Fisher Price Deflation

We have all seen the recent comments by Mr T and his German friends at the ECB, Stark et Weber.

It is just worth noting that the first thing he did was to confirm the continuation of a LTRO without premium in September, a measure whose impact we just saw in short-term rates, which is a good sign.

And we are looking for the same scenario for the LTRO in December.

What interested us the most were the comments by Mr Fisher of the Dallas Fed, which we reproduce below:

• CEOs are struggling to cope with excess capacity and slack.
• They have an abundance of almost every input and output and no pricing power.
• To maintain sales volumes and clear inventories in the face of weakened demand, they are cutting prices."
• He noted that nearly half of the items contained in the PCE price basket fell in July.
• For the immediate future, the risk to price stability is a deflationary risk, not an inflationary one.
• They will continue to focus on cost control, most painfully by shedding workers and driving those who remain on the payroll to higher levels of productivity.
• The net result is that we are likely to see a prolonged period of sluggish economic performance and uncomfortably high unemployment as businessesreallocate capital and labor to fit the new economic landscape.
• The needed reallocation of labor and capital has been, and will continue to be, impeded by financial markets.
• Although substantially improved from last fall...markets are still a long way from having normalized,
• We know from our own experience and from the experience of other countries that financial headwinds like these take years to abate.
• it will be a long time before we see growth strong enough and sustained enough to make an appreciable dent in excess capacity

You can’t be any clearer, which reinforces our preferences for government fixed rate instruments.

We see the same thing in Japan, where the pace of the fall in activity has slackened (I love these PC formulations), although I doubt those affected by non-financial capital investment think it is so cute, given the 21.7% contraction incombined capital investment by Japanese non-financial companies in Q209 y-o-y, as opposed to the expected -23% (great deal!). These investments effectively declined by Y7,811.1bn, i.e. below the low point of the Q2 2002 recession. This amounts to a 50% contraction in investments, since the highs of 2007, which brings us 22 years backwards to June 1987. And this is in current yens, which surprises no one in that it is characteristic of an economy that has fallen into a deflationist trap. All of a sudden, the profits of Japanese businesses have declined 53% in one year.

But we are so lucky in Europe to have Iron Man Stark explain to us with a straight face that deflationary risks, which he assures us did not exist before, have more or less disappeared today, without seeing the contraction in his argument …

There is just one thing about which we can be sure:

As long as China continues to manipulate the yuan’s exchange rate to prevent its appreciation, and its manufacturing overcapacity and overabundance of manual labour, it will continue to play the role the world’s export deflation workshop.

It is a sort of entropic black hole dragging the rest of the world into a spiral of declining prices.

The economic sector suffering the most from the decline in investments in Japan is manufacturing, which contracted 32% y-o-y in Q2, following -21.2% in Q1.

In the meantime, the debt deflation process continues, the best example Friday being RBS (RBS).

The bank engaged in debt deflation via debt destruction, with its decision not to call certain subordinated securities, under justifiable pressure of the European Commission, which ruled on 19 August that government-funded banks should no longer pay yields on the subordinated securities part of their capital when they are posting losses. RBS and Lloyds (LYG) are also seeking to deflate their debt via the debt to equity swap process, by taking capital stakes in real estate companies in loan payment default.

Disclosure: Long 20 years OAT 0% Coupons, EDF Corp 5 Years 4.5%.

Comments

[PastTense:]

So no one else is getting these "deflationary" 10% health insurance premium increases?

Sep 05 11:06 AM

[whidbey:]

Your opening list leads to Deflation and nothing else. In the end deflation lowers earnings which lowers stock prices (when Earnings fall Price follows) . Eventually it leads to depression deflation. This is widely recognized today, and this speech is important. Thanks.

Pastense (above) says his health insurance prices have risen 10%. I bet they have, but not due to inflation. Price increases are consistent with deflation when demand for health services is based on prices " below the fixed costs of providers". Everyone on Medicare and Medicaid is being subsidized by private users of care SS FICA and private provider subsidies. Rise the price of government programs to their marginal costs and watch private providers compete for business. It is terrible government policy and a great example too. The government screws up everything it touches.

Sep 05 04:21 PM

[Pessimistic...:]

The comments regarding an inventory which is being priced to move equalling less $$ for retailers coupled to lay-offs of employees seems to be the theme of the day.

Add that to incomprehensible fear of investors hording what cash they have managed to rathole in this downtrend which reduces spending of the consumer and what good can be made of the current state of this market? If you really want to drive the nail home look at the current rate of unemployment in some cities, counties and states.

