So Fellas, Do We Have Deflation?

→ Washington’s Blog.

As Absolute Return Partners wrote in its July newsletter:

The
most important investment decision you will have to make this year and
possibly for years to come is whether to structure your portfolio for
deflation or inflation.

So which is it, inflation or deflation?

This
is obviously a hot topic of debate, and experts weigh in on both sides.
I’ve analyzed this issue in numerous previous posts (and try to make
argue the case for inflation here), and every day there are new arguments one way or the other from some very smart people.

But deflation seems to be winning.

Who Says?

Nobel prize winning economist Joseph Stiglitz says:

Deflation is definitely a threat right now.

Alan Greenspan said on September 30th:

We are still, by any measure, in a disinflationary environment.

And the President of the Chicago Federal Reserve Bank, Charles Evans, said on September 9th:

Disinflationary winds are blowing with gale-force effect.

How Bad Could It Get?

The biggest deflation bears are rather pessimistic:

• Former chief Merrill Lynch economist David Rosenberg says that deflationary periods can last years before inflation kicks in

• Renowned economist Dr. Lacy Hunt says that we may have 15-20 years of deflation

• PhD economist Steve Keen says that – unless we reduce our debt – we could have a “never-ending depression”

These
are the most pessimistic views I have run across. Most deflationists
think that a deflationary period would last for a shorter period of
time.

The Best Recent Arguments for Deflation

Following are some of the best arguments for deflation.

Unemployment

Wall Street Journal’s Scott Patterson writes that we won’t get inflation until unemployment is down below 5%:

A rule of thumb is that inflation doesn’t become sticky until the unemployment rate dips below 5%…

“I
see very little prospect of accelerating inflation” partly because of
the employment outlook, said Mark Zandi, chief economist of Moody’s
Economy.com. “I don’t think the risk shifts toward inflation until
2011, or even 2012.”

It could take a lot longer for unemployment to go back down to 5% (and for consumers to have more money to spend again).

Job losses are accelerating.

JPMorgan Chase’s Chief Economist Bruce Kasman told Bloomberg:

[We've had a] permanent destruction of hundreds of thousands of jobs in industries from housing to finance.

A new report from Advance Realty and Rutgers - America’s New Post-Recession Employment Arithmetic - argues that we will not have a full recovery in unemployment until until 2017, and that:

• The Great 2007–2009 recession is the worst employment setback in the United States since the Great Depression.

•
In the twenty months from December 2007 (the start of the recession) to
August 2009 (the last month of available data as of this analysis), the
nation lost more than 7.0 million private-sector jobs.

• The
recession followed a very much-below-normal economic expansion
(November 2001–December 2007) that was characterized by relatively weak
private-sector employment growth of approximately 1 million jobs per
year.

• This was less than one-half of the job-growth gains of
the two preceding expansions (1982–1990 and 1991–2001), when average
annual private-sector employment grew by 2.4 million jobs per year and
2.2 million jobs per year, respectively.

• In the preceding two
expansions combined, private-sector employment growth per year was
approximately 435,000 jobs higher than the annual growth in the number
of people in the labor force.employment deficit.

• The weak economic expansion sandwiched between two recessions (2001, and 2007–2009) produced a lost employment decade.

•
As of August 2009, the nation had 1.3 million (1,256,000) fewer
private- sector jobs than in December 1999. This is the first time
since the Great Depression of the 1930s that America will have an
absolute loss of jobs over the course of a decade.

• From
1980-2000, the US gained a 35.5 million private-sector jobs. During the
current decade, America has lost more than 1.7 million private-sector
jobs.

• Total “employment deficit” could approach 9.4 million private-sector jobs by December 2009.

New jobs aren't being created.

Even Larry Summers says unemployment will remain 'unacceptably high' for years.

The New York Times points out that U.S. job seekers exceed openings by record ratio.

2 out of 5 Californians out of work.

Almost half of 16-24 year olds are unemployed.

(Note:
hyperinflation is obviously an entirely different animal. For example,
there was rampant unemployment in the Weimar Republic during its bout with hyperinflation ).

