Robert Heilbroner who was a student of Schumpeter's). It is sometimes needed, and it's not a bad thing.
What is bad is how you look at it and react to it. Our journalists today will make things worse with their gloom and doom forecasts, because they make things seem much, much worse than they are.
What should they be doing? Helping people prepare for the worst...if they say it's going to be SO BAD, what can we do to prepare? We see very little of this help.
Minyanville is geared toward investors, so the advice here usually is geared toward investment decisions. But investment can ONLY take place after savings and spending are in control. What steps can we take to prepare for potential downturns in THIS regard? Some investors will take severe hits during this period of decline and NOT be prepared to deal with the hard times that follow, but there are survival tactics. Let's hear them.
I am not invested at all today, aside from my 401(k)s. I recently went through a 6 month layoff and am rebuilding my savings. I have already seen what can happen firsthand, and survived once. I'm sure I can do it again.
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