Exceeding 9.5% in some locals does not make for a recovery. I believe that we will not fully recover until the unemployment rates fall to below 3% which are some of the countrys lowest averages on record.

The injection of fresh capital by the gov't , which some say saved us from economic armageddon, has insured that sooner than later the middle class will be picking up a tab we have not yet considered what DNA strand will be footing the bill on. Basically stated, our great grand children just inherited our debt.

And now the bad news............

Sep 05 06:16 PM

[punk_ash:]

I have a feeling that the doctors will now order 2 times the number of tests for all patients who are insured, to make up for all the revenues from those who cannot afford. That means more radiation in our bodies.


On Sep 05 11:06 AM PastTense wrote:

> So no one else is getting these "deflationary" 10% health insurance
> premium increases?

Sep 06 02:48 AM

[granger:]

under disclosures, I found EDF

But can you clarify OAT? is that the symbol?

Sep 06 08:28 AM

[Greame H:]

While the procession of logic makes sense on the face of it, I do feel it's essentially a static analysis. I don't think you can ignore the
tidal waves of government spending , nor the money supply and velocity. Tipping points can occur and a deflationary vortex can change quite quickly into an inflationary spiral. Keep debasing a currency and see which outcome prevails !

Sep 06 09:53 AM

[W.E. Heasley:]

Interesting Article.

Your article appears to elude to cost-push deflation (reverse of cost-push inflation). Friedman basically theorized that cost-push inflation (Keynes, Tobin, etc.) was only temporary in nature. It would seem logical cost-push deflation is temporary in nature.

You mention:

“As long as China continues to manipulate the yuan’s exchange rate to prevent its appreciation, and its manufacturing overcapacity and overabundance of manual labour, it will continue to play the role the world’s export deflation workshop“.

Believe that at one point Greenspan pointed to low cost items imported from China contributed to a low inflation rates in the US.

Fisher’s statements are accurate. Business operations of most sectors are experiencing weak demand with no pricing power. Business must adjust their Production Function to accommodate the current environment.

However, what “demand” that remains, the price at the intersection of demand and supply may well end up experiencing inflation rather than deflation. That is, Central Banks affiliated with the G-7 have created easy money via QE and artificially low interest rates. Inflation is surely a Monetary event. Too much money will cause demand to accelerate bring you to the point of too much money chasing too few goods.

In the background of your argument exists the following: in many advanced economies the situation is that they have simultaneously deployed QE and Government Deficit Spending in a hyper-debt environment. One must remember that QE and Government Deficit Spending are theories that were developed in zero or low existing Government Debt.

Sep 06 11:24 AM

[user 777:]

could you please let us know what LTRO at least stands for?
Cannot find it.

Sep 06 01:54 PM

[American in...:]

That's not true. Japan experienced deflation for a decade with ample M1 money supply growth.

All the money supply growth was offset by a consistently declining velocity of the same monetary aggregates.

Friedman was wrong. He claimed that velocity is always stable. Not true.

In fact, velocity of money is quite erratic and strongly influenced by interest rates (the higher interest rates, the greater the penalty for holding money).


On Sep 06 11:24 AM W.E. Heasley wrote:

> Interesting Article.
>
> Your article appears to elude to cost-push deflation (reverse of
> cost-push inflation). Friedman basically theorized that cost-push
> inflation (Keynes, Tobin, etc.) was only temporary in nature. It
> would seem logical cost-push deflation is temporary in nature.<br/>
>
> You mention:
>
> “As long as China continues to manipulate the yuan’s exchange rate
> to prevent its appreciation, and its manufacturing overcapacity and
> overabundance of manual labour, it will continue to play the role
> the world’s export deflation workshop“.
>
> Believe that at one point Greenspan pointed to low cost items imported
> from China contributed to a low inflation rates in the US.
>
> Fisher’s statements are accurate. Business operations of most sectors
> are experiencing weak demand with no pricing power. Business must
> adjust their Production Function to accommodate the current environment.
>
>
> However, what “demand” that remains, the price at the intersection
> of demand and supply may well end up experiencing inflation rather
> than deflation. That is, Central Banks affiliated with the G-7 have
> created easy money via QE and artificially low interest rates. Inflation
> is surely a Monetary event. Too much money will cause demand to accelerate
> bring you to the point of too much money chasing too few goods.<br/>
>
> In the background of your argument exists the following: in many
> advanced economies the situation is that they have simultaneously
> deployed QE and Government Deficit Spending in a hyper-debt environment.
> One must remember that QE and Government Deficit Spending are theories
> that were developed in zero or low existing Government Debt.