Debt Overhang and Deleveraging

Steve Keen argues
that the government’s attempts to increase lending won’t work,
consumers will keep on deleveraging from their debt, and that – unless
debt is slashed – the massive debt overhang will keep us in a
deflationary environment for a long time.

Edward Harrison notes:

Nomura’s
Chief Economist Richard Koo wrote a book last year called "The Holy
Grail of Macroeconomics" which introduced the concept of a balance
sheet recession, which explains economic behaviour in the United States
during the Great Depression and Japan during its Lost Decade. He
explains the factor connecting those two episodes was a consistent
desire of economic agents (in this case, businesses) to reduce debt
even in the face of massive monetary accommodation.

When debt
levels are enormous, as they are right now in the United States, an
economic downturn becomes existential for a great many forcing people
to reduce debt. Recession lowers asset prices (think houses and shares) while
the debt used to buy those assets remains. Because the debt levels are
so high, suddenly everyone is over-indebted. Many are technically
insolvent, their assets now worth less than their debts. And the three
D’s come into play: a downturn leads to debt deflation, deleveraging,
and ultimately depression. The D-Process is what truly separates
depression from recession ...

See a presentation by Koo here.

Leading investment advisor Ray Dalio says the same thing.

So does Albert Edwards, who argues
that - even as the government tries to inflate its way out of all its
problems and printing trillion in new treasuries - it is unable to
catch up with the non-governmental balance sheet collapse:

The
US Federal Reserve recently published their comprehensive flow of funds
data for the US. This showed that the household sector continued to pay
down debt for the fourth consecutive quarter. Corporates also started
to pay down debt sharply in Q2 at a similar $200bn pace. The
non-financial private sector paid down debt at a $435bn pace in Q2.
This compares to a $2,116bn pace of expansion in 2007 (see chart
below). Add to that the financial sector unwind and the total private
sector is unwinding debt faster than the government is able to pile it
up (hence the red line is still negative)! The lesson from the balance
sheet recession in Japan is that the massive private sector headwind to
growth has a long, long way to run.

If
that is the case, we can expect, just like Japan, frequent relapses
back into recession. The market now understands how an end of inventory
de-stocking can boost GDP, i.e. it is the change in the change that
matters. Similarly as Dylan Grice points out - link,
it is the change in the fiscal deficit that is a net stimulus or drag
to GDP. A massive 6pp stimulus last year is likely to turn into a 2pp
drag on growth next year (see chart below). With continued
private sector de-leveraging likely next year and beyond, how can one
seriously not expect the global economy to relapse back into recession
next year taking nominal GDP deep into an abyss?

Mish writes:

An over-leveraged economy is one prone to deflation and stagnant growth. This is evident in the path the Japanese took after their stock and real estate bubbles began to implode in 1989.

Leverage is increasing again, according to an article in Bloomberg:

Banks
are increasing lending to buyers of high-yield company loans and
mortgage bonds at what may be the fastest pace since the credit-market
debacle began in 2007…

“I am surprised by how quickly the market
has become receptive to leverage again,” said Bob Franz, the co-head of
syndicated loans in New York at Credit Suisse…

Indeed,
as I have repeatedly pointed out, Bernanke, Geithner, Summers and the
chorus of mainstream economists have all acted as enablers for
increasing leverage.

Mish continues:

Creative
destruction in conjunction with global wage arbitrage, changing
demographics, downsizing boomers fearing retirement, changing social
attitudes towards debt in every economic age group, and massive debt
leverage is an extremely powerful set of forces.

Bear in mind,
that set of forces will not play out over days, weeks, or months. A
Schumpeterian Depression will take years, perhaps even decades to play
out.

Thus, deflation is an ongoing process, not a point in time
event that can be staved off by massive interventions and Orwellian
Proclamations “We Saved The World”.

Bernanke and the Fed do not
understand these concepts, nor does anyone else chanting that pending
hyperinflation or massive inflation is coming right around the corner,
nor do those who think new stock market is off to new highs. In other
words, almost everyone is oblivious to the true state of affairs.

