Elements of Deflation, Part 2

by ilene - September 13th, 2009 5:00 am

Elements of Deflation, Part 2

Courtesy of John Mauldin, Thoughts from the Frontline

water [Click here for Elements of Deflation, Part 1]

Elements of Deflation, Part 2
The Velocity Factor
Y=MV
Sir, I Have Not Yet Begun to Print
There Are No Good Choices
Washington DC, San Diego, and New Orleans, etc.

Just as water is formed by the basic elements hydrogen and oxygen, deflation has its own fundamental components. Last week we started exploring those elements, and this week we continue. I feel that the most fundamental of decisions we face in building investment portfolios is correctly deciding whether we are faced with inflation or deflation in our future. (And I tell you later on when to worry about inflation.) Most investments behave quite differently depending on whether we are in a deflationary or inflationary environment. Get this answer wrong and it could rise up to bite you.

gold The problem is that there is not an easy answer. In fact, the answer is that it could be both. Today I got another letter from Peter Schiff, who seems to be ubiquitous. He says the rise in gold is because of rising inflation expectations among investors. Gold is predicting inflation. Maybe, but the correlation between gold and inflation for the last 25-plus years has been zero. I rather think that gold is rising in terms of value against most major fiat (paper) currencies because it is seen as a neutral currency. The Fed and the Obama administration seem to be pursuing policies that are dollar-negative, and they give no hint of letting up. The rise in gold above $1,000 does not really tell us anything about the future of inflation.

In fact, it is my belief that if the Fed were to withdraw from the scene of economic battle, the forces of deflation would be felt in short order. The answer to the question "Will we have inflation in our future?" is "You better hope so!"

I wrote in 2003, when Greenspan was holding down rates too long in order to spur the economy, that the best outcome or endgame over the course of the full cycle would be stagflation. I still think that is the most likely scenario. The Fed will fight deflation and knows how to do that. They also know what to do when inflation becomes too high. But there is a cost.

It is not a matter of pain or no pain; it…

Tags: deflation, Elements of Deflation Part 2, GDP, Gold, inflation, John Mauldin, Money Supply, Velocity, Y=MV

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ARE WE ABOUT TO SINK INTO A DEFLATIONARY HOLE?

by ilene - September 11th, 2009 10:34 am

ARE WE ABOUT TO SINK INTO A DEFLATIONARY HOLE?

Courtesy of The Pragmatic Capitalist

Despite a 50% rally in equities and the recent surge in gold prices there continue to be little to no signs of inflation in the economy. Consumer credit is still collapsing and banks are still hoarding cash. Perhaps most importantly, the velocity of money actually continues to decline:

SocGen’s Albert Edwards believes the ECRI’s leading indicators are forecasting a drastic and devastating decline in core inflation:

But it is collapsing core inflation that poses the greatest risk to the global economy going forward. We highlighted last week that core CPI inflation descends rapidly, with a lag, after the recession ends. If core US CPI inflation falls by around the 3% shown in the chart below over the next year, that will take the yoy rate to minus 1.5%! Hence the growth in nominal quantities (e.g. corporate revenues) is set to see disappointing lower highs in this upturn after lower lows. And that, in our view, is just a prelude to a 2010 collapse into outright deflation.

All of this makes you wonder just how real the rally in stocks has been and how much of it has been purely based on government stimulus and the return of confidence – perhaps overconfidence.

Source: SocGen

Tags: ALBERT EDWARDS, deflation, inflation, rally, velocity of money

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So What’s Behind Moves In Gold?

by ilene - September 2nd, 2009 1:21 pm

Mish, on gold, Robert Prechter and a few thoughts on socionomics. - Ilene

So What’s Behind Moves In Gold?

gold stage coach, moves in gold Courtesy of Mish

In response to How Will China Handle The Yuan? I received many emails regarding a single statement I made: "Prechter, who does not view gold as money, thinks gold will collapse. Thus, not all deflationists think alike."

