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EJ
09-11-06, 02:10 PM
No Deflation! Disinflation then Lots of Inflation

The "Ka" phase of "Ka-Poom" has officially begun

by Eric Janszen

There will be no deflation. I repeat: there will be no self reinforcing spiral of debt defaults, an irreversible collapse in the money supply and a decline in the general price level. Central banks will never again allow the rate of inflation to fall below short term interest rates, nor fail to supply sufficient liquidity to meet the demands of financial markets. There will be no repeat of a 1930s US depression or the grinding 1990s Japanese deflationary recession. Instead, we will experience something new, with elements of deflations, and inflations and stagflations past – rhymes of past verses of economic misfortune – but unlike any of these past episodes except equally unpleasant. I call this new process "Ka-Poom Theory."

In 1999, in anticipation of the collapse of the stock market bubble, the Fed under Alan Greenspan vowed to never allow a deflation to happen in his back yard, and he kept his word. As a side effect, we got real estate and other asset bubbles, and soaring commodity prices. Bernanke has made numerous similar promises, and I strongly recommend that readers take him at his word. He made these promises because he expects these new asset bubbles to collapse, too. His famous speech about dropping money from helicopters (http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm) earned him the nick name "helicopter Ben." He's not kidding.

The trick to avoiding deflation is to not be too slow on the draw. Once the rate of inflation falls below short term rates, as happened to the BoJ in Japan in 1992, the economy is an airplane flying with no forward air speed. The flaps flap uselessly in the stillness and quiet of a stall. The pilot of the economy, we'll call him Ben, needs to quickly drop the nose and head for the ground and pick up airspeed, although he'd better not be too close to the ground before pulling the maneuver. Ben is now flying a relatively comfortable 4.25 thousand feet in the air. But as we'll see, he has other problems that previous pilots didn't have.


http://www.itulip.com/images/japanzero.jpg
Object lesson: Japan 1990s. Don't let this happen because, if you do...

http://www.itulip.com/images/japandeflation.jpg
...you get this.


Not deflation, but certainly disinflation (http://en.wikipedia.org/wiki/Disinflation), a slowing in the rate of inflation. Evidence of it is popping up everywhere.
Oil, Gold Tumble as Economic Slowing Threatens Commodity Rally (http://www.bloomberg.com/apps/news?pid=20601087&sid=aHDfGK5Dr1LQ&refer=home)
Sept. 11, 2006 (Bloomberg)

Oil fell for a sixth day, its longest losing streak in almost three years, and metals declined as negotiators reported progress to resolve a dispute with Iran and concern mounted the world economy is slowing.

"There's some talk that this could be the beginning of the end" for the five-year rally in commodity prices, said Ron Cameron, a resources analyst at Ord Minnett Ltd. in Sydney. "Tensions seem to be softening" in the dispute with Iran, he said. "That's giving the traders an excuse" to sell.

Gold for December delivery dropped $22.80, or 3.7 percent, to $594.50 on the Comex Division of the New York Mercantile Exchange. The metal is down 18 percent from a 26-year high of $732 an ounce in mid-May.

Movements in oil and gold prices are 81 percent correlated, Merrill Lynch & Co. said in a Sept. 8 report. A correlation of 100 percent would imply the two were moving in lockstep.

"The mega-run for commodities has run its course,'' Stephen Roach, chief global economist at Morgan Stanley, said in an interview Sept 5. Roach in May said the surge in oil and metals was a bubble about to pop.
The period of disinflation, as shown in the Ka-Poom chart below, will likely last for a relatively brief period.


http://www.itulip.com/images/KaPoom2006Q.gif
Ka-Poom V2.0 (Dates represent estimated, approximate relative time intervals, not precise events)


Trade Ka-Poom?

The "Ka" phase of "Ka-Poom," the decline in the price of leveraged assets, as shown has begun. It has been kicked off by the collapse of the housing bubble. Ka-Poom leaves holders of inflation hedges, such as precious metals ETFs or bullion, with two options: 1) trade them, or 2) ride it out.

There are three problems with trading Ka-Poom: timing, transaction costs, and the risk of the wrong kind of random exogenous event. Getting the timing right is art, not science; transaction costs can easily consume your profits via taxes and fees; and an event that sends everyone after inflation hedges at once can leave you locked out of the market, high and dry.

Let's start by looking at the timing question. Using myself as an example, I purchased silver, gold, and platinum 1999 - 2002, mostly in 2001, during the previous disinflationary cycle, based on my first crack at Ka-Poom Theory–was buying gold from the dot com bubble until the Fed started fretting aloud about deflation, 1999 - 2001.

Exhibit A is receipt for purchase Sept. 25, 1999 of 20 PCGS and NGC graded MS63 $20 St. Gaudens at $445 each. Today, per PCGS (http://www.pcgs.com/prices/frame.chtml?type=date&filename=saint_gaudens_twenty), these are priced at $935. This was one of many purchases. In those days, ETFs did not exist. You had to buy the stuff. Now you have many more options.

Before you read on, ask yourself: What kind of freak was buying numismatic gold coins in quantity in September 1999, during the peak of the NASDAQ bubble?
No, not for Y2K . iTulip.com was anti-hysteria on that non-disaster.

In August 1999 we said (http://www.itulip.com/y2k.htm): "What the heck's gonna go down after Dec. 31, 1999? Do we at iTulip.com envision a world in chaos ruled by tribal warlords marauding the strife torn land in ox drawn Rolls Royces, plundering suburban America for precious caches of bottled water and canned tuna fish? Time to invest in a bomb silo apartment (http://infoseek.go.com/Content?arn=BW1087-19990824&qt=Y2K&sv=IS&lk=noframes&col=NX&kt=A&ak=news1486)?

Nah. After the clocks roll over into 2000, a lot of crappy software that doesn't work very well and breaks all the time will continue to be crappy and not work very well and break all the time."
So... consider the source.

Should I sell now? If I do, when should I buy back in? Am I sure I'll be able to? At what price?

To trade Ka-Poom, you need to time the inflection point of the end of the disinflationary phase and the start of the inflationary phase of the Ka-Poom process. The question is, how?

The disinflationary phase will last as long as it takes Ben to get and keep short rates a point or two below a falling rate of inflation. Before Ben can pull the "print" lever and head for the ground to pick up air speed, the bond market needs to be worried about deflation. Ben will hold off rate cuts and liquidity injections as long as is necessary to avoid causing a sell-off in the bond market. Can't look too eager, but can't be too slow on the "pull" either.

One way to try to time a trade is to take a good hard look at the rear view mirror. For this I provide two charts.

One comment before getting to these two charts: Money at Zero Maturity (MZM) is the only reliable published measure left to determine the level of the broad US money supply. MZM data have been collected and analyzed in a consistent way for decades. "M3 does not appear to convey any additional information about economic activity that is not already embodied in the M2 aggregate," said the Fed when they stopped reporting it last year. Fact is, the Fed has for many years used MZM, and so should you.

Likewise, the Producer Price Index (PPI) is the only remaining reliable published measure of prices. The Consumer Price Index (CPI) is continuously re-composed and fiddled with for political and other reasons. The PPI is imperfect because it is heavily skewed by energy prices, but the inflationary impact of energy prices on the economy is more or less proportionately skewed, and the Bureau of Labored Statistics messes less with the PPI than with the political football, the CPI, to which many government liabilities, such as TIPS and Social Security payments, are tied.


http://www.itulip.com/images/PPIvsMZM1990to2006.png


Chart I


Chart I above shows MZM and PPI from 1990 and today. There are many other factors influencing the movement of the PPI other than MZM, such as the dollar exchange rate. To keep the analysis simple, but I hope without negating its value, I focus on the relationship between PPI and MZM only.

A. The 1994 - 1995 period is the last recent reported decline in MZM. This coincided with dysfunction in the commercial banking system following the end of the last real estate boom. That resulted in a near cessation of commercial lending in 1994. The Fed worked the problem and got things going again, as explained in "What (Really) Happened in 1995? (http://www.itulip.com/forums/showthread.php?t=292)"

B. After about a one year lag, after MZM had already started to recover, the PPI declined from mid-1996 to the end of 1999.

C. Following the stock market crash in mid 2000, MZM grows rapidly from mid 2000 to mid 2002 as a result of application of the Keynesian economic cure, including boosting the money supply. Other policies moves: tax cuts, deficit spending and dollar depreciation. The dollar price of gold, as show in (B) of Chart II below, rises during this period.

D. From 2000 and mid-2002, during the (C) period of rapid MZM growth, the PPI declines sharply. However, looking below to Chart II for a moment, gold rises sharply over the period through the end of 2004. This is the period of rapid dollar money supply growth; gold is pricing in future inflation which picks up in 2002. Gold and PPI rise together thereafter as the dollar is allowed to depreciate against other currencies. (This is detailed in the Inflationary Bias #6 chart below).

E. Returning to Chart I above, in 2001, the US economy goes through a recession even as MZM rises rapidly (C) and the PPI declines (D).

F. After the period of rapid MZM growth (C) ends, the PPI begins a rapid increase.

G. From mid-1996 to mid-2000, MZM returns to its trend growth rate, in line with GDP growth, as between 1990 and 1994 and 2003 to now.


http://www.itulip.com/images/au85-pres.png
Chart II


Moving on to Chart II above for a further look at the rear view mirror, the rapid rise in gold (C) coincides with concerted rate cuts and liquidity injections by global central banks. In 2002, gold begins to rise in all currencies, not only the dollar.

In fact, the price spiked. Some analysts, such as Roach quoted above, characterize this rise as a "bubble." It is not. Bubbles are widely held belief systems, and to date very few people "believe" in gold, or any commodity, for that matter. Go look at the shelves of the Investing section of your local book store and you'll see what I mean. It's all stock tips and FOREX trading, although the Get Rich in Real Estate! books have thinned out. The spike is not a bubble but it does represent a phase in the Ka-Poom cycle that is likely to lead to a correction in this disinflationary period.

As the housing and other global asset bubbles end and the commercial banking system comes under pressure, trend MZM growth rates can't be supported and the disinflationary "Ka" period begins. The falling price of gold leads a falling PPI.

How long and far will gold fall during the disinflation "Ka" phase? No one knows, but my best guess is that it is likely to fall below $500 and perhaps even test $400.


Short Term Timing versus Long Term Trends

How will we know when Ben has pulled the lever and the Fed has begun flushing the system with liquidity, and the disinflationary part of the Ka-Poom cycle is about to end? Due to time lags there are no reliable data indicators but there are perhaps a couple of reliable anecdotal tip-offs.

The first is that the Fed will begin to worry aloud about deflation. When Ben starts to talk about deflation again, it will likely mean the presses are already running full tilt and first gold and later commodity prices will soar again within six months.

