Not Your Grandpa's Deflation 15 comments
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Common wisdom holds that depressions are inherently deflationary. The United States in the 1930's. Japan in the 1990's and 2000's.
Combine a depression with other deflationary factors going today in the US - demographics, deleveraging, falling asset prices, even productivity - and you've got some serious deflationary headwinds.
(As a side note - I've warmed to the view that gentle deflation, as a result of increasing productivity, is the optimal, and honest, situation that promotes both savings and economic growth. It's silly to label all deflation as "bad" or "evil"...how can deflation created by increased productivity be bad? But I digress.)
Ben Bernanke, a student of the Great Depression, believes that the Depression could have been averted if deflation had been averted.
Determined not to repeat the mistakes of history - or what he thought were the mistakes of history - Bernanke took unprecedented measures...first, lowering interest rates as far as they would go...next, utterly trashing the Fed's balance sheet...and finally, when all else failed, he cranked up the printing presses.
Printing money always leads to inflation - in fact, printing money, or quantitative easing, is inflation. Rising prices - which follow - are the symptoms of inflation.
But what if you just print the money "for a little while"? That's right - print it up, float it out there to keep the economy from grinding to a halt - and then when things are moving again, start to pull it back in.
Doesn't it sound insane?
Well, this is what is being tried. And as hyperinflationary as this sounds, even the most fervent inflation hounds believe it will be a year or two or three before we start to see inflation creeping into the system.
Too much credit was destroyed, the velocity of money slowed down too much, and logical reasoning dictated that it would take the Fed time to print enough to make up the gap, even at the rapid rate in which they were printing.
Then a funny thing happened while we were chilling out, getting comfortable, and generally not worrying about inflation - commodity prices started to move up. The dollar started to drop. Bond yields started to climb.
Falling Dollar, Rising Bond Yields = An "Uh Oh" Sandwich
Remember when every investor in the world was worried about the dollar's poor fundamentals? McDonald's was poking fun at the dollar in its commercials, music videos were flashing euros, supermodel Gisele Bundchen asked to be paid in euros rather than dollars.
That marked a bottom - at least a short term bottom - in the dollar. Everyone was on the same side of the trade - short the US dollar.
When world financial markets collapsed, a global "flight to safety" and massive short covering propelled the dollar up, up, and up.
For a while, nobody worried about the dollar's fundamentals, at least in the short term. The Fed's printing money? Hey, no problem, the dollar's still the world's reserve currency. Besides, other countries are printing money too. Why worry?
In the meantime, the dollar quietly began to slide, and the dollar index is now sitting at its low point for 2009:
It's a quiet race to get rid of US dollars once again.
(Source: Barchart.com)
Makes you wonder if currency fundamentals do, in fact, still matter, if printing money is indeed bearish for the value of the currency being printed.
Meanwhile, what has the Fed been doing with its newly printed dollars? It's been buying long dated US Treasuries to keep yields down!
Nobody else is buying this trash, so it's up to our printing presses to pick up the slack. The Fed announced this "newly printed cash for trash" program last December - when yields on the 10 and 30 year bonds were dropping, and deflation was king.
Common wisdom held that deflation, combined with these "monetization purchases" by the Fed, would continue to drive rates down, possibly all the way to zero.
But a funny thing happened on the way to Japan - rates bottomed on December 18, 2008, and have been climbing ever since! Long dated Treasuries have been slammed throughout the first half of 2009!
30-Year Treasuries are not behaving like we're in a deflationary environment
(Source: Barchart.com)
Uh oh...this is not good. What a Fed to do?
If they let interest rates rise - that will surely squash whatever is left of the US consumer. Green shoots turn into marijuana buds - game over.
But the only way to prevent interest rates from rising in the near term (short of cutting government debt, which we know is not going to happen) - is to step up their purchase of long term bonds.
So applying a little game theory to the Fed's current hand - we have to expect them to sacrifice the dollar.
The twist, I believe, is that the dollar could get trashed quite soon. So I would strongly advise you to take a hard look at your savings and investments - right now.
Charts don't lie. No matter what our personal beliefs or biases are about the future, no matter what we think is going happen - we have to defer to what the markets are telling us. And right now, the markets are starting to say "uh oh."
It could be a breathtaking move out of the dollar - it's value could feasibly get trashed in a matter of weeks, days, or even hours. Don't be the one left holding the "Old Maid" card as the rest of the world runs for the exits.
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This article has 15 comments:
"Printing money always leads to inflation - in fact, printing money, or quantitative easing, is inflation. Rising prices - which follow - are the symptoms of inflation."
