Announcement

Collapse
No announcement yet.

The Myth of the Slow Crash

Collapse
X
 
  • Filter
  • Time
  • Show
Clear All
new posts

  • The Myth of the Slow Crash

    The Myth of the Slow Crash

    Just because it's big, doesn't mean it can't go down fast. In a debt deflation, the extreme rate of change even fools central bankers.

    by Eric Janszen


    (Image: Second Officer David Blair. Before the Titanic sailed, he left with the key to the locker that contained the pair of binoculars for the designated lookout. Historians believe that if the crew had access to the binoculars the iceberg would have been seen in time to avoid the collision that sank the ship. Nice suit, though.)

    The business press this morning attributed the 280 point DOW rout yesterday afternoon to investors' worries that the ongoing credit crunch and declining housing market may damage the so-called real economy. But the timing suggests that the market reacted to the release of the Fed's meeting minutes.

    The minutes of the early August 2007 closed-door meeting of the Federal Open Market Committee were released late in the afternoon. The markets plunged shortly thereafter. The Fed's stated hope for a "return to more normal market conditions" without intervention is not what investors wanted to hear. They were hoping to read Fed minutes expressing worries that justified the move to cut the discount rate and pour tens of billions into the banking system ten days later. The minutes imply that the Fed was surprised.

    The heart if not the soul of the Fed's role in The System, as Greenspan calls it, is as the all-knowing Wizard of Oz. How can the Wizard be surprised and still be the Wizard? Is the Fed really on top of this?

    This raises a key question about Bernanke. While we deeply respect Bernanke's intellect, is he well suited for the role of head Wizard? He's an academic, not an astute politician and gun-for-hire like Greenspan. Does he have the instincts and nerve for the job, or will he do what comes naturally to him and wait for the data to stop showing apparently conflicting trends and align, at which point reaction will be too late? Can he convey that he is on top of events, even if he isn't, to maintain the appearance of control?

    Watching him in front of a congressional committee at the last hearing, I winced as members of Congress interrupted him when he spoke, chuckled at some of his answers to questions, and generally dissed him. Having run more than 80 board meetings in my career as CEO, my advice to Bernanke is to watch a few tapes of Greenspan and do what he used to do at senate hearings. No matter how badly things are going, never accept disrespect. If you do, you're dead.

    Greenspan, not his inquisitors, controlled those hearings, even when the missiles were flying, such as after the 2000 stock market crash. When he asked a ill-informed question–which, given the average Congress person's knowledge of economics and finance, is most of the time–he'd respond with a short meaningless answer. The more ill-informed the question, the shorter and more meaningless the answer. At one hearing I recall Greenspan was asked a question that was outrageously absurd, even by the standards of the US Congress. Greenspan's answer, after a pregnant pause: "I'm speechless."

    The Fed's Foggy View

    If slashing the discount rate half a percent ten days after hoping aloud that the markets might self-correct appears flip floppy, remember that the Fed considered rate hikes, versus cuts, as recently as May when inflation remained the Fed's predominant concern. Investors have reason to worry that this Fed does not know how to apply, now that the fire is burning, what it learned during the drills.

    Coming off the housing bubble, the Fed is worried about the US experiencing a flavor of runaway debt deflation such as it suffered in the 1930s, and a less severe but no less worrisome debt deflation episode as Japan suffered after since the end of their stock market and real estate bubble collapsed starting in 1992. Preparedness for that eventuality was the gist of Bernanke's now famous helicopter money speech in November 2002, two and a half years before the housing bubble peaked. The monetary downdraft potential of a US recession under current household debt conditions with financial markets risk polluted at red alert levels is severe.

    In my last article, I explained how a financial market crash caused by credit contraction is a long process. As the Japanese learned, when a credit bubble finally pops, the negative economic impact of credit contraction is swift.


