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jk
06-22-06, 06:20 PM
the conventional wisdom from u.s.a. today, quoted by richard russell, is:
"Once foreign investors lose confidence in the dollar, the consequences can be dire. They are, after all, financing a big chunk of the US debt. Foreigners are big buyers of US Treasuries at auction. They own nearly half of all publicly traded US debt and 25% of US corporate debt and mortgage-backed debt. If foreign buyers lose interest in US debt, the Treasury will have to offer higher interest rates to attract buyers. The dollar could fall further, import prices would rise, inflation would surge. Higher rates, in turn would slow the economy."

the reasoning implicit in the predicted series of events runs: lower dollar=> rising import prices and rising rates=> inflation "surges" while the economy slows, i.e. stagflation.

i'd like to focus on the "inflation surges" part. yes, import prices would rise to the extent that the exporters don't absorb the hit, as many of them would try to do to maintain their export industries. but even so, are imports that big a component in the inflation figures? if the dollar drops i suppose oil would rise further and eventually higher energy prices would feed through. but that would take a significant amount of time.

in the meanwhile the higher rates would act immediately to kill housing instantly and altogether, and if the fed defends the buck by raising the discount rate all those floating rate home equity loans would start strangling the finances of even relatively reasonable households [let alone the leveraged-to-the-gills household on the margin]. this seems a recipe for deflation.

to summarize- in a dollar crisis, if the fed defends the buck the interest rate effects are quick, the inflationary effects slow. this produces DEflation.

so, on the other hand, suppose the fed doesn't defend the currency. rates stay low at least on the short end of the curve. if long rates rise too much ben fires up the helicopter for "unusual measures" i.e. buying long-dated bonds to control the WHOLE yield curve instead of just the short end.

that scenario is inflationary, but could take a long while to play out.

am i missing something?

blazespinnaker
06-22-06, 07:15 PM
I think it depends on how you define inflation / deflation.

If you look at housing prices, then yes, deflation could occur.

If you look at rental rates (which I think is what the fed does), I think inflation could skyrocket as people can no longer buy houses and start renting while the bubble bursts.

jk
06-22-06, 08:35 PM
you're right that we have a definitional problem. people are now saying that inflation isn't really so bad because it's distorted upwards by using owner's equivalent rent, which is increased when higher rates price people out of purchasing a house. i have noticed, however, that these people didn't complain that the inflation rate was distorted down by the same mechanism when rates were going down.

if we mean by inflation "that which is measured by the [core?] cpi," then you're right. higher rates will show up as higher owner's equivalent rent.

what i'm wondering is whether a dollar crisis can cause a deflationary crisis, a collapse of prices for all assets as people try to get liquid?

blazespinnaker
06-22-06, 09:15 PM
what i'm wondering is whether a dollar crisis can cause a deflationary crisis, a collapse of prices for all assets as people try to get liquid?

I hope so :)

Seriously, though, this is where I've made my big bet.

Will it happen? And soon, preferably?

I don't know. I'm watching energy / the environment. If energy prices drop hard, I could be seriously screwed as the economy takes off.

jk
06-22-06, 09:48 PM
I hope so :)

Seriously, though, this is where I've made my big bet.

Will it happen? And soon, preferably?

I don't know. I'm watching energy / the environment. If energy prices drop hard, I could be seriously screwed as the economy takes off.

i think the only thing that will drop energy prices hard is a global slowdown/recession/depression/deflation! it's interesting to notice that we can start with the same premises and end up with opposite scenarios.

i think it has something to do with which process leads and which follows.

you start with the hypothesis that energy drops and look at how great that would be for the world economy. i suppose that would be true if the price dropped because of huge new discoveries of oil, or discovery of efficient and cheap alternative energy processes. then, yes, the price of energy would drop and other assets would benefit.

however, i start with energy dropping and look backwards: what might have happened to make energy drop? [here in this world, without wonderful new discoveries]. all i can come up with is the very deflation you say you want but think low energy prices would prevent.

blazespinnaker
06-22-06, 11:43 PM
No I'm completely with you here. I too am looking for commodities to drop because of economic slow down. I'm all over that!

