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Five Things for Thursday, May 14


Loan demand and the unintended consequences of credit reform; real rates and nominal prices... again; the coming tax revolt and more.

1) Loan Demand and the Unintended Consequences of Credit Reform

"And I dreamt of a house
Haunted by all you tweakers with your hands out
And the headstones climbed up the hills
And the headstones climbed up the hills"

- The Mountain Goats, "Palmcorder Yanja"

And the headstones climbed up the hills. Indeed. There's a growing sense these days, even among the uninvolved, that what we are witnessing on Wall Street is something like a horde of zombies crowding around a trough of rotting debt.

Only yesterday we were describing the primary obstacle facing the Federal Reserve in their desperate attempts to feed the walking dead; the Fed can make credit available, but they cannot make lenders lend, or potential borrowers take on more debt. And so there should be little surprise among the living today to find the Wall Street Journal finally sinking their teeth into this story about the other side of the credit equation - demand:

"Banks are under fire for not lending enough and for tightening terms of credit, contributing to a drop in U.S. economic activity. But as the O'Brien family illustrates, the loan market's shrinkage isn't just about the supply of credit. It is also about weak demand for credit, a byproduct of households and businesses wary about the economy."

Meanwhile, as if seeking to add insult to injury, lawmakers in Washington are hilariously busy setting up an unintentional blockade to the very credit demand they want to reignite.

"As part of a sweeping bill to change the rules for credit cards, a pair of senators are pushing to lift constraints that Visa (V), MasterCard (MA) and other credit card networks impose on merchants' ability to offer discounts for paying by cash or check."
- Wall Street Journal, May 14, 2009, "Paying With Cash Could Soon Pay Off"

Get that? What it means is that retailers would be allowed to be more aggressive in setting higher prices on customers using credit cards. In other words, the bill would actually make credit more expensive, and cash more valuable, even as we enter the teeth of a deflationary debt unwind.

2) Real Rates and Nominal Prices

Kevin -

I read yesterday's Five Things, here is my question: Why are my real life experiences with product prices indicating inflation if all these companies have no pricing power and inflation is low?

I'm not just talking about food, which is suffering its own inflation through the use of smaller packages sold for the same price as the older larger package.

For example, I went to Lowe's (LOW) yesterday. Looking around the store and checking prices, I saw multiple examples of higher prices. For example, I had bought a 26 foot 300lb commercial extension ladder 10 months ago for $380. This was not a sale price. That same ladder is now $460.

I could go on and on but either real prices are going up or the amount of the product is smaller for the same price.

So how can there be deflation when all of us are seeing inflation?

Minyan MT


Inflation is an increase in the money supply. When the effects of that increase are rising nominal prices then the real value of money is eroded. We have had inflation for decades now, which necessarily sows the seeds for deflation, and which can only occur after prior inflation.

Deflation occurs when the money supply EVEN IF INCREASED fails to exceed the demand to hold dollars at the prevailing price level. Following nominal price levels alone will never yield an accurate view of whether we are experiencing deflation. As noted in the article, the money supply has increased dramatically, but the velocity of transactions has continued to decline because people are using those increased dollars to destroy debt, or simply saving them.

Again, following nominal prices alone is at best misleading, and at worst irrelevant to understanding REAL deflationary effects. Prices are merely one symptom of inflation and deflation, not in and of themselves predictors of or indicators of them.

In order to understand deflation it is necessary to tear yourself away from price levels and focus on 1) declining asset values, 2) availability of AND DEMAND FOR credit, 3) real liquidity and 4) debt destruction and balance sheet repair.

But it is really much simpler than all of that. Why does nominal price not matter? Think about it this way: does any producer anywhere really want the price of what they make to remain the same forever? Perhaps, if living in a vacuum. But in the real world, it is hoped that the real value of the goods they produce will increase. But this can happen regardless of nominal price levels! It can happen through productivity increases or even through changes in the psychology of consumers. It can happen as well via changes in real interest rates and the value of the currency that is being used as a medium of exchange.

Because we live in a world where the central bank has been constantly increasing the supply of money in the economy, we have been conditioned to view nominal price changes (which have been mostly up for many things) as real indicators of profitability and value. The reality is that nominal prices are nothing of the sort.

3) Unfinished Business?

Just a quick note on the market's unfinished business we are facing with my interpretation of DeMark indicators. Based on the weekly charts, The S&P 500 still needs a new high either this week or next week above last week's high of 930.17 in order to perfect a TD Sell Setup.