The previous mini-"Ka-Poom" 2000 to 2006 delivered the disinflation I expected, but not the level of inflation. To hold that off a while, The Three Desperados (http://www.alwayson-network.com/comments.php?id=P8853_0_4_0_C) came to the rescue.


http://www.itulip.com/kapoom.gif
Original Ka-Poom Hypothesis – V1.0 – 1999


My current hypothesis is that the inflation I expected in the first iteration is likely to show up in the second. Here's why.

Unlike in the year 2000, reflating the economy today involves pouring liquidity into a system that is already riddled with inflationary biases left over from the previous Keynesian cure of rate cuts, tax cuts, liquidity injections, deficit spending and currency depreciation that followed the stock market bubble collapse.

Let's compare 2006 to 2000.


http://www.itulip.com/images/BrentCrude1988to2006.gif



Inflation Bias #1: High energy prices. Oil is at $65/bbl today vs $25/bbl in 2000, and OPEC is talking about lowering production to maintain the oil price above $50.




http://www.itulip.com/images/currentaccount.png


Inflation Bias #2: Current account deficit of 1.75% of global GDP today, 30% higher than 1.25% of GDP in 2000.




http://www.itulip.com/ForeignNetAquiFinAssets.gif



Inflation Bias #3: Deepening US dependence on global capital flows to fund trade deficits, up to 80% of all global capital flows today from 60% in 2000.




http://www.itulip.com/images/feddeficitsurplus1900-2008.gif



Inflation Bias #4: Largest fiscal deficit today since the 1990s recession versus a fiscal surplus in 2000, which was the largest since 1940.

http://www.itulip.com/images/taxgdp.png


Inflation Bias #5: Taxes were generating revenues of 21% if GDP in 2000 against outlays of 18.5% of GDP. Today, taxes are generating only 17.5% of GDP against outlays of 20% of GDP, the largest spread since the recessions of the early 1980s. Additional tax cuts will further explode fiscal deficits.



http://www.itulip.com/images/globalexchange.png



Inflation Bias #6: The dollar has depreciated 15% against the yen and 25% against the euro since 2002.


The inflationary "Poom" is what happens when the liquidity spigot is turned on with this set of six inflation biases already in place.

For these reasons, Ka-Poom theory asserts that we will experience a post-bubbles disinflation followed by a reflation program what will effectively prevent deflation–as promised by the Bernanke Fed–but create a period of high inflation and economic stagnation.

Beyond Timing

Back to our question, what do holders of inflation hedges like precious metals ETFs or bullion do in the face of Ka-Poom: 1) trade it, or 2) ride it out? Above, I attempt to address the question of timing. It's tough to get right. I also mentioned that in addition to the difficulty of timing Ka-Poom, trading Ka-Poom involves transaction costs and the risk of a Random Exogenous Event that leaves you on the wrong side of the trade.

I won't go into transaction costs except to say that here in the US, paying 28% capital gains taxes on profits from sales of "collectables" is unappealing, and that apparently applies to gold and silver ETFs as well as physical gold. Throw in the 2% premium on both sides of the trade when you buy and sell physical and it's not hard to calculate the trade-off.

As for Random Events, in the face of the disinflation in leveraged assets now in progress, given the inflationary biases, the Fed wants to wait before pulling the "print" lever in order to not tank the bond market or the dollar. But a financial crisis in China (http://www.itulip.com/forums/showthread.php?p=2735#poststop%29,), a terrorist attack against the US, or a derivatives or other financial crisis may happen that puts immediate demands on the Fed for liquidity. The Fed will then immediately begin to supply it. And if there isn't a random event handy that demands a liquidity injection when they want to inject it, well, the Fed can always invent one, such as when the Fed used Y2K as an excuse to keep the NASDAQ bubble going a bit longer. Quoting the "old" Stephen Roach (http://www.morganstanley.com/GEFdata/digests/20010716-mon.html), "Although Greenspan & Co. began to take back their extraordinary monetary accommodation by mid-1999, by then it was too late–the damage had been done. Moreover, it was compounded by the Fed’s now infamous Y2K liquidity injection of late 1999." The result of the next "emergency" liquidity injection will be unpredictable short term but, as the inflationary biases above show, are more predictable long term. Short term, the dollar may strengthen, as flight capital heads to US shores, especially from China, assuming the Chinese government allows it (this is typically accomplished via Hong Kong banks). But the six inflationary biases are likely to determine the longer term outcome.

Conclusion

To me, this all adds up to a hold. Ka-Poom is a hypothesis that a long term trend is in place that supports holding inflation hedges long term. I'm no better at timing trades using rear view mirrors (charts) than anyone else. However, I remain confident that the antecedents lead inexorably to the medium and long term trends of a period of disinflation followed by a period of chaotic pricing of securities and currencies, followed by a declining dollar and rising US inflation in assets that do not need to be purchased with additional credits, resulting in new debts.

Two final observations. First, I realize that since I bought PMs near the bottom of the market, it is easier for me to be philosophical about their prices as they go through inevitable periods of volatility. I understand that buying at gold at $270, watching it rise to $380, fall to $320, rise to $580, fall to $460, rise $720, fall to $550, rise to $630, fall back to $580, and so on, is a different experience than buying at $700, watching it fall back to $580, and putter around $620 for years. It's a personal decision whether to try to trade these fluctuations, just as it's a personal decision to buy into this whole Ka-Poom Theory at all.

Second, watching PM prices day to day, or even month to month, and trying to see a trend is like sitting on a beach and trying to determine whether the tide is coming in or going out by measuring how far each wave laps on shore compared to the one before. Sometimes, even when the tide is coming in, one wave laps higher than the previous one. If you go away for a few hours and return, the direction of the tide becomes obvious. Markets are unkind to the obsessive, unless he or she is a professional trader and has put that character trait to constructive use. On the other hand, if you wait until the tide is either mostly in or out before deciding on its direction, you've waited to long–you've missed it.

A large part of the art of investing in trends is to watch long enough to know the direction of the tide, but not so long you miss the ride.

______

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Jim Nickerson
09-11-06, 06:16 PM
EJ,

I always like your perspective on things and this is a good article.


Conclusion

To me, this all adds up to a hold. Ka-Poom is a hypothesis that a long term trend is in place that supports holding inflation hedges long term. I'm no better at timing trades using rear view mirrors (charts) than anyone else. However, I remain confident that the antecedents lead inexorably to the medium and long term trends of a period of deflation followed by a period of chaotic pricing of securities and currencies, followed by a declining dollar and rising US inflation in assets that are not purchased on credit.

I do not understand exactly what you mean in the underlined phrase.
For example, does it say a house being bought via a mortgage will not inflate, but one for which cash was paid will inflate? That does not make sense to me.

Finster
09-11-06, 07:30 PM
EJ,

I always like your perspective on things and this is a good article.



I do not understand exactly what you mean in the underlined phrase.
For example, does it say a house being bought via a mortgage will not inflate, but one for which cash was paid will inflate? That does not make sense to me.

That would be assets that, as a group, tend not to be purchased on credit. For example, houses in general are largely purchased on credit, while gas and groceries are largely not.

Jim Nickerson
09-11-06, 08:03 PM
Finster,

If inflation were to be rampant e.g. >10-15%, why would homes as an asset class not also inflate?

Finster
09-11-06, 09:40 PM
Finster,

If inflation were to be rampant e.g. >10-15%, why would homes as an asset class not also inflate?

This goes back to my comments about inflation washing through an economy in waves. Mortgages and home equity extractions were one of the chief channels through which new money supply made its way into the economy in the past few years. Home prices were on the forefront of this wave of inflationary price increases. So in fact homes as an asset class did inflate.

Now we see the same process in reverse. The Fed is (ever so gingerly) taking its foot off the monetary accelerator. Home prices are now in deflationary mode; again at the forefront of the monetary wave. But a lot of the excess money that drove them up in the first place is still out there, in places like India and China. This excess money is what has been pushing up the prices of energy and other commodities. At the same time, a lot of the excess money that pumped up the stock bubble in the second half of the 1990's is still out there, doing much the same thing.

This is one of the insidious aspects of inflation. Inflation, in the early stages, often "feels good", as it drives up prices of things we own, like stocks and houses. But the excess money eventually also must drive up the prices of things we buy, like gas and groceries. The Greenspan Fed fell into this trap, lulled by the failure of consumer prices to rise aggressively, thinking that it could expand the money supply with impunity. Greenspan was dubbed "The Maestro" because stock prices were soaring but the rest weren't. It was all just timing, though, as that's how inflation works in the early stages. Now we are paying for it.

metalman
09-12-06, 01:05 AM
what he said

Jim Nickerson
09-12-06, 09:38 AM
I got this as an email from Fred but do not see it posted in this forum. This is a good answer that I understand, and I appreciate the clarification




because in the kind of inflationary conditions prognosticated here, you get limited access to credit but nominal incomes increase, so things you buy out of cash flow from income... food, except these days poeple charge a beer and a condum on their credit card.. rise in price faster than things you buy using credit... houses, cars, etc., go down in real terms compared to things you buy... necessities... that you buy with your nominally increasing income.

will try it this way.

say you make $100K a year now and the median home price is $500k.

the only way anyone buys a house is in credit - no one uses cash - but that's not easy when interest rates are 15% and the banks are tight on lending standards. so the only guys buying houses are those that are going for a job that pays enough to cover the mortgage on a house with a 15% mortgage and have AA credit.

the house now has to be cheap enough to be affordable on a 15% mortgage. remember... during the housing bubble $500k houses pre bubble became affordable when the price went to $1M because the rates fell by half. think the same process in reverse.

now your nominal income is $200K and a house that was $500k before the bubble and $1M after is down to $400K now but even tho your income is up 2x from $100K to $200K you still can't swing it because a 15% mortgage on a $400K house is a big monthly nut vs 5% on a $1M mortgaqe.

plus there are no TV shows on every channel about fixing up your house, the stuff at the home depot is cash only and expensive due to trade wars and the whole culture is downsizing and offthegrid and and so on. so real estate is dead.

but you still gotta eat and heat your house. a big chunk of your $200k income goes into buying food and energy and you feel good about it because there are alot of people who cannot afford that and count on the govt for it and that's where a lot of the other chunk of your income goes -> taxes!

we having fun yet?

did i mention your kids are off in some war someplace to help keep the oil flowing and loans and interest rates a mere 15%.

'nuf said.

Thanks, metalman.

FRED
09-12-06, 11:49 AM
I got this as an email from Fred but do not see it posted in this forum. This is a good answer that I understand, and I appreciate the clarification

Actually, credit where credit's due: that was originally posted by metalman but he messed it up and asked for help then I messed it up trying to re-post it, etc.

