The Myth of the Slow Crash

[Rajiv]

Re: The Myth of the Slow Crash

Here is what happened in Agentina -- that is not what I am suggesting will happen here, but the Argentinian case is worth reexamining.

From Argentina 2002

"Don't Cry For Me Argentina" (from Andrew Lloyd Webber's Evita) was a big hit song around the world in the late 1970s. This year the world is lamenting Argentina's economic woes. The country is currently on course to set a record for the largest number of people to lose the most wealth in the shortest period of time. Argentina is surely an economy to cry for.

Unemployment in Argentina has climbed to 25%. The real GDP is projected to decline this year by approximately 10-15%, the largest single-year decline on record and following three consecutive years of recession that began in 1999. After nearly a decade of relatively stable prices, inflation is currently in triple digits. In April the IMF tentatively estimated that prices would increase by 30% or more this year. However, month-to-month prices jumped by 10% in April alone. If prices were to continue to escalate at that monthly rate for twelve consecutive months, then the annual rate of inflation would exceed 200%! Currency markets have already factored in April's inflation rate, and the floating peso has fallen to about $0.27 from the 1 peso = 1 dollar parity that Argentina managed to fix throughout most of the 1990s. Argentina's MERVAL stock market index has declined by nearly 75% since the end of last year. Measures of macroeconomic activity for a semi-industrialised economy rich in natural and human resources don't get much worse than these.

Like the Great Depression of the 1930s, the stagflation of the 1970s, and the economic implosion of the former Soviet Union in the 1990s, Argentina's economic collapse should remind us all of how fragile economic systems really are and how important it is to have sound economic institutions in place and effectual corrective policy on stand-by when things start to go wrong. The consequences of a dire economic performance have devastating and long lasting negative psychological effects on those persons who suffer and endure the hard times. Individual confidence is shattered, and hope is overwhelmed by despair. Fear and uncertainty paralyze the economy. Practical solutions get lost in a deluge of ideological polemic while the economy continues to flounder. Years, if not decades, of economic stagnation can pass by before confidence, stability and growth are eventually restored. This, it would appear, is Argentina's fate.
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It was in 1999 that Argentina's economy turned "bad." Real GDP fell by 3.4%. Unemployment began to rise. Stock prices began to fall. Hopes for a quick recovery were dashed when the economy declined by nearly 1% again in 2000. The year 2001 was even worse when the economy recorded another 3.7% decline in real GDP. By this time, Argentina had become bogged down in an "L" shaped recession. There are several explanations for Argentina's downward slide. Most explanations focus on a series of adverse external shocks including a decline in international commodity prices, the rising cost of of capital for emerging market economies, the Brazilian real devaluation, an overvalued peso pegged to an appreciating US dollar, and higher interest rates caused by a restrictive monetary policy in the United States. Argentina's currency board system and commitment to a fixed exchange rate made it virtually impossible for monetary authorities to respond to these shocks.

This is where the proverbial rock and a hard place comes for the US. US is in a similar bind to Argentina. I don't think the "Helicopter Trick" will work -- Too much of the manufacturing infrastructure has been off-shored - and it will take a generation to rebuild.

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!

[Finster]

Re: The Myth of the Slow Crash

I am not EJ, but my impression on reading the entire thread was that it appears that the Fed is between the proverbial "Rock and a Hard Place" and the question really is whether it can find any cracks to squeeze though -- and that is yet to be determined. If I look at Hudson's theories, and also look at the state of leveraged debt -- I do not see any way out other than stagflation.

Finster,

I can't speak for EJ, but it seems to me that the statements are pretty clear:

1) The worst won't come until the Fed (and all other 'saviors') lose credibility. At this point I think only the Fed has it; the government does not, nor do the banks/hedgies/PE etc.

2) The Fed knows it must cut early and often; dragging this out just results in Post-Japan

3) However, unlike Japan the Fed does not have the economic luxury of doing so. The US being a debtor nation and also with an unsound economy would be crushed if the dollar were then punished and US inflation/interest rates rose as a consequence.

The point - which I am perhaps completely off base on - is that the Fed does not have a safe path to proceed on to get out of this mess.

Thus unless Bernanke and Co. pull a Nobel Prize in Financial Engineering out of of their collective ivory throne seats, we're all in the pot.

