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The specter of deflation has economist sounding worried
Seattle Times ^ | March 16, 2003 | Scott Burns

Posted on 03/16/2003 1:32:38 AM PST by sarcasm

"We shall go on to the end, we shall fight in France, we shall fight on the seas and the oceans, we shall fight with growing confidence and growing strength in the air, we shall defend our Island, whatever the cost may be, we shall fight on the beaches, we shall fight on the landing grounds, we shall fight in the fields and in the streets, we shall fight in the hills; we shall never surrender ... "

— Winston Churchill,

June 4, 1940

Earlier this year, economist Gary Shilling had those words, probably the most widely repeated Churchill quote, inscribed on a plaque along with lesser-known and more recent words from a gentleman named Ben Bernanke.

Then he went to visit Bernanke at the Federal Reserve Bank in Washington. He gave Bernanke, one of the 12 governors of our central bank, the plaque.

"He said he had been compared to a lot of people in his life, but this was the first time he had been compared to Winston Churchill," the puckish economist told me in a recent phone interview.

A speech Bernanke gave last November at the National Economists Club in Washington, however, sounds a bit like the Federal Reserve vowing to fight deflation "whatever the cost may be," including printing lots of money.

Shilling thinks it's a sign that the Federal Reserve, after decades of inflation-fighting, is now worried that it has a new, and tougher, beast to fight.

"You can stuff the banks with money, but you can't make them lend. He (Bernanke) really admitted that the Fed was pushing on a string when it comes to deflation. They're scared silly of this. But I don't think they can do much about it. The banks take money in and they're buying Treasuries," Shilling said.

I asked if there was some limit to Treasury purchases by banks.

"Not really. During deflation, cash goes up in value. Any positive return is just added to deflation and looks good."

Where would deflation start?

"If we're right and we see a crack in the housing market, then the two asset classes that people own — their houses and stocks — will change their views and habits," he said.

What about economist Karl Case, who says that housing prices are slow to sink because, unlike stocks, you can always live in them?

"It's the lower end that's vulnerable," Shilling said. "There are all these programs that require little or nothing in down payments to become a homeowner.

"But if we're going into a second down leg (of recession), jobs disappear and demand (for housing) disappears. The buyers remain renters. Some owners become renters. "

How much did he think the rate of homeownership could change?

"It was about 64 percent back in the late '80s and early '90s. Now it's about 68 percent. It could go back, perhaps to 66 percent. ...

"Couple that with tightening lending standards. Add the current delinquency rate. And you're at a point where any significant income loss from layoffs will reduce demand."

Significantly, recent figures show the delinquency rate on FHA mortgage loans has risen from 8 to 12 percent in the last five years, while the delinquency rate on VA loans is now 8 percent compared to only 3 percent on conventional home mortgages.

So what do we watch out for?

"If (housing) prices break, you'll have a saturation, like Texas in the late '80s. The things to watch are houses and consumer credit. We'll have to work off the excess."

How long could that take?

"Didn't it take about six years in Texas (in the '80s)? It will be rougher this time because if we're right about deflation, debts will cost still more," he answered.

Shilling was quick to point out this wasn't just about housing. He pointed to excess capacity in virtually all areas. He also pointed to a broad shift in spending.

"For 20 years we've had consumer spending outpace income by half a percent a year. Now we're moving to a savings spree."

That, he pointed out, takes spending out of the economy.


TOPICS: Business/Economy; News/Current Events
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1 posted on 03/16/2003 1:32:38 AM PST by sarcasm
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To: sarcasm
Accurate portrayal of how the housing bubble will deflate, not pop.

I don't see how he supports the deflation other than to say banks aren't lending and consumers are trading in their uniforms for savers uniforms.

These two factors will definitely lead to recession and that's the only certainty that I see from this post. And then, all of this is very foreboding for the world economy.

The truth about how China is the biggest potential consumer (the lie) will then be proven. I feel it was always only PR hype to make the corporate manufacturing move to China acceptable to the American public. It was all just desertion for profit and greed.

I have yet to hear of SUV sales, TV'S, delivered pizza's and beer being big business in China. Now there's consumption ! They are still 3rd world and their society doesn't even come close to France's yet.
2 posted on 03/16/2003 10:22:58 AM PST by imawit (and I know what I'm talking about)
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