Jim Nickerson
09-12-06, 12:41 PM
because in the kind of inflationary conditions prognosticated here, you get limited access to credit but nominal incomes increase, so things you buy out of cash flow from income... food, except these days poeple charge a beer and a condom on their credit card.. rise in price faster than things you buy using credit... houses, cars, etc., go down in real terms compared to things you buy... necessities... that you buy with your nominally increasing income.

will try it this way.

say you make $100K a year now and the median home price is $500k.

the only way anyone buys a house is in credit - no one uses cash - but that's not easy when interest rates are 15% and the banks are tight on lending standards. so the only guys buying houses are those that are going for a job that pays enough to cover the mortgage on a house with a 15% mortgage and have AA credit.

the house now has to be cheap enough to be affordable on a 15% mortgage. remember... during the housing bubble $500k houses pre bubble became affordable when the price went to $1M because the rates fell by half. think the same process in reverse.

now your nominal income is $200K and a house that was $500k before the bubble and $1M after is down to $400K now but even tho your income is up 2x from $100K to $200K you still can't swing it because a 15% mortgage on a $400K house is a big monthly nut vs 5% on a $1M mortgaqe.

plus there are no TV shows on every channel about fixing up your house, the stuff at the home depot is cash only and expensive due to trade wars and the whole culture is downsizing and offthegrid and and so on. so real estate is dead.

but you still gotta eat and heat your house. a big chunk of your $200k income goes into buying food and energy and you feel good about it because there are alot of people who cannot afford that and count on the govt for it and that's where a lot of the other chunk of your income goes -> taxes!

we having fun yet?

did i mention your kids are off in some war someplace to help keep the oil flowing and loans and interest rates a mere 15%.

'nuf said.

So if the credit spigot is turned off what will be the fallout with regard to hedgefunds?

Spartacus
09-12-06, 04:23 PM
I don't know that Bernanke's path of action is sealed in stone.

Certainly his earlier statements implied that Bernanke was deathly afraid of DEflation and would move heaven and earth, risking tons of INflation to prevent even the thought of deflation.

Remember that while Bernanke did make those pro-inflation speeches, he's also commented that central banks should orally bully the markets with (my words) feints and diversions - I forget his exact words- "manage expectations" or some such.

But he may have been bluffing. And his actions thus far, in the face of some strong deflationary hints look like the world is calling Bernanke's bluff and he's NOT backing it up.

EJ
09-12-06, 05:19 PM
So if the credit spigot is turned off what will be the fallout with regard to hedgefunds?

metalman's got the gist of it. Imagine that the prices of imported goods are rising as the dollar depreciates and interest rates are rising, increasing the monthly payments on everything that is typically purchased on credit. Nominal incomes lag behind goods prices. The Monthly Payment Consumer Economy goes into the toilet.

Hedge fund managers I've talked to are largely wise to the whole scenario, and I can't find anyone in the investment banking/wealth management biz who isn't pushing their clients to diversify into non-dollar denominated assets. Some hedge funds may blow up if they are using leverage and make the wrong bet on interest rate differentials and rates of change, but I suspect many will make a bundle.

EJ
09-12-06, 06:09 PM
Quick definition of terms:

Deflation: Negative rate of inflation, e.g., "CPI inflation averaged -1.3% in 2007." You will not hear anything like this.

Disinflation: Declining rate of inflation, e.g., "CPI inflation declined to 2.1% in Q4 2007 from 2.5% in Q3 2007." You will hear something like this.

During the previous "Ka" the US economy did experience actual deflation; CPI averaged <small>-3.3% for the month of October 2001. </small><small>CPI inflation during 2001 averaged a mere 1.6%. In other words, the economic airplane, by analogy, did bounce off the ground very briefly before heading back into the sky. Had the plane not been moving fast enough, because the Fed had not aggressively cut interest rates and flooded the system with money, it would have stayed on the ground as happened in Japan in the early 1990s. It took the BoJ nearly 15 years to get their economic airplane back in the air.

Ben's speech on deflation was intended to supply a context for future Fed actions. At the time he made it, there was no deflation in sight. But the spector of deflation, in light of all the leveraged asset bubbles around, is certainly on the bond market's collective mind.

The Fed's public talk of deflation in the context of any specific financial markets crisis that threatens to spill over into the so-called "real economy," such as the collapse of the stock market bubble in 2000, is intended to explain to the bond market why the Fed is about to dramatically drop interest rates and open the floodgates. If the Fed did so without first talking about deflation, the bond market is left to wonder whether the Fed has some other intention besides economic rescue, or, conversely, is not on top of the problem.

In the context of a market "event," the bond market must believe that inflation is falling and in danger of declining into negative territory, so that bond traders accept higher bond prices and allow long term interest rates to fall in line behind the Fed as it cuts rates, else a deflation may become self-fulfilling.

The Fed is never talking to you or I, nor to the puny little stock market that has a capitalization that is a fraction of the bond market's. When the Fed talks, it's talking to bond traders, and the Fed and bond traders don't have a kidding-around kind of relationship. Next time you hear Ben talk about deflation after a financial markets "event," you can be certain that the money drop is already in progress, and that the Fed has reflation Plans B, C, D, and E in case the Plan A doesn't work.
</small><small> </small>

FRED
09-12-06, 10:59 PM
Hedge fund managers I've talked to are largely wise to the whole scenario, and I can't find anyone in the investment banking/wealth management biz who isn't pushing their clients to diversify into non-dollar denominated assets. Some hedge funds may blow up if they are using leverage and make the wrong bet on interest rate differentials and rates of change, but I suspect many will make a bundle.
To wit...

HOME FIRES DYING (http://www.nypost.com/business/home_fires_dying_business_roddy_boyd.htm)
FUND BETS ON BUST

September 12, 2006 -- A New York hedge fund is betting big time what apartment-obsessed New Yorkers have been whispering about for months: that the real estate boom is over.

In July, Paulson Credit Opportunities Funds raised $147 million in equity and promptly put it to work on a leveraged $1.8 billion bet that home owners are going to have a very difficult time paying their mortgages.

The bet is concentrated on the lower end of the credit world, reckoning that the housing bubble will crack first among borrowers with the worst credit.

Although a Paulson fund spokesman declined to comment, its July letter to investors made clear that when it comes to the housing market, its research team doesn't just see the glass as half-empty, but more likely, as broken.

According to Paulson, their bet is working nicely, the fund's one month of operation has returned 2.87 percent before fees.

"Most recent housing trends continue to deteriorate," the Paulson letter said, citing "the lowest monthly [housing price] increases in 11 years." The letter also pointed to a spike in housing inventory as a sign of what it called "declining fundamentals."

The Paulson letter to investors also noted that it had hired veteran economist A. Gary Schilling to provide economic analysis for the new fund.

A quick review of Schilling's research - attached to the letter - shows that he won't be arguing with Paulson's team about the direction of home prices.

"The U.S. housing bubble is deflating, and bulls hope average house prices will not drop the 20 percent or more we foresee," Schilling predicts. "With [house price] appreciation evaporating, refinancing will dry up and foreclosures leap."

(Thanks for the link, anon.)

DanielLCharts
09-14-06, 03:06 PM
Erik, I like your writing. But I believe you may be making an imprudent mistake by declaring that deflation will not soon be a problem for the United States economy. I can't say that any outcome, be it deflation, disinflation, inflation or hyperinflation, will or won't happen for sure. Doing so seems presumptuous. Additionally, I'm not convinced of your belief that if the Greenspan Fed could prevent deflation during the dotcom fallout, then doubtless the Bernake Fed can do it during this slowdown, granted the Fed doesn't cut rates too slowly.

For one, a fallout from a housing speculation bust is not the same animal as the fallout from the dotcom speculation bust. The difference is debt. It looms around for consumers after a housing bust, but not after a stock bust. Yes there were margin calls when the Nasdaq crashed - but for most individuals, even those aggressively invested in technology shares - their financial obligations did not persist beyond the original capital they invested. Their 401k's and IRAs may get hammered, but that's about it. This is not true of the money that has recently flowed into housing.

Almost all housing is purchased with a measure of debt. I don't have the numbers in front of me (I'll look them up), but I fear a majority of home buyers have purchased their homes with a less than 20% down payment. In the markets that have had the largest run-ups, like Miami, San Diego, and Las Vegas, many investors use loan products where they put 0% or even take out a loan to pay a down-payment. Cooling housing and tiny down-payments have combined to put many neighborhoods across the country has already put many of 2006's home buyers underwater.

To extend the water metaphors, the Fed at some point will probably need to cut rates in order to prevent more Americans from drowning in their mortgage obligations. Thus, the liquidity spigots openeth (ironic to save a metaphorical drowner with liquidity, eh?). But will the liquidity necessarily cause inflation? Maybe not. You assert, "The trick to avoiding deflation is to not be too slow on the draw". But is this truly all that the fed needs to do to steward the American economy away from deflation? Japan succumbed to deflation because its citizens preferred to hold money instead of borrowing. If housing prices fall, MEW stops and speculators, with their flipper income, leave the market. All deflationary. There is a very good chance that Americans reduce their borrowing habits and the demand for credit shrinks.

bart
09-14-06, 03:35 PM
...
To extend the water metaphors, the Fed at some point will probably need cut rates in order to prevent more Americans from drowning in their mortgage obligations. Thus, the liquidity spigots openeth (ironic to save a metaphorical drowner with liquidity, eh?). But will the liquidity necessarily cause inflation? Maybe not. You assert, "The trick to avoiding deflation is to not be too slow on the draw". But is this truly all that the fed needs to do to steward the American economy away from deflation? Japan succumbed to deflation because its citizens preferred to hold money instead of borrowing. If housing prices fall, MEW stops and speculators, with their flipper income, leave the market. All deflationary. There is a very good chance that Americans reduce their borrowing habits and the demand for credit shrinks.


My $.02 worth - I think Erik is right on track. Your points about many 2006 buyers being underwater already are a given in my book and there'll be more to come.

The situation in the US, while having similarities to Japan, also has many differences for which you either fail to account for or haven't mentioned. The cultures are very different in attitudes about debt and credit and I don't doubt that credit demand will fall - indeed, consumer credit has been falling on a year over year annual rate of change basis since 2000 - but its unlikely the US will break the debt habit that has been a much larger part of the culture and for more decades.

And not only has the Fed learned from the Japanese experience and is well aware of it, but also Bernanke did take a trip to Japan in '02 and in my opinion helped them out with how to better resolve the situation.

Here's a busy chart from BoJ data that not only shows the 2002-3 trip effects, but also shows how rapidly and significantly the BoJ removed stimulus in the late '80s and early '90s.

http://www.nowandfutures.com/images/boj_money.png


It also shows that on the whole, they were not trying very hard to reverse the light overall deflation as measured by their CPI. Most monetary growth rates as you can see were growing at 5% or less, and considering the mess in their banking system from the excesses of the '80s, that's almost trivial.

