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  • FIRE inflation vs real economy deflation

    [fred, i didn't know where to post this. it certainly is not "news." so i put it here. feel free to move it somewhere else if you think there's a more appropriate forum for it.]


    Flation II


    i've been thinking about this question for a while: where's the bubble?


    For some time myanswer was bonds, but I realize that it's really all financialassets, every FIRE asset with the possible recent exception ofcommodities. Very high end luxury condos in nyc can sell for over$100million, and about half the high end sales are to llc's, hidingthe real buyers' identities. It is believed these llc's are screensfor foreign buyers wanting to place and hide assets in the u.s. Thebond market keeps surprising by finding more reasons to drive ratesdown further and bond prices further up. the global equitiesmarkets are still at very high levels historically, albeit they are feeling some stress lately.


    What has powered thebubble, of course, is q.e. in all its global flavors. The cb's havebeen successful in keeping the money in the financial markets and asmuch as possible out of the real economy. They don't think assetinflation “counts,” and they are still keeping down the kind ofinflation [wages, really] they do recognize.


    So here I want toinsert something I wrote in May, 2003, because I want to update it.


    Originally posted by jk
    5/03
    Flation: causes andconsequences
    The financialmarkets are in turmoil, stuggling to predict the future of
    flation. Will wehave de-flation? Or in-flation? I suggest that we have
    plain old flationviewed on a macro level, and dys-flation on a micro level.
    Costs as measured bythe cpi or ppi are essentially steady, although
    commodity indicesare up. The lack of price movement across the economy
    in general I'm goingto call plain old flation. One might think that
    such steadinessbespeaks tranquility in the economy but, looking more
    closely, that is notat all the case.
    Instead we see areasof falling prices, especially in manufactured
    goods: cars,televisions, cell phones, computers, cameras, sneakers,
    clothes, anythingthat can be imported or competes with something
    imported from lowwage but relatively high productivity countries, most
    notably China. Thusmanufacturing jobs keep disappearing in the Unitied
    States. Overcapacityremaining from the '90's tech build out exacerbates
    this problem. Also,jobs delivering services which can be delivered
    electronically byphone, fax, or modem - help desks, customer services
    for credit cardcompanies, banks and airlines, etc - are also being
    exported, mostcommonly to the large, relatively well-educated, English
    speaking andlow-paid population of India. These are the areas of
    American deflation.
    Locally deliveredservices, on the other hand, cannot be imported.
    Housing, medicalcare, education and tuition, state and local government
    services, are alllocal products, and their prices are rising steadily.
    These are oursources of local inflation.
    Think of waterbubbling out of springs in some areas and being sucked
    down drains inothers. This is the balancing act of the American economy.
    Now price movementsin general have never moved in lock-step, but I
    believe that theextremes that we are witnessing between the different
    areas of the economyrepresent a dangerous dysregulation of the economy
    and its pricesignalling function. This problem is only in part
    post-bubble stressdisorder because of overinvestment in technology and
    mal-investment infinancial services. Changes in world trade,
    globalization, wouldhave pushed in this direction in any event, but the
    bubble made itworse. I suggest we call the current price situation
    dys-flation: widelydisparate changes in the general price level in
    different sectors ofthe economy.
    Where do we go fromhere? I've seen described essentially 3 prototypical
    scenarios - theJapanese, the Argentine, and a muddle through. The
    Japanese scenariopredicts deflation - likely triggered by debt
    deflation as therates of credit card and mortgage delinquincies
    continue to risefrom current high levels, and major corporate
    bankruptciescontinue to turn billions of dollars in corporate bonds
    into waste paper.The Argentine scenario focuses on Fed Governor
    Bernanke's now(in)famous "printing press" speech, in which he took a
    blood oath to printany amount of money, and buy any number of assets,
    to prevent theJapanese scenario. Now the Fed is not about to start
    buying governmentlong bonds to support the mortgage market, for
    example, withoutprovocation. So the Argentine scenario I think
    presupposes that weswing close to the Japanese scenario, perhaps via a
    crisis (how aboutFannie Mae as the next LTCM?) scaring the Fed to start
    buying bonds,futures, indicies, and so on to pump up the financial
    markets and pumpbucks into the economy. These dollars will go
    somewhere, and ingeneral liquidity chases the rising asset. It's hard
    to predict what thatmight be in this scenario but one imagines safety
    being a primeconsideration, leading to Treasuries and hard assets -
    real estate,perhaps, and gold. Thus we can have falling interest rates
    and rising goldprices. The muddle-through scenario says that the
    bubbling springs andsucking drains will remain in rough balance,
    allowing a gradualwrite down of redundant assets, a deleveraging from
    the enormous debtthat has been accumulated by individuals and
    corporations (theU.S. government increases its debt levels again as the
    private sectorreduces its debt), and adjustments in the composition of
    our economy toprovide for different kinds of jobs for people who would
    formerly have workedproducing now-imported goods and services.