Sep 06 03:45 PM

[tripleblack:]

If we were going to experience inflation driven by M1 dolalr surpluses, this would have already occurred, and we would be witnessing the second wave as it accelerated due to the huge oceans of liquidity set in motion during the last 6 months.

Of interest will be whether or not the world econonomic powers once again back Washington's play, which looks to be more of the same.

For money to be in the system chasing assets, it must first EXIT the banks. With lending standards in a perpetual state of chaos, a situation aided and abetted by the very same bureaucrats vowing NOT to "pull back prematurely" in their efforts to address the recession...

Don't look for banks to open the flood gates to potential customers any time soon.

One potential group of customers not getting much notice just yet...

Local governments who can borrow money (or who issue bonds). I would predict a dramatic easing of the various restrictions on this group to funnel megatons of money into local governments, with States following close behind.

Private enterprise (other than the political winners who have some special claim) will be spurned when the money spigots creak open, left at the altar, stuck in a precarious position circling the drain, starving for capital, but not QUITE pulled under.

Sep 06 08:07 PM

[LKofEnglish:]

not everyone is getting squeezed. plus this is a private economy not a public one. in other words, no profit from producing=simply produce less. fisher really is a texas moron if he actually believes this hooey. inflation is too much money producing too few goods. only a fed bank governor would look at goods and, while printing money in the trillions say, "look, fewer goods=lower prices. yaaaaaayyyyy!!" and will you all leave it alone with japan for once. THEY HAVE NO RAW MATERIALS TO PRODUCE ANYTHING PERIOD. OF COURSE THEY SUFFERED A HUGE DEFLATION WHEN THEIR CENTRAL BANK BURST THEIR STOCK MARKET BUBBLE. THE ALTERNATIVE WAS RICE FARMING AND THAT WASN'T PROFITABLE EITHER. Besides, certain private american interests moved in and created TOYOTA which cleaned out GM and Chrysler without even breakin' a sweat. Not bad for a "worthless economy," no? In other words the only thing dumber than Fisher is quoting the guy. GOLD PRICES ARE ABOUT TO SOAR TO OVER $1000 AND A SO CALLED BANKER IS BLABBIN' ABOUT THE PROBLEM OF DEFLATION!!!

Sep 07 12:49 AM

[Erwan Mahe:]

Yes ir. OAT is the namle for french Government bonds.


On Sep 06 08:28 AM granger wrote:

> under disclosures, I found EDF
>
> But can you clarify OAT? is that the symbol?

Sep 07 03:13 AM

[Erwan Mahe:]

LTRO is the Long Term Refi Operation, which is used by the ECB to provide 1 year funds to banks in the Eurozone, at 1%, up to any amount requested.


On Sep 06 01:54 PM user 777 wrote:

> could you please let us know what LTRO at least stands for?
> Cannot find it.

Sep 07 03:18 AM

[Erwan Mahe:]

keep cool LK, otherwise you may have to wait waaayy longer to sit again on any trone...
But go on betting that gold will 'soar to over 1000$' when it trades 998, and you may be right, incidentally, from time to time...

On Sep 07 12:49 AM LKofEnglish wrote:

> not everyone is getting squeezed. plus this is a private economy
> not a public one. in other words, no profit from producing=simply
> produce less. fisher really is a texas moron if he actually believes
> this hooey. inflation is too much money producing too few goods.
> only a fed bank governor would look at goods and, while printing
> money in the trillions say, "look, fewer goods=lower prices. yaaaaaayyyyy!!"
> and will you all leave it alone with japan for once. THEY HAVE NO
> RAW MATERIALS TO PRODUCE ANYTHING PERIOD. OF COURSE THEY SUFFERED
> A HUGE DEFLATION WHEN THEIR CENTRAL BANK BURST THEIR STOCK MARKET
> BUBBLE. THE ALTERNATIVE WAS RICE FARMING AND THAT WASN'T PROFITABLE
> EITHER. Besides, certain private american interests moved in and
> created TOYOTA which cleaned out GM and Chrysler without even breakin'
> a sweat. Not bad for a "worthless economy," no? In other words the
> only thing dumber than Fisher is quoting the guy. GOLD PRICES ARE
> ABOUT TO SOAR TO OVER $1000 AND A SO CALLED BANKER IS BLABBIN' ABOUT
> THE PROBLEM OF DEFLATION!!!

Sep 07 03:23 AM