Finster
09-14-06, 04:56 PM
My $.02 worth - I think Erik is right on track. Your points about many 2006 buyers being underwater already are a given in my book and there'll be more to come...

Daniel is right. You are just giving him a hard time because he has "chart" in his name. :p ;)

But we all may not hold views as divergent as they sound. Eric says no deflation. I say we have already entered deflation. How can these statements both be right?

Semantics, grasshopper... what exactly do we mean by deflation? Eric has defined it as follows:


Quick definition of terms:

Deflation: Negative rate of inflation, e.g., "CPI inflation averaged -1.3% in 2007." You will not hear anything like this.

Disinflation: Declining rate of inflation, e.g., "CPI inflation declined to 2.1% in Q4 2007 from 2.5% in Q3 2007." You will hear something like this.

Nothing wrong here. But when we talk about inflation, there is also an element of a time frame. People might say inflation was X percent for the first quarter annualized, or the might say the year-over-year inflation was Y percent. X and Y will generally be two different numbers. Even if the mid point of the time periods in question is the same, the inflation figure will generally be different if you measure it over a longer or shorter time frame.

Not only that, but there is the question of what measure of inflation you use. CPI will say one thing, GDP deflator another, etceteras.

So I say we've been experiencing deflation. But it's only been for a few months. Year over year, we still are in inflation territory. And unless the deflation persists, it will stay that way. What's more, if you're going to use the CPI, you have to remember it is a very slow and inertial indicator. Unless the deflation is very sharp or persists for more than a year or two, the CPI is unlikely to dip into negative territory.

DanielLCharts
09-14-06, 05:04 PM
"The situation in the US, while having similarities to Japan, also has many differences for which you either fail to account for or haven't mentioned."

That's right, the Japanese actually had savings to dip into to buffer them against deflation.

"but its unlikely the US will break the debt habit that has been a much larger part of the culture and for more decades."

I don't know if you're referring to consumers or to the government, but I'm guessing you're referring to consumers. If so, I think it's pretty easy to envision a scenario where consumers borrow much less. If their assets decline in value and lending Lending standards tighten (which are both very possible in the aftermath of the housing bubble) you might have to get used to a scenario in which fewer people qualify for loans.

Plus, I probably wasn't clear enough, but when I talk about credit I'm including the dollar amount of MEW and mortgages, and to my knowledge that figure has not been shrinking one bit until maybe very recently. And when I mean contraction, I don't mean a slowing of growth, I mean an absolute contraction.

"And not only has the Fed learned from the Japanese experience and is well aware of it, but also Bernanke did take a trip to Japan in '02 and in my opinion helped them out with how to better resolve the situation."

Maybe you were privy to Ben's interactions with his Japanese peers. I'm guessing you were not. I think the Bernanke-as-helper opinion is based on speculation and is not very valuable, but I'm willing to learn and be open.

"Here's a busy chart from BoJ data that not only shows the 2002-3 trip effects, but also shows how rapidly and significantly the BoJ removed stimulus in the late '80s and early '90s."

No way we can say with absolute certainty that the liquidity helped or defeated deflation in Japan. About every 4-6 years we hear the story about how Japan's economy is coming back. And every time the US economy slows down, Japan's deflationary spiral gets a little rougher. Maybe the liquidity helped. Let's wait and see until about 2007-2008 - when the US is "probably" entrenched in a down cycle - to really see if Japan's inflation has been nipped in the bud.

Also, I do find the recession markings on your chart a curiosity. I think a recession has probably already started here in the US, but who is omniscient enough to know for certain that it indeed has? Whoever is that omniscient has marked the chart accordingly and seems to know the start of the 2006 recession. Does this mystery man also know which free agent WR has a breakout year in 2006-2007 because my Fantasy Football team really needs the help?

EJ
09-14-06, 05:25 PM
Welcome to our forum, Mr. Charts. Good questions. Will attempt to address them, below.


Erik, I like your writing. But I believe you may be making an imprudent mistake by declaring that deflation will not soon be a problem for the United States economy. I can't say that any outcome, be it deflation, disinflation, inflation or hyperinflation, will or won't happen for sure. Doing so seems presumptuous. Additionally, I'm not convinced of your belief that if the Greenspan Fed could prevent deflation during the dotcom fallout, then doubtless the Bernake Fed can do it during this slowdown, granted the Fed doesn't cut rates too slowly.

It's important to understand how much "belief" plays into the outcome. There is an excellent piece on deflation by Adam Posen, "What Japanese deflation did and did not do (pdf) (http://www.international-economy.com/TIE_W06_Posen.pdf)," where he argues convincingly how much speech and action by the Fed on inflation targeting and deflation fighting contribute to the outcome. This Fed has been quite vocal on both inflation targeting and deflation fighting.


For one, a fallout from a housing speculation bust is not the same animal as the fallout from the dotcom speculation bust. The difference is debt. It looms around for consumers after a housing bust, but not after a stock bust. Yes there were margin calls when the Nasdaq crashed - but for most individuals, even those aggressively invested in technology shares - their financial obligations did not persist beyond the original capital they invested. Their 401k's and IRAs may get hammered, but that's about it. This is not true of the money that has recently flowed into housing.

Almost all housing is purchased with a measure of debt. I don't have the numbers in front of me (I'll look them up), but I fear a majority of home buyers have purchased their homes with a less than 20% down payment. In the markets that have had the largest run-ups, like Miami, San Diego, and Las Vegas, many investors use loan products where they put 0% or even take out a loan to pay a down-payment. Cooling housing and tiny down-payments have combined to put many neighborhoods across the country has already put many of 2006's home buyers underwater.

To extend the water metaphors, the Fed at some point will probably need to cut rates in order to prevent more Americans from drowning in their mortgage obligations. Thus, the liquidity spigots openeth (ironic to save a metaphorical drowner with liquidity, eh?). But will the liquidity necessarily cause inflation? Maybe not. You assert, "The trick to avoiding deflation is to not be too slow on the draw". But is this truly all that the fed needs to do to steward the American economy away from deflation? Japan succumbed to deflation because its citizens preferred to hold money instead of borrowing. If housing prices fall, MEW stops and speculators, with their flipper income, leave the market. All deflationary. There is a very good chance that Americans reduce their borrowing habits and the demand for credit shrinks.

You raise two excellent points here. One, that debt was not a major factor in the dot com bubble, thus the Fed was mostly fighting negative wealth effects versus in the case of the deflating housing bubble both wealth effects and the potential insolvency of households and banks; two, that the dot com bubble collapsed rapidly while the housing bubble will collapse slowly.

I agree whole heartedly on the first points, and made the point in <small>Housing Bubbles Unlike Stock Bubbles (http://www.itulip.com/forums/../housingnotlikeequities.htm) in Jan. 2004 that housing bubbles decline slowly. As for household and bank insolvency, the difference between healthy and unhealthy deflation is that latter is associated with a dysfunctional banking system and the former it has not. The Fed's job #1 is to keep the banking system working, and to the extent that the Fed believes that deflation cannot be healthy and can only lead to banking system dysfunction, it will use all means to prevent it.

To give you and idea of just how serious the Fed is about staying on top of deflation, I'll point to two papers issued since 2002. The first:

Board of Governors of the Federal Reserve System
International Finance Discussion Papers – Number 729 – June 2002
Preventing Deflation: Lessons from Japan’s Experience in the 1990s (pdf) (http://www.federalreserve.gov/pubs/ifdp/2002/729/ifdp729.pdf)
</small>
<small>"Once inflation turned negative and short-term interest rates approached the zero-lower-bound, it became much more difficult for monetary policy to reactivate the economy. We found little compelling evidence that in the lead up to deflation in the first half of the 1990s, the ability of either monetary or fiscal policy to help support the economy fell off significantly. Based on all these considerations, we draw the general lesson from Japan’s experience that when inflation and interest rates have fallen close to zero, and the risk of deflation is high, stimulus–both monetary and fiscal–should go beyond the levels conventionally implied by baseline forecasts of future inflation and economic activity."
</small>The second, and more colorful, comes from Evan F. Koenig, Vice President, Jim Dolmas (htttp://www.dallasfed.org/research/indepth/2003/id0304.pdf) (pdf), Senior Economist, Federal Reserve Bank of Dallas, May 2003:


http://www.itulip.com/images/USdeflation.png
Don't let this happen

http://www.itulip.com/images/Japandeflation.png
Or this

http://www.itulip.com/images/USnodeflation.png
Do use all means to keep inflation above the zero bound, like this

http://www.itulip.com/images/moneydrop.png
Drop Tons of Money

http://www.itulip.com/images/feasibleinstruments.png
In the future, if necesssary, do so by changing the rules to reclassify restricted instruments as unrestricted


Given an apparently high degree of committment by this Fed to change whatever existing rules need to be changed to keep inflation above zero, that leaves us with the question of whether this strategy will work.

Ka-Poom Theory is a hypothesis that says not only will "<small>stimulus – both monetary and fiscal – beyond the levels conventionally implied by baseline forecasts of future inflation and economic activity</small>" succeed to halt deflation, these unconventional means will work too well. The reason is that during the deflationary depresssion in the US in the 1930s and the deflationary recession in Japan in the 1990s, both countries were net creditors whereas today the US is a net debtor. The Fed now needs to be mindful that there are trillions of dollars held overseas by creditors who will want to see the US take some of the same medicine the IMF demands of countries that are using money borrowed from other countries to restructure: fiscal discipline in the form of higher taxes and spending cuts. Here the Fed proposes the opposite policy strategy for the next round of post-bubble deflation fighting, even further cuts in taxes, even more government spending and all manner of new kinds of printing to "pay" for it all.

In other words, I don't think these laxatives can cure the next post-bubble economic constipation without causing severe monetary diarrhea.

bart
09-14-06, 05:47 PM
So I say we've been experiencing deflation. But it's only been for a few months. Year over year, we still are in inflation territory. And unless the deflation persists, it will stay that way. What's more, if you're going to use the CPI, you have to remember it is a very slow and inertial indicator. Unless the deflation is very sharp or persists for more than a year or two, the CPI is unlikely to dip into negative territory.

Yes, and it took me quite some time to fully understand your deflation frame of reference and that you include everything (including assets) in it too... which means you're both right... and thank gawd for definitions so its easier to keep the score card straight. ;)

bart
09-14-06, 06:26 PM
I don't know if you're referring to consumers or to the government, but I'm guessing you're referring to consumers. If so, I think it's pretty easy to envision a scenario where consumers borrow much less. If their assets decline in value and lending Lending standards tighten (which are both very possible in the aftermath of the housing bubble) you might have to get used to a scenario in which fewer people qualify for loans.