    I still think wehave dys-flation with segments in inflation – FIRE assets – andsegments in deflation – the real economy, especially real wages. This follows the structure of ej's diagram of the mostly separateFIRE economy and the production/consumption economy. [I haven't beenable to find that diagram. Metalman, are you still here?]


    the question we haveis whether the FIRE inflation will spill into the real economy – asit has in real estate, especially high end, for example. Or does thedeflation in the production/consumption economy spill into financialassets – as it has to some degree lately in global equity markets,and as it has to a greater degree in financial assets tied tocommodity prices. Or do the world's puppet masters somehow continueto stagger ahead between these possibilities?


    This process hasbeen evolving for much longer than I thought possible, albeit with acouple of scary near-catastrophes along the way. Witness the factthat my old note inserted above was written 12 years ago. So perhapsthis can go on a great deal longer.


    This ever-pending,never-happening but potentially huge crisis also characterizes thedollar. Anybody holding their breaths lately, waiting for the end ofthe dollar-centric global monetary system?


    If this system isgoing to destabilize, will we be able to identify that process earlyenough to protect ouselves or even profit from it? In the late1990's it was easy to see that there was a tech bubble, especiallythe dot com bubble. In the mid 2000's it was easy to see there wasa housing bubble. In both cases it was hard to predict what wouldtrigger the end of those bubbles, or when they would end, but theirfuture was pretty clear.


    Now, faced with abubble in all FIRE assets, it is still hard to know what mighttrigger its end. And it is even harder to think of where to hide. If all assets are up, then – pace finster – it is the same assaying the dollar is low. Finster's fdi has been rising lately, butit is still very low in a broad historical context. Saying it willcontinue to rise, and rise markedly, is saying that the deflation inthe production-consumption economy is going to “win” in thisstruggle of countervailing forces. Hold cash. Or maybe a spike inthe fdi is just the “ka” to be followed by a “poom.”


    many years ago thissite hosted deep discussions about what was going on in the economy. We haven't been having those discussion lately, I think at least inpart because of the artificiality of the current economicenvironment.


    But if we step backfar enough, and look at a broad enough picture, perhaps there issomething to discuss after all. At a minimum, we can look for earlysigns of bubble destruction – like the bankruptcy of those 2cdo-based bear stern hedge funds in '07, presaging the carnage of'08. we might also address the question of whether, in thisabnormal, manipulated, “disney exhibit” economy, we can justallocate assets as if the economy were normal. or is something different enough to require some other strategy? if so, what?

  • #2
    Re: FIRE inflation vs real economy deflation

    Originally posted by jk View Post
    [fred, i didn't know where to post this. it certainly is not "news." so i put it here. feel free to move it somewhere else if you think there's a more appropriate forum for it.]


    Flation II


    i've been thinking about this question for a while: where's the bubble?


    For some time myanswer was bonds, but I realize that it's really all financialassets, every FIRE asset with the possible recent exception ofcommodities. Very high end luxury condos in nyc can sell for over$100million, and about half the high end sales are to llc's, hidingthe real buyers' identities. It is believed these llc's are screensfor foreign buyers wanting to place and hide assets in the u.s. Thebond market keeps surprising by finding more reasons to drive ratesdown further and bond prices further up. the global equitiesmarkets are still at very high levels historically, albeit they are feeling some stress lately.


