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  • #31
    Re: Saving, Asset-Price Inflation, and Debt-Induced Deflation (Log in to read comment

    This is another great and thought provoking piece. Well done Itulip for bringing this to the board!

    Now, allow me to weigh in with full gravity of my stature as a newly minted "Special Member" of itulip.;) (I guess 20 posts is enough to make one "special", a true meritocracy.)


    Hudson articulates very well the observation that debt growth is more or less a pure exponential function, and it is the debt growth that will always outstrip the growth of the economy to pay back the debt because the economy is cyclical.

    However, if you "zoom out" and look at economic growth over a long period of time, say 100yrs or more, the growth of the economy also has an exponential character to it. This growth in a normal free market economy is tamed however by the "sinusoidal" nature of the business cycle. So, economic growth is an exponential with a sinusoid superimposed. Consequently, the debt growth function is also tamed in a normal free market economy.

    I also skimmed Rajiv's link to Hudson's article about interest rates in the ancient world. He points out the same exponential-debt-growth/outstrip-ability-to-pay problem there as well.

    However, my critique of Hudson's description of this interest bearing debt system is that in the regimes he describes, (modern, ancient Near East, etc.) interest rates are set by something other than the "free market". In Babylonian/Sumerian times the interest rates were set by cultural custom. Today the Fed sets rates on the short end and in effect the "Prime Rate".

    It is my contention that the "inflexibility" of these interest rate setting mechanisms exaggerates the problems of this inconsistency between debt and economic growth. I realize I'm not saying anything new, just that this observation has not been made in this thread.

    Of course the new bankruptcy laws don't help the inconsistency either.

    Comment


    • #32
      Re: Saving, Asset-Price Inflation, and Debt-Induced Deflation

      Originally posted by Jim Nickerson
      The second "future world" would come closer to achieving what I think this country needs, if effect, a very hard slap of the face--for those who can go along with corporal punishment. The second seems to me to be more like Japan since 1990, and I don't see where the Japanese populace has devolved into penury or anarchy, though I haven't lived through it as a Jap.
      Couple of notes I would posit concerning Japan's 13 year downturn with what would happen were a similar scenario to occur in the US:

      1) Japan was the first major economy to go into the dumps; first one in first one out? Or at the very least, Japan has clearly been able to retain more intrinsic manufacturing capability than the US and thus has some trade counterbalance.

      2) Japanese on average save tons of money - they are socially very afraid of being poor and not 'pulling their own weight' in society.

      3) Japanese government and Japanese companies feel a very strong force to maintain everyday employment and stability. Even after the Japanese big corporations had to lay people off, I would almost guarantee that the sum numbers of layoffs in total up to now is probably fractions of what US companies are doing every year. In my own industry - semiconductors - I can only think of less than 30000 layoffs in total, whereas Sun and IBM have had individual layoffs larger than that.

      Thus in sum Japan is probably not a good example to see where US society would evolve into should scenario 2) occur.

      I'd personally lean more toward the labor vs. management struggles in the IWW (worker's of the world) era.

      Comment


      • #33
        Re: Saving, Asset-Price Inflation, and Debt-Induced Deflation

        Scenario 1 is actually good for the banks - their balance sheets will be showing renewed, massive amounts of new loans.

        Remember that financial statements are not inflation adjusted.

        Bank profits would be incredibly high.

        Scenario 1 is of course very, very, very bad for people on fixed incomes.

        Originally posted by grapejelly
        scenario 1 bails out the debtors while scenario 2 favors creditors. I think the US government will do everything in their power to prevent scenario 2 because of what it would do to government debt.

        Comment


        • #34
          Re: Saving, Asset-Price Inflation, and Debt-Induced Deflation

          Originally posted by EJ
          You take a five year Rip Van Winkle nap. You wake up in 2012 to find that the debt pyramid has indeed collapsed. Just to get you imagining possible future worlds, which do you think is the least bizarre?
          My guess for least bizarre is option A, inflation with tariffs. The main reason I say that is because of the political and social mood of the herd who will not mind nor notice that they are less well off as long as they can sell for higher prices. Deflation, though it may be needed to cleanse the system, so to speak, will have people rioting outside the White House regardless of who occupies it.