The first half of that statement "Prechter, who does not view gold as money" is an inaccurate representation of Prechter’s views.

Inquiring minds pointed out that the title of Chapter 1 in Prechter’s Gold and Silver eBook (a publication you can download for free) is "Gold Is Still Money".

Apologies go to Robert Prechter.

That out of the way, there are many things worthy of discussion from the same eBook. Please consider the following image snip.

From the chapter: Does Gold Always Go Up In Recessions and Depressions?

Click On Image To Read Text

When Does Gold Act Like Money?

While Prechter states "gold is still money", the above paragraph shows that he thinks gold acts differently when "gold is officially money".

On the other hand, I think gold is money and gold acts like it as well, regardless of whether or not governments make it "official". Please see Misconceptions about Gold for a detailed explanation.

In the eBook, Prechter notes "All the huge gains in gold have come when the economy was expanding".

That is a true statement. However, this is a true statement as well: "All the huge losses in gold have come when the economy was expanding."

Please consider the following charts.

Gold 1980 To 1988

click on chart for sharper image

Gold 1988 - 2000

Instead of asking "Does Gold Always Go Up In Recessions and Depressions?" one could easily ask "Does Gold Always Go Up In Expansions?"

Gold does not always do anything. However, given that recessions make up minimal periods from 1980 through 2000, this is an accurate representation of the period.

Gold 1980 - 2000

click on chart for sharper image

Gold collapsed from over $850 to just above $250 during one of the biggest expansionary periods in history. That is the reality and the charts show it perfectly well. Thus the statement "all of gold’s gains were in expansions" is very misleading, at best.

What’s Behind Moves In Gold?

1) What was behind gold’s move in the Great Depression?
2) What was behind gold soaring to $850 in the 80’s?
3) What is behind gold collapsing to $250?
4) What is behind gold soaring again now?

Clearly it is not expansion or contraction driving the price of gold, but…

Tags: deflation, Dollar, Gold, greater fools, inflation, Mish, Robert Prechter, social attitude, socionomics

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Creative Destruction

by ilene - August 27th, 2009 3:57 pm

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Excellent, educational article, courtesy of Mish

Creative Destruction

creative destruction Van Hoisington and Lacy Hunt have figured out what few others have, that excessive debt and falling asset prices have conspired to render the best efforts of the Fed impotent.

Please consider the Hoisington Second Quarter 2009 Outlook.

One of the more common beliefs about the operation of the U.S. economy is that a massive increase in the Fed’s balance sheet will automatically lead to a quick and substantial rise in inflation. [However] An inflationary surge of this type must work either through the banking system or through non-bank institutions that act like banks which are often called “shadow banks”. The process toward inflation in both cases is a necessary increasing cycle of borrowing and lending. As of today, that private market mechanism has been acting as a brake on the normal functioning of the monetary engine.

For example, total commercial bank loans have declined over the past 1, 3, 6, and 9 month intervals. Also, recent readings on bank credit plus commercial paper have registered record rates of decline. The FDIC has closed a record 52 banks thus far this year, and numerous other banks are on life support. The “shadow banks” are in even worse shape. Over 300 mortgage entities have failed, and Fannie Mae and Freddie Mac are in federal receivership. Foreclosures and delinquencies on mortgages are continuing to rise, indicating that the banks and their non-bank competitors face additional pressures to re-trench, not expand. Thus far in this unusual business cycle, excessive debt and falling asset prices have conspired to render the best efforts of the Fed impotent.

