Posted on 07/08/2009 9:19:30 PM PDT by sickoflibs
The surprise is going to be the dollar strengthening. At this point the widely accepted “can’t fail” trade is to bet against the dollar. Buy gold and commodities and foreign currencies. It’s almost as popular a bet as buying real estate was a few years back. Real estate can’t go down. The dollar can’t go up. Until it does.
The refusal of banks to lend is telling us something. I suspect it’s that the destruction of their capital has been much more extensive than most imagine. Unless they start lending the money supply isn’t going to grow. The Fed can inject a trillion dollars into the banking system, but if there is no appreciable lending it’s not going to affect anything. The countervailing force of massive credit destruction is dwarfing the creation of high powered money by the Fed.
In the 70s we had a rapidly expanding money supply and all the lending you could want. There was no credit destruction to offset it. The smart move was to borrow all that you could, and everybody was trying to do exactly that. This went on until Paul Volcker choked off the creation of new credit in order to break the back of inflation.
Stagflation also has an industrial/manufacturing component: capacity utilization will be maxed out. That’s why expansion of the money supply went straight to inflation during the 70s. There was no excess capacity to come online as demand was stimulated. This is why Reagan’s program was designed to shift the supply curve to the right, to increase the production possibility frontier of the economy, so that new demand would let the economy grow rather than simply drive prices higher.
Today we have excess capacity up the wazoo. There are thousands of excess factories being closed down in China, there are thousands of excess retail stores being closed down in the US. This is a much different environment than what existed during the 1970s. I don’t see stagflation in our future. I think we will see prices fall, but so will incomes. In that fashion our standard of living on average will fall.
I understand the credit destruction argument. Assets disappearing and debt relatively constant on bank balance sheets means deteriorating equity. New reserve borrowing will be used by banks, if at all, to restore asset integrity as a balance sheet class. Purchase of Fed bonds and "safe" assets. No real passion to lend to consumers and struggling businesses and risk more asset decay. Asset decay works to constrict money supply, notwithstanding Fed attempts at stimulus by cutting reserve rates, etc. I'm on board so far.
How does this translate into a strengthening dollar? Scarcity of dollars to borrow? What causes the dollar to strengthen against foreign currencies and commodities? Also, I understand the Reagan era supply side stimulus to sop up excess consumer demand. More goods means stable prices. But, here, consumers are pulling back to clean up personal balance sheets. Aggregate demand is down and stimulating supply would be folly. The supply curve is sliding to the (pardon the pun) left at an accelerating pace as companies are slashing costs and going out of business. The Federal stimulus package seems like an irrelevancy as it only creates an artificial bubble in demand. Capital is too smart for that old trick. Who would invest capital and hire labor to meet an artificial demand signal? Not me.
I am haunted by the fear that the world will shun the dollar because of our current economic mismanagement. This will cause huge price increases in imports, and, as most consumer stuff in America is made elsewhere, consumers will pay a higher price for most goods. This could create an inflationary effect akin to the 1970's oil bump where prices kept rising while the economy slugged along. As always, your thoughts are appreciated.
They are sitting on mountains of reserve cash in an attempt to weather the coming storm.
That's the way I see it. To some degree they can't lend, their capital has been too badly damaged. The new cash is needed to restore their capital and isn't free to be loaned.
And those that do have free reserves are wary of lending in this environment. They may hold extra reserves against the possibility of new waves of loan losses.
How does this translate into a strengthening dollar? Scarcity of dollars to borrow?
Yes. The money supply is determined by the willingness of local banks to make loans against their fractional reserves. The Fed can supply banks with high-powered money and encourage them to loan, but it can't make them loan. It's the 'pushing on a string' problem. Think of the Fed's actions as being arithmetic increases in the money supply, and local banks' actions being geometric. The real action is at the local level, not at the Fed level. And at the local level credit is scarce. Even a return to normal lending will seem like a credit crunch after the casino atmosphere of the last decade.
What causes the dollar to strengthen against foreign currencies and commodities?
This is a global credit crisis. Foreign central banks are going to be trying the same tricks that the Fed is trying, with no greater success. The dollar will continue to look better, or at least less-worse, than the alternatives.
Commodities will be driven by demand. They need real demand for price rises to stick. Real demand won't show up until the next upswing in the business cycle.
The Federal stimulus package seems like an irrelevancy as it only creates an artificial bubble in demand.
Yes.
This will cause huge price increases in imports, and, as most consumer stuff in America is made elsewhere, consumers will pay a higher price for most goods.
The big worry continues to be oil and energy. Oil is a huge portion of our import bill. A responsible political class, which we are in no danger of meeting, would be building nuclear reactors and otherwise increasing our electrical supply. This won't solve the problem of vehicle fuel but it would protect the economy to some degree in one of our greatest vulnerabilities.
Shakespearean in quality!
I fear the cost push of import driven inflation ala' the 1970s. oil back then but consumer goods and oil now a days.
I'm stuck on the massive debt thing. Pelham points out we have massive asset destruction on bank balance sheets but the government (state, local and Federal) is piping up massive debt at the same time. I think these offset each other to some extent. But, the decaying assets (bank loans) get written off and disappear. The government debt is a more permanent obligation and I don't see a default. So, government debt crowds out, or, better, displaces private sector debt. We end up with massive debt and no money in the system! Not a great lifestyle. Maybe its time to consider migration to a less insane country...
Let's take the basics: We had a $14 trillion economic (GDP) in 2008, of which 70% is consumer spending. The rest is government and exports.
The consumer has spent two decades pulling forward demand via credit - that is, through the chimera of extracting home equity and charging up the credit cards. After the 1981 recession this really started to accelerate; prior to that point most Americans lived largely off their paychecks, rather than pulling out the "magic plastic card" any time they wanted to buy something. Checks were common as was good old-fashioned cash.
In 1981, US GDP was $3.1 trillion dollars.
In 1992 it was $6.3 trillion, a double.
In 2005 it was $12.4 trillion dollars, another double.
Doubling in roughly 12-13 years. Not bad, right?
Let's look at it a different way, this time in "current" (not inflation-adjusted, since GDP isn't) dollars.
In 1981 the per-capita income in the US was $8,476.
In 1992 it was $14,847, a 75% gain.
In 2005 it was $25,036, a 69% gain.
Notice anything?
Its not really that subtle, is it?
GDP slightly more than doubled in each of those above periods, but per-capita income lagged, and the lag rate is increasing.
Now let's norm it for population growth: We've added about 30% to the population in the same time frame. This makes per-capita GDP go from $13,700 to $41,000, and when you check again, you see the ratio of GDP to income is about the same.
But what are we spending?
In 1981 we spent $1.941 trillion, or $8,600 per capita, about $200 more than we made. That is, we barely spent more than we made - this was the start of the "gluttony of credit."
But in 2005 we spent $8.694 trillion, or $29,000 per capita, or about $4,000 per person more than we made, or a spending deficit of some sixteen percent!
How's that possible?
We haven't been spending income - that is, human productivity, as is clearly obvious. We're pulling forward demand through the use of credit and as we have continued to do it we have started to pay interest on interest; ergo, the amount of debt being taken on has exploded in an exponential spiral!
The following graph makes clear "how we did it": http://market-ticker.denninger.net/archives/1212-Morning-Madness-Economic-Fundamentals.html
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