My fear is some big leaps forward in alternative fuel / discoveries / etc. Damn scientists!

Fortunately, my downside has a lot of general global upside. The idea that if I suffer everyone (including me) will gain, isn't such a bad thought.

Jim Nickerson
06-23-06, 01:24 AM
you're right that we have a definitional problem. people are now saying that inflation isn't really so bad because it's distorted upwards by using owner's equivalent rent, which is increased when higher rates price people out of purchasing a house. i have noticed, however, that these people didn't complain that the inflation rate was distorted down by the same mechanism when rates were going down.

if we mean by inflation "that which is measured by the [core?] cpi," then you're right. higher rates will show up as higher owner's equivalent rent.

what i'm wondering is whether a dollar crisis can cause a deflationary crisis, a collapse of prices for all assets as people try to get liquid?

Regarding the definition of inflation, I found the following to help my understanding of what inflation may be and the problems, according to this author (Michael Shedlock), of measuring inflation.

http://globaleconomicanalysis.blogspot.com/2006/02/inflation-what-heck-is-it.html

It is fairly long, but he concludes with:

Inflation is best described as a net expansion of money supply and credit.
Deflation is logically the opposite, a net contraction of money supply and credit.

zmas28
06-23-06, 09:25 AM
I think the usual definition of inflation/deflation is growth/contraction of the money supply in relation to the goods & services available, & is taken to be in the aggregate sense, ie, not sector or item related. But it seems to me that if there is too much money chasing Item A this upsets the exchange balance between the dollar on 1 hand, and Item A on the other (supply-demand balance), resulting in inflation or deflation of item A. We see this when discussing currency exchange rates also. It is possible for the dollar to be under-valued measured against New Zealand currency, but over-valued (inflated) in relation to the renminbi.
So is it not possible to have inflation in some sectors (the stock market or real estate sector) while having deflation in others (e.g., computer industry due to cheap imports) at the same time?
I think the unravelling of debt, due to loan defaults & debt being taken off the books, represents a deflationary effect on the associated sectors (banking, home construction, etc): Sector X. The external deficits, associated with over-consumption by the American consumer, would seem to represent inflationary pressures. The return of dollars to the US, were they to go into Sectors Y of the economy, would result in inflationary pressures in Sectors Y of the economy. Of course, Sectors X and Y would impact the rest of the economy also, presumably to reduced degrees.
Anyway, my point is that shouldn't this be looked at on a sector by sector of the ecoonomy basis, rather than just on the aggregate?

blazespinnaker
06-23-06, 06:30 PM
Anyway, my point is that shouldn't this be looked at on a sector by sector of the ecoonomy basis, rather than just on the aggregate?

Yes though I think the original intent was a valid one - that a dollar crisis could lead to a significant contraction in the economy and at a time when assets have been inflated, we could seem them significantly deflated.

zmas28
06-23-06, 07:04 PM
My line of thought was to determine investment direction during the upcoming period. I think we are in a secular bear stock market for some time, but its not clear to me as to whether this would be in an inflationary environment (like the 70's) or whether history would rhyme with the Japanese deflationary experience.
In an inflationary environment, real assets like commodities and real estate are expected to do well. In a deflationary environment, its cash.
It appears that there are strong deflationary pressures (represented by the huge debt overhang) and strong inflationary pressures (represented by the declining dollar and rise in commodity prices).
Then, of course, if one believes the Kondratieff cycle model, we are in for a rough deflationary "winter" period.
There's a school of thought that says that the Fed will respond to deflationary pressures by trying to reflate the economy, so we would end up with high inflation. Akin to the ka-Poom theory? But looks like the last time around, the Fed had a difficult time getting us out of the hole. Also, I've read somewhere that it gets more difficult each time and that it took about $4 of credit extended by the Fed to generate $1 of GDP.

