Luke L

Dow 10,000: Show Me the (Real) Money

Every once in a while, someone writes something that is stunning in its clarity on an issue that is so obvious we should all know it intuitively. Yet the fact is we don’t see it because we refuse to believe ourselves to be in the position of realizing the consequences of our actions. I think now, though the evidence is ubiquitous, we still deny what stares us in the face, we just can’t believe where we are and what we’ve done. We’re now a very rich third world country by every definition.

Inflation vs. Deflation: A Matter of Money Supply and Demand

I think you make two mistakes in your analysis.

'The situation in which we find ourselves today is one of a plentiful supply of money on the part of the Fed, but a reduced volume of goods and services coming from businesses. To date, the extra money has been mostly absorbed (but not entirely, which is why inflation remains positive) by consumers and businesses that want to increase their money balances, but with time this extra demand for money will fade and money will become abundant relative to…..”

To say that there is abundant money supply is misguided. While the money supply has increased, its circulation in the economy has decreased. Real estate and consumer spending prove this. Both these sectors of the economy are in a deflationary mode. If conditions continue to improve then demand for money will increase rather then decrease as business and consumers spend more on plant and equipment and goods, etc. and require an increased money supply to fund this spending.

“The value of the dollar relative to other currencies is depressed and falling; the value of the dollar relative to gold is depressed and falling; the prices of sensitive assets such as commodities are rising…”

In the early years of the Great Depression there was a race by countries to inflate their currencies in order to make their exported manufactured goods more competitive. This was the primary reason Roosevelt went off the gold standard. If all major economies inflate at the same (or similar) rate then the relative cost of these goods remains the same. One point you make here is true notwithstanding the previous thought. Commodities, which have intrinsic value, do reflect relative price change to commonly inflated Fiat currencies. This fact is going to substantially reward exporters of basic commodities and punish net consumers of the same.

Thanks for the discussion.

July Retail Sales: The Economic Storm Is Not Over

One thing I agree with Mr. Denninger is to look past the opinion and view the facts. Core CPI has just been released and we are down 2.1% for the year. With all the talk of inflation what we are seeing is deflation. I have written previously about the possibility of having inflation and deflation at the same time. We have deflation for the things we want and inflation for the things we need. As a real estate developer, I can give you the facts of my industry which represents a large portion of the economy. We have deflation, severe deflation, no opinion just fact. Residential, commercial, retail and industrial. Debt from our market is gone. With no debt all deals are equity and equity demands a high return. Since real estate (other than residential) is sold on cap rates, if return (cap rate) increases, value goes down. Investment real estate is held mainly by high net worth individuals either directly or through investment vehicles. An investor's return in real estate is either through recurring return of disposition appreciation. Investment real estate is leveraged with debt to a high degree and small changes in value can have enormous impacts on equity. For people in real estate this recession began in January of 2007.
Back to the high net worth individuals whose income and net worth is now highly impacted by this deflation in asset values. They are the buyers of things we want. Expensive homes, cars, expensive consumer goods, etc. These are all high profit items. This sector of the economy is taking a big hit. No possibility for a recovery here and ergo we have deflation in this sector of the largest part of our economy. Deflation equals joblessness, demand destruction, capacity destruction, capital destruction and crushing debt. Now, these same people still have to eat, by gas, go to the doctor and consume the other necessities of life along with the rest of the population and here we can simultaneously have inflation. Inflation means loss of purchasing power, reduced lifestyle, joblessness, shortages, fear, etc. The two good points about inflation, diminished debt (paying back with cheaper dollars) and increased asst values do not apply in our current situation because that portion of the economy is stuck in deflation. We seem to be in a loose-loose situation and I have to agree with the author that if you look at the facts, i.e. if you look at company sales, if you look at debt availability, if you look at asset prices and mainly if you look at our leadership the only positive reality we have right now is hope.

Cash for Clunkers May Cost Up to $45,354 Per Vehicle

This program is nothing more than a redistribution scheme. Money is taken (read borrowed) from the taxpayer and given to people who by chance happen to need a new car now. The purchasers taking advantage of this program, almost all of, would have purchased a new car anyway and in that way only shift the timing of their purchase. This may be good for our situation at this time but will certainly pirate sales from the immediate future. It will also have the unintended consequence of pirating consumer sales from the current period and ergo merely shifting sales from the consumer goods side to the auto industry. This is what happened to a similar program in Germany.
The benefit to the U.S. auto industry will also be muted by the percentage of cars which are sold under the program but produced outside the country. By example, I purchased a car under the program. I traded an old Mercedes with no nominal value for a VW diesel. My decision was influenced by the program. I purchased the VW because my first choice, a new Mercedes, would not qualify because of the price. I purchased a diesel because the MPG qualified for the higher rebate and an additional tax credit off my taxes next year. The upside to the program was that an old dirty low mileage car is gone from the roads, but I would have done that anyway. The downside is that the taxpayer is now saddled with $5,800 in debt ($4,500 rebate and $1,300 tax credit). The car I purchased is assembled in Mexico with parts made in Germany, the Czech Republic, Poland, Mexico and the US (in that order). I assure you we as citizens will be paying the debt generated by my purchase off long after the car I purchased under the program has been itself scrapped. What was gained? I personally gained a lot. The taxpayer who didn’t or couldn’t take advantage of the program, I think lost. Such is life in the U.S. these days.