The most likely outcome is thus a series of timid moves - none of which betray the Fed's weakness - all of which don't do squat in the market.

This will then be followed by the 'what the heck, we might as well cut anyway' capitulation which will do no good.

Then all heck breaks loose!
…
:eek:

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.

[c1ue]

Re: The Myth of the Slow Crash

My question is whether your comments here relate to alternative scenarios or the same one. That is, do you foresee that this 1987'-type event comes even if the Fed does indeed "cut early and often"? The first quote forecasts that the Fed intervenes aggressively, it "hits the fan" anyway, hope is lost, and the stock market crashes. The second quote urges the Fed to intervene aggressively, suggesting that by such action dire consequences might be avoided. Does the second comment modify the first, or merely contemplate that 1987' still happens but that even greater consequences would be averted by aggressive Fed easing?

Finster,

I can't speak for EJ, but it seems to me that the statements are pretty clear:

1) The worst won't come until the Fed (and all other 'saviors') lose credibility. At this point I think only the Fed has it; the government does not, nor do the banks/hedgies/PE etc.

2) The Fed knows it must cut early and often; dragging this out just results in Post-Japan

3) However, unlike Japan the Fed does not have the economic luxury of doing so. The US being a debtor nation and also with an unsound economy would be crushed if the dollar were then punished and US inflation/interest rates rose as a consequence.

The point - which I am perhaps completely off base on - is that the Fed does not have a safe path to proceed on to get out of this mess.

Thus unless Bernanke and Co. pull a Nobel Prize in Financial Engineering out of of their collective ivory throne seats, we're all in the pot.

The most likely outcome is thus a series of timid moves - none of which betray the Fed's weakness - all of which don't do squat in the market.

This will then be followed by the 'what the heck, we might as well cut anyway' capitulation which will do no good.

Then all heck breaks loose!

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[c1ue]

Re: The Myth of the Slow Crash

Welcome back C1ue.

Lukester,

Did you miss me? Or did my admitting to buying a big pile of GLD put me on your posse? ;)

[Rajiv]

Re: Question For EJ

Question For EJ
. Does the second comment modify the first, or merely contemplate that 1987' still happens but that even greater consequences would be averted by aggressive Fed easing?

I am not EJ, but my impression on reading the entire thread was that it appears that the Fed is between the proverbial "Rock and a Hard Place" and the question really is whether it can find any cracks to squeeze though -- and that is yet to be determined. If I look at Hudson's theories, and also look at the state of leveraged debt -- I do not see any way out other than stagflation.

[Finster]

Question For EJ

Question For EJ

In another thread, (Fed Cuts Discount Rate - Post 15), you stated:

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. That's when the shit really hits the fan. Now there's still hope, and as long as their is hope there will be high volatility but no 1,000+ crash days. But those days are coming.

Later you commented in the opening post above as follows:

…

The lesson the Fed learned from the Japanese experience is: once debt deflation forces are in play, don't delay cutting rates. In a credit contraction, disinflation can get away from you quickly, driving up real rates of interest and shutting down the money creation machinery. Keep inflation above zero at all costs.
…
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.
…

My question is whether your comments here relate to alternative scenarios or the same one. That is, do you foresee that this 1987'-type event comes even if the Fed does indeed "cut early and often"? The first quote forecasts that the Fed intervenes aggressively, it "hits the fan" anyway, hope is lost, and the stock market crashes. The second quote urges the Fed to intervene aggressively, suggesting that by such action dire consequences might be avoided. Does the second comment modify the first, or merely contemplate that 1987' still happens but that even greater consequences would be averted by aggressive Fed easing?

Re: The Myth of the Slow Crash

China to begin exporting a nascent inflation back out to the world? That trend could be a very big deal - first and foremost for America.

Welcome back C1ue.

[c1ue]

Re: The Myth of the Slow Crash

I'm imagining this inflation would be a short term occurrence with either a return to the mean or into deflation?

The jury is of course still out - but I personally am a big believer in mean reversion: all of the housing price gains and inflation controls experienced in the past 10 years will be returned.

Thus inflation will not be a short term phenomenon; 10+ years of offshoring reducing prices here will be returned by a similar time duration multiplied by increased inflation.