In trying to think this through, I thought it might be more a question of individual sectors of the economy being affected in different ways. The trick is to determine which asset classes would perform best on a relative basis.

I'm a complete "newbie" at this, and I'm regurgitating what I've absorbed on the Internet including Eric's really insightful stuff. But its an important question, I think.

blazespinnaker
06-23-06, 09:30 PM
Yes, I think it's an expectations game. As longs as the fed has credibility they can reflate the economy ... Two things are working against this fed in that department:

- greenspans recent reflation
- switchover in chairmans

So, you're right, I think any attempt to reflate at this point will lead too massive inflation... best just to bite the bullet and pay the piper.

There is, of course, the muddle through school of thought which has a suprisingly good track record. And that is we'll see higher inflation, a weaker dollar, and lack lustre returns, but nothing overly painful in any particular sector ... at least nothing so bad that you should take a capital gains hit in order to rebalance your portfolio.

zmas28
06-24-06, 01:28 AM
I guess a possible scenario is that if deflation were to set in, people started to save & become more debt averse, then that would strengthen the dollar. Would this mean that interest rates would have to rise as debt instruments would have to provide greater yield? With the dollar now buying more, our international creditors would buy more US assets (companies perhaps, China's ill-fated pursuit of Unocal comes to mind). US international debt could unwind in this way, through reduced demand for imports and sale of US assets.

jk
06-24-06, 09:24 AM
I guess a possible scenario is that if deflation were to set in, people started to save & become more debt averse, then that would strengthen the dollar. Would this mean that interest rates would have to rise as debt instruments would have to provide greater yield? With the dollar now buying more, our international creditors would buy more US assets (companies perhaps, China's ill-fated pursuit of Unocal comes to mind). US international debt could unwind in this way, through reduced demand for imports and sale of US assets.

i don't see why an increase in savings would strengthen the dollar. an increase in savings would slow consumption, including consumption of imported goods. but it would slow the economy in general and lower interest rates, making the dollar less attractive.

zmas28
06-24-06, 02:00 PM
My thought here was that reduction in domestic spending would reduce the amount of money in circulation in a deflationary setting, resulting in a general price drop of US assets, making them more attractive to international buyers.

Jim Nickerson
06-24-06, 03:07 PM
i don't see why an increase in savings would strengthen the dollar. an increase in savings would slow consumption, including consumption of imported goods. but it would slow the economy in general and lower interest rates, making the dollar less attractive.
Below is a quote by Henry Kaufman noted at http://www.safehaven.com/article-5429.htm I found Kaufman's thoughts worth reading.

"Kathleen Hays: "Final moments, how high do you expect the Federal Funds rate to go?"
Mr. Henry Kaufman: "I really feel that somewhere in the next twelve months we'll head to at least 6%.""

Carl Swenlin 5/5/06 discussed the US$ and showed a nice monthly chart of US$ Index since 1983 http://www.decisionpoint.com/ChartSpotliteFiles/060505_USD.html This appears worthwhile to look at because it clarifies where the $ is relative to its peak almost 20 years ago.

The current chart of the US$ Index suggests to me that the $ is strengthening, why I am not exactly sure, but pershaps because of the current rise in interest rates.
http://0302.netclime.net/1_5/1258066/1151128338_14222/USDOLLAR_062306.png

With regard to EJ's Ka-Poom Theory http://www.itulip.com/retrospective2006.htm
and since John Serrapere's comments http://www.itulip.com/peakriskmay2006.htm
I have been trying to comprehend what the relationship has been between Deflation and the markets (S&P 500 as a proxy). My wonderment is whether or not presently the so-called "Ka" is upon us--a questioned asked recently somewhere in these fora, and which I am not inclined to find and cite directly?