Flattening Yield Curve Points Toward Deflation

PIMCO's Bill Gross said:

There
has been significant flattening on the long end of the curve,” Gross
said in an interview from Newport Beach, California, with Bloomberg
Radio. “This reflects the re- emergence of deflationary fears. The U.S.
is at the center of de-levering as opposed to accelerating growth.

David Rosenberg, Tyler Durden and Mish also believe that a flattening yield curve indicates deflation.

Bloomberg notes:

The
difference in yield between nominal and inflation-protected Treasury
securities maturing in one year is negative 0.4 percent, suggesting
investors expect deflation during the next 12 months.

Pension Crisis

Pension expert Leo Kolivakis writes:

The global pension crisis is highly deflationary and yet very few commentators are discussing this.

Collapse of the Shadow Banking System

Hoisington’s Second Quarter 2009 Outlook states:

One
of the more common beliefs about the operation of the U.S. economy is
that a massive increase in the Fed’s balance sheet will automatically
lead to a quick and substantial rise in inflation. [However] An
inflationary surge of this type must work either through the banking
system or through non-bank institutions that act like banks which are
often called “shadow banks”. The process toward inflation in both cases
is a necessary increasing cycle of borrowing and lending. As of today,
that private market mechanism has been acting as a brake on the normal
functioning of the monetary engine.

For example, total
commercial bank loans have declined over the past 1, 3, 6, and 9 month
intervals. Also, recent readings on bank credit plus commercial paper
have registered record rates of decline. The FDIC has closed a record
52 banks thus far this year, and numerous other banks are on life
support. The “shadow banks” are in even worse shape. Over 300 mortgage
entities have failed, and Fannie Mae and Freddie Mac are in federal
receivership. Foreclosures and delinquencies on mortgages are
continuing to rise, indicating that the banks and their non-bank
competitors face additional pressures to re-trench, not expand. Thus
far in this unusual business cycle, excessive debt and falling asset
prices have conspired to render the best efforts of the Fed impotent.

Ellen Brown argues
that the break down in the securitized loan markets (especially CDOs)
within the shadow banking system dwarfed other types of lending, and
argues that the collapse of the securitized loan market means that
deflation will – with certainty – continue to trump inflation unless
conditions radically change.

Support for Brown’s argument comes from several sources.

As the Washington Times notes:

“Congress’
demand that banks fill in for collapsed securities markets poses a
dilemma for the banks, not only because most do not have the capacity
to ramp up to such large-scale lending quickly. The securitized
loan markets provided an essential part of the machinery that enabled
banks to lend in the first place. By selling most of their portfolios
of mortgages, business and consumer loans to investors, banks in the
past freed up money to make new loans. . . .“The market for pooled
subprime loans, known as collateralized debt obligations (CDOs),
collapsed at the end of 2007 and, by most accounts, will never come back.
Because of the surging defaults on subprime and other exotic mortgages,
investors have shied away from buying the loans, forcing banks and Wall
Street firms to hold them on their books and take the losses.”

Senior economic adviser for UBS Investment Bank, George Magnus, confirms:

The restoration of normal credit creation should not be expected, until the economy has adjusted to the disappearance of shadow bank credit,
and until banks have created the capacity to resume lending to
creditworthy borrowers. This is still about capital adequacy, where
better signs of organic capital creation are welcome. More importantly
now though, it is about poor asset quality, especially as defaults and
loan losses rise into 2010 from already elevated levels.

And McClatchy writes:

The
foundation of U.S. credit expansion for the past 20 years is in ruin.
Since the 1980s, banks haven’t kept loans on their balance sheets;
instead, they sold them into a secondary market, where they were pooled
for sale to investors as securities. The process, called
securitization, fueled a rapid expansion of credit to consumers and
businesses. By passing their loans on to investors, banks were freed to
lend more.

Today, securitization is all but dead. Investors have
little appetite for risky securities. Few buyers want a security based
on pools of mortgages, car loans, student loans and the like.

“The
basis of revival of the system along the line of what previously
existed doesn’t exist. The foundation that was supposed to be there for
the revival (of the economy) . . . got washed away,” [economist James
K.] Galbraith said.

Unless and until securitization rebounds, it
will be hard for banks to resume robust lending because they’re stuck
with loans on their books.