Plus, I probably wasn't clear enough, but when I talk about credit I'm including the dollar amount of MEW and mortgages, and to my knowledge that figure has not been shrinking one bit until maybe very recently. And when I mean contraction, I don't mean a slowing of growth, I mean an absolute contraction.

Yes, I was referring to consumers especially since I cited consumer credit - I thought that was pretty obvious but perhaps not.

I think that EJ covered the credit contraction and going negative possibilities and how the Fed feels about it quite well, as usual. I was aware of all but one of them, and would have cited them if and as necessary.





"And not only has the Fed learned from the Japanese experience and is well aware of it, but also Bernanke did take a trip to Japan in '02 and in my opinion helped them out with how to better resolve the situation."

Maybe you were privy to Ben's interactions with his Japanese peers. I'm guessing you were not. I think the Bernanke-as-helper opinion is based on speculation and is not very valuable, but I'm willing to learn and be open.


The way it looks from here, you have your mind made up that the trip to Japan wasn't related to anything the BoJ did afterwards. Fine with me.




"Here's a busy chart from BoJ data that not only shows the 2002-3 trip effects, but also shows how rapidly and significantly the BoJ removed stimulus in the late '80s and early '90s."

No way we can say with absolute certainty that the liquidity helped or defeated deflation in Japan. About every 4-6 years we hear the story about how Japan's economy is coming back. And every time the US economy slows down, Japan's deflationary spiral gets a little rougher. Maybe the liquidity helped. Let's wait and see until about 2007-2008 - when the US is "probably" entrenched in a down cycle - to really see if Japan's inflation has been nipped in the bud.

Also, I do find the recession markings on your chart a curiosity. I think a recession has probably already started here in the US, but who is omniscient enough to know for certain that it indeed has? Whoever is that omniscient has marked the chart accordingly and seems to know the start of the 2006 recession. Does this mystery man also know which free agent WR has a breakout year in 2006-2007 because my Fantasy Football team really needs the help?


*yawn* - "No way we can say with absolute certainty" can apply to virtually anything said by anyone.

Believe what you like about the t-e-r-r-i-b-l-e Japanese deflation (that at max was -3% per their CPI) and it causes and effects, money supply figures and BoJ policy apparently make little difference to you (/sarcasm).



Of course I'm not omniscient enough to be 100% certain about a recession - but now I'm not allowed to have an opinion on a public graph from my own site about a recession having started?! - wow!!!

Those comments are well beyond tacky, especially considering the lack of any icons to show it may have been tongue in cheek!

Finster
09-14-06, 08:23 PM
Of course I'm not omniscient enough to be 100% certain about a recession - but now I'm not allowed to have an opinion on a public graph from my own site about a recession having started?! - wow!!!

FWIW, whether we are in recession or not seems to come down to no more than a pronouncement to that effect.

Being a matter of opinion, how could one be wrong?


... Last week the National Bureau of Economic Research announced that the recession which began in March 2001 had ended in November of that year. But the fact that it took the NBER’s Business Cycle Dating Committee 20 months to conclude the recession was over indicates that the supposed “recovery” of the US economy is quite unlike anything seen in the post-war period...

http://www.wsws.org/articles/2003/jul2003/usec-j23.shtml

Much too much is made out whether the economy can be said to be in "recession" status or not. Even if one assigns an objective definition, for example consecutive quarters of negative GDP growth, the question makes light of important differences and great hay out of trifling ones.

Supposing we had GDP growth of 0.1% for six quarters. No recession. But let it be a mere 0.2% less for two quarters. Suddenly it's a Big Deal because we're having a recession.

Meanwhile, suppose we had GDP growth of 9.0% for six quarters. No recession. The simple binary descriptor of recession/no recession lumps this huge difference in the same category as 0.1% growth, while sharply distinguishing on the basis of a mere 0.2% difference between 0.1% & -0.1%.

Economic growth is a continuum of shades of grey, not on or off. GDP is a quantity, not a quality. Collapsing the whole spectrum of reality into either recession or expansion and ignoring other much more significant distinctions, despite its popularity, has far more capacity to mislead than inform.

jk
09-14-06, 10:38 PM
Much too much is made out whether the economy can be said to be in "recession" status or not. Even if one assigns an objective definition, for example consecutive quarters of negative GDP growth, the question makes light of important differences and great hay out of trifling ones.

Supposing we had GDP growth of 0.1% for six quarters. No recession. But let it be a mere 0.2% less for two quarters. Suddenly it's a Big Deal because we're having a recession.

Meanwhile, suppose we had GDP growth of 9.0% for six quarters. No recession. The simple binary descriptor of recession/no recession lumps this huge difference in the same category as 0.1% growth, while sharply distinguishing on the basis of a mere 0.2% difference between 0.1% & -0.1%.

Economic growth is a continuum of shades of grey, not on or off. GDP is a quantity, not a quality. Collapsing the whole spectrum of reality into either recession or expansion and ignoring other much more significant distinctions, despite its popularity, has far more capacity to mislead than inform.


just as finster talks about the way the concept "recession" may be a hindrance to thought, so might the concepts "inflation" and "deflation." finster has his "fdi" with which he attempts to measure the value of the dollar against all the myriad ways it might be spent, for consumables or for assets. and then he concludes that we are experiencing "inflation" if the dollar will buy less of everything-lumped-together, and "deflation" if it will buy more of everything-lumped-together.

but our consumption, and even more significantly our investments, are not made in pieces of everything-lumped-together. we distinguish among goods and asset classes.

maybe we need to disaggregate the concepts of "inflation" and "deflation." if we use the metaphor of liquidity, we should think in terms of fountains, pools and drains. some places in our metaphorical landscape may be overflowing, other places drained dry.

eric, for example, argues for an inflationary outcome based on a housing collapse, so in his "inflation" the value of THE major asset class for most americans is shriveling. most people don't think of collapsing housing values as consistant with "inflation." or maybe this statement of mine ignores important issues of timing: the housing collapse triggers institutional responses which lead to inflation which perhaps pumps up nominal housing values but not real housing values. is this "inflation"?

i suppose the operational definition of "deflation" is an economic condition in which you want to hold a significant portion of your assets in cash. the more deflationary the environment [for surely deflation may be more or less severe], the more you want in cash.

similarly, the operational definition of "inflation" is an economic condition in which you want to get out of cash, and into.... what?

i would like to propose that we move our discussions away from a global dichotomy of inflation/deflation, and towards an analysis of mixed "flation," and distinct asset classes, within a framework of processes evolving over time. we collapse too much information when we try to predict "inflationary" or "deflationary" outcomes.

Jim Nickerson
09-14-06, 11:34 PM
i suppose the operational definition of "deflation" is an economic condition in which you want to hold a significant portion of your assets in cash. the more deflationary the environment [for surely deflation may be more or less severe], the more you want in cash.

similarly, the operational definition of "inflation" is an economic condition in which you want to get out of cash, and into.... what?

i would like to propose that we move our discussions away from a global dichotomy of inflation/deflation, and towards an analysis of mixed "flation," and distinct asset classes, within a framework of processes evolving over time. we collapse too much information when we try to predict "inflationary" or "deflationary" outcomes.

If I understand this picture, copied from a post above, from 1929 to 1932-1933 there was a really big KA-POOM, though EJ was not around at the time to sound the warning siren.

http://www.itulip.com/images/USdeflation.png

For anyone bruised by the down-draft in PM's the past 6 weeks, I found some comfort in Martin Weinberg's comments this evening on Financialsense.com http://www.financialsense.com/Market/wrapup.htm.

In that article Weinberg linked http://www.gold-eagle.com/editorials/great_crash.html titled "GOLD STOCKS AND THE GREAT CRASH OF 1929 REVISITED" which makes some strong argument for gold stocks during such periods that might represent Ka-Poom.

From what I know about Richard Russell's position on the current markets, his positioning in 90 day T-Bills and gold may be quite wise.

bart
09-14-06, 11:41 PM
...

Economic growth is a continuum of shades of grey, not on or off. GDP is a quantity, not a quality. Collapsing the whole spectrum of reality into either recession or expansion and ignoring other much more significant distinctions, despite its popularity, has far more capacity to mislead than inform.

Indeed, and I basically and simply called it to indicate that I expect general conditions to be significantly worse for the next six months or so.

The old definition of recession as two declining quarters in a row in an era of very high spin and BS stats like the BLS's CPI just plain doesn't work.

Of course, a real and better definition could be invented and agreed upon but unless the underlying stats don't change meterially thereafter and get their own new & improved spin, it'd be almost a worthless task.

bart
09-14-06, 11:44 PM
i would like to propose that we move our discussions away from a global dichotomy of inflation/deflation, and towards an analysis of mixed "flation," and distinct asset classes, within a framework of processes evolving over time. we collapse too much information when we try to predict "inflationary" or "deflationary" outcomes.

Here's one starting point:

http://www.nowandfutures.com/download/asset_allocation.png

EJ
09-15-06, 12:14 AM
If I understand this picture, copied from a post above, from 1929 to 1932-1933 there was a really big KA-POOM, though EJ was not around at the time to sound the warning siren.

http://www.itulip.com/images/USdeflation.png

For anyone bruised by the down-draft in PM's the past 6 weeks, I found some comfort in Martin Weinberg's comments this evening on Financialsense.com http://www.financialsense.com/Market/wrapup.htm.

In that article Weinberg linked http://www.gold-eagle.com/editorials/great_crash.html titled "GOLD STOCKS AND THE GREAT CRASH OF 1929 REVISITED" which makes some strong argument for gold stocks during such periods that might represent Ka-Poom.

From what I know about Richard Russell's position on the current markets, his positioning in 90 day T-Bills and gold may be quite wise.

The way they did it under the gold standard was to confiscate gold and reprice it by 25% – presto! The 25% inflation that you see in the chart.

Same thing will happen this time, but the modern way, post gold standard way. They'll just print money and buy stuff.

On the gold/90 day t-bills advice, better late than never, I guess. Glad that Richard's finally got the religion. iTulip's been recommending t-bills and gold since 2001 (http://www.itulip.com/gold.htm):

"At the early crisis stage of this structural re-adjustment of the U.S. economy and markets, the immediate reaction of most U.S. and foreign investors alike will be to buy short-term U.S. treasury securities. This will help support the dollar through the initial crisis, to some degree countering the fall in demand for other dollar denominated assets, especially equities. As the U.S. economy contracts, however, a weakening dollar trend will begin as foreign investment in U.S. debt subsides, and this decline will tend to be self-sustaining. At this point the yield curve becomes deeply inverted, as demand for short term debt outpaces demand for long term debt by a large measure, due to fears of a growing recession and rising interest rates. Rising short-term interest rates will compensate purchasers of U.S. treasuries for the rise in inflation. A convenient way for investors to participate is to set up a Treasury Direct (http://www.publicdebt.treas.gov/sec/sectrdir.htm) account, buy 91 day T-bills and have Treasury Direct services re-invest them -- all of which can be done online. One can request that T-bills be re-invested up to ten times automatically. The advantage of this over inflation indexed treasuries is that one isn't counting on the U.S. Labor Department to set the actual level of inflation that the Treasury is using to index interest rates on the notes. If you re-invest 91 day T-bills, the market sets rates for you, not the government. Still, the biggest bargain in inflation-indexed government debt these days is the I Series Savings Bond. These are currently paying a risk-free rate of 7.49%. This compares well to the not at all risk-free -17% annualized rate of return on the DOW over the past 12 months. The bad news is that individuals are limited to only $30,000 of purchases a year, but that's only a problem if you're in the top 10% income bracket."

