Posted on 06/26/2012 4:24:14 PM PDT by blam
The Black Hole Of Deflation
Economics / Deflation
Jun 26, 2012 - 11:42 AM
By: Julian DW Phillips
The Global Picture and Where We Are Now
For the last few years we've watched as the Credit Crunch morphed into the Sovereign Debt crisis in Europe, which may re-cross the Atlantic to hit the U.S. Treasury market. During that time, we have watched a series of patch-up jobs on the crisis that have only succeeded in prolonging the crisis without any real structural remedies. We've also watched how central bankers have seen the 'buck' passed to them, when their role is strictly in support of government action that should have led the way. Central bankers are running out of tools to tackle the task they should never have been asked to tackle alone.
Political leaders (who usually act only in concern of the consequences to their political careers) have only been willing to provide hormone-free measures that have yet to see any convincing success. Much as people look for someone to blame or an interest to protect, the fault lies with the underlying structure of national affairs. Not only do we find banks bound by the interests of their shareholders to achieve profits, but politicians working in a democratic set of national systems guarding their voting base with future elections in mind. These diverse objectives are not consistent with the needed objectives of targeting global growth at all levels to the point that national debt levels can be reduced while national cash flows are boosted to provide the needed funds to achieve these goals.
Almost five years after central banks took the first actions to buoy the world economy, political leaders are being forced to react to a third successive annual fading of recovery hopes as Europe's debt crisis threatens to engulf Spain and Italy, hiring in the U.S. stalls and China slows. Estimate for growth worldwide this year have fallen to 3.2% from the May forecast of 3.4% and it continues to slow.
Developed economies are running into the limits of monetary policy, the Bank for International Settlements said in its annual report last week. Central bank balance sheets now contain $18 trillion of assets, about 30% of global gross domestic product, double the ratio of a decade ago, and interest rates are as low as they can go, the B.I.S. said.
Governments have "cornered" central banks into prolonging stimulus, and have dragged their feet on restoring fiscal order, said the B.I.S., which holds currency reserves on behalf of global central banks. Monetary policy only "buys time" in the short run for leaders to act, and leaving an easy stance for a prolonged period poses economic risks, it said.
The failure of politicians -or should we say in fairness the political system?-- to apply vigorous, focused measure to achieve these goals over such a long period of time is causing a fundamental loss of confidence in the financial and monetary systems of the developed world. The emerging world is patterning their newer systems on those of the developed world and ultimately reinforcing that failure.
Amazingly we are now hearing talk that the emerging world should be becoming the driving force in the global economy, when the entire pattern of Asian development has been to replace the manufacturing industries of the West. In addition, China's targeting the internationalization of the Chinese Yuan, an objective which inevitably will have the same impact on the dollar as Chinese manufacturing is having on the West. The net result is inexorably, the continuation of the shift of power and wealth to the East that undermines the power and future of the developed world.
Christine Legarde of the I.M.F. and other realistic financial leaders are warning that there is less than 3 months to save the euro. If they fail to do so, we move to the next catastrophic phase of deflation, the Black Hole. We have seen this in the past, and it's the greatest fear a central banker can have.
Gold as an Alternative Day-to-Day Currency
Many gold supporters believe that gold can replace fiat currency as money. We're not one of those believers. We realize that it's not a matter of being right, but in the current powers that be, it is a matter of accepting its use in the system. At this moment, they're showing no inclination or support for the idea of gold as money. But they do see it being used in a critical way. (Which we will discuss in the next part of this series.)
Fed, Central Bank Fears
For several years now, observers have reported the great 'black beast' feared by the financial world has been inflation. Central bankers fear deflation far more and have done for the entire five years. Inflation has remained extremely subdued during this time.
Indeed, their present stance still appears to be focused on keeping deflation at bay. But that policy is one that keeps central bankers -particularly the Fed-- right up on their toes...Why you may well ask?
Deflation's a Process
What really is deflation? In practical terms, it's a process. In this last five years, we saw it start with a puncture of the housing market in the States, spread to mortgage backed securities, to bank balance sheets then onto their borrowing abilities. In Europe, the same happened but hit the banks hardest, then sovereign debt. As securities lost their value we saw a Domino Effect of asset shrinkage leading right through to the collapse of the institutions holding that toxic paper as asset collapses undermined their solvency.
As this started, fear kicked in as lending dried up, with banks fearful of lending even to other banks, where they might be unpleasantly surprised by defaults. Short-term fear morphed into loss of confidence in the future, prudence stepping in to replace overspending and the velocity of money's circulation slowed, as values fell. As confidence was eroded so was growth and endeavor. In turn, this produced more deflation.
Central Banks attempted to defeat this process by adding liquidity to the system in the hope that lending and borrowing might be resuscitated, but because government was caught in political gridlock in the States and failed to act decisively and quickly in Europe, doing nothing to support central banks quantitative easing, these new funds ended up back in government bonds as banks feared creating more toxic assets that would come back to haunt them.
Meanwhile the economies of the developed world barely grew, causing more loss of confidence. With interest rates at new lows and becoming a medium term phenomenon, here we are at the brink of another stalling of the developed world's economies. This time though, the emerging world is starting to slow its frantic pace of growth, telling us just how far the developed world is slowing. Because the emerging world needs to export to keep its growth high and are now seeing these slow down, they're being forced to turn inwards.
The horrible feature of deflation is that it can't be measured accurately because of its subjective, or emotional, content. It doesn't move at a strictly defined pace and it must be killed early, before it turns an economic summer into winter, where stimulation just won't work. It is truly a "black beast".
This economic direction we now find ourselves in is what the central banks fear the most.
It’s extremely bad out there with oil prices crashing and other commondies following suit. The oil industry will be devestated and we have no idea how far the price of oil will drop.