Credit Still Constrained

US credit has shrunk at Great Depression rate prompting fears of double-dip recession:

Professor
Tim Congdon from International Monetary Research said US bank loans
have fallen at an annual pace of almost 14pc in the three months to
August (from $7,147bn to $6,886bn).

"There has been nothing like this in the USA since the 1930s," he said. "The rapid destruction of money balances is madness."

The M3 "broad" money supply, watched as an early warning signal for the
economy a year or so later, has been falling at a 5pc annual rate.

Similar concerns have been raised by David Rosenberg, chief strategist
at Gluskin Sheff, who said that over the four weeks up to August 24,
bank credit shrank at an "epic" 9pc annual pace, the M2 money supply
shrank at 12.2pc and M1 shrank at 6.5pc...

US banks are cutting
lending by around 1pc a month. A similar process is occurring in the
eurozone, where private sector credit has been contracting and M3 has
been flat for almost a year.

The Independent notes:

A
second credit squeeze and a £200bn national "funding gap" threatens to
sabotage the recovery in the British economy, the IMF warned yesterday.

In its latest Global Financial Stability
Report, the fund said that a combination of a soaring government
deficit and the borrowing needs of British companies and consumers –
coupled with a still broken banking system – would leave the UK with a
national "funding gap" of 15 per cent of GDP, or around £200bn next
year, much higher than in either the US or the euro area.

Housing

Moody's forecasts
that housing won't return to pre-bust levels until 2020, "Florida and
California will only regain their pre-bust peak in the early 2030s"

Treasury says millions more foreclosures are coming.

Fannie Mae's serious delinquency rate is skyrocketing.

Half of all borrower who are getting help with loan modifications end up redefaulting.

And apartment rental prices are falling world-wide.

Business

The creation of small businesses is way down.

Experts are projecting unprecedented corporate defaults.

Ghost fleets of unused ships lie rusting in port.

States

State tax revenues have plunged 17%.

More Signs of Deflation

Bloomberg writes:

The U.S. faces the possibility of deflation for the first time since the Eisenhower administration...

Consumer
prices are experiencing deflation, with the consumer price index
sliding for six straight months from year- earlier levels, the longest
stretch of declines since a 12-month drop from September 1954 to August
1955, according to the Labor Department...

While the economy
contracted 2.7 percent during the 1953 recession, it shrank 3.8 percent
in the current recession, the most since the 1930s. Economists at New
York-based JPMorgan Chase & Co. and Goldman Sachs Group Inc., the
second- and fifth- biggest U.S. banks by assets, say there’s so much
deflationary excess labor and plant capacity in the economy that the
Fed won’t raise interest rates until at least 2011.

Paul Krugman writes:

A
new report from the International Monetary Fund shows that the kind of
recession we’ve had, a recession caused by a financial crisis, often
leads to long-term damage to a country’s growth prospects. “The path of
output tends to be depressed substantially and persistently following
banking crises.”

The U.S. Census Bureau reports that 40 million Americans are living in poverty.

AP writes:

As
in the 1980s, much of that shift will be driven by baby boomers. For
the 78 million people born from 1946 through 1964, the Great Recession
hit at a particularly inopportune time – during peak years of earning
and saving before retirement. Boomers range from 44 to 63 today – the
youngest is nearly 10 years older than the oldest was in 1982. They are
running out of time and are most likely to remain cautious spenders and
become aggressive savers even as the economy improves.

The
housing bubble mistakenly led boomers and millions of others to believe
their home was their retirement nest egg. If they left their home
equity alone during the boom, they've taken a hit the last couple years
but are still ahead. But many treated their home like a personal bank
and spent the gains by tapping a home equity line of credit.

Alix Partners finds:

While
American industry is struggling to get through what could become the
worst recession since the Great Depression, Americans say that even
after the recession ends, their spending will return to just 86% of
pre-recession levels, which would take a trillion dollars per year out
of the U.S. economy for years to come. According to this in-depth
survey of more than 5,000 people, Americans plan to save (and therefore
not spend) an astounding 14% of their total earnings post-recession,
with the replenishment of their 401(k) and other retirement savings
leading the way among their biggest long-term concern.