Price 'inflation' is so uneven across goods, services and asset classes that to use one single metric to attempt to gauge price 'inflation' is a misleading oversimplification.
We need to think in terms of the 'effective money supply' for individual goods, services and assets and the effect on the prices of those individual goods, services and assets.
The effective money supply chasing real estate will continue to fall so real estate prices will continue to fall.
The effective money supply to purchase commodities will continue to rise and prices will continue to rise.
If we just looked at an aggregate measurement of price increases and called that 'inflation' then it would all be a wash and we would all be Larry Kudlow crowing about a 'goldilocks' inflation environment.
But as the fed prints money, the rest of the world seeks alternatives to the USD as its reserve currency and continues to seek the necessities to sustain its citizens and economies.
The countries on the other side of our current account deficit will be shedding USD and increasing the effective money supply chasing necessary items like food, water, industrial metals and energy. These items will experience price 'inflation' in spite of the continued US economic slowdown.
On May 25 08:49 AM D. McHattie wrote:
> Great article.
>
> "Printing money always leads to inflation - in fact, printing money,
> or quantitative easing, is inflation. Rising prices - which follow
> - are the symptoms of inflation."
>
> Price 'inflation' is so uneven across goods, services and asset classes
> that to use one single metric to attempt to gauge price 'inflation'
> is a misleading oversimplification.
>
> We need to think in terms of the 'effective money supply' for individual
> goods, services and assets and the effect on the prices of those
> individual goods, services and assets.
>
> The effective money supply chasing real estate will continue to fall
> so real estate prices will continue to fall.
>
> The effective money supply to purchase commodities will continue
> to rise and prices will continue to rise.
>
> If we just looked at an aggregate measurement of price increases
> and called that 'inflation' then it would all be a wash and we would
> all be Larry Kudlow crowing about a 'goldilocks' inflation environment.
>
>
> But as the fed prints money, the rest of the world seeks alternatives
> to the USD as its reserve currency and continues to seek the necessities
> to sustain its citizens and economies.
>
> The countries on the other side of our current account deficit will
> be shedding USD and increasing the effective money supply chasing
> necessary items like food, water, industrial metals and energy. These
> items will experience price 'inflation' in spite of the continued
> US economic slowdown.
but what then happens to our savings where he says CHECK YOUR SAVINGS?
THANKS
Buying the Keynesianism that a little inflation is o.k. is a political consideration not an economic one. On the trade off of inflation/unemployment it is human nature to choose inflation, unless it is some other guy being unemployed It should be remembered that this is an emotional choice and not an economic one and not necessarily sound. But, we are a "feel good society" where perceptions are more important than reality - some think perceptions are reality which is really naive.
Inflation, aside from being a hidden tax, is an abject example of a country losing all of its economic discipline and can lead to totalitarianism - "don't let a Crisis get away", the mantra of the BHO Administration.
It is difficult to have inflation when there is too much surplus capacity (high supply) and too little demand (job losses, and no credit availability)
Yes this is not your Grandpa's Deflation, it is your Deflation - home prices and wages continue to fall - as everyone can see personally.
the imperial palace in tokyo, had it been available for sale, was worth more than the entire state of California.
even when deflation dropped the property prices by 90%, it remained one of the most expensive places to live on earth.
deflation is not always a bad thing. the double digit interest rates in the 70's were tamed by a decade of deflation in the 80's. in hindsight, we all agree deflation was good..... sometimes.
Currency devaluation. Your article says it well. The problem is, all the casual talk about "deleveraging" does not adequately explain the extent to which our entire system--in terms of asset valuations--is underwater. We're simply looking at debt-to-GDP.
Reagan got the ball rolling, Bush only perfected deficit spending as a goal to reduce the size of government by choking it off - by any means necessary (the obvious preferred means was by incompetent governance).
P.S. save your thumbs down for someone who cares.
Brett you seem to be wrong. The dollar is making a double bottom and is headed up. Gold makes no sense. Its made a double top and is headed down.
We are in a deflation which is a badly needed correction. The govt. is incapable of changing this fact.
To the author: thanks for an unusually entertaining read. I actually chucked aloud at some of your witticisms.
...and, at the same time, I find that there's nothing I really want to buy. The family has 3 cars that are of high quality, a house that suits and more computers/TVs than I know what to do with.
What have I bought recently? tooth implants. This "filled" a real honest to god unmet need. There is an ocean of unmet need in regenerative medicine...but I DEFINITELY do not need yet another car.
So, credit is truly disappearing even for the well-to-do, savings are increasing for those who can, there's little in the way of "gotta have" purchases, all implying continued drops in velocity of money on the consumer side...and that's for people who still have jobs/assets.