Deflation Changes the Rules 16 comments
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Are American high tech companies the big winner from the current bouts of deflation? Is the US itself a winner? Remember, deflation changes all the rules we've been used to. You've got to think upside down now that cash is king, at least temporarily.
Fred Wilson points out that companies like Microsoft (MSFT), Google (GOOG) and Apple (AAPL) have loads of cash and no net debt. He speculates that the others will emulate Microsoft and do massive stock buybacks at their current relatively low trading prices. That would be a pretty boring use of all that cash. Remember that traditional companies in our economy – phone companies, for example – run on mountains of debt. Debt's hard to get now (how's that for an understatement?). Debt you've already got is hard to roll over. Is there an opportunity here?
Well, the high tech companies have been fretting that the phone companies will become gatekeepers on the Internet and suck value and tolls out of the exchanges between the high tech companies and their customers. Should Google just buy AT&T (T)? Or supply it with financing? Should Intel (INTC) begin making the guts of cars and Microsoft supply operating systems for them? I'm sure there are better and more exciting ideas than these, but we are in a time when the nouveau cash rich can run roughshod over the debt-ridden legacy companies even though the two are not usually thought of as direct competitors.
And what about the US itself? Certainly we've got plenty to worry about in our own market meltdowns; most pundits' first reaction was to say that the financial crisis was a step in the downfall of the US. If so, how come the dollar is going up against almost every currency except the Yen? We worried that foreigners might not be willing to finance the borrowing that the US is doing (wisely or unwisely) to prop up markets. Well, the foreigners voted with their money and the interest rate on US bonds keeps going down – for short term US notes the real interest rate is below zero: Uncle Sam is being paid to hold the world's money.
I have a theory about that. See, cash is king, but what's cash? Most of us don't keep it in our mattresses. It's not gold, because that goes down in times of deflation. It used to be money in the bank counted as cash, but people have gotten so nervous about banks that even the strongest are being partially nationalized. Money funds now have a limited guarantee for old deposits in the US, but not much of the rest of the world. So what's cash? Turns out for many people it's an IOU from the US – all anti-Americanism aside for the moment.
Hmmm…
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This article has 16 comments:
I beg to differ you can buy more commodities with gold at 880.00 today than when it was a 1000.00 - more gas- more oil -more corn- more copper - yes the price of gold has gone down but its cash value has increased when compared to all commodities - thats the best cash
how could Google buy AT&T and still keep its corporate motto?
You can buy more gold with $1000 (US) cash today than when gold was at $1000; that's why cash is king. Gold may be better than oil or corn at the moment but it's not cash.
"King is dead, all hail the king." The problems with kings is that they come and go. So even if the Fed IOUs are the king at the moment, gold may soon be the our king again.
It is possible, when there is a lot of turmoil (political, economic, etc.) outside the U.S. relative the U.S. itself both gold and U.S. currency can appreciate. Of course, depending on the relative demand and supply of each their relative prices will fluctuate with respect to each other.
Gold is an interesting question in deflation. We cannot learn from the history of the depression as currencies were unwinding from the gold standard then and then the US government confiscated all the gold in the USA. I have heard several sources that sell gold saying that their sources have dried up in the last week, bullion is hard to get. With supply drying up, the price should be going through the roof, but is not.. Something unusual is going on here...
I would say there are current technical factors as to why the dollar is going up, like European Banks having to raise dollar reserves to cover their dollar denominated mortgage securities (can anyone spell lumps of shi*). The Libor rate is through the roof so they have to go out on the market to buy dollars. How long this will last is anyone’s guess, but eventually the Fed pumping billions and now trillions a day out its window will have to lead to some kind of dilution of Uncle Buck.
Will inflation or deflation win? All of the dollars pumping would say inflation; people quit buying things, losing their jobs and no credit for anything would say deflation. No wonder we all getting whipsawed everyday as deflation and inflation tear each other to pieces. Who ever wins may not leave many of us standing.
Good point YR Dog. Judging by the whipsawing in currencies and commodities, it looks like the market is unsure as well. Perhaps if the mega-bailouts work (or if they don't and the economy recovers in '09 or '10 anyway) we will see inflation. Perhaps if consumer spending finally slows and job losses increase, we will see Japanese-style deflation or a depression. Perhaps it is more likely we will have 70's style stagflation. For some reason, all the articles talking about stagflation have disappeared and been replaced by either inflationary or deflationary arguments.
Note that if we weren't running massive deficits paying for the underwater mortgage investments of foreign sovereign wealth funds, we would be talking about a run-of-the-mill recession with no significant currency effects. That's how stupid we are to have become so dependent on debt to finance our government and lifestyles.
I think we already had some of this and perhaps we will have some more provided that the government succeeds in stabilizing the economy (I'm in this camp). If it doesn't I think that deflationary recession is in the cards. I don't feel that we're in for a traditional inflationary scenario.
I remember the 1970's when the Fed was trying to unwind the unpaid debt of the Vietnam War plus Great Society by inflating. Meanwhile, the economy was stagnating with low growth and high unemployment. If you think that whoever is elected president in November will cut spending, thereby easing the pressure to create cash for the Treasury to borrow, then you may believe we can avoid the inflation scenario.
Alternatively, the world may be so investment shy that it will pile balance-of-trade dollars into the Treasury, financing more debt at low rates. The new administration and Congress will own the economy, and should they want to spend money, what they want to buy will be produced, be it howitzers or health care, which is likely to drive up prices in the favored sectors due to the increase in demand. Meanwhile the stagnation, the drop in demand, will be felt in the consumer goods sector -- including houses -- unless they start throwing money from helicopters, which brings us back to the inflation scenario again. As I see it, the only way to avoid the inflation scenario is to somehow generate a rapid increase in productivity, but when have we seen this except where the conditions are ripe for entrepreneurial risk-taking based ultimately on supplying real consumer demand? In other words, every scenario leads to inflation while at the same time every scenario leads to a recession in the non-government sector of the economy, which is the only productive part.
So the answer is: Stagflation.
As far as I can tell, the only way out of stagflation is to bite the bullet, squeeze the money, allow the recession, and clean out the bad debt.
But we don't believe in those politically dangerous recessions any more, do we? We believe that the government should be able to fix anything. They have the guns, don't they? Just have them _force_ people to produce. And maybe throw another trillon dollars at the bankers -- that sounds productive. Yeah, that's the ticket! /sarcasm off...
The big unknown is what the govt. can do at any point in time. I'm afraid to use my imagination.
It's been mentioned that well over $2 trillion has been lost in the equities market, and this is on top of $2 trillion in real estate values.
Let us suppose that the environment gets a a little worse from here and the total capital base erodes to the tune of $5 trillion. Unless I'm missing something, it will be all but impossible not to have deflation.
On a related note, it is interesting that there has been very little talk about confiscating the fortunes made from this debacle. Surely, between a couple hundred major players we could come up with several hundred billion dollars. That could go a long ways toward shoring up the FDIC and such.