Pomboy: Deflation, Not Inflation, Is The Greater Threat
I am a big fan of Stephanie Pomboy’s economic commentary, even though she has steadfastedly managed to duck my meeting her every chance she gets — conferences, dinners, drinks — I even heard she once hid behind a column in Vail to avoid me ; )
No matter, I still find her work outstanding. Her most recent commentary on Deflation was right up mny alley. Its discussed extensively in Abelson’s Barron’s column this weekend:
“THE INDOMITABLE STEPHANIE POMBOY, who beguiles us week-in, week-out with her feisty, funny and very much with-it MacroMavens commentary, is a member of the small but hearty camp (number us among them) who believe that the immediate threat is deflation, not inflation.
As, among other things, the glistening rise in gold and the heavy shorting of long-dated Treasuries strongly suggest, she notes, the popular investment view is pretty fixated on inflation. And Stephanie mulls whether Jeff Lacker, president of the Federal Reserve Bank of Richmond, “isn’t sure the Fed will be able to make a graceful exit before all inflation hell breaks loose,” shouldn’t we all share his concern? Her answer is a qualified “no.” Qualified because she believes there’ll be inflation, but it’ll be in assets, not goods.
For she’s convinced the consumer’s new-found prudence is no passing fancy, but a behavioral sea change, and that the repair of consumer balance sheets so badly thrown out of whack by a quarter of a century of credit overindulgence will continue. So while equities and commodities, as their recent explosive runs demonstrate, may run hog-wild, the massive decline in consumer credit represents a daunting barrier to a kindred climb in consumer prices. Yet despite mounting evidence of the new frugality on the part of the populace, Stephanie points out, retail stocks are posting their strongest relative performance since March 2007, and junk spreads are the narrowest since October 2002. “Investors,” she shakes her head, “are discounting an environment in which retail sales register 3%-style annual gains.” (emphasis added)
As we noted recently, its even worse than that. The markets have, as is their occasional wont, decoupled form the fundamental economic reality.
Pomboy continues:
To notch such an increase, she gauges, retail sales, now declining at an annual rate of $331 billion, would have to make a U-turn and rise $470 billion! As she says, “An $800 billion swing? You’d have to be certifiable to bet on that.”
Stephanie felt “there’s no way professional investors are betting real money (even if it’s other people’s money) on such an outcome. Is there?” So she went back to the drawing board hoping to arrive at a less frightening conclusion.
Specifically, she turned to what she calls the “broadest proxy of risk appetite,” namely stocks versus bonds, to discover what types of gain in overall consumer spending it implied. The divergence between the two, she explains, is at extremes last seen when consumer spending was chugging along at a 6% clip.
“To reach that milestone today,” she sighs, “would require one whiplash-inducing U-turn if ever there was one, with the present $165 billion annualized decline in spending giving way to a $779 billion gain.” Even these days, that’s a big number.
If the demand for credit revives or employment and income begin to grow, neither of which seems to us likely to happen anytime soon, Stephanie says that’ll be the time to start worrying about inflation in the traditional sense. At the moment, the only serious inflation is in stuff like financial assets, because all the surplus “liquidity” that has been pumped into the economy has nowhere else to go.
She tabs the equity rally as exceedingly long in the tooth. Earnings expectations, she submits, “have never been so far afield of economic reality, and the market’s banking on a $1 trillion spending swing over the next 12 months.”
I cannot disagree with anything she has stated, except the historical factors that suggest that Bear Market rallies that follow collapses can easily run 18-24 months.
>
Source:
All Hail the Hero
ALAN ABELSON
Barron’s September 21, 2009
http://online.barrons.com/article/SB125331269914024113.html
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September 19th, 2009 at 1:17 pm
“At the moment, the only serious inflation is in stuff like financial assets, because all the surplus “liquidity” that has been pumped into the economy has nowhere else to go.”
This one sentence explains the last 7 months in the markets, – equity, bond or commodity. Everything up, dollar down. Does this liquidity have to be removed to reverse the direction of the markets? If it is the dollar carry trade, probably not, as a reversal in the dollar will squeeze all other speculative positions regardless of liquidity. Bank losses, when finally disclosed and recognized, will also eventually offset this excess liquidity. Fighting the FR has been a losing proposition for the last 7 months. Now, the FR is at a crossroads on the dollar. It’s do or die time for the USG currency. Defend it or risk complete collapse. Either move would be negative for the current speculative positions.
September 19th, 2009 at 1:27 pm
Sadly it looks like wages and/or work related earnings is also going down.
Mr. Ritholtz “she once hid behind a column in Vail to avoid me ; )” Strangly I have he same effect on women.
September 19th, 2009 at 1:27 pm
“It’s do or die time for the USG currency. Defend it or risk complete collapse. Either move would be negative for the current speculative positions.”
…and good for gold – either way.
September 19th, 2009 at 1:47 pm
We need to distinguish the risk of deflation vs. inflation, meaning which is more likely, versus the risks of LOSSES FROM deflation or inflation, in the sense of how much either scenario will hurt you as a saver or investor. Deflation may be more likely, but how bad could it be? Even in Japan, I’m not sure it ever went above 1 or 2 % a year. Not good, but a rounding error for portfolios these days. On the other hand, inflation, if it comes, has the potential to be devastating. It can wipe you out in short order. Think about our parents with their 4% passbook accounts in the 70s. They got killed. In short, even if “the risk” of inflation happening may be less than that of deflation, the “risk of loss” from inflation is magnitudes higher. Hence, the interest in gold, commodities, and TIPS.
