Posted on 08/26/2010 11:04:20 PM PDT by Freedom_Is_Not_Free
* What have we forgotten the nature of inflation since the 1970s? * Where is the U.S. economy in the transition from low to higher inflation?
Monetary authorities and economists focus on inflation expectations because inflation expectations have a way of becoming reality over time. Inflation expectations, after falling hard in 2008, have been steadily rising since early 2009, and actual inflation has tracked expectations, with a time lag, as usual. Recently, however, inflation and inflation expectations have started to dip again. Is it time for the Fed to hit the deflation spiral panic button?
Expectations of future inflation are informed by the past experience of consumers, both recent and distant. The longer inflation remains tame, the longer consumers extrapolate low inflation into the future even as evidence to the contrary begins to reveal itself. Wage and manufactured goods price inflation has been so low for so long that most of us can’t recognize the shift to a more inflationary environment as it is happening today, but it is, as we’ll show.
Study the relationship between inflation expectations and all-items price indexes over time and you’ll find that consumers form their short-term expectations of all-items price inflation based largely on current energy prices, and for good reason; all-items price inflation tracks energy price inflation closely as a major input cost both to producers and consumers.
For all practical purposes, today’s consumer expectations for inflation a year from now are the same as today’s energy prices. That’s why monetary authorities focus on energy prices to manipulate both consumer and producer inflation expectations. As a deflation-fighting tool, abandoning the strong dollar policy in 2008 and allowing the dollar to depreciate was the most powerful weapon that policy makers had in the arsenal of deflation fighting tools in a zero interest...
(Click link)
(Excerpt) Read more at itulip.com ...
Comments? Completely out of line? I’m not a subscriber so I have no access to Part II, which is likely where the important information lies, but inasfar as you can read, why is this completely out of line.
I simply don’t ignore Eric Janszen’s analysis.
Yes, I think everything points clearly to a deflation depression. Janszen has stubbornly stuck to his guns that we will have an inflationary depression. I can’t just discard him out of hand.
Where is he wrong? What is he missing?
Banks aren’t lending, they’re just working the carry trade. Meanwhile the Fed, having dumped gallons of gasoline on a smoldering campfire, only sees vapors coming out, They’re going to pour more gasoline on to get the fire going.
Inflation versus Deflation Tournament Game 3 - Part I: The endless saga continues
“Those who cannot remember the past are condemned to repeat it.” - George Santayana
Deflation is back in the headlines. Quantitative easing (QE) is the call.
* Can the government and the Fed keep the money supply growing and prevent deflation?
* Is the deflation a real threat?
* How much QE is required?
* Or is QE irrelevant?
* Double-dip recession or staggering recovery?
* Gee, can’t we just depreciate the dollar again?
* From the Complaints bin: Hey, where’s the inflation you forecast?
* Stealth inflation. Deal with it.
Will the Fed hit the QE launch button soon to head off impending deflation? The question makes two assumptions. One, that the Fed faces a clear and present deflation threat. Two, that QE is an important policy tool to fight deflation. We find clues to the answers in the outcome of the previous two games of the now 12-year-old deflation versus disinflation tournament.
Inflation versus Deflation: Game 1 (1998 to 2001)
Newcomers to the deflation versus inflation debate tournament may be unaware that Game 1 of the debate occurred in the late 1990s. Many economic forecasters were convinced that the collapse of the NASDAQ market bubble was certain to produce a 1930s runaway debt deflation, as first described after the fact by Irving Fisher in his DEBT-DEFLATION THEORY OF GREAT DEPRESSIONS, 1934 appeared to be in full swing in the closing quarter of the year 2000:
Starting from a condition of over-indebtedness, once the process of debt liquidation gets underway after a private credit market shock such as occurred in 1930, “…each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debts cannot keep up with the fall of prices which it causes. In that case, the liquidation defeats itself. While it diminishes the total number of dollars owed, it may not do so as fast as it increases the value of each dollar owed. “Then, the very effort of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed. Then we have the great paradox which, I submit, is the chief secret of most, if not all, great depressions: The more the debtors pay, the more they owe. The more the economic boat tips, the more it tends to tip. It is not tending to right itself, but is capsizing.
Pierre L. Siklos of Wilfrid Laurier University in What is Deflation? offers a modern definition, improving on the inventor:
Deflation is a persistent fall in some generally followed aggregate indicator of price movements, such as the consumer price index or the GDP deflator. Generally, a one-time fall in the price level does not constitute a deflation. Instead, one has to see continuously falling prices for well over a year before concluding that the economy suffers from deflation.
