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The Deflationary Hurricane of Deteriorating Social Mood

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While policymakers may believe the downturn in social mood is transitory, the decision-making behaviors of the consumer suggest that it's anything but.

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This morning, in the aftermath of Fed Chairman Ben Bernanke's speech on Friday, the editorial page of the Wall Street Journal noted, "Mr. Bernanke also lectured that 'U.S. fiscal policy must be placed on a sustainable path,' though not by cutting spending in the short-term. So the Fed chief joins the Keynesian queue of spending St. Augustines – Lord, make us fiscally chaste, but not yet."

As long time Minyans know, I have for some time felt that the plea of the clearly conflicted saint was the perfect analogy for our post-banking crisis world. See St. Augustine Goes to Washington as Government Postpones Actual Recovery, The Problem With Geither's, Summers' G-20 Agenda, Buzz on the Street: Precious Metals Hit New Highs.

Everything we need to do for long-term economic, if not societal success and stability comes with very severe short-term consequences. And so the response of most policymakers (and not just those responsible for fiscal policy but also regulatory policemen like Mr. Bernanke himself) has been to advocate for short-term expansionary programs and rules, while postponing the real teeth of necessary change until some later date in the future. Basel III, for example, has a phased-in capital-strengthening requirement for the banking system that does not finish until 2019 – again, "chaste, but not yet."

I am sure that what is behind the thinking of policymakers is the notion that if we can just get through this tough "transitory" period, the economy will turn up; and at that point, whether it is fiscal or regulatory policy, our ability to handle constraints will be much, much easier to bear.

Pour enough gas on the fire today and eventually you'll be able to throw plenty of water on the blaze and still have enough flames to keep a robust economic stove burning.

My concern with this approach is that I am afraid policymakers have woefully under-appreciated the headwinds of deteriorating social mood. And while policymakers may believe this downturn to be transitory, the decision making behaviors that I see from the consumer suggest that it is anything but that. To look at the data, consumers believe that they have seen the future already and now know that it is no longer bright. And as a result, they are deleveraging, defaulting and getting about as far away from homeownership as they possibly can. And increasingly, their short-term-ism is extending across all consumer goods categories.


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The Keynesians response is that, well, that is just temporary. Give the economy enough fiscal and monetary stimulus, the consumer will come back. While I wish that were the case, I strongly doubt it. Just looking at housing, for example, even with record low mortgage rates and record high housing affordability, homes sales are at best extremely sluggish. And I am now watching the behavioral pattern stretch to other "debt-dependent" consumer goods categories, like automobiles, where the "free money" effect is now gone.

Personally, I think that that was the real message behind Chairman Bernanke's speech on Friday. At this point, I believe Mr. Bernanke knows that his book of monetary stimulus matches is all wet. And even if he could get one match to light, all the tinder for a camp fire is soaked with water. (And then there are those Smokey Bears out there suggesting that he not play with matches, period.)

After 11 years of declining social mood, the notion that further monetary stimulus has limited use is hardly a surprise. As I have cautioned so many times, when it comes to the consumer it is not the depth of a recession that matters, but rather its length. And while for policymakers and financiers this may feel like a three-year-old recession (and for some even just a three-week-old recession!), for the American consumer this is a decade-old recession that has deteriorated well into a depression. The average American is now financially and emotionally exhausted. And given the news reports out of Washington over the past month, they are also now afraid that they are at risk of losing some or all of their government safety net, too. Like the children of fighting, divorcing parents, they are now fearful of what an increasingly uncertain future holds.

While further fiscal stimulus – particularly job-related initiatives – may slow the pace of deterioration, I am increasingly afraid that further fiscal and monetary policy actions are now impotent agents against our current social mood. Where in 2000, the future was so bright that we'd need shades, in 2011, the future for many Americans is so dark that they can't see their way forward.

The consequence will be price deflation -- and not just further price deflation across those debt-dependent purchases like homes and automobiles, but across all categories of consumer goods. And for the first time since the 1930s, American businesses will see that lower prices are not always met with greater demand.

As I noted to friends over the weekend, two weeks ago hotels in Virginia Beach were full with families paying premium high season rates. This weekend, thanks to Hurricane Irene, those few that remained open were all but empty, despite near-free room rates. That is what fear does to demand and prices.

Deteriorating social mood is like a very slow-building, very slow-moving hurricane: The longer it goes on, the stronger it gets. And while some policymakers may be praying like St. Augustine for chastity, and others for a book of dry matches, I'd be moving to higher ground to stand on. The path I am most worried about is not the long-term sustainable inflationary economic one, but the much nearer-term deflationary storm path that comes with deteriorating social mood.

For the northeast, Irene may have now passed. But for all of America, there is another, much bigger storm that bears watching closely.
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