September 19th, 2009 at 1:54 pm
That drop in retail sales rate is in the same territory as the MEW ATM numbers of past years so it may not even be physically possible for it to happen
As for earnings, we do have another one of those seasons on the horizon don’t we? I’ll bet everyone with bull horns on are not looking forward to what is coming up next. This could be where the next set of nasty surprises start to come from. I think this earnings season will begin to tell us where we truly do stand going forward. I think now we will begin to see if the stimulus has either run its course or truly produced green shoots. I know what I’m expecting, though I will be interested to see how non-American markets perform.
And to think we had all those corporate executives dumping stocks over the last little while
….lots to think about going forward….
September 19th, 2009 at 2:02 pm
Commodities will go higher. However, consumers will remain frugal until credit flows easily again…. and that could be several years in the future.
September 19th, 2009 at 2:03 pm
Very keen insights from Stephanie Pomboy
this one is particularly insightful….
She tabs the equity rally as exceedingly long in the tooth. Earnings expectations, she submits, “have never been so far afield of economic reality, and the market’s banking on a $1 trillion spending swing over the next 12 months.”
I found this other one from Dec 2008…
She sees only two potential outcomes of our present interventionist fling: Higher interest rates or devaluation of the currency. She picks the latter, seeing a weaker dollar as being the choice Bernanke’s Fed will make. As soon as interest rates start to climb significantly, they will begin a program of Treasury purchasing to prevent it, which will in turn lower the dollar.
September 19th, 2009 at 2:32 pm
I think she’s on the mark, and in good company:
See:
It’s Hard Being a Bear (Part Five): Rescued?
&
Good article by Ross Gittins on Economics and Equilibrium
http://www.debtdeflation.com/blogs/
BR asked about the recession – depression difference, I think it rhymes with:
1. Personal/ Corporate Debt deflation/ Deleveraging (on a GNP scale)/ Defaulting (see above)
http://www.investorglossary.com/deleveraging.htm
And we may see if Tobin’s Q breaks a record to the downside or gets close (~ > -0.8 in 1920)
http://www.smithers.co.uk/page.php?id=34
2. Grande income inequality.
http://en.wikipedia.org/wiki/Income_inequality_in_the_United_States
http://www.econ.berkeley.edu/~saez/piketty-saezOUP04US.pdf
http://economistsview.typepad.com/economistsview/2009/09/economic-inequality-the-wall-street-journal-is-just-wrong.html
3. Relatively high unemployment. And persistent? (which results in debt default, see #1)
http://www.nytimes.com/2009/09/19/business/economy/19jobless.html?_r=1&ref=business
which leads to:
http://www.nytimes.com/2009/09/19/business/19women.html?ref=business
“Live Long and Prosper”
September 19th, 2009 at 2:41 pm
Love I some Stephanie Pomboy.
A bit OT, I guess…
But does anyone here have a Macro Mavens subscription? Is it even possible to do for the individual? It appears that they only service insty clients…
I’d be interested to read some of their stuff and check out some of their charts. I seem to recall seeing a reprint of one in an old Gartman Letter when I had the free trial that was pretty cool.
September 19th, 2009 at 2:44 pm
There is a great analysis of the situation here:
http://www.leap2020.eu/GEAB-N-37-is-available!-Global-systemic-crisis-In-pursuit-of-the-impossible-recovery_a3797.html
September 19th, 2009 at 2:44 pm
Inflation ISN’T how much stuff costs. Inflation is simply the money supply increasing, which leads to a devalued dollar which can, depending on the asset class lead to higher prices.
Those in the deflation camp: A.) Believe that inflation is higher prices or B.) Believe that the ponzi credit being destroyed will deflate the money supply and strengthen the dollar.
I’d be able to agree with B. save for the fact that our deficit has gotten out of the cage, we take in 2 trillion and piss out 4 trillion. We can only borrow a portion of the difference, the rest Bennie the Paper Hanger counterfeits. Ergo the reason our dollar is headed down the shitter.
September 19th, 2009 at 2:44 pm
Seems like a clear-thinking economist we should add to the select list of 2-3 we should pay attention to. Consumers have retrenched, and it is no passing fancy….
Of course things have stabilized…the Sheeple still have to eat, drink, buy clothes for the kids, etc…
But, that’s not the makings of good economy. You need people buying crap they don’t need to have a good economy. Embrace the new America….frugality is “cool” and being a saver is “in.”
(The Cold Stone Creamery nearby, which had been in business for several years, and was located in a good outdoor mall, just shutdown….guess novelty ice-cream stores that overcharge are hitting a rough patch…)
September 19th, 2009 at 2:48 pm
I believe I wrote the same stuff here on several occasions, sometimes in considerable detail. But they said it better and with numbers.
September 19th, 2009 at 2:52 pm
Re Barrons: It doesn’t matter how the economy or markets turn out, They will have printed a story that predicted it at one time or another (and most other possibilities), and run a cover story about their forecasting prowess when one eventually hits. Still, thanks to them for tagging along with me and adding to the flow of information.
September 19th, 2009 at 2:55 pm
@ drey / DL
Gold and commodities are dollar denominated assets. Deflation, i.e. a drop in money supply, should strengthen the dollar. A stronger dollar should translate to lower commodity prices.
September 19th, 2009 at 3:45 pm
Bernanke studied the GD. He should have studied Japan.
And the WH & Congress are pushing for packages which will involve costs that will exceed by wide margins, the incrementally lower and lower IRS receipts (based on dwindling economic activity). They’ll make up for the shortfall by raising taxes, which will cause people to retrench further and further.
Soon they’ll just wait for handouts.
In order for things “to get good” again in this country, debt has to be paid and things (even ‘assets’) need to cost less. Not the other way around.
September 19th, 2009 at 4:44 pm
I have to disagree with barry. what you’re not talking about is THE RALLY HAS ALREADY HIT 60% OR A FULL 2/3RDS OF THE PREVIOUS 2003-2007 BULL MKT. i have no idea wether we take out the march lows anytime soon BUT I DO KNOW A STIFF CORRECTION IS NEAR. i think were your error is you’re not paying enough caution to the absolute unprecedented worldwide mania at hand which could easily lead to a recollapse as its all air underneath.
