Mish Shedlock's Inflation Scorecard: June 2009 Update

Mish Shedlock, other than engaging in an online battle of economic punditry with Peter Schiff, wrote an article at the very end of 2008 attempting to sum up the arguments for and against inflation in the US.

His core argument was that the rapid expansion of the Fed's balance sheet was not going to be inflationary in the face of the much larger contraction in credit that is still ongoing. He listed a series of indicators that were meant to be a scorecard of the deflation versus inflation debate, which at the time, they all agreed that the direction was deflation (by his scoring not mine, but I am not arguing with his point).

1. Falling Treasury Yields: At the start of 2009, the 1 month bill yielded a measly 0.04, rising until in mid-February they were at 0.26. However, a leg down and up in the market later, and they are back down to 0.10 as of the time of this writing. Overall yields for Treasurys are still low by historical standards, but not necessarily falling. Edge: Deflation
2. Falling Home Prices: Federal programs, foreclosure moratoriums, and other stop-gap measures have been tried, but prices still continue down. Large "shadow inventory" and huge number of underwater homeowners suggest no near-term recovery. Edge: Deflation
3. Rising Corporate Bond Yields: A really great run for the first half of 2009 has pushed the yield on corporate bonds down significantly. Though there is still expected to be 14-16% default rate (says MS), it was much worse around New Years. Edge: Inflation.
4. Rising Dollar: The dollar has been all over the place, rising strongly to start the year, big fall in late-Feb, fought back up by early April, then another big drop until the beginning of June. Right now, lower than it was for most of the last 12 months, but higher than the 12 months before that. Edge: Inflation.
5. Falling Commodity Prices: S&P GSCI is up 25% in just a quarter, but year to date commodities are only up 6.5% and down 60% YoY. Edge: Deflation.
6. Falling Consumer Prices: CPI is zero or negative for most categories, and the Case-Schiller CPI is negative for many months now. Edge: Deflation.
7. Rising Unemployment: Even an optimistic White House admitted 10% is a certainty and rising to 12% is not out of the question. Edge: Deflation
8. Negative GDP: GDP will contract sharply in 2009, and consensus is for a feeble 2010 with minimal growth. Edge: Deflation
9. Falling Stock Market: Still way down YoY, but essentially even YTD. Plunge in early March to 12-year lows, but huge rally since. Hard to call it falling, but much wealth has been destroyed. Edge: Push
10. Falling Credit (Market to Market): Credit card default rates, home foreclosures, and commercial real estate troubles will all cause significant losses that are not yet realized. Though banks have been made to hold reserves against these, there would be more losses were the loans marked to market if sold to investors now. Edge: Deflation
11. Spiking Money Supply Percentage Wise: Not sure that this is actually an indicator of deflation, but it is assuredly the Fed's prescription for the liquidity issues of many banks. Since this did happen during the Great Depression, Mish marks it down as deflationary, but inflation proponents believe that this is the very cause of inflation. Banks clearly aren't lending it, but nothing would stop them from doing so. Since we can't have it both ways, I'm going to call this as push as well. Edge: Push.
12. Banks Hoard Cash: As per the requirements of regulators (and just prudent business in a recession), banks are selling assets, holding large reserves against potential losses, deleveraging loan portfolios, and making fewer loans. Edge: Deflation
13. Rising Savings Rate: Went from below 1% (2005-2008) to over 4% in Q109. Attitudes have changed, making it less likely to return to the low rates of the mid-2000s. Edge: Deflation
14. Purchasing Power of Gold Rises (relative to other commodities): Since the collapse of oil prices in Mid-2008, gold has risen in value versus other commodities. Gold has held strong, and the ratio has yet to move anything close to the lows of ~7g/bbl. Edge: Deflation
15. Rising Number of Bank Failures: FDIC has shut down 40 banks so far in 2009, and there is likely no end in sight for small to mid sized banks that can't get TARP money or access to the liquidity facilities. Few expect this trend to end soon. Edge: Deflation

Total Score: 11-2-2 for Deflation, but not the 16-0 of December 2008.

Clearly, many of the actions of the Fed and Treasury would be very inflationary under normal conditions of full employment, economic growth, and well-functioning global trade.

But that is assuredly not the case now, and until many of the indicators he listed turn to the positive, I expect that we will feel the effects of deflation or at least very low inflation.

For all of the efforts to expand the monetary base and jump start lending, the individual decsions of households and companies will continue the contraction in credit, leading to a net decrease or at least minimal growth in the overall effective amout of money (currency plus credit).

Comments

[Between The...:]

Correction: The gold to oil ratio referenced should have the units bbls/oz, not g/bbl.

