The Myth of the Slow Crash

[c1ue]

Re: The Myth of the Slow Crash

But what happens when all rates are so low that there's no significant differential between rates in Japan and the US? Does that force a revaluing and a relative decline by the dollar?

Iinterest rates are set by the government, but trade flows are a function of the economy.

Japan's economy is much healthier than the US in terms of trade/currency account surplus.

Even with both countries at zero interest, Japan will be fine as they are exporting and bringing in foreign currency to offset their imports. Japan doesn't need high interest rates to attract new loans despite their fiscal indebtedness.

The US needs to import a lot, and has only its own crap currency - not to mention pay interest on the money already owed.

Thus in this scenario the interest rates are only a factor in the performance of the dollar. Ultimately the underlying economies will put pressure on currencies to conform to 'ideal' levels.

As mentioned before, Japan is looking to the US as a military balance point vs. China - they are happy to continue their part of the partnership so long as the US can maintain its military power.

However, the Japanese cannot offset 2.5x as many Americans with bad habits - especially given roughly par per capita wages.

[c1ue]

Re: The Myth of the Slow Crash

it is no longer as clear to me as it once was that cutting rates will tank the dollar. the ecb has backed off its hawkish stance as sarkozy et al are crying out about the difficulties of living with a strong euro. japanese rates remain very low, and the chinese are taking their own sweet time in allowing the renminbi to rise. coordinated cuts by cbs around the globe might be in store. all currencies will decline together against real goods, and the dollar might not look particularly bad, relatively to other fiat currencies. gold would do well in this scenario.

JK,

I agree that the dollar as a ratio to Euro, yen, or other currencies could possible be fairly stable.

However, I have never looked at this ratio as my primary cause for concern.

Rather, what I fear mightily is the purchasing power reduction of the dollar.

It is possible that although the dollar stays stable, that PPP drops dramatically just for the dollar.

My rationale is as for internal China: In the days when there were both 'internal' and 'foreign exchange' RMB, things like washing machines could only be bought with 'foreign exchange' RMB. Although theoretically the 2 currencies were equal, in reality you could by 6x 'internal' RMB (iRMB) vs. each 'foreign exchange' RMB (feRMB). But, of course, there was basically zero reverse trade (iRMB to feRMB) conducted by internal Chinese.

My fears are thusly:

1) Dollar depreciation - this is the most straightforward and perhaps best result: we get our inflation quick, but the incentives for internal manufacturing and labor employment are immediate. Interest rates go up somewhat but are kept from being too high by our government printing credit. This is due to foreigners not wanting to lend credit which will depreciated.

2) Dollar PPP depreciation - looks good, screws the economy really bad. We get the combo punch of inflation without internal economy compensation. Interest rates go up higher than 1) as this is a mild form of dollar repudiation.

3) Dollar repudiation - officially the exchange rates look good. But no one wants dollars. I call this the 'Ebay effect': in the past all transactions by foreign sellers were in dollars. These days it is all in AUS$ and GBp. Basically if you aren't exchanging a physical good, you won't get any foreign currency for it. Not an immediate effect as the rest of the world engages in dollar dumping, but once the dollars outside of the US run out...it gets bad.

Time for FAST kits...

All of these scenarios are based on my view that the US economy has basically sold out almost all physical value creation in favor of financial engineering. Thus even coordinated cuts around the world will affect the least healthy economies disproportionately. Would that be Europe? Russia? China? Brazil? I think not.

[zoog]

Re: Bernanke on helicopters, price indexes

Barry Ritholtz remarks in a recent article on Seeking Alpha: "The risk of focusing on the core is that Fed risks losing credibility in the eyes of the public. Future inflation expectations are not nearly as muted as the Fed's benign core rate."

You got that right! A Fed that persists in pretending inflation is much lower than we know it to be out here in the real world simply cannot be credible.

