Tack

Extraordinary Popular Delusions and the Madness of Crowds

Just two quick rebuttals:

1) The current situation is nothing --not even close-- like the '30's deflation. In the '30's the money supply, due to a tragic government mistake, contracted from 1929 to 1935, whereupon it began to exapnd again, but didn't even reach 1929 levels, again, until the end of 1938. This was the proximate cause of the deflation, and the government's lack of recognition of the mistake they made, followed by a rather tepid attempt to correct it, resulted in many years of deflation and stagnant economic circumstances.

There was debt contraction then, and debt contraction now, but, now, there''s been a flood, worldwide, of currency introduction that will have dramatically different consequences than the '30's.

The trouble is that in today's impatient world if we don't see the logical and inevitable effects of these actions in a few months or a year, we immediately conclude that 'this time it's different," and formulate new theories. It's not different, and the consequences of a monetary flood will be the same as they've been in all other economic contractions, but possibly more so this time, given the unprecedented magnitude of the monetary largesse.

2) Everybody repeats over and over, ad nauseum, that all that new capital is tied up on bank balance sheets and isn't and won't be used for anything other than to counterbalance worthless paper, that, if it were marked own to true market values, would make many banks insolvent.

There are two problems with this argument: a) the mark-to-market values that critics espouse were/are nothing more than the result of highly-manipulated and thinly-trade debt indices that clever shortsellers used, in conjunction with CDS positions, to decimate bank balance sheets and the market. They bear no relationship whatsoever to classical valuations based on actual cashflows being received and expected to be received by the actual note holders. That's why holders of debt assets re unwilling to dump them at nonsensical prices, thankfully, as this would result in the destruction of the financial system because fictitious losses, represented by "market" values, would suddenly be realized; b) for those that wish to track such information, the beleaguered debt indices that created all this angst have been steadily rising for several months, narrowing the gap between the genuine value of debt assets and the hysterical values previously created in the markets. Soon, this will result in the banks having excessive reserves that will start to be released back into earnings and will result in the banks being overcapitalized.

When the foregoing happens, banks will start looking assiduously to put all that "dead" money to work. Coupled with increasing confidence by the vast majority of people employed, this will result in an increase in loan demand that will find amply funds to service it.

The real risk for this economy, as with previous periods of monetary largesse, is that the government will fail to make timely reduction in the money supply until the demand-inflation cycle is well under way, so we'll get the same inflation that has followed most recessionary recoveries.


On Oct 15 07:49 PM derryl wrote:

> Tack wrote,
> "This scenario has been repeated time and again throughout history.
> The price of everything, as measured in fiat currencies, only progresses
> higher over time. The idea that prices will decline systemically
> and stay there has no factual historical basis whatsoever."
>
> The deflation we are talking about is not the idea that prices will
> decline and stay there forever. It is the historical precedent of
> the 1930s balance sheet depression where asset prices (stocks and
> real estate) collapsed and took decades to recover to their 1929
> nominal prices. CPI does not change in direct relation to money supply
> (productivity gains can produce more goods to absorb increased money
> without prices rising, for e.g.). Asset prices do. So it's asset
> prices that inflate and deflate, not CPI prices.
>
> Loan defaults and personal and bank bankruptcy all destroy money
> supply. Money supply and GDP move together, both up and down. So
> when money supply is contracting/deflating GDP contracts/deflates
> with it. Unless there is some renewed exuberance among borrowers
> to take on new debt to re-expand the money supply and the economy,
> the contraction can continue for a very long time. That's where we're
> at right now, overindebted, losing jobs, defaulting and going bankrupt,
> and unwilling or unable to take on more debt.
>
> A balance sheet recession happens when too many people took on more
> debt than they can repay, especially if their income takes a hit,
> and the asset prices that were supported by that debt-money collapse.
> Those collapsed-value assets are the collateral the banks were holding
> against the loans and when the assets are marked to a 20% down market
> value the banks don't have enough capital to extinguish the losses
> so they are insolvent. By law they are then taken into receivership
> and restructured or dissolved, but now bailouts that are presumed
> to be funded by future taxes keep 'too-big-to-fail' insolvent banks
> alive.
>
> The Fed has created something over $1 trillion of new money to buy
> toxic assets from failing banks, but this new money ends up on the
> asset side of bank balance sheets where they must hold it against
> their liabilities on the other side of the sheet. The banks were
> failing because the value of their asset side was shrinking. The
> Fed replaced shrinking assets (mortgages and other loans the banks
> had made) with "cash".
>
> But banks have to HOLD their assets, or trade or sell them for better
> assets, so they can meet their liabilities as demanded. So the banks
> have to hold the Fed's cash, or trade it for a better asset. As an
> asset cash is sterile for the banks, it pays no interest. What asset
> is as liquid as cash AND pays interest? Treasury debt for one. And
> "excess reserves" deposited at the Fed which now pays interest. Any
> way you slice it this new Fed cash is locked into banks' balance
> sheets and cannot 'escape' into the economy and contribute to inflation.
>
>
> Meanwhile bank capital is being destroyed liquidating loan losses.
> People are paying down their debts which extinguishes both the debts
> and the deposit money that those bank loans created. Money supply
> is deflating and GDP is deflating with it.
>
> The Fed can reflate equities markets by making free money available
> to GS and JPM to game the markets, but this rally is a mile deep
> and an inch wide. The government can generate some GDP and real estate
> blips upward with cash for clunkers and $8000 first time homebuyer
> grants, but on the one hand these are just pulling forward future
> demand which will leave holes in the future, and on the other hand
> these are being financed with your future tax payments which will
> produce holes in your spending later.
>
> This is not "the economy" growing. This is just a transfer of debt
> from private borrowers (who have quit and gone home) to public borrowers
> who want to keep playing.
>
> After a really good run since 1947 we have finally reached terminal
> debt. The economy has reached its debt ceiling and cannot or will
> not borrow any more. Rapid population growth and productivity growth
> in the postwar period easily absorbed all the new debt-money that
> was being created as America's middle class took on mortgages and
> raised families. That trend is over and there is no new impetus of
> sufficient scale for renewed economic growth on the horizon.
>
> So from here into the foreseeable future debt growth will trend downward
> and GDP will sink with it, unless the Fed comes up with some innovative
> QE program that can reduce total debt without simultaneously collapsing
> asset prices and the banking system. The secular trend is deflationary.
> CPI prices will inflate only if the dollar declines and oil and other
> imports become more expensive (stagflation). But asset prices are
> in a secular decline and only a renewed period of inflationary real
> economy growth can reverse this trend.

Extraordinary Popular Delusions and the Madness of Crowds

The apprehension that the Fed will call back all their money, and the economy and markets will be left high and dry, is unsupported by any past history. In fact, it's exactly the opposite.

The Fed will in all likelihood fail to make timely adjustments to the money supply, and we'll begin an inflationary period. Whether moderate or severe will just depend on how laggard they are in their actions.

I sincerely doubt that the economy or stock market will collapse, but rather all non-currency assets will be gradually revalued upwards, as typically happens in inflationary periods. Only the dollar will be worth less.

This scenario has been repeated time and again throughout history. The price of everything, as measured in fiat currencies, only progresses higher over time. The idea that prices will decline systemically and stay there has no factual historical basis whatsoever.

As for "inflation-adjusted" returns, it's a meaningless concept because investors cannot control or affect inflation. They can only maximize their nominal rates of return and hope to keep up with or exceed inflation. There's no other discretionary choice.