Here is an excellent article. The link has a couple graphs:
Sunday, January 11, 2009 PM I had been waiting for the new release of the Federal Reserve statistic for "M1 Multiplier". It just came out friday for the 2 week period ending December 31, 2008. I wanted to wait for this particular update because I needed to make sure that we had 2 consecutive periods showing what I believe is ominous and unprecidented in U.S. financial history.
The M1 Multiplier has gone negative and it has been negative for the entire month of December, 2008.
When I say "negative" what I mean is that the multiplier is now below a value of "1.0". The multiplier is related to money velocity. In other words, if the Fed prints up and introduces a new $1 bill into circulation and if the multipler is more than 1 it means the 1st recipient used the money to spend on something to which the receiver uses that dollar to spend on something else, and its receiver spends it.... and so on. Each time a subsequent holder of that dollar spends it, the velocity of money increases, and the multiplier increases, or at least close enough for this discussion.
When the multiplier is exactly "1.0" it means the dollar may have been spent, but its recipient did not use it to spend on something else... either he kept it, perhaps in savings, or used it to pay down existing debt.
So a multiplier value that is less than "1.0" simply means that not all of the first recipients spent the dollar... they kept it for savings without allowing it to circulate through the economy even once. Another way of looking at it is, as the Fed adds more dollars for circulation into the economy, the benefitial effect of those dollars actually works against them. The first holders of those dollars are hoarding them, not spending them. It also means that dollars that are already circulating around the economy are changing hands fewer and fewer times before someone along the way decides to break the chain and saves that dollar.
A multiplier less than 1 means the economy is not growing, it is contracting. In my opinion, this statistic is the essence of "deflation".
This is particularly disturbing if it continues as a trend because it means that Fed is now completely out of bullets for short term stimulus. The interest rate is essentially at 0% so they cannot lower it any more. Pumping more dollars into the economy is not being "multiplied", so each subsequent new dollar added has less and less of an impact. Mr. Bernanke jokingly said in 2002 that he could always twart deflation by dropping unlimited dollars from helicopters -- with a negative M1 Multiplier, those dollars are more likely to be hoarded than spent.
A negative M1 Multiplier means that Bernanke's financial alchemy was a failure and the whole experiment blew up in everyones face.
It also means that Obama's planned individual tax rebate and stimulus package will probably fail because those dollars are more likely to be used to pay down existing personal debt or for personal savings.
The chart below shows the multiplier history since 1984.
Click chart to enlarge.
If I am correct, then I should not be surprised if the Fed stops reporting the M1 Multiplier.
Judging by this chart, I cannot see how anyone can argue that the immediate financial threat is inflation. Clearly, this demonstrates deflation, and not just a little. It means the deflationary death spiral may have already begun.
For those that are stubbornly holding on to an inflationary outlook, you are way too early. Your time will come, but not for several more years. All of these stimulus dollars should eventually slosh through the economy and rear itself in major inflation. But not today, not yet. (See below for more on the deflation/inflation debate).
Deflation has arrived. And none too soon. The Kondratiev (Kondratieff) Winter is already upon us and this is a major deflationary event.
This chart is Ian Gordon's representation of the Kondratieff seasons as "Cycles Within Cycles":
Click chart to enlarge.
For those of you who need a refresher on the Kondratiev cycle (also referred to as the K-Wave or Long Wave) here is something Ian Gordon put together a few years ago: pdf 3.3Mb
Bad Money Drives Good Money Out Of Circulation, Gresham's Law. The essence of this law means that given multiple forms of redeemable "money", people will tend to save or hoard that form of money which they believe to be the best quality or value (ie: Gold, Silver) and use the lowest quality of money (ie: US Dollars) for routine exchange and commerce. This law originated to explain the effect during medievil times when metal coins would be shaved or worn such that some coins actually contained less metal than others -- the coins with more metal were the better quality and were thus hoarded while the shaved and worn coins continued to be used in routine commerce.
Gold is the premier investment during the deflationary K-Winter. Gold just happens to also be a great investment during strong bouts of inflation. As such, gold is very likely to shine as one of the top investments (if not "the" top) for our current era. We are experiencing deflation right now and on the backside of this we are likely to experience a nasty bout of inflation. Gold is the best for both environments.
I have no doubt that once this era has passed we will have seen the DJIA/Gold ratio fall below 2:1, and that is using raw prices without any adjustment for inflation. We have been following this ratio since 2003. The peak was reached in May, 2001 when it was 41:1. The ratio during 2008 traded between a high of 15:1 and a low of 9:1. Friday's close was about 8600 for DJIA and $860 for gold, thus a current ratio of 10:1. My original time target to reach 2:1 was sometime between 2013-2018. While it is possible it could hit early, I am not ready to place any bets on that scenario... 2013 or better for my money.