~~~
BR: Maybe you are right. However, we have heard the same arguments now for 4 months, and they have been wrong so far. They will eventually be right — BUT:
I need a real reason to bailout now — a defendable, quantifiable, evidence based hypothesis as to why to get out here.
So far, no one has offered one up . . .
September 19th, 2009 at 5:00 pm
“For she’s convinced the consumer’s new-found prudence is no passing fancy, but a behavioral sea change…”
As I look back over the last 6000 years of human history, I don’t see many sea changes in human behavior…. even less so ones that are identifiable over the course of 3 quarters.
But I suppose anything is possible in the age of Obama.
September 19th, 2009 at 5:04 pm
So, is she saying that we are in deflation now or is she saying that we are going to be in deflation for a long while?
Because I think the deflationary forces right not are beyond obvious.
Where I think many are wrong is on how inflation is going to pick up. I think we are going to see huge capacity destruction. Right now inventory/sales is still high but wait and see when that excess inventory disappears, at exactly the same time companies start bumping up against cash flow issues.
Furtheremore, America will have to rebuilt a semblance of industrial capacity over the next couple of decades during which time huge amounts of debt will be put on balance sheets to build it up, yet no production will be coming out of it during the ramp up stage. Never mind the fact that it will face a shortage of talent to fill that boom since an entire generation was sidelined and those with the know how will be retiring.
Then you have the boomers who will start retiring and collecting their benefits and using up their 401Ks to keep up the same lifestyle in the initial years (it’s been show that most savings are used up withing the first 5 years of retirement).
Sorry. I just don’t see this deflationary environment lasting more than 1 or 2 years.
When I ask people about their huge mortgage, they always chuckle and say: “They can’t raise rates, they’ll cause a recession”. Most people around me can’t even imagine huge inflation.
September 19th, 2009 at 5:14 pm
Inflation ISN’T how much stuff costs. Inflation is simply the money supply increasing, which leads to a devalued dollar which can, depending on the asset class lead to higher prices.
———–
Whatever.
CPI is not going up so we’re told that inflation is nil. That’s based on consumer prices.
The total money supply could drop but if production falls in tandem or more, consumer prices could remain the same or even increase.
So maybe someone should come up with a strict definition of inflation.
September 19th, 2009 at 5:34 pm
I really think the Fed will overindulge. They’re going to put the CRE and all the other duds on their books. Then the banks won’t have to write down much and the Fed will certainly not write down anything!
The banks’ books will be clean and they’ll start financing all kinds of infrastructure projects. At that point, governments the world over will be selling off all kinds of assets for cheap to fix their balance sheets and banks will participate in those deals also. It happened in every Banana republic, so why not the US?
September 19th, 2009 at 5:47 pm
“Gold and commodities are dollar denominated assets. Deflation, i.e. a drop in money supply, should strengthen the dollar. A stronger dollar should translate to lower commodity prices.”
I could be wrong Cursive (and often am) but I don’t see a significant drop in the money supply occurring anytime soon. What I do see coming is another huge round of stimulus spending and the fed being way late in removing the punchbowl when their hand is eventually forced.
Am also following with interest all the international noise about replacing the dollar as reserve currency with a basket of currencies, gold, or whatever. Behavior/actions of the Chinese will be the key here, I think. Upshot is, we may NEVER see a stronger dollar in any meaningful sense…
September 19th, 2009 at 6:51 pm
There IS a strict definition of inflation — it is an increase in the money supply. It doesn’t matter that the government consistently gets it wrong.
September 19th, 2009 at 6:55 pm
…inflation is too much money and credit (don’t forget the credit part) chasing too few goods
…so, deflation is too little money and credit chasing too many goods
..the shadow banking system (credit) is much larger than the fed’s ability to get the banks to loan new money… the fed is just trying to let the air out of the credit bubble at a measured pace – that is all the fed can do
seems like net deflationary for now…
deflation first, inflation second
September 19th, 2009 at 7:09 pm
danm Says:
So maybe someone should come up with a strict definition of inflation.
_________
We live in a fiat system, and it’s very difficult to define something imaginary (it’s also important to note that you don’t really need strict definitions when what you are selling is bullshit).
Inflation and deflation, like anything else, are ruled — and to a degree, defined — by supply and demand. Only when the two balance can there be a stable currency/prices. The utility of fiat currency (not “money” in the broad sense, but hard cash) is that within a few percentage points, these imbalances can be controlled by the creation and destruction or withdrawal of currency. However, if the imbalance is too great, all hell breaks loose (as we are seeing).
The enormous debt we’ve built up over the last 30 years was in anticipation of there being enough hard cash, eventually, to balance that debt and its associated interest.
Well, the amount of hard cash in existence right now comes nowhere near being enough to balance the existing debt. Demand has outstripped supply exponentially.
The decline of the value of non-monetary assets (I believe what we would call deflation) is a direct response to too few units of currency in circulation. While that decline can stimulate the economy by increasing the velocity of trade (strong currency for relatively cheap assets), it cannot do so to the point of balance, nor can it do so AND reduce the existing debt. If we do not increase the currency supply, the debt can never be repaid.
Once we took the fiat path and committed fully to the (false) concept that the money to pay our debt would be forthcoming (ushered into existence at the stroke of a pen, after all), we committed to either default on the debt (for the reason given, above), or to an increase in the supply of currency to cover that debt (inflation).
Default or inflate? I doubt we’ll default. Eventually, we’ll inflate, but only when the wheels start falling off of our social order (soon).