With that, we can safely add Hoisington to the small group of people who understand that Belief In Wizards Is Misguided. Continuing with a discussion from Hoisington:

The Complex Monetary Chain

The link between Fed actions and the economy is far more indirect and complex than the simple conclusion that Federal asset growth equals inflation. The price level and, in fact, real GDP are determined by the intersection of the aggregate demand (AD) and aggregate supply (AS) curves. Or, in economic parlance, for an increase in the Fed’s balance sheet to boost the price level, the following conditions must be met:

1) The money multiplier must be flat or rising;
2) The velocity of money must be flat or rising; and
3) The AS or supply curve must be…

Tags: Banking System, Bernanke, borrowing, commercial bank loans, creative destruction, deflation, Economy, Equities, FDIC, Fed's balance sheet, global debt bubble, inflation, lending, money multiplier, mortgage entities, Schumpeterian Depression, the Federal Reserve, velocity of money

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Is Higher Education Worth a Lifetime of Debt?

by ilene - August 26th, 2009 10:22 am

Is Higher Education Worth a Lifetime of Debt?

higher education Courtesy of Charles Hugh Smith Of Two Minds

Our latest Sacred Cow to gore: Higher education.

Just this week I’ve demolished the housing "recovery" (was it in a 12-step program?) The Pareto Principle and the Next Wave Down in Real Estate (August 24, 2009), torched the fantasy that Medicare is sustainable The health care elephant in the room: Medicare (Daily Finance) and also deep-fried network/cable TV Television, Symbolic Capital and Empire (August 25, 2009) now… good golly, is nothing sacred? Short answer: not here. The next sacred cow dragged up to be gored: Higher Education.

Correspondent David C. summarized the Medicare-like trend in higher-education costs– double the growth of inflation–and questioned the value of all those "must-have" degrees. David recommended this thought-provoking article: M.I.T. Calls Academia’s Bluff (Gary North) and added these comments:

According to this web site, Financial Aid.com, "A good rule of thumb is that tuition rates will increase at about twice the general inflation rate." I went to Dunwoody College of Technology, AKA private votech, for about $4,000 a year in the early 90s and now it costs about $16,000 a year! After all in our culture, parents are expected to pay the full cost of college. As if one must get a higher education or they’re screwed to a lifetime of crappy lowpaying jobs. Then there’s the snobbish view if you don’t have a college education you’re a moron. Academia pushes the "lifelong learning" dogma as if the only place you can properly learn is in school, they do this of course to increase their customer… I mean students.

I’ve always wondered why the cost to get a "higher" education goes up so much. Is it a conspiracy by the elites/rich to keep poor people ignorant? Or maybe to keep the middle class in debt servitude? Or maybe greedy teacher salaries? Or maybe too much bureaucracy? Or maybe schools that think they need state of the art facilities in order to provide a quality education.

Whatever the reason the increasing costs are going to make a "higher" education from academia impossible for more people. Maybe that’s a blessing in disguise, what is the real value of a college degree these days?

With the average student $20,000 in debt it seems to me a college education is overrated especially in the current depression, few students will find the good paying jobs they are entitled to… I mean want.

The link above…

Tags: college education, higher education, inflation, tuition rates

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Weak consumer spending will last for years

by ilene - August 17th, 2009 11:56 am

This is an excellent overview of our economic situation. Edward goes beyond consumer spending and discusses debt, capacity, a "balance sheet recession," inflation, deflation, retail sales, commercial real estate, government policy, a statistical recovery and the new normal. - Ilene

Weak consumer spending will last for years

consumer spending Courtesy of Edward Harrison at Credit Writedowns

It has been my thesis for some time that we are seeing a secular change in consumption patterns in the United States. This will have grave implications for a world economy used to seeing the American consumer as an economic growth engine and consumer of first choice. Retail sales in the United States have fallen 10% since peaking in November 2007. Much of this decline represents a permanent fall in consumption by overly indebted American consumers.

Having finally had a chance to dissect the retail sales data from last week, I wanted to show you a few graphs which indicate how much consumption has fallen in the present downturn and what the implication is for the future global economy. But, first, I want to start with a broader discussion as to why the fall in US consumption is a longer-term change and not a cyclical one.