          In either scenario it appears that you EJ are siding with Jim Rogers and the secular commodity bull. $200/bl in option A and $100/bl in option B are both higher than today's prices while everything else looks like an either/or for inflation/deflation combined with some import tariffs.
          It's all fun and games until someone loses an eye!

          Comment


          • #35
            Re: tax structure and shopping malls

            tax structure and shopping malls - if you want to skip most of the article, search for tax on that page.

            http://www.newyorker.com/fact/conten...040315fa_fact1

            Can one pinpoint ONE factor here, or "the system".

            If one specific thing had not taken place in the past - if Capital gains were taxed equally to earned income, or if real estate was not allowed to be depreciated, would all this be avoided?

            Or would money find another way to increase itself?

            I think Nasser Saber would argue that these specific things are one manifestation - Speculative Capital seeks return, and seeks to have laws re-written in its own favor. These specific laws that Dr. Hudson cites are just the specific things that have fallen out in this case - in other cases, different laws would still lead to the same end (real estate bubble).

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            • #36
              A breath of fresh air!

              What a relief it is to know that there is an economist in this world other than Kurt Richebacher with the cajones to say where all of this asset price inflation is leading -- i.e., to a DEBT DEFLATION! Thank you, Dr. Hudson, for explaining exactly why the "reverse magic" of compounding interest charges will not permit a hyperinflationary solution for the world's debt problems. Creditors above all will be greatly relieved to know that their seven-year fight to swing the U.S. bankrputcy code egregiously in their favor will not have been in vain.:mad:

              Comment


              • #37
                Re: A breath of fresh air!

                Originally posted by Rick Ackerman
                What a relief it is to know that there is an economist in this world other than Kurt Richebacher with the cajones to say where all of this asset price inflation is leading -- i.e., to a DEBT DEFLATION! Thank you, Dr. Hudson, for explaining exactly why the "reverse magic" of compounding interest charges will not permit a hyperinflationary solution for the world's debt problems. Creditors above all will be greatly relieved to know that their seven-year fight to swing the U.S. bankrputcy code egregiously in their favor will not have been in vain.:mad:
                No so fast, Rick! Listen to all he has to say and you'll find two distinct cross-currents: 1) debt-deflation resulting from a collapse of the finance economy and 2) currency inflation, due to the the massive depreciation of the dollar. Gives you this...



                ...plus this...



                So when are you and I doing the podcast debate we discussed? I'm game. Is the iTulip community interested? Go to the top of this thead to vote.
                Last edited by EJ; 02-07-07, 01:36 PM.

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                • #38
                  Re: A breath of fresh air!

                  Whether it's him or not, it would be great to hear an equally articulate and convincing heavyweight argue in favor of deflationary outcomes.

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                  • #39
                    Re: A breath of fresh air!

                    Originally posted by WDCRob
                    Whether it's him or not, it would be great to hear an equally articulate and convincing heavyweight argue in favor of deflationary outcomes.
                    It's the real Rick. We're working out the mechanical details of the debate.

                    Comment


                    • #40
                      lbo's and pe; junk and cdo's

                      Originally posted by hudson
                      Going into debt to buy assets with borrowed funds experienced a quantum leap in the 1980s with the practice of financing leveraged buyouts with high-interest “junk” bonds. The process got underway when interest rates were still hovering near their all-time high of 20 percent in late 1980 and early 1981. Corporate raiding was led by the investment banking house of Drexel Burnham and its law firm, Skadden Arps. Their predatory activities required a loosening of America’s racketeering (RICO) laws to make it legal to borrow funds to take over companies and repay creditors by emptying out their corporate treasuries and “overfunded” pension plans. New York’s laws of fraudulent conveyance also had to be modified.
                      essentially the same thing is happening now with private equity. the targets are companies that can be levered up to pay "special dividends" to the purchasers.