    A recession is a self-reinforcing process. The Fed is, and should be, afraid of where such a process might take the debt-laden US economy with so much debt riding on housing prices, housing prices riding on employment, and employment riding on consumption. Commentators point out that housing prices are now falling for the first time since The Great Depression. Another respected academic, Professor Robert Shiller, reiterated this point in an interview yesterday. He should also point out that this is the first time national housing prices have declined – ever – in the absence of a recession or depression. Question: what might happen to housing prices when the economy finally goes into recession Q4 2007? The Japanese know: prices collapse and stay there a long time.



    Charts from New Road to Serfdom

    The Fed can guess as well as you or I what the next US recession has in store, and isn't interested in confirming their theories by experimentation. We saw that movie in the US in the 1930s and the Japanese are still watching their own version, fifteen years later.

    The lesson the Fed learned from the Japanese experience is: once debt deflation forces are in play, don't delay cutting rates. In a credit contraction, disinflation can get away from you quickly, driving up real rates of interest and shutting down the money creation machinery. Keep inflation above zero at all costs.



    Don't let this happen




    Or this




    Do use all means to keep inflation above the zero bound, like this


    The Greenspan Fed applied this lesson effectively after the stock market bubble crash in 2001. But that was an easier crisis to manage in many ways. A crashing stock market is a negative wealth effect sledgehammer to be sure, and managing its falling on the US economy meant flooding the system with money and creating new asset bubbles. But a stock market crash is not a credit contraction. Credit is the life blood of the economy and markets. Shut it off, and the economy quickly stalls. A technology stock bust wiped out a lot of equity, forced technology companies out of business, and wiped out a few venture capital finds. But housing bubble bust threatens to bring down the credit markets and banking system, and spread crisis to foreign buyers of securitized debt, spill over into the consumer credit markets, cutting demand for exports and wreck economy havoc generally.

    The confusing and contradictory nature of the economic data may in itself be strong evidence of major dangers that confront the Fed's decision-making process.
    It is of the utmost importance to realize this: given the actual facts which it was then possible for either businessman or economists to observe, those diagnoses -- or even the prognosis that, with the existing structure of debt, those facts plus a drastic fall in price level would cause major trouble but that nothing else would -- were not simply wrong. What nobody saw, though some people may have felt it, was that those fundamental data from which diagnoses and prognoses were made, were themselves in a state of flux and that they would be swamped by the torrents of a process of readjustment corresponding in magnitude to the extent of the industrial revolution of the preceding 30 years. People, for the most part, stood their ground firmly. But that ground itself was about to give way.

    - Joseph A. Schumpeter, Business Cycles, 1939
    As well prepared as the Fed appears to be theoretically to handle the current crisis, helicopters and all, the conditions for applying the cure this time for this purpose are far more challenging than in 2001 and 2002 when they were conceived. An already heavily depreciated dollar, already lowered taxes, a massive fiscal deficit versus a surplus, oil trading over $70 compared to $22, and a low Fed funds rate base of 5.25% all mean that the Bernanke Fed's and fiscal policy options cannot be executed today in the same hell-for-leather way they were in 2001.

    The paradox is that to prevent the recession that can develop into a run-away debt deflation, the Fed needs to cut early and often, but to avoid crashing the bond market and dollar, the Fed has to wait until it sees the whites of bond and currency traders' eyes. Timing, wording, and execution will be critical. And the bond market might get it wrong, too.

    As we've discussed several times in past iTulip ShadowFed meetings, in a perfect world for the Fed, a random event occurs outside the U.S. that the Fed can use as a reason to cut. The greatest challenge for the Fed is that this crisis is US-centric. As David Bloom, currency guru at HSBC, said: "The US needs a trillion dollars a year just to stand still." Modern financial crises have always begun on the peripheries of global economy, setting off a chain reaction. Mr Bloom says the seizure this time will be at the heart of the system as the dollar buckles, pressing down on the "aorta of capitalism."