September 19th, 2009 at 7:11 pm
http://www.merriam-webster.com/dictionary/inflationMain Entry: in·fla·tion
2 : a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services
————-
Usually is a key word.
What if general price level goes up amid a drop in money supply? If production drops faster than money supply.
September 19th, 2009 at 7:15 pm
Once we took the fiat path and committed fully to the (false) concept that the money to pay our debt would be forthcoming (ushered into existence at the stroke of a pen, after all), we committed to either default on the debt (for the reason given, above), or to an increase in the supply of currency to cover that debt (inflation).
——–
They did create money at a stroke of a pen even when gold backed it. Debasing a currency has existed since we invented money, fiat or not.
September 19th, 2009 at 7:16 pm
Eventually, we’ll inflate, but only when the wheels start falling off of our social order (soon).
—–
I agree. As long as there is a semblance of normalcy, the fed will show restraint. After that, the sky’s the limit.
September 19th, 2009 at 7:31 pm
There is no doubt that deflation has already occurred – not monetary deflation but a deflation of the very idea of self-governance, a deflation of the value of the Republic itself, a deflation of grand ideas into bumper-sticker slogans.
A deflation of We the People from the Governors to the governed.
September 19th, 2009 at 7:38 pm
There won’t be any inflation until the D-Cycle abates. It is all the Fed can do to attempt to let the air (credit) out of the balloon (financial system) in an orderly fashion. They are printing money like mad to counterbalance the destruction of capital (credit). They are nearly impotent because in this modern era the size of the shadow banking system now overwhelms the regular (regulated) banking system.
BR has referenced some excellent essays on this dynamic by Mauldin, who writes about the Deleverage Cycle and its impact on deflation / inflation.
September 19th, 2009 at 7:42 pm
danm:
a US $20 gold piece could not be debased. A gold backed bill could be traded for gold coin (sizes may have changed, but not without an act of Congress), See here:
http://upload.wikimedia.org/wikipedia/commons/thumb/7/7f/US_$20_1905_Gold_Certificate.jpg/800px-US_$20_1905_Gold_Certificate.jpg
Notice that this bill is drawn on the Treasury of the US – not a bank.
Here’s another interesting bill (1928, and exchangeable for gold or FR “lawful money”).
http://elainemeinelsupkis.typepad.com/money_matters/images/dead_gold_certificate.png
Currency debasement historically took the form of alloys of precious metals, replacement of one metal for one less expensive (the zinc penny), base metals sandwiched between more valuable metals (think of a late 20th century dime or quarter). Or by making coin denominations smaller (the ridges around some coins are artifacts of precious metals coinage – they’re there to keep the coin from being whittled down for the metal).
September 19th, 2009 at 7:47 pm
MA – you are a purist…sweeet
September 19th, 2009 at 7:50 pm
Wes:
Thanks (I think!) ; )
September 19th, 2009 at 7:54 pm
i hope
September 19th, 2009 at 8:01 pm
There is no inherent monetary magic in gold; there is no inherent evil in fiat currency.
Try to have an industrial revolution on a gold standard and see how far you get with a bounding demand for currency and a limited supply of metal. The argument that the dollar has lost 94+% of its purchasing power since 1913 (how ever much and whenever is quoted) is ludicrous – wage growth for the most part kept pace and it is entirely irrelevant that it now costs $3 for milk that cost $0.25 then because it is more affordable now than then. When you expand the money supply and it travels through the economy in the same ratio as existing wealth, there is no relative change.
What fiat does do is help an industrial nation quickly expand its money supply to match the demand for growth. The fact that governments get drunk on debt is not the fault of the fiat but of the government and the governed for allowing it to happen.
Everyone is looking at the wrong boogey man – it isn’t fiat. It isn’t debt. These are only symptoms. This Halloween, turn your sight toward wage suppression and you will find the real evil behind the mask.
In any healthy economy, supply=demand. Supply comes from productivity. Demand comes from wages and new debt. Without wage growth, what happens to excess productivity? It must be absorbed by new debt. And if there is no willingness to lend or eagerness to borrow, then what happens to all that productivity (supply)?
September 19th, 2009 at 8:11 pm
MA:
I don’t follow you. My understanding is that you blame the fiat system for the trouble we are seeing now.
What I am saying is that the currency could be gold backed and we could still see the printing problem.
For a gold system to work properly we would need gold reserves to increase in parallel with production (GDP). For obvious reasons that’s a problem.
September 19th, 2009 at 8:21 pm
@Winston-
my friend…
are you considering international “free” trade?
the Asian’s are big supporters of our debt – we buy their stuff, they buy are treasuries notes…not that it cannot change or get out of balance
September 19th, 2009 at 8:27 pm
Everyone is looking at the wrong boogey man – it isn’t fiat. It isn’t debt. These are only symptoms. This Halloween, turn your sight toward wage suppression and you will find the real evil behind the mask.
————
The purest form of trade is barter. But it was not efficient so we created money as a medium of exchange. So if one bought something and was promised something in return the next week, it was a form of debt. So you’re right, debt is not an issue as it is at the very heart of trade as soon as we don’t have a concomitant exchange.
The problem is that not everyone recognized this form of money, so we needed to create a currency that everyone recognized and trusted. So our central banks took on this responsibility.
But a few problems arise with this solution:
1. They are not privy to each and every transaction so they have to guess the level of GDP to guess the level of money needed.
2. The money is injected via debt (OK) that charges interest (problem). So more money has to be injected into the economy just to cope with this interest payment. So this one simple issue guarantees that our system will hiccup every now and then.
3. Because they are not privy to each transaction we can be pretty sure that we will end up with misallocation of capital.
September 19th, 2009 at 8:28 pm
MA:
Sorry, I was writing my comment when you posted yours at 8:01.