Below is a graph of the S&P 500, the PPI and CPI, and the PPI minus the CPI. The CPI and PPI data through the last reporting were taken from http://www.bls.gov/opub/ted/2006/may/wk3/art04.htm and http://www.bls.gov/opub/ted/2006/may/wk3/art03.htm. If you wish to look at the data used to construct the graphs, click on the link beneath the graphs.
http://0301.netclime.net/1_5/L/1/R/PPI-CPI-Chart.jpg
http://0302.netclime.net/1_5/1258056/1151126539_13002/PPI-CPI-Chart.jpg

If one looks at the trends of the CPI and PPI, light green and light blue lines, they are currently up for both. The same was true in 1999-2001, the PPI peaked at 4.8% in Jan. 2001, and the CPI peaked at 3.8% in Mar. 2000, and hit 3.7% in Jan. 2001. By Jan. 2001, the S&P 500 was down 10%, measured by month-end closings, from its peak at end of Aug. 2000.

My conclusion (and Henry Kaufman's sentiment) is that interest rates have a ways to go upward--how far they may go up, I have no idea.

Secondly, I do not see the US$ collapsing for the moment.

Thirdly, using what I think might be useful definitons of Inflation and Deflation noted above in item #7 of this forum, and supported by Kaufman's perception that credit still is not "tight," I believe we are a ways in front of the "Ka."

jk
06-25-06, 09:45 AM
great post, jim.

on the dollar, i've seen the chart parsed in 2 ways at james turk's website:
http://goldmoney.com/en/commentary/2006-06-11.html

one way, which you've shown is:

http://goldmoney.com/en/images/commentary-images/commentary-charts/alert_2006-06-11b.gif



alternately, there's:





http://goldmoney.com/en/images/commentary-images/commentary-charts/alert_2006-06-11a.gif



swendlin's charts were done 5/5, turk's 6/11. on 6/11 the dollar index was 85.31. now it's 86.45 and i think it's still in doubt which view will prevail. if rates continue to rise as you [and kaufman] predict, then we may see a test of the "neckline" all the way up at 92. should we get there, that will be one hairy moment! imagine the conditions that would bring us there: i think it would represent a continued flight to [perceived] safety in the dollar, and a corresponding continued crash of global equities, commodities and bonds. how's this for a theory: that would be the moment the fed starts to ease again and gold goes to the moon.

file:///C:/DOCUME%7E1/jeff/LOCALS%7E1/Temp/moz-screenshot.jpgfile:///C:/DOCUME%7E1/jeff/LOCALS%7E1/Temp/moz-screenshot-1.jpg

jk
06-25-06, 10:02 AM
i don't see why an increase in savings would strengthen the dollar. an increase in savings would slow consumption, including consumption of imported goods. but it would slow the economy in general and lower interest rates, making the dollar less attractive.

rereading jim's post and the one of mine he quoted [above], i realize that we have a tremendous difficulty, and lack of clarity, with timing. for example, re this issue of savings rates and the dollar, i start the quote above with an assumed increase in savings. such an increase in savings and decrease in consumption would occur in an environment of financial stingency, probably in the context of still higher interest rates, as henry kaufman predicts. these same higher interest rates would be supporting and strengthening the dollar. the economic slowdown or recession flowing from these conditions would lead to lower rates and a fall in the dollar.

one thing in the notion of "ka=poom" is that it describes an INITIAL REACTION to some set of conditions, here "ka," and then a COUNTER REACTION, "poom." in these discussions it would be worth our whiles to try to analyze and be explicit about what is an intial reaction and what is a later counter-reaction.

Jim Nickerson
06-25-06, 01:37 PM
Partial quote of jk:

one thing in the notion of "ka=poom" is that it describes an INITIAL REACTION to some set of conditions, here "ka," and then a COUNTER REACTION, "poom." in these discussions it would be worth our whiles to try to analyze and be explicit about what is an intial reaction and what is a later counter-reaction.