                      The new cdo-based funding of subprime loans is very reminiscent of the junk bond boom of the ‘80s. Milken sold his junk on the basis of the historical performance of low-rated bonds. But in the past such bonds were “fallen angels” – the credits of formerly successful companies which had run into some trouble and been down-graded. It turned out this was a very different population than Milken’s coterie of never-to-be successful companies which were junk from the word “go.” CDO’s are chopped up pieces of subprime loans put together into diversified packages in which the diversification supposedly makes up for the poor quality of the underlying loans. Again, it is already turning out that the historical data is no guide – the new sub-prime paper is much poorer quality, and the diversification is an illusion. Diversification might have worked if we were not dealing with a national phenonomenon of jacked up prices combined with poor underwriting standards, but of course that is just what we are dealing with.

                      so if milken's junk debacle led to the s&l crisis, where exactly is the just-ignited cdo dirigible taking us?
                      Last edited by jk; 02-10-07, 04:26 PM.

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                      • #41
                        Re: Saving, Asset-Price Inflation, and Debt-Induced Deflation (Log in to read comment

                        I just found the time to carefully read hudson’s piece. I think the main weakness in its arguments is in its decision to ignore globalization. Some brief extracts and my comments follow:



                        Originally posted by hudson
                        Nearly all new fixed capital formation is financed out of retained business earnings, not out of bank borrowing. Banks finance sales, foreign trade, consumer debt and the purchase of property already in place, but hardly ever have they taken the risk of financing new direct investment. Their time horizon is short-term, not long-term.
                        - DISINTERMEDIATION was a phenonomenon of the 80s, with corporations going directly to the bond market instead of the banks.

                        Originally posted by hudson
                        As the economy’s assets are loaded down with debt and its interest charges, this credit growth extracts interest payments that divert revenue away from current demand for goods and services. That is why asset-price inflation usually involves debt deflation. The deflationary effect may be mitigated by lowering interest rates, as occurred in the United States during 1994-2004. The debt/savings overhead can rise without extracting a higher flow of interest payments as interest rates approach their nadir (about 1 percent today).
                        -?TIME TO ADD BACK NON-FINANCIALLY MOTIVATED FOREIGN CB’S? seems to me you’ve got to address the issue of huge bond purchases by non-profit-motivated cb’s here.

                        Originally posted by hudson
                        Today the net savings rate has fallen to zero, and the major factor impairing effective demand is the diversion of revenue to service the economy’s debt overhead. Paying interest and principal reduces the disposable income that debtors have available to spend on goods and services, while the financial institutions that receive this revenue do not spend it on goods and services. They lend out their receipts to enable the buyers to purchase assets that already exist.
                        WHAT ABOUT HOUSING? WHEN BORROWERS BUY HOUSES, FURNITURE, PLASMA SCREENS, ETC, THEY ARE BUYING GOODS. We need to see some numbers about how much actually loaned to acquire pre-existing assets versus new assets.

                        Originally posted by hudson
                        Today’s problem of inadequate consumer demand and capital investment lies on the liabilities (debt) side of the balance sheet, not on the asset (saving) side.
                        WHAT ABOUT THE SAVINGS IN ASIA? HOW CAN YOU DO THIS KIND OF ANALYSIS IN A GLOBALIZED ECONOMY? Also, there is plenty of industrial investment going on in the world, just not so much in the u.s.

                        Originally posted by hudson
                        Keynes did not devote much attention to the accrual of interest on past savings. His General Theory was ambiguous with regard to the specific forms that savings might take. They were identified simply as investment, so that on the macroeconomic plane, S = I. The implication by many Keynesians today is that savings actually cause investment. The reality is that savings not invested directly in new means of production were invested indirectly in stocks, bonds and real estate. Investment in securities and property already in existence had no positive employment effects.
                        IN THIS AND IN OTHER PASSAGES, HUDSON SEEMS TO THINK MONEY DISAPPEARS WHEN IT IS USED TO PURCHASE AN EXISTING ASSET. WHAT DOES THE SELLER OF THE ASSET DO WITH HIS NEW PILE OF CASH? WHY ISN’T THAT EXAMINED? THIS ALSO APPLIES TO THE MONEY CREATED VIA NEW LOANS TO ASSET-PURCHASERS. FOR EVERY ASSET PURCHASER THERE IS AN ASSET LIQUIDATOR WHO ENDS UP WITH A PILE OF CASH. WHAT IS SAM ZELL, HAVING SOLD EQUITY OFFICE PROPERTIES, GOING TO DO WITH HIS NEWLY LIQUIFIED BILLIONS? PUT IT UNDER HIS MATTRESS?