As Huffington Post notes:

"There
will be a fundamental shift in the kind of cars we buy, a fundamental
shift in the homes we buy, and a fundamental shift in consumption
generally," says Matt Murray, an economist at the University of
Tennessee. "And that is not something that took place in the 1980s."

Fed Paying Interest on Reserves

And Naufal Sanaullah writes:

So if all of this printed money is being used by the Fed to purchase toxic assets, where is it going?

Excess
reserves, of course. Counting for $833 billion of the Fed’s
liabilities, the reserve balance with the fed has skyrocketed almost
9000% YoY. Excess reserves, balances not used to satisfy reserve
requirements, total $733 billion, up over 38,000%!

The
Fed pays interest on these reserves, and with an interest rate (return
on capital) comes opportunity cost. Banks hoard the capital in their
reserves, collecting a risk-free rate of return, instead of lending it
out into the economy. But what happens as more loan losses occur and
consumer spending grinds to a halt? The Fed will lower (or get rid of)
this interest on reserves.

And that is when the excess liquidity synthesized by the Fed, the printed money, comes rushing in and inflates goods prices.

Of course, most people who are arguing we will have deflation for a while believe that we might eventually get inflation at some point in the future.

Comments

[Project Mayhem]

Good stuff

[Grand Supercycle]

USD up and DOW down I reckon.

www.zerohedge.com/forum/market-outlook-0

[mannfm11]

Funny how few people believe in deflation.  Those charts that showed the growth in debt by quarter on an annual basis said it all.  Zero new debt in an economy that has to have $5 trillion to swim in place is evidence enough.  No Zimbabwe for a long time.  The entire world banking system rests on the dollar.  The Chinese miracle was built on the dollar.  The rally in the dollar is going to blow a hole in China's britches.  We got a short snort of gasoline near $1 last winter.  It will happen again.  Dubai is going to collapse on this downstroke.  Washington.  I posted a comment on your page.  I have it bookmarked.  I think these guys linked me to it.  You put together a really good post here. 

[JR]

"The Chinese miracle was built on the dollar." 

It has taken others an entire book to say what you said in one line--truly a quote for The Great Quotations.

[delacroix]

I don't understand the excess reserves scenario. I thought the fed bought the mbs crap to provide the banks with funds to cover increased reserve requirements and fund new lending. If they don't need the $ for that why is the fed buying more than necessary, and then paying interest on the cash. Is it so the fed can turn around and lend against it with additional leverage?

[mannfm11]

They bought them so some banks could pay other banks.  Banks don't need but a very small amount of cash for customers, especially since they have us trained on Visa debt cards where they deliver a discounted amount.  Any American worth his salt would use cash for all small purchases and for all little guy businesses.  Let the multinationals pay the factoring.  The reserve stuff is so the banks that don't need the Federal Reserve liabilities can put them back.  They really only amount to a nonclearable check from the Fed. 

[lookma]

Hyperinflation is simply monetary panic in the face of deflation.

[LoneStarHog]

Let's keep it simple for those who keep touting historical data/scenarios:  There has been a Paradigm Shift!

[Miles Kendig]

A shift that continues to gain momentum as the actions undertaken by policy makers only serve to provide depth and breath to the forces feeding the process.

Your "paradigm shift" can well be substituted for the "traffic jam" quote here.  hehe

http://www.youtube.com/watch?v=OSKa3ZR2IaY

[Anonymous]

Deflation is not an option for USA.

It is either inflation or stagflation.

You have to get an Asian perspective to understand why

http://www.systomatics.info/?p=514

[TJW]

If we take "recession" to mean at least two successive quarters of decline in GDP, then the recession may have ended. Fine. The recession has ended. The depression has just begun.

[Anonymous]

"The last point about the Fed stopping interest payments on reserves is an interesting one. Seems like something they could do fairly soon."

The Fed just started paying reserves last fall in the middle of the crisis. That is why the excess reserves graph suddenly leaped skyward. Banks no longer had the need to lend overnight any spare cash so they stopped doing so and left the excess in the Fed account.

