An absolute MUST read article on Deflation
My favorite snips are below but read the whole thing
Mish
weedenco.com
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But guys, I’ve heard warnings about consumers hitting their debt limits for as long as I’ve been watching Wall Street. All wrong. And as for the CPI falling so low, everyone knows the government has an enormous interest in keeping a lid on that statistic—
Prechter: Consider this: None of those earlier calls that the consumer was about to be tapped out were made in a 1% Fed funds rate environment. That is the difference. In other words, they’re virtually giving money away now— and it is nevertheless very difficult for them to get people to continue borrowing. That is what the drop in the money supply is telling us. We’ve just seen the biggest drop in the money supply in 60 years. Now, that doesn’t mean it has to continue. Nothing is certain, but that is some kind of signal—especially coming against a strong economy and a low interest rate.
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Rather unusual, isn’t it, that the Administration has been pumping millions of gallons into the strategic reserve, with oil prices this high?
Shilling: Exactly my point. They may be doing it so they can simply stop and, in effect, reduce demand (and prices) before the election. What I’m getting at is that we all know this, and we all know that inflation rates have been trending down because there are a lot of deflationary forces in the world. A lot of “morning after” from the big investment bubble of the late 1990s. Yet the bullish herd contends that the economy is fine, just having a delayed reaction to all the stimulus that has been applied.
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Makin: Not that I can see. Look at the numbers. In the fourth quarter, business fixed investment grew 6.9%, which was half the growth rate of the third quarter and equal to the second quarter’s rate. And a 6.9% business fixed investment number isn’t even consistent with growing the capital stock. It’s consistent with replacing depreciating assets. So business fixed investment actually has started to slowdown again.
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But this isn’t the 1920s. One huge difference is the third deflationary force Gary mentioned—
Makin: Globalization, to oversimplify, means China, which is on offer in the goods market with a perfectly elastic supply schedule and unlimited labor.
Prechter: And India.
Shilling: India in services, China in goods.
Makin: So we have very little traction for demand policy because they are essentially price takers. They will supply as much as you want at a fixed price. If you’re trying to compete with them, you’re going to relocate your production facilities to China—and that’s somewhat negative for job growth here. And it means it’s very difficult to avoid persistent disinflation.
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If the economy is poised on the brink, what’s going to tip it, either way?
Prechter: Psychology is always the trigger and, to me, the best meter of social psychology is the stock market. So it will take a drop in the stock market, a serious one, to tell me that psychology has changed. People will get more conservative about speculation, with lending and with borrowing. When the stock market drops by 20% or breaks the old lows, that will tell me that the tide has really turned.
Makin: I agree that the stock market is the key here. I see the unwinding process starting in a pretty orderly way as we move into the spring. I’m amazed everybody’s banking on 4%-5% growth in the first half. I think we could print a three handle in the first quarter—and that as we look forward, things aren’t going to get better. So the stock market will struggle—and that will send us a signal.
Prechter: There’s one other thing that’s worth mentioning. As I look around at the psychology of inflation, I find that there doesn’t seem to be any consistent camp arguing that it’s coming to an end. I guess that is why Kate got the three of us together. By contrast, there are loads of bullish economists and stock market analysts who are sure the market is going to continue going up, the economy is going to boom and that inflation is coming again. So they are sure the Fed is going to raise rates—after a “considerable period,” whatever that is—because that is the way it has been for many decades. Even the bears you can find mostly all own gold and silver and other commodities, because they’re looking for a hyperinflationary monetary crisis. It strikes me that it must be pretty rare to have such opposite camps—the bulls saying everything is fine, the Fed is in control and the economy is doing great, and the bears saying the world is facing Armageddon—in complete agreement that inflation is inevitable. I mean, talk about one-sided opinion. That tells me it’s worth looking at the other side.
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Guns and butter, conflict in the Middle East, rising oil prices, a massive supply of money. Yawning budget deficits. Doesn’t that all point towards inflation, just like it did in the 1970s?
Prechter: The difference is that back then, interest rates were soaring, and trying to keep up with the explosion in the money supply. This time, they’re collapsing as the Fed tries to expand the money supply.
Makin: That’s a good point. I’d just say that as a close student of the Japanese economy all through the 1990s, I think the parallels are powerful and somewhat chilling. Right down to the point where the Bank of Japan got to 1% interest rates and said, “We can’t, we won’t, ever go any lower.” But it was ultimately deflation that forced them lower. That is probably where we are now. The momentum towards deflation is still here. Or, more precisely, the momentum is from disinflation to good deflation. But people—including the Fed—are in denial. In fact, as disinflation intensifies, the Fed tells us it is moving from a concern about unwelcome amounts of disinflation to viewing the risks of inflation and disinflation as symmetric! A necessary precondition to deflation is for the central bank to ignore the problem—and so far, they are satisfying that condition.
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So how close are we to seeing the deflation no one but you guys expect?
Prechter: I think we’ve had our delayed reaction. They dropped rates as hard as they could, the stock market bottomed and turned up. The economy was still sluggish, it lagged, but it finally produced an 8% quarter. If you look back over the last 30 years, you see that very often the highest GDP readings come at a top in the stock market, or very close to it. So we’ve had our sequence. It’s been normal in every sense except that it has been weaker than it should have been— and that is the key.
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Shilling: Let’s talk about that for a minute. I think everybody is aware of all the debt out there. I mean, take Bill Gross’ latest epistle on it. [www.pimco.com/LeftNav/Late+Breaking+Commentary/IO/2004/IO_02_04.htm]
In which he rues the disappearance of bond vigilantes?
Shilling: Gross is pretty much expressing what I would regard as the consensus view. “There’s a lot of debt out there and if there’s a problem, it’s going to be because interest rates go up and make the debt onerous from a servicing standpoint.” By contrast, those few of us in the deflation camp would argue that the credit bubble is going to be a problem—not because higher rates will make servicing it onerous—but because the real value of the debt will grow with deflation. |