And then presumably that eventually leads to, or at least ties into, this:

The 1987 type event I warned July 25 is coming does not happen until the market participants lose confidence in the ability of central banks to control events. Typically this happens some time after several of the kinds of Fed interventions that we saw today in a 50 basis point discount rate cut. If a major revelation follows soon after, then market participants start to wonder if there is a bottom at all.

[Finster]

Re: Bernanke on helicopters, price indexes

I must admit, I just read the full text of that speech, and I would encourage anyone who hasn't to do so. In context, the helicopter line is not such a big deal in my opinion. He's simply saying that a money-financed tax cut is a way to get dollars directly to Americans as an extreme method of combating deflation, provided that rate cuts are ineffective and rates are approaching zero. What's so bad about that?

What I was a bit shocked to read was Bernanke's footnote regarding inflation measurements and price indexes.

6. Several studies have concluded that the measured rate of inflation overstates the "true" rate of inflation, because of several biases in standard price indexes that are difficult to eliminate in practice. The upward bias in the measurement of true inflation is another reason to aim for a measured inflation rate above zero.

Does he really think the rigged CPI understates inflation?!? What are these "studies" to which he refers?

Jimmy

This is the one thing that truly worries me about Bernanke. If you just look at the way the Bernanke Fed has conducted itself, you have to give him pretty high marks. But his apparent endorsement of the notion that the CPI overstates inflation has to make you wonder what he's been smoking.

First the "headline" CPI omits a lot of inflation, mostly through its use of so-called "Owner’s Equivalent Rent", as Tim Iacono points out in his Seeking Alpha article "How Owner's Equivalent Rent Duped the Fed".

To make matters even worse, he is fond of taking it yet a step further and focusing on so-called "core" inflation stats. Barry Ritholtz remarks in a recent article on Seeking Alpha: "The risk of focusing on the core is that Fed risks losing credibility in the eyes of the public. Future inflation expectations are not nearly as muted as the Fed's benign core rate."

You got that right! A Fed that persists in pretending inflation is much lower than we know it to be out here in the real world simply cannot be credible.

Cover Up Those Signs! The Problem With Gasoline Prices and "Reported Inflation"

[Finster]

Re: The Myth of the Slow Crash

Good question. Look forward to EJ's clarification.

One thought: Bernanke's Jackson Hole speech included "The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets."

Seems the Fed still views their responsibility as "standing by ready to clean up the mess". If so, isn't any pre-emptive Funds rate cut (before a significant equity market decline) inconsistent, and therefore unlikely? :confused:

Strictly speaking, one can infer that EJ's 1987' scenario would stand intact even after aggressive Fed easing, because that was assumed in his original framing of it - that 1987' would occur after it became apparent that the Fed's machinations were impotent. So presumably 1987' happens regardless, and the aggressive Fed easing would instead act to stave off a subsequent multi-year Japanese-style deflationary mire. On the other hand, it's so widely assumed that Fed cuts would boost the stock market (the market has been rallying as Treasury and Fed funds price in expected easing), and the view EJ states above does not refer to the earlier 1987' outlook. And don't forget we have an avowed deflation-fighting printing-press-armed Fed chairman and a chief executive in the helicoper cockpit, so it's hard to imagine that even if deflation got rolling that it could not be reversed even if the Fed waited for clear evidence of "real economy" spillover before acting.

[WDCRob]

Re: The Myth of the Slow Crash

it is no longer as clear to me as it once was that cutting rates will tank the dollar. the ecb has backed off its hawkish stance as sarkozy et al are crying out about the difficulties of living with a strong euro. japanese rates remain very low, and the chinese are taking their own sweet time in allowing the renminbi to rise. coordinated cuts by cbs around the globe might be in store. all currencies will decline together against real goods, and the dollar might not look particularly bad, relatively to other fiat currencies. gold would do well in this scenario.

JK, I never remember the titles of these things, but I'm pretty sure EJ said exactly that in his 'Gresham's Law' post last year. If CBs coordinate gold does well against all currencies. If they don't gold does well vs the dollar. Either way if you're in dollars gold is good.