The Balance Sheet Recession

Numerous economies seem on there way to recovery: Germany and France, Singapore, and Hong Kong, to name a few, have all posted positive economic growth. China looks likely to hit its 2009 growth target of 8%. But, the U.S., generally assumed to be a leader in recovery, is looking like a laggard. Mind you, there are other laggards like Spain and Ireland too. Why are these countries lagging? The Balance Sheet Recession.

debt Nomura’s Chief Economist Richard Koo wrote a book last year called “The Holy Grail of Macroeconomics” which introduced the concept of a balance sheet recession, which explains economic behaviour in the United States during the Great Depression and Japan during its Lost Decade. He explains the factor connecting those two episodes was a consistent desire of economic agents (in this case, businesses) to reduce debt even in the face of massive monetary accommodation.

When debt levels are enormous, as they are right now in the United States, an economic downturn becomes existential for a great many forcing people to reduce debt. Recession lowers asset prices (think houses and shares) while the debt used to buy those assets remains. Because the debt levels are so high, suddenly everyone is over-indebted. Many are technically insolvent, their assets now worth less than…

Tags: "balance sheet recession, American consumer, capacity, Commercial Real Estate, consumer spending, debt, deflation, government policy, inflation, retail sales, statistical recovery, the new normal

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THOUGHTS ON THIS MORNINGS DATA

by ilene - August 14th, 2009 1:53 pm

THOUGHTS ON THIS MORNINGS DATA

Courtesy of The Pragmatic Capitalist

Another mixed bag of data this morning. Most alarming is the continuing trend in negative consumer data. As we all know by now, yesterday’s retail sales data was weak at best – something we’ve been reporting on here at TPC weekly thru our ICSC and Redbook data reports.

Consumer sentiment readings continue to trend in-line with broader spending habits. This morning’s reading came in at 63.2 – almost 5 points below consensus. This continues to represent the broader economic themes we are seeing; deflation in the things we own and inflation in the things we need.

CPI came in flat which is reflective of the sluggish economy. This morning’s data was in-line with estimates at 0%. The lack of pricing power across the broad economy is in-line with the lack of expansion in corporate revenues. There is little demand for goods and even less pricing power. I’d love to spin this into a positive, but it simply displays the death grip that deflation continues to maintain on the broad economy.

On the bright side, capacity utilization and industrial production posted slight improvements. This is a clear sign that the recession is likely to end in the upcoming quarter. Unfortunately, the rebound in both indicators show clear signs of the sluggish and below trend recovery we are likely to see. It won’t be a technical recession, but it will probably continue to feel like one.

All in all, this morning’s data nicely summarizes the themes we continue to focus on here at TPC. The consumer is weak, deflation remains the bigger concern and the recovery (if we can call it that) is likely to be far from v-shaped. As for the markets, complacency remains the name of the game. Own equities at your own risk – which I believe are highly elevated currently….

Tags: consumer price index, CPI, deflation, Economy, inflation, negative consumer data, sentiment readings, Stock Market

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Predicting CPI…

by ilene - August 14th, 2009 4:31 am

Here’s a couple from Jake at Econompic Data - on CPI expectations and net worth per capita.

Predicting CPI…

So, I got lucky and somehow predicted Q2 GDP the night before the release (as a friend of mine told me, "even the blind chicken gets the kernel of corn"), BUT I’ll try again. Economists (smarter than me) are predicting a month over month CPI print of 0.0%. I’ll go on record here that it will come in lower. To understand my reasoning, lets take a look at details from today’s July import price levels release. Marketwatch reported:

Prices of imported goods fell 0.7% in July, the first decrease since January as petroleum prices declined, the Labor Department estimated Thursday.

Analysts polled by MarketWatch had expected the import price index to fall 0.1%.

Import prices were down 19.3% in the past year, the largest annual decline since the data were first published in 1982. In June, the import price index rose a revised 2.6%, compared with a prior estimate of a 3.2% gain.

In July, imported petroleum prices fell 2.8%, the first decrease since January. The petroleum imports price index is down 49.9% over 12 months. Non-petroleum import prices fell 0.2% in July, and are down 7.3% for the year, the largest 12-month decline since the data began publication in 1985.

We can see below that the change in the import price level was largely driven by the change in fuel (i.e. petroleum) prices.

