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    Default No Deflation! Disinflation then Lots of Inflation - Janszen

    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 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.


    Object lesson: Japan 1990s. Don't let this happen because, if you do...


    ...you get this.

    Not deflation, but certainly disinflation, a slowing in the rate of inflation. Evidence of it is popping up everywhere.
    Oil, Gold Tumble as Economic Slowing Threatens Commodity Rally
    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.


    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, 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: "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?

    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.


    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?"

    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.


    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 came to the rescue.


    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.



    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.





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




    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.




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



    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.




    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, 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, "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.

    ______

    For a layman's explanation of financial bubble concepts, see our book America\'s Bubble Economy: Profit When It Pops
    For macro-economic and geopolitical currency ETF advisory services see "Crooks on Currencies"
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    Last edited by FRED; 05-26-08 at 08:57 AM.

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    EJ,

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

    Quote Originally Posted by Eric Janzen
    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.
    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.

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    Quote Originally Posted by Jim Nickerson
    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.

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    Finster,

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

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    Quote Originally Posted by Jim Nickerson
    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.

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    Thumbs up Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    what he said

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    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


    Quote Originally Posted by metalman
    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.
    Last edited by Jim Nickerson; 09-12-06 at 11:51 AM.
    Jim 69 y/o

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    Quote Originally Posted by Jim Nickerson
    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.
    Ed.

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    Quote Originally Posted by metalman
    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?
    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.

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    Quote Originally Posted by Jim Nickerson
    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.

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    Quote Originally Posted by EJ
    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

    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.)
    Last edited by FRED; 09-12-06 at 11:02 PM.
    Ed.

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    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.
    Last edited by Spartacus; 09-13-06 at 06:06 PM.

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    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 -3.3% for the month of October 2001. 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.
    Last edited by FRED; 09-12-06 at 09:30 PM.

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    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.
    Last edited by DanielLCharts; 09-14-06 at 03:20 PM.

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    Quote Originally Posted by DanielLCharts
    ...
    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.




    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.

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    Quote Originally Posted by bart
    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:

    Quote Originally Posted by EJ
    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.

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    Quote Originally Posted by Finster
    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. ;)
    Last edited by bart; 09-14-06 at 06:05 PM.

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    "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?
    Last edited by DanielLCharts; 09-14-06 at 05:25 PM.
    check out the charts at blog.myspace.com/dannycharts

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    Quote Originally Posted by DanielLCharts
    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.




    Quote Originally Posted by DanielLCharts
    "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.



    Quote Originally Posted by DanielLCharts
    "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!

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    Default Re: No Deflation! Disinflation then Lots of Inflation - Janszen

    Quote Originally Posted by bart
    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/ju...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.
    Finster
    ...

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