    What has powered thebubble, of course, is q.e. in all its global flavors. The cb's havebeen successful in keeping the money in the financial markets and asmuch as possible out of the real economy. They don't think assetinflation “counts,” and they are still keeping down the kind ofinflation [wages, really] they do recognize.


    So here I want toinsert something I wrote in May, 2003, because I want to update it.





    I still think wehave dys-flation with segments in inflation – FIRE assets – andsegments in deflation – the real economy, especially real wages. This follows the structure of ej's diagram of the mostly separateFIRE economy and the production/consumption economy. [I haven't beenable to find that diagram. Metalman, are you still here?]


    the question we haveis whether the FIRE inflation will spill into the real economy – asit has in real estate, especially high end, for example. Or does thedeflation in the production/consumption economy spill into financialassets – as it has to some degree lately in global equity markets,and as it has to a greater degree in financial assets tied tocommodity prices. Or do the world's puppet masters somehow continueto stagger ahead between these possibilities?


    This process hasbeen evolving for much longer than I thought possible, albeit with acouple of scary near-catastrophes along the way. Witness the factthat my old note inserted above was written 12 years ago. So perhapsthis can go on a great deal longer.


    This ever-pending,never-happening but potentially huge crisis also characterizes thedollar. Anybody holding their breaths lately, waiting for the end ofthe dollar-centric global monetary system?


    If this system isgoing to destabilize, will we be able to identify that process earlyenough to protect ouselves or even profit from it? In the late1990's it was easy to see that there was a tech bubble, especiallythe dot com bubble. In the mid 2000's it was easy to see there wasa housing bubble. In both cases it was hard to predict what wouldtrigger the end of those bubbles, or when they would end, but theirfuture was pretty clear.


    Now, faced with abubble in all FIRE assets, it is still hard to know what mighttrigger its end. And it is even harder to think of where to hide. If all assets are up, then – pace finster – it is the same assaying the dollar is low. Finster's fdi has been rising lately, butit is still very low in a broad historical context. Saying it willcontinue to rise, and rise markedly, is saying that the deflation inthe production-consumption economy is going to “win” in thisstruggle of countervailing forces. Hold cash. Or maybe a spike inthe fdi is just the “ka” to be followed by a “poom.”


    many years ago thissite hosted deep discussions about what was going on in the economy. We haven't been having those discussion lately, I think at least inpart because of the artificiality of the current economicenvironment.


    But if we step backfar enough, and look at a broad enough picture, perhaps there issomething to discuss after all. At a minimum, we can look for earlysigns of bubble destruction – like the bankruptcy of those 2cdo-based bear stern hedge funds in '07, presaging the carnage of'08. we might also address the question of whether, in thisabnormal, manipulated, “disney exhibit” economy, we can justallocate assets as if the economy were normal. or is something different enough to require some other strategy? if so, what?
    Some random thoughts on a Saturday morning:

    "This ever-pending,never-happening but potentially huge crisis also characterizes thedollar. Anybody holding their breaths lately, waiting for the end ofthe dollar-centric global monetary system?"

    Predictions of the imminent demise of the US Dollar date back to at least the 1970s inflation era. Much has been made in this forum in recent years about the "sophisticated" Chinese manoeuvres to compromise the US (Petro)Dollar via the accumulation of gold, the establishment of bilateral trade agreements in non-Dollar currencies, the formation of the BRICS Bank and so forth.

    The presumption has been that a new monetary order will be needed because of a "Dollar collapse" (generally expected from some sort of (inexplicably) deliberate Chinese led takedown or, alternatively, a supremely incompetent Federal Reserve Board armed with helicopters). It would appear that the greatest damage to the world economy today is coming from the deflationary influence of a rising US Dollar. Could it be that the RoW needs (and eventually calls for) a new monetary system to insulate itself from the ravages of a runaway to the upside reserve currency?