I argued starting in 1998 that the risk of “a persistent fall in some generally followed aggregate indicator of price movements” was well understood by the Greenspan Fed. The central bank planned radical reflation measures to prevent it. As a result, we’d get a brief period of deflation known as disinflation in the economics literature.
The debate is over four possible short-term and long-term outcomes of asset bubbles and reflations:
1. Deflation (reflation fails and disinflation turns into runaway deflation ala Fisher’s definition)
2. Disinflation (reflation succeeds after a brief period of deflation)
3. High inflation (reflation succeeds too well and leads to high inflation but not hyperinflation)
4. Hyperinflation (reflation succeeds too well and leads to runaway inflation)
My short-term forecast for each post-bubble period has been for disinflation with a long-term forecast of high inflation after the economic conditions that created the asset bubbles comes to a head.
My 1998 short-term post tech bubble disinflation forecast was mostly but not entirely correct.
As it turned out, we didn’t get any deflation at all, brief or otherwise. The disinflation was of the falling inflation variety rather than a period of negative inflation.
For Game 1, score one for the believers in the power of an aggressive central bank operating without the constraints that existed during the 1930s in the U.S. Not only did the Greenspan Fed halt the debt deflation process but maintained low rates and loose lending standards so as to give rise to the housing, commercial real estate, and private equity bubbles.
The economics blogging community has expanded vastly since Game 1 of the inflation versus deflation debate tournament began in 1998. The outcome and lessons of the first debate are either unknown to newcomers or has been largely been forgotten. Too bad because that experience taught us that in the absence of the 1930s circumstance of fixed exchange rates and a philosophy of allowing debt deflation to run its natural course, central banks can and will create sufficient liquidity to prevent a disinflation from turning into deflation. The lesson applied to Game 2.
Inflation versus Deflation: Game 2 (2005 to 2009)
The inflation versus deflation debate re-appeared three years into the housing bubble that started in 2002 as observers began to worry about the aftermath. In 2005 I wrote “Debtor Nations Dream of Deflation” for AlwaysOn and made a presentation to Trident Capital that forecast a large-scale credit and financial crisis resulting from mortgage credit risk to arrive “within two to three years.”
As late as early 2008, the assertion that a massive recession was certain to follow from the aftermath of the housing bubble was still debated by mainstream economists. Here I am in January 2008 debating a Chicago School economist on the coming recession that began the month before but was not officially announced until a year alter, after the Presidential elections.
Anticipating a recession so severe as to require New Deal type stimulus programs to pull the economy out of a death spiral, I hopefully suggested energy infrastructure development programs that promised a return on investment rather than one-off jobs programs that add to the already untenable liabilities on the national balance sheet. The economist debating me held the view that bubbles are good. You don’t hear that much anymore.
The rest of Part 1 for the non-subscribers is here:
Zero interest helps the banks, it all about the banks, the Federal Reserve and US Treasury doesn’t have to pay much interest on the money in circulation with low interest rates in effect.
I think you need more historical context to arrive at a clearer picture of what is happening because it repeats itself in history on a cyclical basis.
Try Martin Armstrong’s latest, I suggest you start reading at page 4....
http://armstrongeconomics.files.wordpress.com/2010/08/armstrongeconomics-market-outlook-grand-unified-theory-081510.pdf
An deflation/inflation writing by him here...
http://armstrongeconomics.files.wordpress.com/2010/08/armstrongeconomics-deflation-to-be-or-not-to-be-08-05-2010.pdf
A list of his writings here...
http://armstrongeconomics.com/writings/
a) He’s a gold guy. He’s talking his book, which he is allowed to do, but I think one should realize this up-front when reading his analysis.
BTW, much of his analysis supports deflation. He pivots at the end and leaps to a conclusion of inflation, when charts like the MZM chart clearly depict deflation. PCE supports deflation. The consumer debt de-leveraging supports deflation. The decrease in household wealth, income and home equity support deflation. Rising levels of defaults supports deflation.
His argument that capacity utilization is a pre-cursor to inflation is a bit out of line. It is a well known pattern that after a collapse such as we’ve had, there is a quick rebuild of inventories after the corporate management sold out of inventories to raise cash. We’re now pretty much through that, I think, from the recent durable goods report.
b) What is the market doing? In particular the stock and bond markets?
Well, stocks have gone nowhere since April. If the markets were expecting inflation, stocks would be going up, and money would be pouring into stocks.