I'm especially glad I took my own advice on the Series I's. The 7.49% "risk free" that those bonds are paying looked obscene back when CDs were paying less than 2% but even today look good.

bart
09-15-06, 12:25 AM
For anyone bruised by the down-draft in PM's the past 6 weeks, I found some comfort in Martin Weinberg's comments this evening on Financialsense.com http://www.financialsense.com/Market/wrapup.htm.

In that article Weinberg linked http://www.gold-eagle.com/editorials/great_crash.html titled "GOLD STOCKS AND THE GREAT CRASH OF 1929 REVISITED" which makes some strong argument for gold stocks during such periods that might represent Ka-Poom.




Regarding gold stocks in 1973-74, do also take into account that gold itself went from a under $65 in 1/1973 to over $190 in 12/1974.

DanielLCharts
09-15-06, 04:09 AM
FWIW, whether we are in recession or not seems to come down to no more than a pronouncement to that effect.

Being a matter of opinion, how could one be wrong?


... Last week the National Bureau of Economic Research announced that the recession which began in March 2001 had ended in November of that year. But the fact that it took the NBER’s Business Cycle Dating Committee 20 months to conclude the recession was over indicates that the supposed “recovery” of the US economy is quite unlike anything seen in the post-war period...

http://www.wsws.org/articles/2003/jul2003/usec-j23.shtml

Much too much is made out whether the economy can be said to be in "recession" status or not. Even if one assigns an objective definition, for example consecutive quarters of negative GDP growth, the question makes light of important differences and great hay out of trifling ones.

Supposing we had GDP growth of 0.1% for six quarters. No recession. But let it be a mere 0.2% less for two quarters. Suddenly it's a Big Deal because we're having a recession.

Meanwhile, suppose we had GDP growth of 9.0% for six quarters. No recession. The simple binary descriptor of recession/no recession lumps this huge difference in the same category as 0.1% growth, while sharply distinguishing on the basis of a mere 0.2% difference between 0.1% & -0.1%.

Economic growth is a continuum of shades of grey, not on or off. GDP is a quantity, not a quality. Collapsing the whole spectrum of reality into either recession or expansion and ignoring other much more significant distinctions, despite its popularity, has far more capacity to mislead than inform.

this is very very very correct. very nice post.

Finster
09-15-06, 10:02 AM
just as finster talks about the way the concept "recession" may be a hindrance to thought, so might the concepts "inflation" and "deflation." finster has his "fdi" with which he attempts to measure the value of the dollar against all the myriad ways it might be spent, for consumables or for assets. and then he concludes that we are experiencing "inflation" if the dollar will buy less of everything-lumped-together, and "deflation" if it will buy more of everything-lumped-together.

but our consumption, and even more significantly our investments, are not made in pieces of everything-lumped-together. we distinguish among goods and asset classes.

maybe we need to disaggregate the concepts of "inflation" and "deflation." if we use the metaphor of liquidity, we should think in terms of fountains, pools and drains. some places in our metaphorical landscape may be overflowing, other places drained dry.

eric, for example, argues for an inflationary outcome based on a housing collapse, so in his "inflation" the value of THE major asset class for most americans is shriveling. most people don't think of collapsing housing values as consistant with "inflation." or maybe this statement of mine ignores important issues of timing: the housing collapse triggers institutional responses which lead to inflation which perhaps pumps up nominal housing values but not real housing values. is this "inflation"?

i suppose the operational definition of "deflation" is an economic condition in which you want to hold a significant portion of your assets in cash. the more deflationary the environment [for surely deflation may be more or less severe], the more you want in cash.

similarly, the operational definition of "inflation" is an economic condition in which you want to get out of cash, and into.... what?

i would like to propose that we move our discussions away from a global dichotomy of inflation/deflation, and towards an analysis of mixed "flation," and distinct asset classes, within a framework of processes evolving over time. we collapse too much information when we try to predict "inflationary" or "deflationary" outcomes.

I don't distinguish between asset classes with the FDI simply because it really only targets one asset class - the US dollar. (Or in iTulip parlance, the Bonar ;-). Other than that, of course, distinguishing asset classes is pretty much a sine qua non for investors.

But I completely agree with your extension of my remarks on recession-expansion to deflation-inflation. Exactly the same thing applies. There is much more difference between inflation of 0.1% and 9.0% than between inflation of 0.1% and deflation of 0.1%, although the terms lump the former together while sharply distinguishing the latter..

Finster
09-15-06, 10:07 AM
Indeed, and I basically and simply called it to indicate that I expect general conditions to be significantly worse for the next six months or so.

The old definition of recession as two declining quarters in a row in an era of very high spin and BS stats like the BLS's CPI just plain doesn't work.

Of course, a real and better definition could be invented and agreed upon but unless the underlying stats don't change meterially thereafter and get their own new & improved spin, it'd be almost a worthless task.

Just in case it wasn't clear, I wasn't getting on your case about it. :) Your application of the term is at least as legitmate as any other I've heard. A general deterioration in economic conditions. Yeah, works for me ... :)

bart
09-15-06, 11:27 AM
Just in case it wasn't clear, I wasn't getting on your case about it. :) Your application of the term is at least as legitmate as any other I've heard. A general deterioration in economic conditions. Yeah, works for me ... :)

Now I'm shocked - you not getting after me? ;)

And on a more serious note, if the Fed keeps pumping the way it has been doing the last few days I might even back off on my "recession" prediction.

jk
09-15-06, 11:52 AM
On the gold/90 day t-bills advice, better late than never, I guess. Glad that Richard's finally got the religion. iTulip's been recommending t-bills and gold since 2001 (http://www.itulip.com/forums/../gold.htm):

you owe russell a bit more respect. he called a top in equities in late '99, and recommended gold and gold shares as of 5/02. [i looked it up in his archives] for a while in recent months he's been saying to be mostly in cash and gold [about 2/3 gld or metal, the rest stocks], and some oil and utilities. lately he's talking more about just gold and tbills. not the worst advice.

Finster
09-15-06, 01:31 PM
you owe russell a bit more respect. he called a top in equities in late '99, and recommended gold and gold shares as of 5/02. [i looked it up in his archives] for a while in recent months he's been saying to be mostly in cash and gold [about 2/3 gld or metal, the rest stocks], and some oil and utilities. lately he's talking more about just gold and tbills. not the worst advice.

I second that motion, JK. Gold and TBills together make up about the most defensive combination I can think of, and I've been suggesting for quite some time to anyone who will listen to make them a healthy portion of their portfolio. But RR was there first. Nobody' perfect, but RR is definitely due our respect.

Finster
09-15-06, 01:36 PM
Now I'm shocked - you not getting after me? ;)

And on a more serious note, if the Fed keeps pumping the way it has been doing the last few days I might even back off on my "recession" prediction.

Hark! Fed pumping? Last comment of yours I recall on the subject was to the effect the Fed had been behaving itself pretty well for the past 4-5 months. Just in time for it to start misbehaving again?

No confirm from the FDI yet, but tomorrow it gets its weekly update, and Fed pumping would go a long way towards explaining this week's bout of irrational exuberance in the stock market ...

bart
09-15-06, 02:03 PM
Hark! Fed pumping? Last comment of yours I recall on the subject was to the effect the Fed had been behaving itself pretty well for the past 4-5 months. Just in time for it to start misbehaving again?

No confirm from the FDI yet, but tomorrow it gets its weekly update, and Fed pumping would go a long way towards explaining this week's bout of irrational exuberance in the stock market ...

Just in round numbers, there's been over $30 billion of short term hot money injected in the last 2-3 days.

Finster
09-15-06, 03:28 PM
Just in round numbers, there's been over $30 billion of short term hot money injected in the last 2-3 days.

Injected WHERE??? I guess I wouldn't mind so much if they injected some of that into my bank account. :D

Seriously though, doesn't this whole money creation business smack of the old boy's club? Why, for example, does this all work through the interest rates and the banking system? Assuming the Fed had a legitimate interest in creating new money, couldn't it just declare that every bank account in the country has, say one percent more dollars? Wouldn't seem so tough in this age of computers. It present methods put preferred parties at the head of the money line; not exactly a neutral and fair money creation scheme.

bart
09-15-06, 03:51 PM
Injected WHERE??? I guess I wouldn't mind so much if they injected some of that into my bank account. :D

Seriously though, doesn't this whole money creation business smack of the old boy's club? Why, for example, does this all work through the interest rates and the banking system? Assuming the Fed had a legitimate interest in creating new money, couldn't it just declare that every bank account in the country has, say one percent more dollars? Wouldn't seem so tough in this age of computers. It present methods put preferred parties at the head of the money line; not exactly a neutral and fair money creation scheme.

There's a 2 week $26B TIO operation and a 2 week $10B temp repo recently.


Very much so on the old boy's club or cabal, or as EJ prefers the "system".

As for why, and putting my sarcasm buttons on my tinfoil hat - because the Fed & Co. are having too much fun being transparent? :eek: :rolleyes: :rolleyes:

WDCRob
09-16-06, 04:07 PM
If someone could expand a bit on the mechanics of how dropping rates/printing money would overcome a strong and collective desire on the part of consumers to avoid additional debt/save money I'd be grateful.

i.e. can the Fed reflate without the cooperation of Main Street/Joe Sixpack? And if so, how?

bart
09-16-06, 04:39 PM
If someone could expand a bit on the mechanics of how dropping rates/printing money would overcome a strong and collective desire on the part of consumers not to avoid additional debt/save money I'd be grateful.

i.e. can the Fed reflate without the cooperation of Main Street/Joe Sixpack? And if so, how?

Yes, the Fed can reflate without their cooperation.

Two of the simpler ways are literally to just tell the Treasury to print a more currency, and another is to do what is called monetizing the US debt. There are many other ways too.

The way that monetizing happens is that when the US Treasury issues new bonds to fund more debt, the Fed just buys them direct via creating the money to pay for them out of thin air. You can see it by looking at the balance in what the Fed calls the System Open Market Account (SOMA).

Here's a record of the SOMA activity since about 2000:

http://www.nowandfutures.com/images/fed_soma.png

Finster
09-16-06, 04:49 PM
Yes, the Fed can reflate without their cooperation.