September 19th, 2009 at 8:32 pm
Winston:
I agree that wage suppression has happened, and it has hit the middle class particularly hard (he rich keep getting richer — same as it ever was, but more so over the past 30 years). I do think that fiat currency is the bogeyman, and not just because it is reliant on inflation (although inflation kills savers). In a sense, what I don’t care for is the distinction between what something is “backed by” and what it’s “redeemable for.” If our currency holds it’s value because its “backed by the full faith and credit of the United States, that’s not saying much nowadays. Non-Russian holders of old USSR Rubles don’t have much chance of redeeming those “holders of value” now.
damn:
Anything defined in units must have a fixed basis for that unit. Otherwise, the idea of a “unit” is, as I said in my earlier comment, bullshit. What if the length of a meter were to be defined by fiat? How far from my hand to the light switch? 1 meter. How far from here to the grocery store? 1 meter.
September 19th, 2009 at 8:37 pm
MA:
I finally get you!
I agree but even if you peg it to gold, they’ll cheat. Empires always cheat. The UK did it. When currencies were backed by gold and fixed, they just printed more.
September 19th, 2009 at 9:12 pm
@danm-
in the old days, they changed the composition of the currency,
slip in a little silver, slip a little bronze, try silver coating the bronze…oops it wore off
clip a little off the corners, change the number of cruzados for reals…whatev’
September 19th, 2009 at 9:18 pm
Wes:
That’s what I implied when I spoke of currency debasement. It’s not because it’s pegged that all is good. They can print more paper or clip some edges.
September 19th, 2009 at 9:20 pm
“Specifically, she turned to what she calls the “broadest proxy of risk appetite,” namely stocks versus bonds, to discover what types of gain in overall consumer spending it implied. The divergence between the two, she explains, is at extremes last seen when consumer spending was chugging along at a 6% clip.”
It seems to me that the biggest risk is in the bond market. Why would anyone wish to own a 10 year treasury bond when we know that the Fed will do all that it can to add liquidity in the system and keep printing as much money as is required to prevent deflation? The simple fact is that we have never seen a country with a fiat currency see a major increase in purchasing power. While some will point to Japan as an example of what could happen it is clear that Japan did now owe much money to foreigners, did not run trade deficits and did not see much in the way of CPI deflation as the government resorted to the printing presses.
And history is clear that when you have debtor nations with fiat currencies and trade deficits the natural and logical path is towards a currency devaluation that acts to reduce the debt burden for borrowers. While such a path could lead to hyperinflation, it is clear that nobody is worried about that at this point. It is also clear that there is no political incentive to have the Fed tighten or to let the USD rise in value in the year before a Congressional election in which the balance of power is at stake. (Imagine the response when Chinese funds step in and use the proceeds from their interest payments to purchase assets from bankrupt Americans at fire-sale prices. ) I see the USD rallying for a short period of time before it resumes its downward path. Americans will see the purchasing power of their currency decline and will see an increase in the price of goods and services keep increasing even if the value of their homes and stocks keep falling. Of course, they may not fall at all in nominal terms if the Fed is successful in printing enough and keeps destroying the currency as it has ever since it was formed in 1913. The purchasing power of the FRN is already down more than 90% so nobody should be surprised if it goes down another 90% from here over the next decade or so.
Personally, I would rather own gold and oil instead of bonds over the next ten years. And while the deflation play may work out for short periods of time it is clear that its proponents have been very wrong for so long because they never understood the nature of fiat money and fractional reserve banking. As the man said, in a social democracy with a fiat money system all roads lead to inflation.
September 19th, 2009 at 9:41 pm
“the Asian’s are big supporters of our debt – we buy their stuff, they buy are treasuries notes…not that it cannot change or get out of balance”
It seems to me that the Asians are worried about the purchasing power of the USD and are looking to diversify by reducing the amount of reserves they hold in the form of USTs. The Chinese are buying copper, gold, silver, etc., and are looking to buy large commodity producers that have USD denominated debt on the books as a way to diversify their exposure. The Russians are buying gold and are worried about the decline in the value of the USD. So are the Brazilians and Indians. Other nations that hold a great deal of USTs are worried that they can get left without options once the music stops and other players have made their move out of the USD.
At the same time as foreign holders of American debt are nervous, the US government is trapped because it cannot afford to allow a major slowdown that would destroy its tax revenues and do grievous harm to the domestic capital goods sector, which is extremely vulnerable when there is a real economic reduction in activity. Keep in mind that most of the federal income taxes are paid by the top few percent of the population and that it is this segment that takes the biggest hit in a serious economic crisis. Also keep in mind that those companies in China that made consumer goods for the US market were buying their machinery from American producers. While American industry has seen a great loss of jobs over the past 30 years the US has been very productive and was producing and exporting goods near the all time historical highs before the crisis hit. The machines and assembly lines that made consumer goods were often made in the US. So was the heavy equipment that was used to drill for oil, mine coal or copper ore, smelt zinc, etc. If the US government protects the purchasing power of the USD to make its lenders happy, it will do a great deal of harm to the capital goods producing sector and will force many American companies, consumers, and governments into bankruptcy. If it does not, it will harm the foreign lenders and domestic savers that were naive enough to trust the government to keep their purchasing power from decreasing. Given the political incentives and the history of the people who advise the Obama Administration I am betting that the USD will be sacrificed. Buy a bit of gold and silver as protection and hope that your purchase will be dead money.
September 19th, 2009 at 9:47 pm
Barry, Might I recommend you pore thru this Washington Post webchat with Elizabeth Warren, who said a lot of good things and was extremely forthcoming about our problems, much more than most of the bureaucrats in charge http://www.washingtonpost.com/wp-dyn/content/discussion/2009/09/02/DI2009090201597.html
September 19th, 2009 at 10:12 pm
Marcus Aurelius,
A commodity-backed currency is simply a representation of the commodity – I take it this is what you mean by “redeemable for”. All you are doing with this concept is taking paper and using it as a note to represent an amount of some commodity, usually gold – it is simply a gold-based system using paper for utility.