Money is coming out of stocks... and going into bonds.
Bonds: Bonds have been on a screaming tear, with every week bringing record-breaking low yields on US Treasury debt. The effective 5-year TIPS rate is now negative. So much for inflation there. 2s10s are getting flatter and lower every week. No inflation expectation being priced in there.
Norfolk Southern Railroad has just re-opened a 100-year bond they issued in 2005, adding an additional $100 million to the prior $300 million. And the market is ready to snap it up at around 6%. If the case for inflation were so obvious, even if the inflation would kick in a few years from now, wouldn’t some of the folks buying 6% paper for 100 years demand higher yields? Like, oh, at least 8%?
There are new MLP ETF’s being formed about every week it seems, making a basket of high-yielding stocks more available to investors who are chasing yield.
In deflations, investors chase yield - and we’re seeing that now. In abundance.
c) In deflations, bond holders also worry about return OF capital, not return ON capital. And we see that recently with Bill Gross (of Pimco) calling for the US government to explicitly back all RMBS (and implying that Uncle Sugar should back all asset-backed securities). So we see the guy running the biggest bond house in the world is worried about defaults, which are deflationary, not inflation.
d) Lastly, people pointing to commodity prices (food and fuel) increasing seem to forget that we’re not competing in a world market for these commodities. The price of these items is more reflective of both demand factors and the strength of the US dollar vs. other currencies than inflation within the US. A significant amount of the price spike in commodities in 2007-2008 was the result of hedge funds and commodity funds speculating with very high leverage - the speed with which those prices came down points to there being no increase in demand that corresponded to the geometric price hikes. It was all about speculation. These commodities’ contracts were liquid and were sold as quickly as they were bought. Therefore, I’m dubious of people pointing to this particular price spike as a justification for calling for inflation. Since the CFMA of 2000, energy futures are no longer regulated and are subject to scams and corner-runs by some funds. Look at Amaranth and natural gas for an example. This is one of the reasons why I would like to see the CFMA repealed and all futures go back to being regulated as they were since the 1920’s.
If you had told me one year ago that the yields on US debt would be plumbing these depths, I would have said “No way. Not yet. The amount of ‘stimulus’ will forestall that decline in yields until the money has run out.” I was thinking that rates would stay pretty much in-line with how the Fed wanted them - the 10 year at around 3%, the 2s10s curve as steep as they could make it, and mortgage rates around 5%, thanks to QE. I’ve been holding off on a re-fi of our house, because I think we might get a rate well under 4% for a 15 year note with the way we’re going now.
Well, so much for my predictive powers. There’s no way to ignore the bond markets, and as I’ve said repeatedly, the story of this charlie-foxtrot is being told in the bond market. And right now the bond market is calling for deflation. With hundreds and hundreds of billions of dollars.
Well we are sitting around reacting to what they do and complaining about it... Not good.
I value your analysis.
You’ve brought up items I didn’t consider and a lot of what you said makes a great deal of sense. I am defensive of falling into a mindset of “just because we are deflating now means we will be deflating for years to come”. I’m not so convinced that inflation will result, I just don’t want to be complacent and assume inflation cannot occur, so I keep investigating contrary indicators to my own belief.
Everything is pointing to a deflationary depression - from history to Obama’s completely misallocated debt spending.
Sorry to keep hitting you with information from the inflation hawks like Schiff, Janszen and the others like Faber and Celente. I don’t want to be complacent. I don’t want to put all my eggs in the deflation basket and be completely caught off guard by inflation. I don’t think I can be caught off guard to the extent that, sometime after this deflationary depression runs its course, the economy will begin to grow and it is about then that I am going to be watching like a hawk for ANY inflation expectations.
Everything you wrote makes sense. It is obvious to me that the flight to safety and to bonds tells me the world believes deflation is coming. The RR bond offering is especially intriguing.
Pardon me for being a tad leary after the world told me housing would go up forever. Then again, you were on the right side of that call and you knew the rise in house prices was artificial.
I agree with you that everything looks to be pointing to a long period of deflation. I just am so fearful of the uncertainty, I can’t convince myself that inflation is impossible.
Anyway, I deeply appreciate your deconstructing the article I posted. I’ll read your points again. I don’t mean to bother you with my questions. I envy that you have confidence in your convictions at this point. I’m still struggling with putting a fork in the notion of inflation and going “all in” with deflation.
I agree with you about mortgage rates in the future. The banks have jacked up closing costs so high now that I’ve decided it isn’t worth refinancing unless I can get a 15-year loan for well below 4%. I’m talking 3.5% or so.