    "Now, faced with abubble in all FIRE assets, it is still hard to know what mighttrigger its end. And it is even harder to think of where to hide. If all assets are up, then – pace finster – it is the same assaying the dollar is low. Finster's fdi has been rising lately, butit is still very low in a broad historical context. Saying it willcontinue to rise, and rise markedly, is saying that the deflation inthe production-consumption economy is going to “win” in thisstruggle of countervailing forces. Hold cash. Or maybe a spike inthe fdi is just the “ka” to be followed by a “poom.”

    Individual bubbles seem to end in exhaustion - the object of desire runs out of buyers willing to pay more than the last transaction. Then the hunt starts for the next, new object of desire to inflate.

    This global "bubble in everything" seems a unique circumstance with which no one is intimately familiar. As the EMs, led by China, collectively unleashed their vertically integrated manufactured goods tsunami (from mining the raw materials to railways, ports, bulk ships to, and container ships from the China-located factories) on the world it seems unprecedented monetary expansion became the order of the day everywhere. In the developed (consuming) economies this monetary stimulus was needed to offset the deflationary effects of ever cheaper EM sourced imported goods and the related hollowing out of the domestic productive economy manufacturing sector. In the EMs the monetary stimulus was needed to counter the upward pressure on their currencies from the "commodity supercycle" and the "China story" - printing the local currency to buy US$ & recycling those Dollars in a giant vendor finance scheme (EJ's Economic M*A*D) through the accumulation of US Treasuries (whether Riyals or Reals, Dinars, Dirhams or Yuan, it was the same hold-the-peg story).

    Credit has flowed in such quantities that expatriate Emirates flight attendants buy overpriced apartments in Dubai, the UK filled with "buy-to-let" landlords convinced negative cashflow is the on-ramp to the road to riches, summer cottages on the mosquito & blackfly infested lakefronts of Central Canada trade for millions (Chinese billionaires? Doubtful!), and the Singapore-Shanghai-Vancouver Pacific Rim arc has disconnected itself entirely from reality. Not to be left behind, our governments, developed economy and EM alike, beneficiaries of windfall taxes on inflating properties and financial asset capital gains, have extrapolated these out to an infinity of future revenues and undertaken an orgy of credit fueled infrastructure investment, complete with the inevitable misallocation of funds for overbuilt freeways in southern Europe (loans at German rates) and bridges to nowhere. Everywhere. This "new normal" apparently now disallows global CBs from "normalizing" policy voluntarily...suggesting an involuntary reversal is in the offing.

    Could it be the unexpected, rapid and very large increases in US domestic crude oil production will, in retrospect, be seen as the catalyst that started the unwind? Such a shift in the reserve currency nation's current account and volume of Treasury issuance to fund energy imports would seem to have induced something more than a minor perturbation in the global credit system balancing act...
    Last edited by GRG55; 09-05-15, 01:08 PM.

    Comment


    • #3
      Re: FIRE inflation vs real economy deflation

      GRG55 you present a great summary of the problem

      Originally posted by GRG55 View Post

      ...It would appear that the greatest damage to the world economy today is coming from the deflationary influence of a rising US Dollar.
      Could it be that the RoW needs (and eventually calls for) a new monetary system to insulate itself from the ravages of a runaway to the upside reserve currency?...

      And then you present the solution:

      ... bubbles seem to end in exhaustion - the object of desire runs out of buyers willing to pay more than the last transaction...
      Finster is fond of reminding us of the yin and yang of price movements.
      The cure for high prices is high prices.
      Either supply increase or demand diminishes when prices get high enough.

      Should not the same be true for the price of the dollar?

      Comment


      • #4
        Re: FIRE inflation vs real economy deflation

        Originally posted by thriftyandboringinohio View Post
        GRG55 you present a great summary of the problem




        And then you present the solution:



        Finster is fond of reminding us of the yin and yang of price movements.
        The cure for high prices is high prices.
        Either supply increase or demand diminishes when prices get high enough.

        Should not the same be true for the price of the dollar?
        I agree. My contrarian nature is already contemplating whether the US Dollar is now becoming "expensive", and whether it is time to start trading US Dollars for things that appear (to me) to now be "cheap". Crude oil and select other commodities, for example.