But gold is not any more money than sea shells or tomato soup cans. Money is a concept. It is an expression of a value. Money expresses the value of labor, either intellectual labor or physical labor. Money can be anything that a society agrees upon to utilize as money. What gives fiat money its value is trust that government that issues it will distribute it in a proper ratio – that it will be supplied only to meet demand and the wage-productivity ratio will be maintained.
Inflation is only harmful to fixed incomes and savings. If one has an income rise that matches the inflationary rise there is no change in the relative values of what can be purchased, and if one’s savings interest/investment gains match inflation there is no loss in future purchasing power. Inflation is not evil and deflation is not good. They are simply words to express concepts.
Real destructive power comes from policy, and the might with which it can be enforced.
Wages have been stagnant for 10 years – that means all wage earners have been living on a fixed income for 10 years. The productivity went to the wealthy while wage earners were required to add personal debt to maintain their standard of living and delude themselves into believing they were well off and that all was well with the U.S. – that we were indeed exceptional and were endowed with the right to live beyond our means while the world picked up the tab.
This is not a problem of fiat versus gold; it is a problem of policy, of governance. Of oligarchy. Of power.
September 19th, 2009 at 11:26 pm
danm, MA, winston, Wes
Good discussion. Not the same old tired inflation/deflation debate that is getting quite tiresome lately (although a topic of utmost importance, I know)
Thanks
September 19th, 2009 at 11:28 pm
The seachange is that we no longer have $700B annual mortgage equity withdrawls hitting the system. Cash out refis are more stimulative than debt fueled spending.
September 20th, 2009 at 12:24 am
Wes,
Sorry but I didn’t see your question earlier. To answer, yes, I am including global free trade as part of policy that created the wage arbitrage that still benefits capital and punishes labor.
The key economic ingredient that has changed over the past 20-30 years is the alteration of the wage-productivity gap. As I have mentioned before, in a healthy economy supply=demand. Supply is mainly provided by productivity, while demand is based on wages and new debt. The difference between productivity and wages=profit. This is represented by a productivity-wage ratio. The critical issue is not the absolute numbers of the ratio but that the ratio – whatever it needs to be to absorb supply – must remain constant.
Obviously, if supply exceeds wage increases (a violation of the productivity-wage ratio), the only way to absorb the added supply is new debt – but this has more than one consequence. The new debt not only substitutes for increased wages, but it also causes a decrease in cost to the supplier – meaning corporate profits rise dramatically, driving share prices substantially higher.
The only thing you need is low, low, low interest rates and easy, easy, easy credit access. And what do you get….
A bubble, based on debt that eliminates required wage increases of a healthy economy and at the same time reduces supplier costs (by freezing wages) that in turn magnifies corporate profits which leads to higher share prices until the whole Ponzi scheme collapses upon itself because of that evil word s-0-l-v-e-n-c-y. The fly in the ointment is that someone eventually has to really pay the bills, and no amount of sorcery or ideology can change that reality.
Doesn’t that pretty well describe what has just happened? Unprecedented corporate profits, wage stagnation, and unprecedented increases in personal debt? Ya think?
That is the gimmick that was used by Alan Greenspan and all the free marketers to bamboozle the world. It was the illusion of debt as a substitute for wages, a fantasy spun out of whole cloth that increasing asset prices could turn lead into gold.
And now you know the rest of the story…
September 20th, 2009 at 12:28 am
Stephanie Pomboy is correct as to asset inflation. Since it is harmful to the system to have any market unwind due to the overhang of debt, there will be continued asset inflation. There is no reason to stop … at any particular number such as S&P @ 1800 or 2200 or 22,000 …
until oil prices break out of the $65- 75 trading range. If oil prices go higher, the real economy will break. You can check James Hamilton or you can sit back and see for yourselves.
Oil prices at levels + $45 are causing much if not all of the economic instability. Our economy was built on dirt cheap crude and other resources. The 500% rise in crude prices since 2000 has turned worldwide business activity inside out. Credit deflation is a consequence. As to outcomes, everything will be fine as soon as oil returns to $25 or $35 a barrel … when the equivalent of four more Saudi Arabias are put into simultaneous production.
If oil prices decline outside of the 4 Saudi Arabias, it will be because an outlier has unbalanced the effects of the flood of Fed liquidity/stimulus. Who knows what that could be? It could be a crisis in China leading to flight to dollars. Or, it could be the Mets winning three in a row.
September 20th, 2009 at 1:14 am
The natural course for prices is deflationary due to productivity increases and innovation. Inflation via fiat money printing steals those productivity increases.
Secondly, inflating the currency devalues the worth of some work below others.
If you are an investment genius and you earn dollars from your work you will be able to survive in this economy. If you are a genius at fixing cars and flop at investing your money but good at saving it, you will still die destitute. Therefore inflation produced by fiat currency printing gives the bankers and their ability to invest their money a greater advantage in society over those who have to spend their entire days laboring at their skill.
It also makes those people dependent upon bankers because they can no longer put their money in a mattress and know that in 40 years time their fairly earned dollar is still worth a dollar. They either are time taxed by having to learn the skill of investing on top of their inherent skill or they are income taxed by having to pay someone to invest their money for them. Something a banker does not have to do
September 20th, 2009 at 4:21 am
A strict definition of inflation?
In a credit based economy, (that which we clearly are), the only sensible definition is an increase in money supply and credit. My own preference is credit has to be marked to market.
http://globaleconomicanalysis.blogspot.com/2009/02/fiat-world-mathematical-model.html
Those watching money supply only, ignoring the destruction of debt are really missing it big time.
http://globaleconomicanalysis.blogspot.com/2008/12/humpty-dumpty-on-inflation.html
Only those watching the destruction of credit could possibly have foreseen new all time lows in treasury yields. Those watching money supply blew it big time.