                        Originally posted by hudson
                        Not being limited by the course of income or the ability to pay, the exponential growth of savings tends to exceed growth of the real economy. This is what occurs when economies are loaded down with debts, which could equally well be thought of as the savings overhead that is lent out. Rising savings on the asset side of the balance sheet connote a rising debt overhead on the liabilities side. In this case saving does not necessarily reflect an increase of productive powers and the means of production, nor does it tend to employ labor. Rather, the debt service that results from lending out savings tends to shrink markets and employment.
                        EXTEND THIS TO THE GLOBAL ECONOMY, HOWEVER. CHINESE SAVINGS ARE RECYCLED INTO U.S. CONSUMPTION, BUT INVESTMENT IN PRODUCTIVE CAPACITY [IN CHINA] IS GROWING QUITE NICELY, AS IS CHINESE EMPLOYMENT

                        Originally posted by hudson
                        This growth of savings and loanable funds in the hands of financial institutions is lent out mainly to buy property in place and financial securities, not to fund tangible capital formation.
                        AGAIN, THERE IS A SELLER AS WELL AS A BUYER. THE SELLER NOW HAS FUNDS FOR SOME USE OR OTHER.


                        Originally posted by hudson
                        The problem occurs when current income no longer can carry the interest charges. The financial sector absorbs more income as debt service than it supplies in the form of new credit. Asset prices turn down – but the debts remain on the books. This has been Japan’s condition since its bubble peaked in 1990. It may result in “negative equity” for the most highly leveraged mortgage borrowers in the real estate sector, followed by debt-ridden companies.
                        .pushing on a string? The financial sector will absorb more as income than it supplies as new credit only if no one wants to borrow. That point doesn’t seem to be in sight. Also bernanke has said that the fed will, if necessary, monetize via the direct purchase of assets, putting cash into the hands of individuals and institutions.

                        Comment


                        • #42
                          Re: Saving, Asset-Price Inflation, and Debt-Induced Deflation (Log in to read comment

                          I wish you'd elaborate on your argument more as I think I'm missing your point and I'd like to understand it.

                          But I'll try here to comment on what I think you are saying and why I don't think it's valid.

                          Look at US homeowners who have borrowed to buy "too much house" go to jobs in the "services" sector and use their debt-backed money to consume goods paid to China...

                          Total debt levels in the US keep increasing at a rate faster than the underlying economy. This is a longterm trend in the US, going back to perhaps 1990. If you want to look back longer you can go back all the way to 1933 when the gold backing was removed from the dollar. Every dollar printed from then on was backed by debt.

                          Dr. Hudson says interest received is plowed back into more loans and more loans rather than being distributed into the "real" economy. So the loans balloon.

                          That seems to describe what I see happening.

                          He says that the underlying "real" economy becomes dwarfed by this "FIRE" monster and then collapses.

                          I think if anything the counter argument to what he is saying is devaluation of the currency happening faster than earnings accrual to the FIRE sector. We are seeing this in the form of negative real interest rates in the US and much of the Western world. US treasurys pay 4.8% today while the money supply grows at 12% (M3 approximated by www.nowandfutures.com) This makes the real debt levels less...

                          Dr. Hudson says that the solution is massive defaults or loan forgiveness which he says is inevitable.

                          But with enough inflation, I am not sure this is true. Even today's beleagured homeowners may be fine if they simply wait for high inflation to increase their wages and raise the nominal values of their homes. This may be in fact what happens rather than a "housing crash" and it may be true of all other debts and assets as well.

                          Eventually the negative real rate of return earned by the financial sector will remove the attractiveness of FIRE speculation and return that sector to its historical position as a percentage of GDP.
                          Last edited by grapejelly; 02-10-07, 05:59 PM.