        However, all of the non-US Central Banks are furiously trying to offset the deflationary credit unwind (and fiscal "austerity" policies of their governments) now underway. My view is that if they are partially successful the US$ index will continue to strengthen against other global currencies. If they are wildly successful their economic growth rates will improve sufficiently that capital flows will change and the US$ may decline instead. It's a crap shoot imo.

        Comment


        • #5
          Re: FIRE inflation vs real economy deflation

          Originally posted by GRG55 View Post
          ...whether it is time to start trading US Dollars for things that appear (to me) to now be "cheap". Crude oil and select other commodities, for example.
          i've been having similar thoughts. i want wti to retest 38-40 first. sept-oct is often the season to make new lows, and we appear to be headed that way. otoh, maybe it is silly to wait. if 38-40 is attractive, maybe in the long run it's silly not to just accept 46.

          we are all exploring the assumption here that the recent bout of deflation over roughly the last 12 months will soon end and the dollar resume its long long term slide. ie. we are all rejecting the idea of a runaway deflation. otoh, assets could go significantly lower, non?


          http://www.itulip.com/forums/showthr...663#post297663

          Comment


          • #6
            Re: FIRE inflation vs real economy deflation

            Originally posted by GRG55 View Post
            Some random thoughts on a Saturday morning:

            "This ever-pending,never-happening but potentially huge crisis also characterizes thedollar. Anybody holding their breaths lately, waiting for the end ofthe dollar-centric global monetary system?"

            Predictions of the imminent demise of the US Dollar date back to at least the 1970s inflation era. Much has been made in this forum in recent years about the "sophisticated" Chinese manoeuvres to compromise the US (Petro)Dollar via the accumulation of gold, the establishment of bilateral trade agreements in non-Dollar currencies, the formation of the BRICS Bank and so forth.

            The presumption has been that a new monetary order will be needed because of a "Dollar collapse" (generally expected from some sort of (inexplicably) deliberate Chinese led takedown or, alternatively, a supremely incompetent Federal Reserve Board armed with helicopters). It would appear that the greatest damage to the world economy today is coming from the deflationary influence of a rising US Dollar. Could it be that the RoW needs (and eventually calls for) a new monetary system to insulate itself from the ravages of a runaway to the upside reserve currency?


            "Now, faced with abubble in all FIRE assets, it is still hard to know what mighttrigger its end. And it is even harder to think of where to hide. If all assets are up, then – pace finster – it is the same assaying the dollar is low. Finster's fdi has been rising lately, butit is still very low in a broad historical context. Saying it willcontinue to rise, and rise markedly, is saying that the deflation inthe production-consumption economy is going to “win” in thisstruggle of countervailing forces. Hold cash. Or maybe a spike inthe fdi is just the “ka” to be followed by a “poom.”

            Individual bubbles seem to end in exhaustion - the object of desire runs out of buyers willing to pay more than the last transaction. Then the hunt starts for the next, new object of desire to inflate.

            This global "bubble in everything" seems a unique circumstance with which no one is intimately familiar. As the EMs, led by China, collectively unleashed their vertically integrated manufactured goods tsunami (from mining the raw materials to railways, ports, bulk ships to, and container ships from the China-located factories) on the world it seems unprecedented monetary expansion became the order of the day everywhere. In the developed (consuming) economies this monetary stimulus was needed to offset the deflationary effects of ever cheaper EM sourced imported goods and the related hollowing out of the domestic productive economy manufacturing sector. In the EMs the monetary stimulus was needed to counter the upward pressure on their currencies from the "commodity supercycle" and the "China story" - printing the local currency to buy US$ & recycling those Dollars in a giant vendor finance scheme (EJ's Economic M*A*D) through the accumulation of US Treasuries (whether Riyals or Reals, Dinars, Dirhams or Yuan, it was the same hold-the-peg story).