June 26 2008 Is The Inflation Scare Over Yet?
http://globaleconomicanalysis.blogspot.com/2008/06/is-inflation-scare-over-yet.html
Those focused on the CPI failed to see any chance of the Fed Fund’s Rate at 2.00 again. On the other hand, those focused on the destruction of credit from an Austrian economic perspective got this correct. That is just one reason why it makes more sense to watch the credit markets than the CPI. The second is the CPI is so distorted it is useless.
In my opinion, it is very likely new all time lows in the 10-year treasury yield and 30-year long bond are coming up.
============================+
Pick a definition wisely
A definition of inflation based on prices or money supply ignoring credit is not a good choice
BTW the 1957 Miriam Webster definition of inflation was “An increase in money supply an credit”
Think the Fed was not largely responsible for getting people to focus on prices so they could inflate at will?
Mish
September 20th, 2009 at 5:28 am
Mish,
Since all credit dollars have to be honored and thus printed up by the Treasury on demand, should they not be considered an increase in the money supply too. Thus it is a semantic argument to differentiate between credit and money supply. Credit to money is like a baby in a pregnant woman. It is still a baby, it just isn’t born yet
September 20th, 2009 at 8:52 am
A lot of comments equating money supply with inflation. I ‘m not an economist but doesn’t it also require velocity. If the money is parked in bonds ,AAII statistics indicate individuals are buying mostly bonds, instead of buying crap doesn’t that lower the ability to raise prices and increases competition for a dwindling market? My guess is that our inflation is caused by consumers not the gov.
September 20th, 2009 at 8:53 am
Only those watching the destruction of credit could possibly have foreseen new all time lows in treasury yields. Those watching money supply blew it big time.
————–
I would argue that up to now, not much credit has been destructed (written off). Yes, a lot of it is non performing but they are not letting the big write-downs happen. Investors are getting their money back (money market, CP…), banks have been given fresh money in exchange for non performing stuff and all have been investing in safer treasuries lowering the yield.
I would argue the opposite, that the reason yields have been coming down is because money is being printed faster than credit is being written down.
September 20th, 2009 at 9:02 am
A lot of comments equating money supply with inflation
———–
Most economists follow past theories (Keynes, monetarist…) forgeting (or not realizing) that each theory was a product of its times, focusing on a few variables when in fact, the economy is multi-variate. For example, we’ll go through a generation of tax cutting, then a generation of pushing supply, then a generation of cutting rates. We’ll focus on one single variable until another variable becomes totally overextended until we need to focus on that one. Human being are very linar, and economics theories clearly demonstrate this.
So those who directly equate inflation to money supply are trying to store their world in a comfortable little box, focusing on 1 single variable once again.
September 20th, 2009 at 11:02 am
Winston Munn Says:
“A commodity-backed currency is simply a representation of the commodity – I take it this is what you mean by “redeemable for”. All you are doing with this concept is taking paper and using it as a note to represent an amount of some commodity, usually gold – it is simply a gold-based system using paper for utility.”
_______________
Correct. But not just any commodity. As with the meter, the commodity must be fixed in quantity (as much as is possible), and the division of that quantity into units must be fixed in number or governed by a rule for its division into units, so that It cannot be created at will or counterfeited. Gold just happens to meet that criteria (as well as several other criteria which make it naturally valuable as a medium of exchange and a repository for value). Fiat would also work, if he who would make the proclamation of it’s existence and value — along with those who would trade that fiat “commodity” being in agreement, would fix the value and quantity of it at it’s creation.
There is a reason gold us universally accepted as having value, despite it’s relative worthlessness as a material.
When the unit of trade itself becomes a commodity (subject to revaluation by proclamation or supply at the whim of “markets” or individuals), the unit of trade is no longer valid. Anything that can be created in unlimited supply is worthless.
September 20th, 2009 at 11:05 am
Oops. Last line should read:
When the unit of trade itself becomes a commodity (subject to revaluation or supply by proclamation or at the whim of “markets” or individuals), the unit of trade is no longer valid. Anything that can be created in unlimited supply is worthless.
September 20th, 2009 at 11:09 am
Ask an economist to define inflation or search virtually any current dictionary for that word and you will discover a near universal understanding that inflation is defined as a rise in the prices of goods and services.
It really serves no useful purpose to invent a personal definition that is different than the norm and then make an argument based on that definition. Better, in my opinion, to take one’s argument and apply it to the common definition and explain how it produces affects or why it is not producing current effects.
If we use the normal understanding, then there can be real debate about the causes of inflation, such as expansion of money and credit, and an attempt to understand the timing of any causal effect of such expansion. After all, even Milton Friedman did not say inflation equates to money expansion – he said that inflation was a monetary e-v-e-n-t.
The concept that money expansion is inflationary may make sense – but in my estimation it is relatively unimportant. For example, one could double the money supply tomorrow and see a doubling of all prices, but as long as the new money were distributed throughout the economy in the same proportions as the previous day, there would be absolutely no effect on purchasing power. If I have $1 and want to buy something that costs $2, that is the same ratio as having $2 and a price of $4.
When it gets dicey, when it becomes meaningful is when price goes from $2 to$4 but earnings remain stagnant at $1.
Who profits from any debt/money expansion and in what proportion those profits are distributed is a function of policy. Enabling the rich to grow richer and the poor to grow poorer is not an accident and not the providence of natural selection. It is an event tied directly to government policy.
September 20th, 2009 at 11:18 am
Marcus Aurelius,
I have no quibble with the concept you present; however, my personal belief is that the issue of the gold standard is not about the value of the currency but about limiting the power of the federal government.