    Assuming the Fed pulls off a magical combination of rate cuts with global central banks' cooperation, which appears to still be in place given the ECB's recent noises about suddenly halting its rate hikes program, along with more tax cuts and fiscal stimulus to prevent a hard crash at this time, in the long run the Fed is still a one trick pony. It can print or not. When, not if, the US goes into recession in Q4 this year as unemployment begins to rise, the housing market will take its next and more serious turn down. As inflation falls toward negative rates the Fed will cut drastically. But if they wait that long, the Japanese experience is that the moves will then be too late.

    iTulip Indicators of a Sharp Reaction

    We are starting to collect iTulip Prosper Lending Group members data. One of our reasons for setting up the group last year was to establish a baseline so we'd have more proprietary data for the iTulip ShadowFed to use to make its decisions. We checked with a few other members informally this week and they are seeing a huge spike in defaults in August after almost no defaults before July 2007. One reported only one default among 100 loans and that was in July 2007, then six so far in August. Things can change very quickly, as I've said, and this may be an indicator. If you are an iTulip Prosper Lending Group member, please send default data to info@itulip.com.

    iTulip Select: The Investment Thesis for the Next Cycle™
    __________________________________________________

    To receive the iTulip Newsletter or iTulip Alerts, Join our FREE Email Mailing List


    Copyright iTulip, Inc. 1998 - 2007 All Rights Reserved


    All information provided "as is" for informational purposes only, not intended for trading purposes or advice.
    Nothing appearing on this website should be considered a recommendation to buy or to sell any security or related financial instrument. iTulip, Inc. is not liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. Full Disclaimer
    Last edited by FRED; 01-11-09, 09:48 AM. Reason: Out of date ads
    Ed.

  • #2
    Re: The Myth of the Slow Crash

    But i Want HIGH rates!
    Sky HIGH!
    In fact i think the Banks will want it to help recoup their lossers?
    Mike

    Comment


    • #3
      Re: The Myth of the Slow Crash

      Poom won't start until the commentators on CNBC are screaming about deflation. That has not happened yet; but just wait, it will.

      That is my personal buy signal.

      Comment


      • #4
        Re: The Myth of the Slow Crash

        Buy what?
        Mike

        Comment


        • #5
          Re: The Myth of the Slow Crash

          Originally posted by dbarberic View Post
          Poom won't start until the commentators on CNBC are screaming about deflation. That has not happened yet; but just wait, it will.

          That is my personal buy signal.
          I don't watch financial TV, so when you get the signal will you annouce it here and email me too. Thanks.
          Jim 69 y/o

          "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

          Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

          Good judgement comes from experience; experience comes from bad judgement. Unknown.

          Comment


          • #6
            Re: The Myth of the Slow Crash

            Originally posted by Mega View Post
            Buy what?
            Mike
            Things that you think will go up; if they don't go up, don't buy them--a la Will Rogers, -American cowboy and philosopher.
            Last edited by Jim Nickerson; 08-29-07, 10:09 PM.
            Jim 69 y/o

            "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

            Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

            Good judgement comes from experience; experience comes from bad judgement. Unknown.

            Comment


            • #7
              Re: The Myth of the Slow Crash

              Originally posted by Fred View Post
              [EJ:] ...in a perfect world for the Fed, a random event occurs outside the U.S. that the Fed can use as a reason to cut.
              Is that another one of these

              Originally posted by EJ View Post
              We hope our market warnings July 25 "Before the Stroke of Midnight" and in our Newsletter Monday were not too subtle, and everyone was ready in their own way for this correction.
              or was that just an academic hypothetical?

              Comment


              • #8
                Re: The Myth of the Slow Crash

                Originally posted by Mega View Post
                Buy what?
                Mike
                Investments expected to benefit from the Poom phase....

                Comment


                • #9
                  Re: The Myth of the Slow Crash

                  Originally posted by Jim Nickerson View Post
                  I don't watch financial TV, so when you get the signal will you annouce it here and email me too. Thanks.
                  The Fed would love to cut rates; but it is more than just the Fed interpreting the statistics, it is also “Great Theater” that the Fed is trying to put on.

                  Cut to quickly and the Fed looks week, the bond vigilantes come out, and the dollar gets crushed. But convince the market that a rate cut is not by choice, but out of necessity due to an exogenous random event or threat of deflation, and the bond vigilantes will be more forgiving as will foreign holders of USD.

