[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.

Quote Originally Posted by jk
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?