Now the significance. There has been a very strong relationship between the price level of imports and broad CPI, as changes in the price of petroleum has been the main driver of CPI. Thus, the fact that July’s import prices declined makes me think we may be in for a surprise regarding July’s CPI print. The below chart shows the longer term relationship.

Regardless of the month over month figure, expect a sizable drop in the year over year number. As we can see below, prices spiked last July as the bubble in oil was in full gear. Thus, if prices are flat month over month (as expected), the year over year CPI will move down to -1.9%.

The important question… how do you position for this? I personally own TLT (a long positon in the long bond). My view is if CPI comes in lower than expected, long bonds will rally.

So would I rather be wrong about CPI or TLT? CPI of course…

Source: CPI - BLS; Import Prices - BLS

*****

Net Worth…

Tags: consumer price index, CPI, household net worth, import prices, inflation, population growth, real net worth per capita

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US Consumer Credit Shows Steepest Contraction in Over 5 Decades

by ilene - August 11th, 2009 10:38 pm

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US Consumer Credit Shows Steepest Contraction in Over 5 Decades

Breakfast with Dave, at the cafe Courtesy of Mish

Please consider Monday morning’s Breakfast With Dave regarding an unprecedented drop in consumer credit.

No Credit Where Credit Is Due

U.S. consumer credit outstanding fell $10 billion in June, the fifth decline in a row during which the debt balance has shrunk $60 billion or 5.5% at an annual rate — both figures are unprecedented. As the chart below shows, the YoY trend, at -2.8%, is also running at its steepest contractionary rate in over five decades.

Welcome to the new paradigm of savings, asset liquidation and debt repayment — the era of consumer frugality. After 20 years of living beyond their means, American consumers will be spending the next several years living below their means, and no, this will not be the end of the world, but it will put a firm ceiling on overall demand growth for some time to come.

Consumer Credit Outstanding

10-Year Treasuries vs. Consumer Credit

CPI vs. Consumer Inflation

Consumer Spending vs. Consumer Credit

Record Slide In Bank Lending

We just received the monthly data on commercial bank lending in July and it showed a record contraction of $64.0 billion, which is the equivalent of a 12.0% annualized decline. This was the third month in a row of declining bank credit to households and businesses during which the contraction has totaled $149.0 billion (again, an unprecedented 9.0% decline at an annual rate). We are not sure if a recovery can be sustained without credit creation — we haven’t seen it happen in the past, but maybe there is a new paradigm of a credit-less recovery awaiting us.

Thanks to Dave Rosenberg for the above series of 5 stunning charts that highlight the inflation/deflation debate. The key take away is those charts all show deflation.

Indeed, in a credit based economy a better title for chart 3 might be "Credit IS Inflation".

With that thought, you may wish to review the Fiat World Mathematical Model that explains why the money multiplier lag theory fails and why it’s credit, not base money supply that is important.

Mike "Mish" Shedlock

Photo: Morning Glory Coffee Shop, originally posted to Flickr, was uploaded to Commons using Flickr upload bot by Nguy?n Thanh Quang. License at Wikimedia here.

Tags: credit based economy, David Rosenberg, deflation, inflation

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A REAL BULL MARKET OR A MARKET FULL OF BULL?

by ilene - August 5th, 2009 4:24 pm

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A REAL BULL MARKET OR A MARKET FULL OF BULL?

Courtesy of The Pragmatic Capitalist

Can you have a true bull market without a rising currency? The S&P 500 is up 11.5% year to date, but the dollar is down 7% 5.5% year to date. As we saw during the 2003-2007 bull the real returns of the bull market were fairly poor and turned out to be built on a foundation of horrible underlying fundamentals, most obviously represented by a plummeting dollar. As the Greenback continues to fall into the abyss you have to wonder whether it’s possible to have a real bull market with a plunging currency and whether the collapsing dollar doesn’t represent the true economic outlook….

Source: WE Pollock

Tags: BULL MARKET, deflation, dollar collapse, hyperinflation, inflation

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