But what happens when all rates are so low that there's no significant differential between rates in Japan and the US? Does that force a revaluing and a relative decline by the dollar?

[zoog]

Re: Bernanke on helicopters, price indexes

What I was a bit shocked to read was Bernanke's footnote regarding inflation measurements and price indexes.

6. Several studies have concluded that the measured rate of inflation overstates the "true" rate of inflation, because of several biases in standard price indexes that are difficult to eliminate in practice. The upward bias in the measurement of true inflation is another reason to aim for a measured inflation rate above zero.

Does he really think the rigged CPI understates inflation?!? What are these "studies" to which he refers?

Jimmy

I think you meant to say "Does he really think the rigged CPI overstates inflation?"

Probably the Boskin Commission report in 1996. Greenspan was claiming the CPI overstated inflation by around 1% back in 1994. So Bernanke is just repeating the party line. The Boskin recommendations resulted in further tampering with the CPI calculations, skewing them even further from reality, which is, of course, higher inflation than reported. I'm sure Bart could give you a more detailed answer.;)

[Rajiv]

Re: The Myth of the Slow Crash

To me that would result in a worldwide stagflationary trend -- one that cannot be sustained - because an exponetial rise in currency supply at some time becomes impossible to accomplish

[jk]

Re: The Myth of the Slow Crash

Good question. Look forward to EJ's clarification.

One thought: Bernanke's Jackson Hole speech included "The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets."

Seems the Fed still views their responsibility as "standing by ready to clean up the mess". If so, isn't any pre-emptive Funds rate cut (before a significant equity market decline) inconsistent, and therefore unlikely? :confused:

it's not inconsistent if they think someone's already made a mess.

[GRG55]

Re: The Myth of the Slow Crash

Thanks, guys. I pretty much got that. Guess it was my question that wasn’t so clear. I was trying to get clarification on whether his call for the 1987' event is altered by whether the Fed follows his prescription for aggressive easing.

Good question. Look forward to EJ's clarification.

One thought: Bernanke's Jackson Hole speech included "The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets."

Seems the Fed still views their responsibility as "standing by ready to clean up the mess". If so, isn't any pre-emptive Funds rate cut (before a significant equity market decline) inconsistent, and therefore unlikely? :confused:

[GRG55]

Re: The Myth of the Slow Crash

...My guess is that the situation will be similar to Argentina - but with very few options left until the infrastructure can be rebuilt. The big question in this will be -- can the US shift to a low volume oil economy while doing it - relying only on North American Petroleum resources. I am assuming that Mexican and Canadian economies are too intertwined with the US economy to be separable. If Canada or Mexico bailout, things will be extremely tough!

By dint of shared history, and geography, Canada has a high dependence on US markets that long pre-dates NAFTA. Canada is unable to insulate itself from the side effects of US economic contractions. The vocal minority of Canadians that advocate Canada restrict energy exports, if necessary, fail to recognize it would only greatly compound the damage. These are the same people that would hoard the food on a desert island for themselves, letting all others starve. They end up well fed. And alone.

I interpret the (heavily criticised) tripartite SPP initiative as recognition of this reality at the highest political levels.

[zoog]

Rate cut seems likely

As well prepared as the Fed appears to be theoretically to handle the current crisis, helicopters and all, the conditions for applying the cure this time for this purpose are far more challenging than in 2001 and 2002 when they were conceived. ... The paradox is that to prevent the recession that can develop into a run-away debt deflation, the Fed needs to cut early and often, but to avoid crashing the bond market and dollar, the Fed has to wait until it sees the whites of bond and currency traders' eyes. Timing, wording, and execution will be critical. And the bond market might get it wrong, too. ... When, not if, the US goes into recession in Q4 this year as unemployment begins to rise, the housing market will take its next and more serious turn down. As inflation falls toward negative rates the Fed will cut drastically. But if they wait that long, the Japanese experience is that the moves will then be too late.