But keep in mind that it is hard to fund Empire without looting the vanquished.
September 20th, 2009 at 11:25 am
Hey, Winston,
Glad you checked back here. It’s been a good exchange. Thanks.
September 20th, 2009 at 11:29 am
“Inflation is only harmful to fixed incomes and savings. ”
Winston, you apparently believe in the neutrality of money (perhaps even the “superneutrality”). Come one, you have to go out of your way to ignore reality to believe this.
The new money clearly benefits those who receive it first, and as is most obvious now, enables bankrupt businesses that otherwise would be liquidated/reorganized to stay in business.
Its absurd to contend money is neutral. The FED G is underwriting 80% of the mortgage originations in the USA, funded by the FED’s 1.25 trillion dollar mbs purchase program. New money makes a huge difference to the real economy – its
September 20th, 2009 at 11:36 am
Last line should be-
“its impact is real.”
=================
Why are we pointing to treasury rates in support of a position on inflation/deflation? The FED is monetizing US debt, and the only grey area is the extent to which the FED is manipulating the market for Treasuries securities.
September 20th, 2009 at 11:43 am
Food for thought:
The deflation that we see is very real. It is the collapsing economy and paper financial structure. It is real deflation. But is the dollar the true base of the financial pyramid, or is this simply a temporary phenomena of the last 38 years?
Hyperinflation is a currency event that is always concurrent with deflation (economic malaise). The dollar is only paper, and it is being printed like crazy. So to measure things in dollars becomes very confusing when looking to the future. In this crisis, the health of currency is the key.
September 20th, 2009 at 11:48 am
re. Winston@11:09
I had only heard of the Austrian defintion – the definition to which you refer seems like the symptoms of inflation, not the cause…
“How Mainstream Economists Define Inflation
If you ask mainstream economists what inflation is, they typically respond that inflation is an ongoing rise in the consumer price index of more than 2 or 3 percent per annum; if the increase remains between zero and 2 to 3 per annum, these economists would speak of price (or price-level) stability…
Austrians’ Definition of Inflation
In sharp contrast, Austrians hold that inflation is an increase in the money stock, and that the upward drift of money prices is a consequence of a rise in the money stock; from the Austrians’ viewpoint, rising prices are a symptom of an increase in the money stock.”
September 20th, 2009 at 11:50 am
“But keep in mind that it is hard to fund Empire without looting the vanquished.”
Winnie,
no doubt, though, I hope you are referring to the, formerly, Free people of the united States (as well ).
as We should remember, there’s never been an ‘Empire’, projected, without an overarching State, erected.
also, We should wonder when the last time a “Free People”, on all available (contemporaneous) facts, elected to go “Empire Building”..
those Designs, found in History, are the province of perverted Statecraft, not the desire of a perspicacious Polity.
http://www.thefreedictionary.com/contemporaneous
http://www.thefreedictionary.com/Statecraft
http://www.thefreedictionary.com/perspicacious
September 20th, 2009 at 11:56 am
jr,
You may not have seen all of what I wrote:
“Who profits from any debt/money expansion and in what proportion those profits are distributed is a function of policy. Enabling the rich to grow richer and the poor to grow poorer is not an accident and not the providence of natural selection. It is an event tied directly to government policy.”
You make my own argument for me with this, “The new money clearly benefits those who receive it first…”
Who receives new money first is a policy decision – not a monetary one.
September 20th, 2009 at 12:03 pm
Mark,
Of course, the vanquished includes all that are made subservient to Empire’s designs.
September 20th, 2009 at 1:58 pm
Winnie,
Claro~
and this: “Who receives new money first is a policy decision – not a monetary one.”
is the Primary reason for the Duopoly of the USG + FedRes.
makes it easier to pass the sleight of ‘right hand/left hand’/'good cop/bad cop’ off on a somnolent/ “Soma-ed’/ drugged populace..
http://www.thefreedictionary.com/somnolent
September 21st, 2009 at 3:23 am
Pomboy, like the great majority of economic analysts/commentators, is focused on the short to mid term horizon.
Those familiar with the work of Chris Martenson will find the following quite familiar. To those who don’t know it, take a look. Lots of food for thought in there.
Postulate: One of the most fundamental assumptions underlying economic and social behaviors for the last century is about to be proved wrong.
This assumption (well, more a dogma) states that “growth is prosperity”. The obvious corollary is that growth must take place if we want prosperity.
So, how do you get constant growth in a universe with finite resources?
The answer is obvious: It is not possible. Technology can make the resource extraction and transformation to products more efficient, but cannot repel the law of physics. It’s that simple.
BTW, money growth and debt creation is only possible if the great majority believe that the future will be bigger and better than today. The rates of money growth and debt creation in the last 20 years assumed the future will be MUCH better and bigger than today.
This imply that either we will find vast amounts of new resources to satisfy population growth and fulfill the natural desire for better lifestyle, or that the basic growth dogma was an accident of history made possible by the amounts of Net Energy available thanks to an Oil-based economy, but was unsustainable over the long-term.
I think we’re about to hit the wall and realize the fallacy of the “growth is prosperity” dogma.
If the above is true, deflation is inevitable.
What’s next after that? Who knows? Hyperinflation, long period of stagdeflation, stagflation, stag-flagellation…take your pick.
I just know one thing: If one look past man-made numbers called balance sheets, earnings and all that jazz, this puppy does not look like anything we’ve seen in a very long time.
Time will tell.
November 1st, 2009 at 1:31 pm
I’m in the camp of those who believe that the near term enemy we face is deflation. Check out the 2nd chart in this article.
http://europe.theoildrum.com/node/5917
It presents total US credit as % of GDP. We’re in a far worse position by that measure than the great depression. This fools rally in stocks is merely the calm before the storm.