Inflation was here, where did it go? Last summer, we witnessed crude oil prices reach just shy of $150/bbl. Crude Oil represents our modern demand and consumption of energy. As the price of oil rises, all other energy products must also rise. Likewise, any product or service that relies upon it must endure higher energy prices, and at some point those higher costs must get passed on to higher prices for the product or service. While this is not the strict definition of monetary inflation, the fact remains that high energy prices eventually induces higher consumer prices. There is no significant product or service in the U.S. that does not directly or indirectly require energy. The price spike last summer was incredible in how far it got, along with the entire World caught up in it, when the only real push behind it was a speculative mania over peak-oil. As I have said before, peak-oil is a very real phenomenon, but it is a very long-term event. Investors must resist trading short-term for a long-term event. It was incredible how so many people got sucked into the alure or momentum of the oil rally. Had the fundamentals of oil been solid on its own, without the peak-oil cheerleaders, the price would still be high. But, alas, because of the high price, people hoarded all things energy (oil, natural gas, gasoline, etc) and refineries geared toward better efficiency and the slimmest of margins to crack out more gasoline. Once the bubble popped, all of that inventory came gushing out into the open. I think the price has over-reacted to the downside like a rubberband snap from $150. Enjoy it while you can, the current low prices at the pump are temporary, even considering this onset of K-Winter.
There are some spotty examples of inflation floating around. Enough that many people are confused whether we are seeing inflation now or deflation. Perhaps the biggest argument for inflation comes from the Fed's response to the financial crisis by providing a near-unlimited amount of dollars to banks and financial institutions. If the Fed prints up $100 trillion dollars and then sits on it, that money is not inflationary because it is not participating in the commerce of the economy. In a similar angle, if the Fed provides bailout dollars to a bank and the bank hoards it, the same thing happens, no impact on inflation because the dollars don't get into circulation.
As with many of my CyclePro Outlook updates, I created a long list of topics I wanted to discuss, but ran out of time to compose adequate discussion material. So as a compromise, here are a few quick topics for 2009:
GM is in deep trouble. The UAW is strangling them. The GM pension was largely funded with GM stock - now that the stock price has fallen -90% from $40 to $4 over the past 14 months the pension funding is woefully underfunded. GM is legally obligated to meet certain funding requirements - the money will have to come from somewhere. If bailout money is used to shore up the pension then it means GM will have that much less funds with which to keep their company operating. If Congress passes legislation to relax defined-benefit plan obligations then retired workers lose.
Candy is dandy but liquor is quicker (Ogden Nash). Liquor sales in late-2009 and through the next 4-5 years should rise. People will look for creative ways for escapism, but like the cute poem, liquor will be the easiest. Fancy foreign vacations will wane, opting instead for entertainment in the home or domestic, local destinations.
RTC 2009, the modern equivalent of the Resolution Trust Corporation (RTC) is likely to be born this year. The new RTC will attempt to re-value existing mortgages and find new owners for foreclosed properties. In the same ways as it worked in the 1980's, the new RTC will likely become overwhelmed with the volume of foreclosures such that they will dump them at rediculous prices, just to move inventory.
The RTC will have its hands full since the current trend among re-contracted mortgages is a persistent high rate of foreclosure. These were mortgages at risk of foreclosure that were re-negotiated to help the homeowner. But the homeowners of these re-contracted mortgages are still defaulting at around 50%.
Residential homes are level-II assets. With home values continuing to fall, homeowners feel about their homes in a similar way that banks feel about their MBS's, CDO's, and other level-II and level-III assets.
Commercial R/E is next to implode. We are already seeing signs of it, this down-trend should accelerate in 2009.
Traffice citations are on the rise as an alternate form of taxation. In Florida not only the volume of citations are increasing but the dollar amount of each violation has also increased.
Dwindling number of US banks. The competition among small banks is fierce and getting tougher. Making this worse will be large banks that benefit from sucking on the Fed teat will have an unfair advantage. Expect consolidation as small banks merge to better compete, and large banks gobble up anything they can afford using taxpayers (bailout) dollars.
Morgan Stanley is apparently interested in buying the Smith Barney brokerage division from Citibank. Morgan Stanley has cash? Hmm, is this buyout being financed by their dollars or our dollars?
Is inflation the answer to falling R/E prices? A quick answer is yes, a significant inflationary spell (which includes comparable rising incomes) could raise homes prices back to where they were at the peak. But unfortunately, the wealth value of those dollars are greatly diminished.