It is darkest before dawn, when all of the Chicken Littles are convinced that the end is near. Then the Sun rises.
Private Investment is up 10%.
Web 3.0 is revolutionizing the online world.
Fracking is increasing U.S. oil and natural gas production that is driving down gasoline and electricity costs.
In other words, the Recovery has begun with investment and major tech revolutions.
no
I do a lot of travel, domestically and internationally, as a consultant to manufacturing and investment firms. While there may some positives that can be found, they are growing fewer and fewer. There is a significant slow-down occurring, and it is gaining speed. The question before any real recovery happens, is how hard the stop will be before we reverse direction, and what type of damage will be left in the wake.
I appreciate your anecdotal insight.
All those toxic and non-performing real estate loans out there, which have still not been foreclosed or written down, continue to deflate much of the wealth, because their presence continues to depress overall real estate values. Once these toxic mortgages are drained out of the system, the real price of real estate may then be re-established, and we shall have a “new normal”. This allows a slower but more orderly growth of new construction, or rehabilitation of existing housing, both major drivers of any employment recovery, leading back to a healthier overall employment picture. But first, enormous numbers of restrictive government actions will also have to be reversed, both as regulations and as taxation, and imposed mandates that have no rational basis in fact. In fact, there are a LOT of toxic factors that are paralyzing recovery right now, much like what fed the Great Depression from 1933 through the Second World War. The New Deal kept trying to “fix” things, and only made the mess worse and more tangled, until the demands of wartime mobilization made much of the regulations either dead letter, or modified so much as to remove most of their former restrictiveness. After the war was over, a lot (though by no means all) of the New Deal was repealed, often over the objection of then-President Harry Truman. The effects of that boom were felt through most of the Eisenhower years (which had a couple of slowdowns of its own, but only for a year or two at a time).
In retrospect, that was kind of a “Golden Age”, though not recognized at the time.
Then we got Kennedy-Johnson and the “Great Society” the effects of which STILL drag on the economy, through a vast expansion of the welfare state. For example, the “War on Poverty” contributed almost the entire cost of our national debt (yes, the $16 trillion or so), essentially, we have done it all on borrowed money, and what do we have to show for it. The money is still borrowed, and hanging over our heads like the Sword of Damocles.
The writer of this piece surely doesn’t go to the grocery store, buy auto and health insurance and most definitely isn’t putting any children thru university.
If there is one thing you can count on, it is that they will do ANYTHING to inflate/devalue the currency.
What we really have is a form of late 1970s stagflation. Prices of what you need (oil, food) are on the rise (although WTI is now under $80) while prices for your biggest asset (your house typically) is shrinking and looks to do so for a while. Add that it looks like taxes will go up and the middle class is getting squeezed big time.
schu
“The writer of this piece surely doesn’t go to the grocery store, buy auto and health insurance and most definitely isn’t putting any children thru university.”
Yep. Spot on.
We have inflation on what people have to spend money on. (Food, Medical, etc).
Were having Asset deflation right now however.
Someday when the Economy truly does pick up is when were going to have lots of inflation across the board. (Velocity of Money).
That is only half the story -- the demand for loans was minimal, because business was contracting because of the lack of consumer demand for their products.
There is both deflation (in housing and other assets, in employment and average income, etc.) and inflation (food, energy) going on at the same time.
None of those are related to the amount of money in circulation. “Inflation/deflation are always and everywhere a monetary phenomenon.” ~ Milton Friedman
There is a lot of cash waiting for 0bama to be gone before it is spent/invested.
I’d rather see runaway deflation than runaway inflation. In deflation, there is a bottom. In inflation, there’s always more inflation. Plus, if you are a saver, deflation makes your savings worth more.
You'll be turned upside down and your last change will be shaken out of your pockets before the psychos who run the financial system let you have a penny. The politicians haven't put all that 401K money in a "lockbox" yet. Whatever it takes to screw the Muppets will be done. Deflation may make somebody's savings worth more but your probably not on the right family tree.
Liberal beliefs about wealth guides their thinking about Americans being resource and energy pirates, stealing from the rest of the world, especially the Third World. We could not have all that expansion/inflation unless we stole it from other countries.Liberals/Keynesians do know that inflation effectively sucks in to the government the value from holders of the money.
Keynesians/Liberals have split minds. On the one hand they are frantic to have inflation and on the other hand they are appalled at the expanding/inflating USA stealing resources from poor third worlders. Thus they are frantically trying at the same time to expand the American economy by inflation and raging about America starving the less developed countries.
Your facts are true, however all of the pluses you detail are under assault by this administration. We need a good November outcome to lift the national mood and our credibility in the world.
What we've seen for the past going on four years has been liquidity finding its way into those areas with reliable demand. There has been speculative excess, driving up commodities and creating a situation with food, oil, precious and industrial metals that is for all intents and purposes inseparable from actual inflation as far as the general public is concerned, as the difference is purely academic. The consequence is the same.
Those areas without reliable demand have suffered. Housing, non-necessary consumer goods, etc. have fallen in value, ie deflated. Stocks are widely suspected of being propped up via government intervention.
Absent the bizarre, almost unfathomable spending spree we've witnessed, we'd be experiencing a deflationary depression far worse than the Great Depression. Technology has enabled the appearance of normalcy, no soup lines, very few people literally forced out into the streets.
As we see with Greece, however, that possibility does still loom. It hasn't been eradicated. Government spending does have a practical limit, even if that limit is imposed from outside.
How all this will ultimately pan out is unknown but there aren't many potential good outcomes. It looks a lot like penury in store for all but the very wealthiest few no matter which way this shakes out, sad to say.
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