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                          • #43
                            Re: Saving, Asset-Price Inflation, and Debt-Induced Deflation (Log in to read comment

                            grape, i didn't really have an "argument" so much as a series of comments about missing pieces in hudson's analysis.
                            trying to summarize my comments, however, i'd say that:

                            1. i question analyzing the u.s. economy as a closed system when the phenomena he describes are totally dependent on flows to and from the rest of the world. these flows are the flows of goods being consumed as imports and the flow of money recycled into dollar based financial instruments. the latter, of course, serves to hold down u.s. interest rates, which fosters all the credit he discusses.

                            2. there's plenty of growth in productive capacity and there are enormous increases in productive employment, just not in the u.s.

                            the fire sector is growing as part of the u.s. economy but it is not clear it's growing as part of the global economy. does it matter, then? if we say, for example, that the fire sector dominates lower manhattan does that prove anything? and if not, is it important if it dominates the u.s. economy?

                            i actually do think a lot of what hudson delineates is important and scary. the simplest way i summarize his argument is by looking at the growth of debt versus gdp. i think that it currently takes about 5 dollars of debt growth to get 1 dollar of gdp growth. the ratio of debt to gdp growth has itself been rising steadily. if interest rates were 20%, for example, 5 dollars of debt to 1 of gdp would be checkmate- the whole of the gdp growth would be required to pay the interest on the corresponding debt. of course interest rates are lower than that, but that's the idea, isn't it?

                            getting back to the globalization issue, i think this process is serving as a pump, pumping productive growth to the developing world, while we in this particular part of the developed world stagnate economically. there are some bizarre side effects of this process, i know, side effects which will cause some problems, but viewed from afar i'm not sure it's a bad thing for humanity.

                            this is all part of a transition from a u.s.-centric world.

                            Comment


                            • #44
                              Re: Saving, Asset-Price Inflation, and Debt-Induced Deflation (Log in to read comments)

                              Grapejelly,

                              While inflation will help all those who have debt, it will equally destroy all those who have credit but who either don't have enough to diversify offshore and/or don't know any better.

                              From my personal recollection of my parent's situation in the '80's, even that relatively low (10%+) inflation made life pretty damn difficult.

                              A look at Mexico, Argentina, Russia, and any number of other examples also shows that hyperinflation does NOT help the overall populace.

                              The difference between here and these other countries? A huge amount of US societal infrastructure is based on income and/or property taxes. This is not the same as with any of these other examples where most of various forms of government income are trade, corporate tax, or national industry related.

                              A hyperinflationary cycle in the US could mean a complete collapse of public schools, local government, likely many of the state governments, and a lot of business relying on these institutions and/or re-channeled salaries.

                              Various of these items happened in the above examples.

                              In turn, the failure of many local banks and possibly some of the larger institutions could have interesting possibilities.

                              Instead of a situation such as Russia - where the government owned all land and thus could distribute free housing to whoever was occupying the domicile, there could be a reverse situation where either the quasi-governmental entities such as Fannie Mae, or large banks wind up owning a significant chunk of the property here.

                              It could be a redux of the Great Depression in terms of property changing hands from the many to the few.

                              Comment


                              • #45
                                Checkmate

                                "i actually do think a lot of what hudson delineates is important and scary. the simplest way i summarize his argument is by looking at the growth of debt versus gdp. i think that it currently takes about 5 dollars of debt growth to get 1 dollar of gdp growth. the ratio of debt to gdp growth has itself been rising steadily. if interest rates were 20%, for example, 5 dollars of debt to 1 of gdp would be checkmate- the whole of the gdp growth would be required to pay the interest on the corresponding debt. of course interest rates are lower than that, but that's the idea, isn't it?"

                                ***

                                Recent data (per Richebacher) suggest that it is taking closer to $10 of borrowing these days to produce that marginal dollar of GDP growth. In any event, it is the real, not nominal, rate of interest that matters. If, say, mortgage rates were at 6.5% at a time when home values were falling by 10%, THAT would be checkmate, since it would subject tens of millions of homeowners to implied real rates of 16.5%. Come to think of it, isn't that about where we are right now?

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