According to a Marketwatch report, it sounds like a rate cut in September is likely.

Most of the economists at Jackson Hole believe that a rate cut by the Fed is a foregone conclusion unless there is a dramatic turnaround in the economy before the Federal Open Market Committee meeting on Sept. 18.

Influential economist Martin Feldstein told the Jackson Hole forum that the Federal Open Market Committee should lower the federal funds rate by as much as a percentage point.Hatzius of Goldman Sachs said that his expectations of a rate cut later this month "were cemented" by Friday's speech by Fed Chairman Ben Bernanke. He would not rule out a half a percentage-point cut in September.

...

In effect, Mussa said, Bernanke "has promised a rate cut on Sept. 18 unless the problems in the credit market miraculously disappear." ...

Mickey Levy, chief economist at Bank of America Corp. ... "I am virtually certain [the Fed] will ease on Sept. 18," Levy said, adding that the move would be enough to keep the economy from going into recession.

...

Overall, Hatzius has forecast three-quarters of a percentage point in rate cuts by the end of 2007.

They are also talking about recession being increasingly likely...

Hatzius agreed there was a "significant risk" of recession, putting the odds at one in three.

...

Gramley, the former Fed governor, said that the odds of a recession are somewhere between 33% to 50%. "This is a severe problem which will have to be dealt with," he said.

Furthermore, as I believe EJ and others have surmised, the Fed may be ill-prepared to handle the current situation.

David Hale, an economist and a regular at the Jackson Hole conference, called the current environment "a crisis of information."

...

The hard data on the impact of the credit crunch and market turmoil on the U.S. economy is also a few months away. The third quarter was almost half over when the crisis erupted.


Economists at BNP Paribas wrote in a research note that it "will be months" before the impact shows up in unemployment data.


The tightening of financial markets is likely to have a negative impact on GDP, especially in the fourth quarter. Fourth-quarter GDP data won't be released until January 2008.


In the meantime, Fed officials "will have to play it by ear," said Michael Mussa, formerly chief economist for the International Monetary Fund.

[jimmygu3]

Bernanke on helicopters, price indexes

Coming off the housing bubble, the Fed is worried about the US experiencing a flavor of runaway debt deflation such as Japan suffered after their real estate bubble collapsed starting in 1992. Preparedness for that eventuality was the gist of Bernanke's now famous helicopter money speech in November 2002, two and a half years before the housing bubble peaked.

I must admit, I just read the full text of that speech, and I would encourage anyone who hasn't to do so. In context, the helicopter line is not such a big deal in my opinion. He's simply saying that a money-financed tax cut is a way to get dollars directly to Americans as an extreme method of combating deflation, provided that rate cuts are ineffective and rates are approaching zero. What's so bad about that?




What I was a bit shocked to read was Bernanke's footnote regarding inflation measurements and price indexes.

6. Several studies have concluded that the measured rate of inflation overstates the "true" rate of inflation, because of several biases in standard price indexes that are difficult to eliminate in practice. The upward bias in the measurement of true inflation is another reason to aim for a measured inflation rate above zero.

Does he really think the rigged CPI overstates inflation?!? What are these "studies" to which he refers?

Jimmy

[jk]

Re: The Myth of the Slow Crash

it is no longer as clear to me as it once was that cutting rates will tank the dollar. the ecb has backed off its hawkish stance as sarkozy et al are crying out about the difficulties of living with a strong euro. japanese rates remain very low, and the chinese are taking their own sweet time in allowing the renminbi to rise. coordinated cuts by cbs around the globe might be in store. all currencies will decline together against real goods, and the dollar might not look particularly bad, relatively to other fiat currencies. gold would do well in this scenario.

[Rajiv]

Re: Question For EJ

state of leveraged debt

See Rating Agencies : The Monopoly Of The "three Usa Sisters"