Also, I didn’t know Janszen was a gold seller.
I’ve heard people kind of bash Peter Schiff for talking his book, but he’s not selling gold, he is buying. Rather than talking his book, I think the guy is putting his clients money where his mouth is, for good or for ill, as we will see in hindsight. If he really believed we were going into deflation and was just talking his book to pump up gold, he would have to dump at some point. If he keeps buying and not dumping, that isn’t talking your book so much as taking a position that gold is the place to be. Who in their right mind would expect deflation and then go heavily into gold only to see the gold bubble collapse with deflation?
Anyway, thank you sincerely for the analytical response. I hate to tie up your time and at some point soon I have to get off the pot and just come down on one side or the other. I agree that every indicator I can see looks like we are heading for a painful multi-year deflationary depression with real suffering among all the long term unemployed and general economic contraction with the reduced consumption, credit, employment and production. Nothing is buoying this thing but government debt, which is robbing the real economy.
OK, I made some searches and Janszen is definitely a gold guy. I didn’t know that.
It’s deflation. How may I count the ways?
NVDave makes the cogent points. I too, point to the bond market, as the smartest guys in the room. That, IMO, is the master data point if you had to boil it down and remove all the “on the other hands”.
A lot of things could happen, and the only meaningful thing I can say is that we are obviously, obviously NOT in your garden-variety inventory-style recession that can be expected to abate pretty much on its own after 12-18 months or so.
My strongest argument against inflation is that while it’s what Bernanke would like, he is beginning to sense that he will be badly punished should he print with abandon. Contrary to all the yammering, there has been very little “printing” that has gone on. Believe me, if and when the bond market senses that it will begin in earnest, rates will sky. That will devastate the housing market another leg down, should it happen. And probably the stock market as well. Very deflationary. The Fed is really in a box in this regard.
But also, nobody can predict whether there will be some magical fairy dust sprinkled down from the sky. Perhaps an across-the-board $100K mortgage forgiveness?
There really aren’t any good answers, at least that I can see.
The Fed can't just set a long rate, they mostly set expectations. The expectations right now are for massive QE to light a fire under housing and preclude a double dip. It doesn't matter too much whether the housing has the ability to pull the economy up without literally burning the extra housing stock. The QE expectations drive what I call the greatest fool theory. Folks with some dollars figure they will sell to other fools who will buy because QE expectations will be even higher in the future. This has nothing to do with quality or safety for the next 2, 5, or 10 years, just a quick pump and dump. It's easy to pump too, just put out double dip rumors.
Who isn't when the other choices are cash and equities. Janszen has a holistic view and I agree with what he says. Also he is not snowed by aggregate statistics like drops in overall consumer demand. Consumers aren't waiting around for prices to drop, they are buying if they need it and can buy it. Some people are buying for long run holding, collectables are pretty strong considering how few people are in the market. To me those measure inflation expectations, not PPI or CPI.
Question about MLPs. I thought they were ETNs, but, if there are now ETFs, how do they handle the tax issues? It would be really nice to not have to worry about the taxes...for IRAs especially. The issue I had with the ETNs is that you don't really own the company, but a bond.
The True National Debt is $ 18.964 Trillion
Government debt is really 130% of GDP. This is far beyond the levels reached during World War II. The U.S. is no longer the manufacturer to the world. We are the consumer to the world. Our country adds $4 Billion per day to the National Debt. Our GDP is stagnating with future growth no better than 2% being realistic.
Add to the mix the level of Personal Debt for Americans and the results are truly frightening.
Right, the Fed doesn’t set a long end rate, but the QE actions of the last year have helped depress long end rates. The Fed’s QE 1.0 was about $1.2T of RMBS and about $330B of US Treasury paper, as I recall.
BTW — the buying of Treasury paper in this year’s run-up appears to be coming from domestic banks.
MLP’s are still what they were. Several i-banks have created ETF’s of a collection of MLP’s for ... whatever reason they have. I have always bought MLP’s directly.
In an IRA, MLP’s have a tax complication. I’ll get you that information later on tonight.
” Government debt is really 130% of GDP. This is far beyond the levels reached during World War II. The U.S. is no longer the manufacturer to the world. We are the consumer to the world. Our country adds $4 Billion per day to the National Debt. Our GDP is stagnating with future growth no better than 2% being realistic. “
Correct as usual. Good to see you here, my FRiend!
Thanks!
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.