Most CBs pay interest on reserves but the Fed couldn't. Now that they just started the policy they won't end it.

[mannfm11]

There are no reserves any more.  There is either liquidity or no liquidity.  Banks lend against capital and does anyone here really believe they have any?  This mess got started when it became apparent that Citi's checks weren't any good and that quite likely neither were Bears, Merrill's or Lehmans.  They weren't good because there weren't any liquid funds to be had and truthfully, they didn't have anything they could sell to get any.  Everyone is confusing the beer in the urinal for the beer in the keg. 

[i.knoknot]

+1 love the beer line.

[Anonymous]

Blah Blah Blah. Traditional paradigm this and that.

All previous recessions. The last one did this and did that.

EVERYONE IS WRONG.

They ignore reality and it is inescapable.

Oil is $70/barrel. It was $27 in 2002. The depletion of oil will kill 40% of the human population over the next few decades and no one wants to address it.

BTW, you don't address it with electric cars. You address it by making DAMN SURE you win the wars that are coming.

[monkeyshine]

Oil was $150 in 2008.  How much of this spike (of which we are possibly on the back side of the hill) is due to an abundance of liquidity?   Demand, while increasing, did not outstrip supply at any time in history.  I totally agree that if oil is depleting that we must win all wars to come, but I don't agree that the price of oil has anything to do with the supply right now.  Just the demand (including speculation).  It is entirely possible oil can drop back to $9 a barrel (it was under $10 just a decade ago) as demand for oil dries up, supply remains constant and cash illiquidity drives speculators out of the market. 

I know OPEC claims to want stability around $60 a barrel (up from $45 just a few years ago) but it is not entirely in their hands, and they are not entirely a cohesive group.

[monkeyshine]

Oil was $150 in 2008.  How much of this spike (of which we are possibly on the back side of the hill) is due to an abundance of liquidity?   Demand, while increasing, did not outstrip supply at any time in history.  I totally agree that if oil is depleting that we must win all wars to come, but I don't agree that the price of oil has anything to do with the supply right now.  Just the demand (including speculation).  It is entirely possible oil can drop back to $9 a barrel (it was under $10 just a decade ago) as demand for oil dries up, supply remains constant and cash illiquidity drives speculators out of the market. 

I know OPEC claims to want stability around $60 a barrel (up from $45 just a few years ago) but it is not entirely in their hands, and they are not entirely a cohesive group.

[Anonymous]

Your article, like all other articles posted on economics blogs, also completely fails to address politics and geo-politics. The dollar is strong because America is strong militarily, and vice-versa.

1.How will we continue to pay for empire under your scenario?
2.Which politicians will be elected under the banner of national fiscal responsibility and austerity?
3.Where will the money come from to pay for high unemployment rates that will occur under your scenario (on top of the already high percentage of non-producers living off the fat of the land, social security, medicare, etc) for the decades-long period of your scenario? What happens politically if there is no money?
4.What happens to the USD if the U.S. military abandons (or is economically forced to abandon) its global power role?
5.How will we pay interest on the ever-increasing national debt?
Thank you in advance for your earnest replies.

A. The dollar was strong because people trusted the US to pay its debts. Not because of military might.

1. Kennedy in The Rise and Fall of the Great Powers
confirmed as historical model that the use of military as a means to try and hold top place in the world is a scenario doomed to fail, and which in fact accelerates the decline. The Reagan world view was doomed to fail when it was announced. In classic stupid think, the Neo cons took the OPPOSITE view of Mr. Kennedy's cogent conclusions from historical examples. To answer your question directly, the US cannot and the sooner the collective wisdom recognizes this the better. As to what we need, I would refer to the book "The House of Saud." The US deal with the House of Saud is protection for cheap oil--and that does not require the US stay in the rest of the world.

2. Which politicos? Good question. Who knows. Tne Pubs are the ones who ran up the debts and repealed\refused to enforce the finance banking rules which added to these problems. But many (wrongly) believe they are the fiscal conservatives--a false premise for the last 30 years.

3. The transfer payments are also something which the US/State/local gov't cannot afford. There will be cut backs of necessity.