The Nasdaq-100 does not require a new high and will this week either record a perfected TD Sell Setup or a bearish price flip.

4) The Coming Tax Revolt

In In the U.S., as bailouts and "economic stimulus packages" continue, and ultimately fail, inevitably the question will arise as to why it makes sense for, say, the citizens of one state to subsidize via federal tax payments foreclosure relief for citizens in other states, or banks located hundreds of miles from them, or auto companies, or the airline industry. The list goes on and on. There are individual counties in the state of CA right now asking that very question about the state government. If that sounds like tin foil hat stuff, consider the success of tax revolt during the Great Depression.

I recently ran across a paper - written by Mark Thornton of the Ludwig von Mises Institute with Chetley Weise, "The Success of the Great Depression Tax Revolts," - which made the case that tax revolts during that era, which are rather obscure because of their perceived ineffectiveness (most of us have never even heard of them), were actually quite successful.

"[T]he enactment of tax limitation statutes and the Repeal of Prohibition are shown to be tangible evidence of the [tax revolt] movement's success. These policy victories mark the end of the revolt because the primary goals of the movement had been achieved. How else
would one explain the rather sudden demise of a movement that consisted of local organizations unconnected by a national network? In our view the timing of these events
support our hypothesis that the revolt was a success and that Repeal, which affected the entire nation, was indeed a pivotal event for the tax resistance movement.

Like many, I suspect, I assumed the government eventually repealed prohibition because 1) it was stupid, and 2) it was ineffective. The paper makes the case that prohibition was actually repealed for tax relief.

5) News & Weirdness

Paulson Told Bankers to Take U.S. Taxpayer Aid or Be 'Exposed' - Bloomberg
First Blush:
Paulson, government strong-armed banks to accept bailout money they didn't want.
Reality: Banks were operating either from a position (take your pick) of denial or incompetence, refusing to acknowledge the fact they were bordering on insolvency.

U.S. "Sham" Bank Bailouts Enrich Speculators - Telegraph (UK)
This would be just one more lunatic conspiracy if it were not being said by the chairman of the buy out firm that is leading the joint public-private bank rescues.

Office Rents Crash in City of London to 1991 Prices - Bloomberg
The City already has enough empty offices to hold two-thirds of Canary Wharf, some 9 million square feet, expected to increase to 12 million by the end of this year.

Thriving Norway Provides an Economics Lesson - NYT
"The strongest man is he who stands alone in the world." - Norwegian playwright Henrik Ibsen. However, I prefer the daily @AntiMotivation quotes available via Twitter, e.g. "The average estimate themselves by what they do, the above average by what they are, you by how much available credit you have til Friday."

Meanwhile, Away from Norway: Spain CPI Declines to 47-Year Low - Guardian (UK)
Year-on-year prices fell 0.2 percent in April, compared with a 0.1 percent dip in March, to reach the index's lowest rate since records began in 1962, according to data from Spain's National Statistics Institute.

Bill to Punish China as "Currency Manipulator" Revived - Telegraph (UK)
The legislation stalled last year but is being re-introduced with 40 co-sponsors.

White House Drug Czar Calls for End to 'War on Drugs'
- ($) Wall Street Journal
Indeed. It is hoped that former enemies can drop their differences and come together as one, sealing this truce with a long, slow drag from the national peace pipe. These are high times for all Americans.

Craigslist to Remove 'Erotic' Ads - NYT
Craigslist said yesterday it would close its erotic services category, which critics maintain - get this - is nothing but a forum that fosters prostitution and other illegal activities! Say what?! Looks like my 4:20 appointment this afternoon with a Canadian ski instructor seeking a marriage of convenience may turn into just another missed connection.

Direct Sales Jobs Offer "Safety Valve" for Laid Off Workers - USA Today
Don't worry, if you have recently been laid off by Craigslist from your job as an online prostitution solicitor, you have a "safety valve" available in street corner "direct sales."

Electronic Arts (ERTS) Looking to Make Sims 3 More Sociable - NYT
Sure, you may be unemployed and sitting in your underwear right now drinking gin while the bills pile up, but your Sims life is absolutely outstanding.

'Superfood' Promoted on Oprah's Site Robs Amazon Poor of Nutrition Staple - Bloomberg
U.S. consumers are turning a "a typical poor people's food (the acai, a purple Amazon berry) into something like a delicacy," said Oscar Nogueira, who specializes in the fruit at Embrapa, Brazil's agricultural research company.
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