Two of the simpler ways are literally to just tell the Treasury to print a more currency, and another is to do what is called monetizing the US debt. There are many other ways too.

The way that monetizing happens is that when the US Treasury issues new bonds to fund more debt, the Fed just buys them direct via creating the money to pay for them out of thin air. You can see it by looking at the balance in what the Fed calls the System Open Market Account (SOMA).

Here's a record of the SOMA activity since about 2000:

...

Just to make sure we understand this, you're saying that the Treasury is not obligated to repay this debt monetized by the Fed?

Does it pay interest on this monetized debt?

jk
09-16-06, 05:08 PM
If someone could expand a bit on the mechanics of how dropping rates/printing money would overcome a strong and collective desire on the part of consumers not to avoid additional debt/save money I'd be grateful.

i.e. can the Fed reflate without the cooperation of Main Street/Joe Sixpack? And if so, how?

bernanke's famous helicopter speech was called "can it [deflation] happen here?" what he said was that if necessary the fed could use non-traditional means of intervention, starting with buying tbonds further out on the yield curve. this, in itself, would be major in dropping not only short rates but also longer rates which determine mortgage rates. if that didn't work, they'd buy other things. by purchasing assets they both raise prices on similar assets still in private hands, they put cash into the pockets of the sellers. basically they flood the system with cash so as to overwhelm any hypothesized increase in the desire to hold cash and cash-equivalents.

you might ask whether this isn't in fact what the boj did. it is, but bernanke's point was to do it much earlier, i.e. before deflation actually sets in. if done early enough, rates can get below a positive rate of inflation and pump things up. the trick is avoiding "the zero bound." sure, you can hypothesize a desire by consumers to repair their balance sheets, but if rates drop quickly enough all along the yield curve people will want to hold real assets, and debt will be attractive because rates will stay below inflation. their houses will be going up in nominal value, their stock holding will be going up in nominal value: why worry? be happy!

a lot depends on timing. my deflation fear depends on a very rapid dominos-falling daisy chain of bankruptcies and counterparty failures. if the process is slow enough then bernanke's helicopters should work.

bart
09-16-06, 05:33 PM
Just to make sure we understand this, you're saying that the Treasury is not obligated to repay this debt monetized by the Fed?

Does it pay interest on this monetized debt?

No - the Treasury is obligated to repay/redeem debt sold to the Fed as much as any debt it sells to anyone else. But in actual practice as you can see in the chart, the Fed keeps buying so repaying doesn't become an issue.

Yes, the Treasury pays interest to the Fed on the bonds and bills owned by the Fed, to the best of my knowledge.

WDCRob
09-16-06, 07:22 PM
Thanks for the replies.


if that didn't work, they'd buy other things. by purchasing assets they both raise prices on similar assets still in private hands, they put cash into the pockets of the sellers.

What other assets can they buy? Is EJ (above) suggesting that the rules governing what the Fed can buy outright would be changed if necessary?


basically they flood the system with cash so as to overwhelm any hypothesized increase in the desire to hold cash and cash-equivalents.

Would it be fair to say that the greater level of fear re: additional debt (whether driven by a decline in housing prices or due to an 'exogenous shock'), the greater the level of POOM when it finally arrives?

If the Fed faces resistance to it's initial reflating efforts and continues to print money or becomes ever more creative with its reflation strategies in order to 'overwhelm' debt aversion aren't they pretty much guaranteeing EJ's almost-hyper inflation?

JK, what are you watching as early indicators regarding deflation vs Ka-Poom? What would make you decide that deflation is no longer a possibility?

jk
09-16-06, 07:48 PM
Thanks for the replies.



What other assets can they buy? Is EJ (above) suggesting that the rules governing what the Fed can buy outright would be changed if necessary?



Would it be fair to say that the greater level of fear re: additional debt (whether driven by a decline in housing prices or due to an 'exogenous shock'), the greater the level of POOM when it finally arrives?

If the Fed faces resistance to it's initial reflating efforts and continues to print money or becomes ever more creative with its reflation strategies in order to 'overwhelm' debt aversion aren't they pretty much guaranteeing EJ's almost-hyper inflation?

JK, what are you watching as early indicators regarding deflation vs Ka-Poom? What would make you decide that deflation is no longer a possibility?

from bernanke's famous speech, available at:
http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm



So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure--that is, rates on government bonds of longer maturities.<sup>9</sup> (http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm#fn9) There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time--if it were credible--would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.

Lower rates over the maturity spectrum of public and private securities should strengthen aggregate demand in the usual ways and thus help to end deflation. Of course, if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years. Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association).


To repeat, I suspect that operating on rates on longer-term Treasuries would provide sufficient leverage for the Fed to achieve its goals in most plausible scenarios. If lowering yields on longer-dated Treasury securities proved insufficient to restart spending, however, the Fed might next consider attempting to influence directly the yields on privately issued securities. Unlike some central banks, and barring changes to current law, the Fed is relatively restricted in its ability to buy private securities directly.<sup>12</sup> (http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm#fn12) However, the Fed does have broad powers to lend to the private sector indirectly via banks, through the discount window.<sup>13</sup> (http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm#fn13) Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral.<sup>14</sup> (http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm#fn14) For example, the Fed might make 90-day or 180-day zero-interest loans to banks, taking corporate commercial paper of the same maturity as collateral. Pursued aggressively, such a program could significantly reduce liquidity and term premiums on the assets used as collateral. Reductions in these premiums would lower the cost of capital both to banks and the nonbank private sector, over and above the beneficial effect already conferred by lower interest rates on government securities.<sup>15</sup> (http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm#fn15)

The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.<sup>16</sup> (http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm#fn16)


and

Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.<sup>17</sup> (http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm#fn17) The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.


and the famous "helicopter" passage, making it clear that bernanke did not coin the concept

Each of the policy options I have discussed so far involves the Fed's acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money.<sup>18</sup> (http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm#fn18)

jk
09-16-06, 07:55 PM
Would it be fair to say that the greater level of fear re: additional debt (whether driven by a decline in housing prices or due to an 'exogenous shock'), the greater the level of POOM when it finally arrives?

If the Fed faces resistance to it's initial reflating efforts and continues to print money or becomes ever more creative with its reflation strategies in order to 'overwhelm' debt aversion aren't they pretty much guaranteeing EJ's almost-hyper inflation?

i think that implication is correct, but presumably they only go to more extreme measures in the face of stronger deflationary forces. we are talking about going where no central bank has gone before.


JK, what are you watching as early indicators regarding deflation vs Ka-Poom? What would make you decide that deflation is no longer a possibility?

the only deflationary scenario that makes sense to me arrives totally unexpectedly in the form of a financial accident. it would be like the day i recall hearing that the continental illinois bank went belly up. or how about when ltcm had its little problem. yes, we knew that russia had defaulted, we knew that emerging markets were all getting hit, but we didn't know that ltcm was leveraged as much as it was, and to such an extreme that people in high places thought our whole financial system was at risk. so it will be a surprise. the only way to prepare is to have some assets you expect to be worth something after the fall.

Finster
09-17-06, 06:08 PM
No - the Treasury is obligated to repay/redeem debt sold to the Fed as much as any debt it sells to anyone else. But in actual practice as you can see in the chart, the Fed keeps buying so repaying doesn't become an issue.

Yes, the Treasury pays interest to the Fed on the bonds and bills owned by the Fed, to the best of my knowledge.

Thanks for the comment, bart. This is the first time I can recall anyone having directly addressed that question.

So (correct me if I'm wrong) what this boils to is that principal repayment - because the net balance owed keeps increasing - never really becomes an issue. Even the debt service is unlikely to as long as the pace at which the Fed buys new bonds exceeds the combined burden of principal repayment and interest payment.

Aside from the risk of hyperinflationary collapse, this has the potential to continue indefinitely. Or is there some other structural element that could fail first?

bart
09-17-06, 06:19 PM
Thanks for the comment, bart. This is the first time I can recall anyone having directly addressed that question.

So (correct me if I'm wrong) what this boils to is that principal repayment - because the net balance owed keeps increasing - never really becomes an issue. Even the debt service is unlikely to as long as the pace at which the Fed buys new bonds exceeds the combined burden of principal repayment and interest payment.

Aside from the risk of hyperinflationary collapse, this has the potential to continue indefinitely. Or is there some other structural element that could fail first?


I've never seen it officially stated anywhere but my assumption, which is borne out by the fact of SOMA almost always rising, is that when the treasuries do mature that the Fed rolls them over.

As far as another structural element failing first, I haven't given it any thought to speak of but given the at least partially Ponzi nature of the beast, I'm sure there are a few. There's always the full derivatives meltdown that some fear too, although I think that's a low probaility event given the continued success over the decades of "rescue" operations by the Fed and others.

Finster
09-17-06, 07:12 PM
I've never seen it officially stated anywhere but my assumption, which is borne out by the fact of SOMA almost always rising, is that when the treasuries do mature that the Fed rolls them over.

As far as another structural element failing first, I haven't given it any thought to speak of but given the at least partially Ponzi nature of the beast, I'm sure there are a few. There's always the full derivatives meltdown that some fear too, although I think that's a low probaility event given the continued success over the decades of "rescue" operations by the Fed and others.

The historically-resorted-to "rescue operation" would presumably be the inflationary option. In a manner of speaking, it "worked" in 1933, again in 1971, and (so far) in 2003 ... :mad:

bart
09-17-06, 07:20 PM
The historically-resorted-to "rescue operation" would presumably be the inflationary option. In a manner of speaking, it "worked" in 1933, again in 1971, and (so far) in 2003 ... :mad:

There's also the post 9/11 operation which did pretty much succeed in stabilizing the markets too - so not everything the Fred does in Open Market Ops is dark or deserving of tinfoil hat enabled comments. Off the top of my head, I think they injected about $150 billion in a very few days.

doom&gloom
10-13-08, 05:00 AM
It seems all the foreign creditors ALONG with the US have decided now to
pump things up all at the same time, thus, no 'begger thy neighbor' policy
to occur anytime soon. I would think that after the EU actions to prop up
their banks, we will see the US action done by next weekend for sure, and
another rate cut in the offing soon for good measure.

I tell people there will be no deflation and no depression and they look at
me like I am nuts. How can I know these things can never occur? I tell
them simly -- all the national gov't around the world own printing presses
and they are not afraid to use them!