4. As long as the US pays it debts, WGAF if the US say, withdraws its troops from Korea and lets the South Koreans and Japan pay for their own protection.

5. I've got no answer. But the Clinton idea of paying down the debt or at least not increasing it makes sense to me.

[Bruce Krasting]

Great piece. Very hard to argue with all of the information you present. A wager on individual prices in one year.

-Prices of food will be higher. Milk, sugar, rice,soy fish,chicken, beef,spices, oils and vegtables will be all be more costly. The cost of any imported food (a big number) will all be higher.

-Price of secondary education will be higher.

-The cost of everything related to health care will be higher. It is likely that health insurance will be much higher.

-The cost of all fuels will be higher. These are global prices and we will lose ground on the dollar.

-Borrowing costs will be higher ( they can't be any lower).

-All taxes will be higher. Payroll, income, sales, property and State taxes are all going up.

-The cost of mainting a vehicle will increase.

-The cost of your average Taurus may fall, but import prices will be higher. The cost of new fuel efficent cars will be significantly higher.

-The cost of electric motors of all kind will rise. (rare earth problem)

-Life insurance will cost more. So will property insurance.

-Air travel domestically will cost more. International travel will be significantly more expensive.

-Starbucks will raise prices. So will Microsoft Intel and Apple. A wide screen TV could cost a good bit more. Clothing could go up a lot after the inventory is depleted. We don't make any of this stuff here any longer.

-The cost of public transportation will rise in every major city.

-The cost of water in some areas could rise significantly.

-Electricty rates will go up.

On the flip side we will have deflation.

-RE will be lower. It is likely that $1mm+ homes will fall significantly.

-Wages will be lower.

-Unemployment will be about the same. But those working will be making less to pay for the increases.

-Rents will be lower. Both commercial and residential.

-Most asset classes will suffer. (gold is a wild card in that??)

So is this deflation? Yes but it really is that old stagflation. It is the worst of both worlds. The cost of the metal to make a new hip will double. But the stock of the company who makes will go down.

[JR]

Thanks for an excellent post.

IMO, the Consumer Price Index was designed not to measure price increases, but to camouflage inflation.

The government’s CPI and the Fed’s calculation of  “core inflation” are bank inventions to use inflation to steal the people’s money.  If these indexes showed exact price increases,  the Fed couldn’t get by with its financial policies.

Even the name, “Consumer Price Index,” is a camouflage.  As Wikepedia says: “[T]he CPI focuses on approximating a cost-of-living index not a general price index.”

How horrid it is for people to discover that the government indexes don’t measure changes in the prices of products and services that they buy on a regular basis.

Then, there’s the confusion of the CPI-W, the CPI-U, the Core CPI and finally the latest—the Chained CPI for All Urban Counsumers (C-CPI-U) “intended to capture consumers’ behavior as they respond to relative price changes.” In other words, the index is used to camouflage a generally lowered standard of living as consumers substitute downward among other commodities as prices go up, “such as buying more chicken when the price of beef increases”—or, perhaps, finally, rotted potatoes culled from the fields. 

I have a suggestion.  Why don’t the BLS and the Fed just make it up and forget all the contorted configurations.

What does it mean or matter, really, as far as inflation or deflation are concerned when Bloomberg writes above that:

Consumer prices are experiencing deflation, with the consumer price index sliding for six straight months from year- earlier levels...

Or that Edward Harrison notes: Recession lowers asset prices (think houses and shares)…

when houses and shares aren't even included in the government's cost-of-living measurements?

Which I guess means that if you've had your house for 20 years and not bought any shares in that time, you're not involved in inflation or deflation anyway.

IOW, your prices are going up and down but your government is telling you it just ain't so.  As Richard Pryor said, "Who are you going to believe, me or your lying eyes?"

[Miles Kendig]

+1.  Prop-up risk assets in the quest to reflate the debt capacity of assets.  Bruce, you are correct.

[exportbank]

It seems we're in a "dual" environment. Anything to do with the public sector is going up. Property taxes, school taxes, government fees, state (provincal) and local taxes. In areas where the government supplies the electricity & water - these are ramping up while most private sector costs seem to be flat or down.

