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Deflation Redux


Lending is a function of productivity, and productivity is a function of price.

I don't want to rehash old ground; not much has changed. The US, along with its trading partners, is going through a deflation. The markets are slowly trying to destroy the massive debt that's been built up over years and years of bad government policy that drove capitalism off a cliff.

So far, a lot of debt has been transferred to the government (and our children), but not much has actually been destroyed. Everything the government is doing will only prolong the process, and perhaps make it worse. They're systematically destroying productivity. I know everyone wants "them" to do something, but they're responding reflexively and in a bad way. The markets, no matter how much the government socializes the debt, will take its flesh.

How does a deflation end? All this debt was created by a fiat system that didn't care about return on investment for risk taken. Therefore, all this debt went to create assets like houses, strip malls and office buildings that aren't productive. Lending to create productive assets is done by savers who want a decent return. They stopped lending long ago because the return for risk wasn't there.

So a deflation ends when savers, once again, see a reasonable return for the risk. This requires prices to come down - a lot. The president can say all he wants about the fact that we have to "kick start" lending, or that "lending is the life-blood of the economy," but unfortunately, this is a non sequitur. Lending is a function of productivity, and productivity is a function of price. When savers finally see property cheap enough, materials cheap enough and labor cheap enough, they will build a store (a metaphor) to make money.

We're far from that in time and price. The debt pool is still enormous to the savings pool.

There's constant talk about "all that cash in money markets, the highest percentage in several decades." This isn't savings. Do you remember how the pundits were saying years ago that "debt doesn't matter because consumers' balance sheets were so good, and that's what matters"? Well, we're seeing the flip side now.

If someone had a $500,000 mortgage, $5,000 in the bank, and $100,000 in stocks a few years ago, what do they have today? Suppose they sold all their stocks 6 months ago. They'd have $65,000 in a money-market, but still have a $500,000 mortgage. But the value of their house is much lower, as well.

So, money-market assets have climbed, but that "money" is there as a result of the debt of the mortgage. That money isn't coming back into stocks anytime soon.

Risk is high.
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