Jun 24 06:28 AM

[Righteous Dude:]

11 out of 12 things you list are things that journalism majors like to talk about -- but have little if anything to do with inflation

Jun 24 09:23 AM

[Glen L.:]

It's the same old misunderstanding: monetary inflation vs. price inflation. There is no question we've had monetary inflation, as the Fed has more than doubled the money supply. Banks have parked TARP funds back in the Fed at rock bottom interest rates, afraid to lend in this market, therefore most of the new money has not made it into the general economy. From here, price inflation is a matter of when and how fast that money does enter the economy, as it surely must. The safest prediction, in my opinion, is mass, but not hyper, inflation, beginning next year. The genii at the Fed will sort everything out, not to worry..... :-(

Jun 24 10:47 AM

[Ken Sherman:]

Mish defines inflation as expansion of money and credit. According to this definition, we are experiencing deflation because the huge amount of credit in the system has collapsed. Thus, declining equity and home prices. Can the Fed print enough money to replace all of the lost credit? Certainly. Looking forward, guess who will get to spend the money? Why, the government, of course. The US central government has first use of all the newly printed dollars. Thus, the government will get bigger, and the private sector smaller. Corruption will increase. There will be more bureaucrats telling you what to do - it's their job after all. Taxes will rise to service the debt. Unless you are a government contractor, you won't have cash to raise salaries. Government (& govt contractor) salaries will keep pace with inflation, but private salaries will lag. Remember, some animals are more equal than others. In the Soviet Union the party members lived well, while the mass of the population was poor. If you want to get a glimpse of the future of the west, look to the states of the former Soviet Union. 60 hour+ work weeks for those lucky to have a job. The equivalent of $200/month salaries. The inflation/deflation debate is really not that helpful. The central question of economics is the allocation of goods and services. It goes to those who have the money. How should you invest in such an environment? Gold is the best store of value, but you may not be allowed to keep it. Invest in necessities - energy, food, commodities. Any gains will be heavily taxed, though, so it may not be worth the risk. Buy a farm and live on it. Hopefully you will be allowed to keep your private property, but you will be heavily taxed for the privilege, forcing you to work to earn dollars. Most of us will just get poorer, while the politically connected get richer.

Jun 24 11:49 AM

[CLH:]

Mish is right and Schiff is crazy as a fruitcake.

If gold sails past 1000 I will change my mind. I sold my gold in March of 2008 at 1000 and dont regret it.

Jun 24 01:07 PM

[Carlos Lam:]

When all is said and done, the investor wonders: what is the greatest threat to my purchasing power? Food, energy, and insurance--things that we buy on a constant basis--are rising in price. Real estate--which we buy infrequently--is sinking in price. The rising food, energy, and insurance prices affect the consumer's psyche; they see the rising costs more frequently and, accordingly, are more affected. I respect Mish's ability and writing, but I will not believe his "general deflation" thesis until I begin paying LESS for a BIGGER box of cereal; purchase gas for under $1/gallon; and see health and auto insurance come down.

Jun 24 03:16 PM

[austrian63:]

That's all very nice but all has to do is look at a few historical and empirical facts:

Check out the historical chart of the CPI for all items from 1913, the birth of the Fed to May 1, 2009.

research.stlouisfed.or...

Sorry about the link. Paste this into your browser. Does anyone seriously think we are at risk of an appreciating dollar because that is really what deflation entails. The past 96 years shows no evidence of a tendancy for sustainable deflation in a fiat currency regime. The period from 1921 to 1941 had relatively flat price levels but once deficit spending was in vogue, this stability disappeared forever.

You can look at the various charts on the St. Louis Fed's web site for differenct periods, etc. The trend toward inflation/currency devaluation is the same.

Jun 24 11:18 PM

[Between The...:]

On Jun 24 11:18 PM austrian63 wrote:
> Does anyone
> seriously think we are at risk of an appreciating dollar because
> that is really what deflation entails. The past 96 years shows no
> evidence of a tendancy for sustainable deflation in a fiat currency
> regime. The period from 1921 to 1941 had relatively flat price levels
> but once deficit spending was in vogue, this stability disappeared
> forever.

Japan 1987-present is a fiat regime which experienced sustained deflation. The contraction of credit and asset values was so large that it did cause appreciation of the yen even though the Japanese government deficit spent it's way to ~175% of GDP in debt. Don't think it can't happen in the US.

Jul 16 02:50 PM

[austrian63:]

There is an excellent article by Richard C B Johnsson that shows the CPI index in Japan fluctuated between +1.0% and -1.0% year over year from 1993 to 2001. I would call this price stability not deflation.


On Jul 16 02:50 PM Between The Numbers wrote:

> On Jun 24 11:18 PM austrian63 wrote:

Sep 18 01:37 PM