Incidentally, the prognosis for stocks to continue to dive opver time ignores
certain segments. I believe that as oil continues to become
more expensive, stocks in companies that own energy assets will only
become more expensive. To this lot I add RDS/A, TOT, E, COP, XOM
etc.

zenith191
06-03-10, 05:20 PM
CPI-U published monthly by the BLS
<table bordercolorlight="#003300" bordercolordark="#006600" id="table2" border="1" bordercolor="#003300" cellpadding="2" cellspacing="0"><tbody><tr bgcolor="#006633" height="17"><th width="48" bgcolor="#004000" height="17">Year</th><th width="37" bgcolor="#004000">Jan</th><th width="37" bgcolor="#004000">Feb</th><th width="37" bgcolor="#004000">Mar</th><th width="37" bgcolor="#004000">Apr</th><th width="37" bgcolor="#004000">May</th><th width="37" bgcolor="#004000">Jun</th><th width="37" bgcolor="#004000">Jul</th><th width="37" bgcolor="#004000">Aug</th><th width="37" bgcolor="#004000">Sep</th><th width="37" bgcolor="#004000">Oct</th><th width="37" bgcolor="#004000">Nov</th><th width="37" bgcolor="#004000">Dec</th><th width="66" bgcolor="#004000">Ave</th></tr> <tr class="cpi" height="17"><td width="48" align="center" height="17">2010</td><td width="37" align="center">2.63%</td><td width="37" align="center">2.14%</td><td width="37" align="center">2.31%</td><td width="37" align="center">2.24%</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td></tr> <tr class="cpi" height="17"><td width="48" align="center" height="17">2009</td><td width="37" align="right">0.03%</td><td width="37" align="right">0.24%</td><td width="37" align="right">-0.38%</td><td width="37" align="right">-0.74%</td><td width="37" align="right">-1.28%</td><td width="37" align="right">-1.43%</td><td width="37" align="right">-2.10%</td><td width="37" align="right">-1.48%</td><td width="37" align="right">-1.29%</td><td width="37" align="right">-0.18%</td><td width="37" align="right">1.84%</td><td width="66" align="right">2.72%</td><td width="66" align="right">-0.34%</td></tr> <tr class="cpi" height="17"><td width="48" align="center" height="17">2008</td><td width="37" align="right">4.28%</td><td width="37" align="right">4.03%</td><td width="37" align="right">3.98%</td><td width="37" align="right">3.94%</td><td width="37" align="right">4.18%</td><td width="37" align="right">5.02%</td><td width="37" align="right">5.60%</td><td width="37" align="right">5.37%</td><td width="37" align="right">4.94%</td><td width="37" align="right">3.66%</td><td width="37" align="right">1.07%</td><td width="66" align="right">0.09%</td><td width="66" align="right">3.85%</td></tr> <tr class="cpi" height="17"><td width="48" align="center" height="17">2007</td><td width="37" align="right">2.08%</td><td width="37" align="right">2.42%</td><td width="37" align="right">2.78%</td><td width="37" align="right">2.57%</td><td width="37" align="right">2.69%</td><td width="37" align="right">2.69%</td><td width="37" align="right">2.36%</td><td width="37" align="right">1.97%</td><td width="37" align="right">2.76%</td><td width="37" align="right">3.54%</td><td width="37" align="right">4.31%</td><td width="66" align="right">4.08%</td><td width="66" align="right">2.85%</td></tr></tbody></table>
Hmm, isn't negative inflation by definition deflation not disinflation?

metalman
06-03-10, 07:00 PM
strictly speaking... yes. but it never turned into this...

http://www.itulip.com/images/cpi192801935.gif

as the deflationists told. only this...

http://www.itulip.com/images/cpi2000-Aug2009.gif

zenith191
06-03-10, 07:29 PM
Ah, so the title of this post was meant to read as: No Deflation Spiral! Disinflation then Lots of Inflation - Janszen ;)

That's fine by me - I'm rooting for inflation to deflate my debt away.

WDCRob
06-03-10, 07:51 PM
CPI-U published monthly by the BLS
<table bordercolorlight="#003300" bordercolordark="#006600" id="table2" border="1" bordercolor="#003300" cellpadding="2" cellspacing="0"><tbody><tr bgcolor="#006633" height="17"><th width="48" bgcolor="#004000" height="17">Year</th><th width="37" bgcolor="#004000">Jan</th><th width="37" bgcolor="#004000">Feb</th><th width="37" bgcolor="#004000">Mar</th><th width="37" bgcolor="#004000">Apr</th><th width="37" bgcolor="#004000">May</th><th width="37" bgcolor="#004000">Jun</th><th width="37" bgcolor="#004000">Jul</th><th width="37" bgcolor="#004000">Aug</th><th width="37" bgcolor="#004000">Sep</th><th width="37" bgcolor="#004000">Oct</th><th width="37" bgcolor="#004000">Nov</th><th width="37" bgcolor="#004000">Dec</th><th width="66" bgcolor="#004000">Ave</th></tr> <tr class="cpi" height="17"><td width="48" align="center" height="17">2010</td><td width="37" align="center">2.63%</td><td width="37" align="center">2.14%</td><td width="37" align="center">2.31%</td><td width="37" align="center">2.24%</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td><td width="37" align="center">NA</td></tr> <tr class="cpi" height="17"><td width="48" align="center" height="17">2009</td><td width="37" align="right">0.03%</td><td width="37" align="right">0.24%</td><td width="37" align="right">-0.38%</td><td width="37" align="right">-0.74%</td><td width="37" align="right">-1.28%</td><td width="37" align="right">-1.43%</td><td width="37" align="right">-2.10%</td><td width="37" align="right">-1.48%</td><td width="37" align="right">-1.29%</td><td width="37" align="right">-0.18%</td><td width="37" align="right">1.84%</td><td width="66" align="right">2.72%</td><td width="66" align="right">-0.34%</td></tr> <tr class="cpi" height="17"><td width="48" align="center" height="17">2008</td><td width="37" align="right">4.28%</td><td width="37" align="right">4.03%</td><td width="37" align="right">3.98%</td><td width="37" align="right">3.94%</td><td width="37" align="right">4.18%</td><td width="37" align="right">5.02%</td><td width="37" align="right">5.60%</td><td width="37" align="right">5.37%</td><td width="37" align="right">4.94%</td><td width="37" align="right">3.66%</td><td width="37" align="right">1.07%</td><td width="66" align="right">0.09%</td><td width="66" align="right">3.85%</td></tr> <tr class="cpi" height="17"><td width="48" align="center" height="17">2007</td><td width="37" align="right">2.08%</td><td width="37" align="right">2.42%</td><td width="37" align="right">2.78%</td><td width="37" align="right">2.57%</td><td width="37" align="right">2.69%</td><td width="37" align="right">2.69%</td><td width="37" align="right">2.36%</td><td width="37" align="right">1.97%</td><td width="37" align="right">2.76%</td><td width="37" align="right">3.54%</td><td width="37" align="right">4.31%</td><td width="66" align="right">4.08%</td><td width="66" align="right">2.85%</td></tr></tbody></table>
Hmm, isn't negative inflation by definition deflation not disinflation?

Is that what you think people were worrying about when they talked about 'deflation?' I envisioned a much more dramatic scenario going on much longer.

Down Under
06-03-10, 07:54 PM
Ah, so the title of this post was meant to read as: No Deflation Spiral! Disinflation then Lots of Inflation - Janszen


Exactly; and this would've communicated the point much more clearly than persevering with the disinflation line when inflation was in fact negative. It just created unnecessary confusion and disagreement; that's my take.

Down Under
06-03-10, 07:59 PM
Is that what you think people were worrying about when they talked about 'deflation?' I envisioned a much more dramatic scenario going on much longer.

You are correct, in that when people were talking about 'deflation' they meant 'deflation spiral'. However, I think iTulip would've been better served by simply stating no 'deflation spiral' instead of using the word disinflation; to me, no 'deflation spiral' communicates much more clearly the point iTulip was making, instead of using the word disinflation.

It may just be me, but I think iTulip have realised this.

bart
06-03-10, 08:26 PM
Is that what you think people were worrying about when they talked about 'deflation?' I envisioned a much more dramatic scenario going on much longer.


Now add at least 3-5% (if not 6-7%) to those numbers to account for all the BLS BS in the false CPI statistics.

*That* is the disinflation to which iTulip refers - there was zero, nada, zip actual deflation.

WDCRob
06-03-10, 08:59 PM
You are correct, in that when people were talking about 'deflation' they meant 'deflation spiral'. However, I think iTulip would've been better served by simply stating no 'deflation spiral' instead of using the word disinflation; to me, no 'deflation spiral' communicates much more clearly the point iTulip was making, instead of using the word disinflation.

It may just be me, but I think iTulip have realised this.

I kind of agree, but 'spiral' was said from time to time and it was always clear to me what they meant (and, honestly, I'm enough of a novice at this that if it was clear to me it should have been clear to all).

I appreciate precision with language (a lot), but I just don't understand the need to try and bust someone's balls when they were, at the end of the day, right about something that so many others were not.

ThePythonicCow
06-04-10, 01:32 AM
However, I think iTulip would've been better served by simply stating no 'deflation spiral' instead of using the word disinflationThe (in/de/dis/hyper/.../flation) controversy serves our understanding poorly in my view.

Moderate price changes in the cooked CPI numbers do not tell us the major points we need to know.

We are not fundamentally dealing here with too much or too little fiat money in circulation. Prices are mostly moving only moderately one way or the other, depending on production volume (lower volumes require higher per-unit prices to cover fixed costs), financing availability and balance sheet health (weak balance sheets and limited financing options require higher prices to stay out of bankruptcy), and various other shifting factors. Meanwhile asset prices are either shell shocked (real estate) or on Plunge Protection Team steroids (stocks.) Personal incomes are either holding steady (no raise) or devastated (out of work), with no more "ATM machine" to fund the difference from one's increasing home equity.

The essential problem is that an absolutely monstrous pile of derivatives was built on top of a huge pile of debt, temporarily masking huge systemic risk. That Debt and Derivative Death Star is imploding, leaving black holes on the balance sheets of many individuals, corporations, governments (local, state and national), GSE's (Fannie, et al), pension funds and hedge funds, and leaving potholes in most of the remaining balance sheets. The stunning increase in the size of the Federal Reserve's balance sheet (and related off-book balance sheets, such as I presume behind the curtains at Maiden Lane, Goldman, JPMorgan and Blackrock) does not represent some vast influx of circulating currency in the economy. Rather it is evidence of the double entry bookkeeping shenanigans being done in an effort to fill in these black holes and potholes.

The idea that the major event going on is that the Fed is printing fiat dollars which are causing strongly rising inflation, risking hyperinflation is missing the point (at least for now.)

Companies are raising prices a little and reducing quality and package sizes a little more, mostly in an effort to keep from going belly-up in the face of declining sales volumes, devastated balance sheets and tight commercial lending.

We may get to some serious fiat money inflation or hyperinflation, or not. This may happen sooner or later. We live in stormy financial times. But that's not where we are now (outside of a few isolated places such as Zimbabwe I suppose.)