First, let me correct an error (at least the one I see) in my post #15 above. After referencing EJ's revised Ka-Poom Theory, I used "Deflation" rather than the appropriate "Disinflation." http://en.wikipedia.org/wiki/Disinflation

It seems clear to me that currently, just 6 weeks after EJ put up his revision, that we are still in the first "Poom." In his theory the "Ka's" are periods of decreasing rates of inflation, ie, disinflation. If it were to turn out there is some reality to his first "Poom" of annual CPI rates reaching something above 12.5%, then we are quite a ways from that.

Specifically to jk, the initial reactions are periods of disinflation and are 'Ka's." The "Poom's" are periods of inflation.

It occurs to me as I write this, that in my mind I have not carefully differentiated the words "disinflation" and "deflation" as I have read them many times in so many places. In our own economy, I ask this question: If one looks at the chart I put up in #15 above, when the PPI (the light green line) dropped below 0% between 10/01 and 10/02, was that a period of deflation?

jk is correct, in that everyone should strive for specificity and precision in the terms we use.

The most confusion about all of these considerations for me are the determination of what measurements to use to note Inflation and Deflation. One one hand, all we get from bls.gov are the "doctored" figures each month for PPI and CPI. Then there is periodic reference to John Williams' Shadow Government Statistics http://www.gillespieresearch.com/cgi-bin/bgn/?ref=234993. I have no quarrel with Williams' endeavor to put out truthful data, but from what I can tell the FOMC and the markets do not move based on what John Williams puts out as the real picture concerning inflation.

If one reads about the problems with defining and measuring inflation as I referenced above in #7, Shedlock's conclusion for the best method of describing inflation would be to follow "net expansion of money supply and credit." Now I do not know personally now to track expansion of money supply and credit on any valid basis, though it appears to me something worthwhile to follow. Any precise advice about how to do so is solicited.

I think Shedlock's attention to both money supply and credit availability explains a lot of what went on in Japan from 1989 until recently. I certainly am not in any position to seriously doubt Henry Kaufman, but if he says it is still easy to get credit in the US, then until someone counters that with cogent data, I'll accept Kaufman's contention. If Kaufman were to be correct, and if Shedlock's conclusion about best descibing "inflation" is correct, then we are in a period of inflation--first occurring "Poom" in EJ's theory.

jk
06-25-06, 01:49 PM
the best place that i know of to get overwhelmed with information on this subject is doug noland's weekly credit bubble bulletin over at prudentbear.com. every week he goes through reams of information and anecdotes which make it clear that, yes, credit is still expanding enormously. the rate of expansion might be slowing a bit, and that relative slowing has been enough to cause the recent fall in asset prices. imagine if credit were to actually contract!

Jim Nickerson
06-25-06, 02:25 PM
great post, jim.

on the dollar, i've seen the chart parsed in 2 ways at james turk's website:
http://goldmoney.com/en/commentary/2006-06-11.html

one way, which you've shown is:

http://goldmoney.com/en/images/commentary-images/commentary-charts/alert_2006-06-11b.gif



alternately, there's:





http://goldmoney.com/en/images/commentary-images/commentary-charts/alert_2006-06-11a.gif



swendlin's charts were done 5/5, turk's 6/11. on 6/11 the dollar index was 85.31. now it's 86.45 and i think it's still in doubt which view will prevail. if rates continue to rise as you [and kaufman] predict, then we may see a test of the "neckline" all the way up at 92. should we get there, that will be one hairy moment! imagine the conditions that would bring us there: i think it would represent a continued flight to [perceived] safety in the dollar, and a corresponding continued crash of global equities, commodities and bonds. how's this for a theory: that would be the moment the fed starts to ease again and gold goes to the moon.

file:///C:/DOCUME%7E1/jeff/LOCALS%7E1/Temp/moz-screenshot.jpgfile:///C:/DOCUME%7E1/jeff/LOCALS%7E1/Temp/moz-screenshot-1.jpg