                  Excluding a random exogenous event, when the roar of the main stream investment media turns into overwhelming screams of deflation (e.g. CNBC), they are simply providing the defense so that Ben can come in and do his lay-up shot into the basket.

                  Comment


                  • #10
                    Re: The Myth of the Slow Crash

                    Something totally unexpected will trigger the collapse. And, because it will be "over everyone's horizon", there will not be time for the majority to adjust their thinking and act in a calm manner. Fear of the unexpected will trigger panic and then no one will be able to forecast the movement of the value of any asset. That is why the market rules supreme.

                    Comment


                    • #11
                      Re: The Myth of the Slow Crash

                      "The lesson the Fed learned from the Japanese experience is: once debt deflation forces are in play, don't delay cutting rates. In a credit contraction, disinflation can get away from you quickly, driving up real rates of interest and shutting down the money creation machinery. Keep inflation above zero at all costs..."

                      this was the wrong lesson to take away from the Japanese experience, and that's why the Fed has effectively destroyed America's future.

                      Japanese deflation wasn't caused by credit rates being too dear - it was the result of demographics - too many old folks depending on not enough young workers. ungodly low raters allowed the Japanese govt. to spend the past 15 years priming the pump to the point where all that Japanese "savings" we hear so much about is now probably deeper underwater than the typical spendthrift American's negative savings account.

                      when a population like Japan's is basically dying off and yet does not allowing immigration, housing prices will fall. America, on the other hand, saw the writing on the wall. that's why in the Simpson's episode where Lisa gives her speech to Congress, she says "250 million Americans". who wants to bet there's now about 320 million? ( US population figs are probably about as accurate as US financial date). That's 70 million in 20 years! that explains Greenspan's conumdrum. yet New Orleans is good example of why reckless amounts of immigration are a bad idea. so is traffic.

                      Comment


                      • #12
                        Re: The Myth of the Slow Crash

                        While I think demographics accounts for some of the effects, the major problem this theory does not explain is, why the SUDDEN drop?

                        Did the population age 30 years in one year?

                        Also look here

                        http://research.stlouisfed.org/publi...aiet/page7.pdf

                        http://research.stlouisfed.org/publi...apan/japan.pdf

                        Where's the GENERAL deflation? I don't see it.

                        There may have been specific industries / economic segments that experienced falling prices, but GENERAL, widespread, economy-wide, across the board price drops did not happen.

                        Originally posted by stumann View Post

                        Japanese deflation wasn't caused by credit rates being too dear - it was the result of demographics - too many old folks depending on not enough young workers. ungodly low raters allowed the Japanese govt. to spend the past 15 years priming the pump to the point where all that Japanese "savings" we hear so much about is now probably deeper underwater than the typical spendthrift American's negative savings account.

                        Comment


                        • #13
                          Re: The Myth of the Slow Crash

                          Greetings ...newbie first post.

                          Looking at the news today suggests some sort of rate drop but as I understand it here one should look to a larger amount of deflationary MSM 'noise' to get a real idea of this?

                          I'm imagining this inflation would be a short term occurrence with either a return to the mean or into deflation?

                          (Bigger the noise the bigger the interest drop? Should one be watching Cramer for massive body twitches etc?)

                          Comment


                          • #14
                            Re: The Myth of the Slow Crash

                            Originally posted by Black
                            I'm imagining this inflation would be a short term occurrence with either a return to the mean or into deflation?
                            The jury is of course still out - but I personally am a big believer in mean reversion: all of the housing price gains and inflation controls experienced in the past 10 years will be returned.

                            Thus inflation will not be a short term phenomenon; 10+ years of offshoring reducing prices here will be returned by a similar time duration multiplied by increased inflation.

                            Note that while housing prices didn't cause inflation to rise when house prices went up, neither will a housing price decline affect inflation in reverse.

                            Note that housing prices in the future will be a function of inflation as well...

                            Comment


                            • #15
                              Re: The Myth of the Slow Crash

                              China to begin exporting a nascent inflation back out to the world? That trend could be a very big deal - first and foremost for America.

                              Welcome back C1ue.

                              Comment

                              Working...
                              X