Note that while housing prices didn't cause inflation to rise when house prices went up, neither will a housing price decline affect inflation in reverse.

Note that housing prices in the future will be a function of inflation as well...

[Black]

Re: The Myth of the Slow Crash

Greetings ...newbie first post.

Looking at the news today suggests some sort of rate drop but as I understand it here one should look to a larger amount of deflationary MSM 'noise' to get a real idea of this?

I'm imagining this inflation would be a short term occurrence with either a return to the mean or into deflation?

(Bigger the noise the bigger the interest drop? Should one be watching Cramer for massive body twitches etc?)

[Spartacus]

Re: The Myth of the Slow Crash

While I think demographics accounts for some of the effects, the major problem this theory does not explain is, why the SUDDEN drop?

Did the population age 30 years in one year?

Also look here

http://research.stlouisfed.org/publi...aiet/page7.pdf

http://research.stlouisfed.org/publi...apan/japan.pdf

Where's the GENERAL deflation? I don't see it.

There may have been specific industries / economic segments that experienced falling prices, but GENERAL, widespread, economy-wide, across the board price drops did not happen.

Japanese deflation wasn't caused by credit rates being too dear - it was the result of demographics - too many old folks depending on not enough young workers. ungodly low raters allowed the Japanese govt. to spend the past 15 years priming the pump to the point where all that Japanese "savings" we hear so much about is now probably deeper underwater than the typical spendthrift American's negative savings account.

[stumann]

Re: The Myth of the Slow Crash

"The lesson the Fed learned from the Japanese experience is: once debt deflation forces are in play, don't delay cutting rates. In a credit contraction, disinflation can get away from you quickly, driving up real rates of interest and shutting down the money creation machinery. Keep inflation above zero at all costs..."

this was the wrong lesson to take away from the Japanese experience, and that's why the Fed has effectively destroyed America's future.

Japanese deflation wasn't caused by credit rates being too dear - it was the result of demographics - too many old folks depending on not enough young workers. ungodly low raters allowed the Japanese govt. to spend the past 15 years priming the pump to the point where all that Japanese "savings" we hear so much about is now probably deeper underwater than the typical spendthrift American's negative savings account.

when a population like Japan's is basically dying off and yet does not allowing immigration, housing prices will fall. America, on the other hand, saw the writing on the wall. that's why in the Simpson's episode where Lisa gives her speech to Congress, she says "250 million Americans". who wants to bet there's now about 320 million? ( US population figs are probably about as accurate as US financial date). That's 70 million in 20 years! that explains Greenspan's conumdrum. yet New Orleans is good example of why reckless amounts of immigration are a bad idea. so is traffic.

[Chris Coles]

Re: The Myth of the Slow Crash

Something totally unexpected will trigger the collapse. And, because it will be "over everyone's horizon", there will not be time for the majority to adjust their thinking and act in a calm manner. Fear of the unexpected will trigger panic and then no one will be able to forecast the movement of the value of any asset. That is why the market rules supreme.

[dbarberic]

Re: The Myth of the Slow Crash

I don't watch financial TV, so when you get the signal will you annouce it here and email me too. Thanks.

The Fed would love to cut rates; but it is more than just the Fed interpreting the statistics, it is also “Great Theater” that the Fed is trying to put on.

Cut to quickly and the Fed looks week, the bond vigilantes come out, and the dollar gets crushed. But convince the market that a rate cut is not by choice, but out of necessity due to an exogenous random event or threat of deflation, and the bond vigilantes will be more forgiving as will foreign holders of USD.

Excluding a random exogenous event, when the roar of the main stream investment media turns into overwhelming screams of deflation (e.g. CNBC), they are simply providing the defense so that Ben can come in and do his lay-up shot into the basket.

[dbarberic]

Re: The Myth of the Slow Crash

Buy what?
Mike

Investments expected to benefit from the Poom phase....

[zoog]

Re: The Myth of the Slow Crash

[EJ:] ...in a perfect world for the Fed, a random event occurs outside the U.S. that the Fed can use as a reason to cut.

Is that another one of these

We hope our market warnings July 25 "Before the Stroke of Midnight" and in our Newsletter Monday were not too subtle, and everyone was ready in their own way for this correction.

or was that just an academic hypothetical?