GE Results Validate Theory: Severe Economic Contraction

Thanks for articulating the obvious to the oblivious. Funny that all the cash on the sidelines keeps up this fallacy of the “Green Shoots”. You’d think if you were smart (or lucky) enough to have not been stung by this depression and have cash to invest you’d be carefully looking at some fundamentals. No one seems to care about the facts. Yes, some companies have reported higher earnings but each and every one has done so on substantially lower sales. The profits have come from draconian cost (read layoffs) cutting. This is creating a short term blip in earnings but a longer term death spiral of continued unemployment and reduced economic demand (read deflation). One only needs to look at the real estate market both residential and commercial to see substantial deflation. The effects of the residential meltdown have devastated the banking sector and the commercial side of this trend has not hit yet. The further loss of the securitization market in commercial real estate will have a double effect. First it will impact bank earnings as securitization was a big profit center for the banks; and second, massive loan write downs related to short term bank funding for larger projects that have nowhere to refinance will drag down the capital of the already severely stressed banks. There is no where to point to future earnings for the banks other than short term government subsidization. With capital impaired and no prospects for substantial earnings in the medium term, lending will remain in the dumps and ergo profits and capital rebuilding.
Capital and equity is now unrealistic in its earnings expectations. I see it every day. Anyone with any cash expects fantastic returns and is willing to overlook any risk in pursuit of these unrealistic expectations. I call this the second wave of capital devastation. I will hit as surely as the first one hit in 2007. Sometimes all you can do is preserve capital and sometimes even not that. These are those times. One thing’s for sure, the market is efficient, efficient at extracting money from the foolish and unaware.
Thanks for the article.

Is Meredith Whitney Now a Bull?

I’m dumbfounded. I watched the same interview as everyone else and came away with a completely different perspective. Yes, Ms. Whitney predicted that GS would have good earnings, but why shouldn’t they. GS has received every gift the Feds have to give and then some. As to BofA, I heard her say in the short term they could have an earnings boost but would be plagued by write downs far in the future.
As to the economy in general, she spoke of “high mid teens” for unemployment through 2012. This is way above any current consensus and if comes to pass will be devastating to the banking sector. I’m thinking GS should be the beneficiary of Ms. Whitney’s comments but hardly the stuff to rocket the Dow up 185 and the S&P up 22.
Trading was thin; I have to think the smart money stayed on the sidelines. Anyone looked at the ten year or the long bond lately? It’s whispering “watch your rear” not shouting “good times ahead!”
My grandfather said, “Nobody ever went broke taking a profit”. If you’ve got some profits, especially in the banking sector, I’d take them.

New Unemployment Claims Fall: Hold Off on the Bubbly

I think we are all missing the glaring difference between now and the recent past. Look at the divergence between the continuing claims and the initial claims. Are these 500k odd unemployed the new underclass who are unemployable? Is this saying the economy will not be able to generate sufficient employment to ever employee these people in jobs that will support their previous lifestyle? This is ugly stuff and the ramifications to the economy both long and short term is significant. Not withstanding the pain and suffering to these unemployed are they just going to be written off? Does the editor have any data of divergence of these two statistics going back further?

Existing Home Sales Rise: Good News, But Don't Get Carried Away

As a real estate developer with over 35 years in the business of residential development, I tend to look at the current trend. The currently released numbers state that we lowered our inventory from 10.4 to 10.2 months inventory of unsold homes nationally. That represents a .2 month's reduction in the past month. Extrapolated that equals to 51 month supply of houses at the current absorption rate. Not factoring in anything else, it would be hard for me to get excited about the prospects of any new deal much less convincing a lender to take the plunge. There simply exists too much conflicting information and theory on the housing situation to make a large financial decision at this time. Most residential projects have a time horizon of numerous years and once committed to involve a substantial financial risk by the parties involved.
Talk is always cheap but useful while we wait for a consensus on a verifiable and lasting trend that will allow the prudent to commit to the future.

Bond Auction Final Words and the Importance of Macro Thinking

You may use it as you see fit. "You can tax a rich man only until he takes his wealth out of the taxman's reach. You can tax a poor man only to revolution."

Luke


On Jun 12 09:55 AM Economic Disconnect wrote:

> Luke L.
> Excellent observations. May I include your comments in a future post?
>
> As for your question:
> "can you have deflation for some goods and services while at the
> same time have inflation for other goods and services?"
> This phenomena is termed by Minyanville as "Inflation in the things
> you need (gas, food, eductaion, health etc) and deflation in the
> theings you want (electronics, clothes etc)."
>
> This was on full display for the years of 2002-2007 where inflation
> was tame by CPI standards, but was raging full ahead in reality (home
> prices, gas prices, etc).
>
> The US government through the treasury and FED have failed to stop
> deflation as defined to this point. If you accept that they will
> take their ball and go home and give up, then it will be deflation
> for a long time. If you think they will simply increase money supply
> and/or use alternate tricks to get money velocity back NO MATTER
> what to stop deflation then inflation is on the way, albeit, at some
> point.
>
> I take the government at their word and think they will do whatever
> they see fit to stop deflation. Just my 2 cents, on its way to $2
> in defaltion or 0.00002 in inflation.

Bond Auction Final Words and the Importance of Macro Thinking

I too, am perplexed by all the conflicting signals. I further agree that one must step back out of the trees to see the forest. If the government is sucking up all the capital and then is ineffective at redistributing that capital what happens to the rest of us? With a constantly diminishing supply of capital available to the populace there are fewer dollars chasing the goods and services of the economy at large? In this scenario deflation must result almost by definition. For good or bad we (Americans) are stuck with the dollar. You can hedge dollars but practically speaking you still need dollars to facilitate your transactions. If the country becomes poorer (i.e. the destruction of household wealth) it makes sense that there will be greater wealth disparity as the remaining wealth will become more valuable. It follows that you will also have greater price disparity. I then pose the question can you have deflation for some goods and services while at the same time have inflation for other goods and services? Am I imagining it or do I see that now?