I don't know what comes first, the chicken or the egg. To reference the chart I put in #15 again, the markets as indicated by the S&P 500 (dark blue line) went up from 1997-2000 as did inflation using the government's figures. On that same chart inflation is currently going up, though there has been over 34 days now about a -7.75% loss from high--which is not severe. If the FOMC is serious as Benanke presumably is about inflation fighting then more interest rates are coming, and if interest rate rises are supporting the UD$'s present rise, until there are signs inflation is ebbing, then why should the UD$ not continue up? Were the US$ Index get to 92 that is about 6% higher than US$ Index close Friday at 86.88. For whatever are all the reasons the $ is up, and to me its chart looks good, if it gets to 92, then the circumstances that exist then will determine what is next. Gold indexes XAU and HUI also look positive to me, and I cannot say that the CRB is not about to bounce. (I look at these charts at stockcharts.com if anyone wishes to look at them).

jk, you may be correct totally or in part, that money that has been in the emerging markets is seeking safety in the $ for the moment, and perhaps in gold too.

jk
06-25-06, 06:12 PM
jim, the egg came first. [fish, amphibia and reptiles were laying eggs long before there were chickens.]

markets, unfortunately, are not as easy to analyze. on the one hand you have evidence of softening economy, and especially a softening housing market. on the other hand you have increasing evidence of commodity inflation feeding through so strongly that it actually shows even after all the bls manipulations of the statistics. on the third hand you have a new fed chief being challanged to show his mettle.

bill fleckenstein, longtime bear and hedge fund mgr, says "one and done" -- that is, the fed raises 25bp but announces its intention to then pause. the markets have been toying with the possibility of a 50bp hike, but that seems unlikely. and you have henry kaufman's position of several hikes to go.

given the "transparent" and "measured" approach of the fed, i guess i could picture a remake of the 70's stagflation. the fed raises rates but credit keeps expanding. the fed keeps raising but is afraid to kill the economy. so it stays behind the inflation curve, which leads to more raises, but always too little too late.

if the fed pauses soon i'd expect a failing rally in equities, a large rally in gold, a drop in the dollar and likely a sell-off in bonds. in the stagflation scenario the fed doesn't pause for a long, long time. and the dollar could strengthen.

i've got to take a break from this stuff. i can talk myself into about any outcome you care to mention, and my brain is turning to mush.

Jim Nickerson
06-25-06, 07:40 PM
jim, the egg came first. [fish, amphibia and reptiles were laying eggs long before there were chickens.]

i've got to take a break from this stuff. i can talk myself into about any outcome you care to mention, and my brain is turning to mush.

I no doubt knew once that eggs came before chickens, but then there is the joke about the rooster on a bed with an egg, and the rooster is smoking a cigarette. Now, which came first?

Your brain is good and your abilities to conjure scenarios far exceeds mine. You put forth a lot to contemplate. I too am tired, everytime I look around you have posted another note. Take a break, read a journal.

fogger
06-26-06, 03:01 AM
The argument always leads in circles doesn't it? What was that theory from 1940s computer science? "You can't solve a problem using the same tools used to define it."? Or something like that. So let's back up to the definitional problems.


Government and the Fed have done an excellent job of making "inflation" a synonym for "rising prices" and further, that "inflation" is a synonym for a rising CPI.

But, as stated above, the true definition of inflation is "an increase in the money supply that results in rising prices". Of course price rises can occur for many reasons (such as supply/demand imbalances), but in the public's mind all price rises are simply termed "inflation".

This obfuscation of cause and effect allows the Fed to more easily control inflation perceptions. They can now show that inflation is contained by manipulating the metrics such as CPI or mis-directing the cause of "inflation" to "greedy oil companies". The effect has now become the cause.

This is done to hide the true cause of inflation: The Fed and government are continually spending new money into the supply. Targeted at a benign 2% so we don't start asking too many questions.


jk is absolutely correct. In our banking system a flat money supply growth has the effect of deflation. This system requires constant money supply expansion to keep afloat. Even a temporary pause in the expansion can have devastating effects.


So it's obvious the Fed's statements are for public consumption and have nothing to do with their true goals. They are managing perception. They are acting with a separate intention. Once that is understood, analysis becomes much simpler.