            Credit has flowed in such quantities that expatriate Emirates flight attendants buy overpriced apartments in Dubai, the UK filled with "buy-to-let" landlords convinced negative cashflow is the on-ramp to the road to riches, summer cottages on the mosquito & blackfly infested lakefronts of Central Canada trade for millions (Chinese billionaires? Doubtful!), and the Singapore-Shanghai-Vancouver Pacific Rim arc has disconnected itself entirely from reality. Not to be left behind, our governments, developed economy and EM alike, beneficiaries of windfall taxes on inflating properties and financial asset capital gains, have extrapolated these out to an infinity of future revenues and undertaken an orgy of credit fueled infrastructure investment, complete with the inevitable misallocation of funds for overbuilt freeways in southern Europe (loans at German rates) and bridges to nowhere. Everywhere. This "new normal" apparently now disallows global CBs from "normalizing" policy voluntarily...suggesting an involuntary reversal is in the offing.

            Could it be the unexpected, rapid and very large increases in US domestic crude oil production will, in retrospect, be seen as the catalyst that started the unwind? Such a shift in the reserve currency nation's current account and volume of Treasury issuance to fund energy imports would seem to have induced something more than a minor perturbation in the global credit system balancing act...
            With a nod of appreciation for your insights, perhaps the game is a bit simpler than that. The fiat dollar - uncontested champion of printed money - is embedded in its magic circle of dollars - oil - military spending - dollars - oil - military spending ... ad infinitum, or so some would hope. Fatigue at undermining the US global military may be the incentive to cobble together a basket of alternatives - not the 'collapse of the dollar'.

            Comment


            • #7
              Re: FIRE inflation vs real economy deflation

              i just put up a post in the "yes, virginia..." thread in a discussion of the huge expansion of and speculation in the chinese corporate debt market., and just prior to that i wrote in another thread about cdo's reappearing.

              this sparked a new thought for me. for some time i've been wondering: "where is the bubble?" it seemed like the bubble was everywhere, in all financial markets, but nowhere in particular. then i started thinking that the bond market, pushing into negative interest rates, was the central bubble. but i couldn't figure out how it would burst.

              now i see an analogy: cdo's of subprime mortgages were the first instruments to blow up in '07 - they were junk to the junk power, so of course they were the spark that went first, but was not contained.

              now we have chinese corporate debt and american energy-based corporate debt, and probably other classes of corporate debt beyond my knowledge, that are teetering. the spark won't be in the center of the global debt markets, that is the treasury market. the spark will be in the junkiest kind of corporate debt, or cdo's of corporate debt, or leveraged funds of corporate debt, or as in the chinese case daisy-chained repos of junky corporate debt. i.e. junk to the junk power. i expect another "flight to quantity" as bill fleckenstein described the move to treasuries last time around. treasuries and the dollar should both rise even further. but i don't know when.

              Comment


              • #8
                Re: FIRE inflation vs real economy deflation

                Yup. That is why last year the fed floated the idea of exit fees on bond funds & just recently Larry Summers suggested central banks should buy lower quality debt to lower spreads, etc.
                The central banks of Europe and Japan need to be clear that their biggest risk is a further slowdown. They must indicate a willingness to be creative in the use of the tools at their disposal. With bond yields well below 1 percent, it is doubtful that traditional quantitative easing will have much stimulative effect. They must be prepared to consider support for assets such as corporate securities that carry risk premiums that can be meaningfully reduced and even to recognize that by absorbing bonds used to finance fiscal expansion they can achieve more.

                Comment


                • #9
                  Re: FIRE inflation vs real economy deflation

                  Originally posted by seobook View Post
                  Yup. That is why last year the fed floated the idea of exit fees on bond funds & just recently Larry Summers suggested central banks should buy lower quality debt to lower spreads, etc.
                  i guess if they could buy mbs, they can buy anything. not directly, though, which i believe would be illegal. but referring back to bernanke's "making sure..." paper, he discussed offering banks guaranteed profits along with loans so that the banks could buy any damned thing the fed wanted them to. but just as the subprime market had to crash before the fed stepped in, i would suspect some lag in fed action- some piece of the corporates market has to crash first. they probably won't wait as long as the last time, but i very much doubt they would act pre-emptively - otherwise the fed's intervention would likely trigger the very sell-off they're hoping won't happen.
                  Last edited by jk; 10-22-15, 10:45 AM.

                  Comment

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