For example, if J. Doe makes $60,000 per year and bought a $400,000 home at the peak, and the home is now worth $300,000, inflation at a high-enough rate could eventually cause the real estate market to rise again such that the Doe home could be priced at $400,000 again. But if the Doe income rises to $80,000 they are really no better off: 300/60 = 400/80. The only thing that changes is J. Doe's perception of wealth. In other words, if his paycheck is larger, he "feels" more wealthy. The fact is, he is no better off.
If the current deflation trend deepens into a depression, will we as individuals have to resort to self-sufficiency to survive, similar to what happened in 1930's? The TV show "The Walton's" took place during the great depression and showed how people had to resort to self-sufficiency. But a modern depression should be quite different. First of all, the US is largely a service economy rather than manufacturing or agrarian. When money gets tight what's one of the first things households cut back on, services that they can do themselves. If people provide services for others, and those get cut back, then that in itself is a big factor to enforce a deflationary spiral.
Exposing the fragility of a service economy. Here is an example, as simple as CyclePro can make it: Let's say I own a landscaping and grass trimming company with a staff of workers and plenty of regular clients. I own a nice home with a swimming pool in the back yard. My neighbor runs a pool maintenance company so I hire him to clean my pool each week. His wife is a fung shui expert and people hire her to help them decide how to position their sofa for the most benefitial "chi". If the economy starts to deflate, some of my clients may decide to trim their own lawns - maybe I might have to layoff a couple of my workers. Worse yet, I may have to learn how to clean my own pool and terminate the service from my neighbor. His wife's clients may decide they can position their sofas on their own and no longer need her service.
So you see, in a largely service oriented economy, everyone provides a "service" to someone else. In booming economies, everyone is happy providing these services and expanding their business. But once the economy starts to sour, people hunker down and pull back a little. Pulling back means prioritizing which services you need to continue and which you can do yourself to save money. A terminated service to one can beget a terminated service to another. This can create a death spiral of a chain reaction of cutting back on unnecessary services. The more the spiral tightens, the lower their priority, or less necessary these services become. In theory I suppose, it is possible for an ultimate collapse of a service economy is when everyone is out of work because no one wants to pay someone else to do something they can otherwise do themselves.
This is particularly scary since the M1 Multiplier indicates that the delation death spiral may have already started to tighten. As the economy contracts, the need for services wanes. This tends to contract the economy even more. And the deflation death loop continues, twisting tighter and tighter. Since our GDP includes all of these "services", GDP should also contract... but not a little - alot, because we have very little manufacturing to fall back on.
Florida's deflating real estate is on track. Last April, CyclePro Outlook forecasted real estate to collapse by -40% to -50% from its peak. That forecast has been proven to be quite accurate. While searching through Miami, FL property tax records I found the following condominium in Sunny Isles Beach with sales history that goes back to 1980. Note the shape of the peak and crash is falling almost exactly inline with the forecast:
Click chart to enlarge.
Using sales price per square foot we can see the highest price was about $340 in 2006. The most recent low was about $140. That's -58% for these two extreme cases. The red moving average line shows a drop of about -30%. In this particular property there have been no reported sales for the past 5 months, but there are over a dozen units listed in foreclosure. This means the price per square foot is likely to drop even more. I expect to see the red average line move below $150 by the end of 2009 and the extreme low should get to $100 or less. If this property follows my generic Florida forecast chart then by perhaps as early as 2013 we might see an extreme price drop to $50. Judging from the sales history that would be a bargain. However, once the extreme washout is over, prices should rise and stabilize closer to $100 during the following decade.
To follow up on my earlier article on the Trump Towers (also in Sunny Isles Beach), the first tower started closing on sales in Januray, 2008. Of the 271 units in each building, 110 have been sold with the most recent sales occuring in August, 2008. The 2nd tower has been open for occupancy for two months, but the county property tax records do not yet show any sales. The 3rd tower remains under construction but should be ready for occupancy sometime late Q1, 2009.
Just to refresh you on this property, the Trump Towers was completely sold out before construction began on the first tower. But because so many of the buyers were property flippers having put down only minimum deposits ($20,000), many have walked away. To compound that problem, apparently there is a class action lawsuit in progress where allegedly Donald Trump only "lent" his name to help sales of the property. Apparently the developers were planning to change the name after sales were completed. Buyers are apparently upset that they paid a premium as a "Trump" property, only to find out later that the name would be changed. Perhaps this explains why the 2nd tower has no units with lights on after dark.
Good night John-boy.
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