[putbuyer]

Now add the social/psychological impact of the holiday season and the depressing colder months, coupled with the costs of heating homes, and you have the potential for something explosive.

[Anonymous]

The last point about the Fed stopping interest payments on reserves is an interesting one. Seems like something they could do fairly soon. Any theories on the timing of that? What are the dynamics that argue for the continuation of these interest payments?

[Miles Kendig]

Sweden has been doing a limited test drive of this concept for several weeks now.  The interesting dynamic would be if central banks were to follow this idea to the conclusion advocated by Wilem Buiter at his Mavercon blog at the FT.  This concept is to effectively "clip the coin" or drive real nominal interest rates negative via charging depositors interest on their deposits as well as central bank depositors as is the case in Sweden currently.

If final demand continues to be crushed upon the altar of prudential liquidation of debt leading to (in the minds of fed policy makers and shapers) a negative feedback loop of ever decreased final demand, debt resolution, squeezing profit via manpower look for ever more dynamic trends along these lines in the attempt to push liquidity up the chain to support the push to reinflate & revalue underlying asset valuations to support releveraging reaches ever more desperate heights.

Timely question.

[London Banker]

Deflation.  I called it last December.  It's still true.  Without wage growth, inflation cannot gain any traction as the defaults will outpace the monetisation.

Friday, 12 December 2008 Deflation has become inevitable Thursday, 31 July 2008 Fisher's Debt-Deflation Theory of Great Depressions and a possible revision

[Miles Kendig]

Following the graphic representation of defaults and monetization being unable to keep up, this visualization of dust bowl farmers attempting to keep their family plot producing via irrigation by the hand pumped bucket full while the cattle choke to death on the dust. 5:45-7:15

http://www.youtube.com/watch?v=sIEAJM-C3QE

[Hephasteus]

The fed will only allow the deflation long enough for it's loyal minions to buy up stuff then it will inflate the hell out of the currency as the banks open a floodgate of loans which people will take because they will be broke either by being suckered into the stock market before 2nd crash or brutally taxed.

[I need more cowbell]

That comment makes zero sense. People will take loans because they are broke? And banks will loan to them, expecting them to pay back how?

[jdun]

Anyone that thinks the Fed has power to inflate at will is delusional.

[Anonymous]

Then Bernanke, who is smarter than you, is delusional. The Fed can't inflate in this environment through conventional channels, that is true, but the PAIN hasn't gotten nearly as bad as it is going to. Just wait, extraordinary measures will be in the offing. How do you think all the crap got rammed through in the '30s?

[jdun]

You really don't get it do you? Bernanke used everything he has and failed. If there were someway they could get inflation they would already done so by now. Trillions wasted for nothing.

This kind of logical and critical thinking skills should have been taught to you in high school.

[Hephasteus]

They just showed pictures of Hitler screaming and then showed the invoices for all the stuff that the english rothchilds and german rothchilds and US fed's 15 billion bought him. And then threatened to point him at whoever didn't go along. All you have to do is read hitler quotes to see the mind of god and the mind of the banking industry.

I mean come on they crammed fear and pain up Roosevelt the DAY he was inaugurated before he even KNEW what he was dealing with. These people know how to use any feeling of being unsupported or not understanding to their advantage.

[George Washington]

Please read link on inflation, also.

[SWRichmond]

Ah, the revival of deflation-thesis.  Mish, is that you?

I've never been able to get anyone (including Mish) to explain how, during a persistent deflation, tax revenues will continue to fall while sovereign borrowing will continue to rise, and yet there will be no sovereign debt trap leading to a default / currency crisis.

Let me elaborate: your article lays out the case for a continuing collapse in employment, falling tax revenues, death of the American consumerist society.  If this deflation persists for decades, tax revenues will continue to collapse, while government spending demands will continue to rise in order to support increasing numbers of unemployed. Since the consumerism in fact funded American sovereign borrowing from our trading partners, this essentially primary source of American government borrowing under your scenario will disappear.  The other source of this borrowing was domestic, and you have clearly laid out why the domestic economy will collapse, cutting off this source as well.

Your article, like all other articles posted on economics blogs, also completely fails to address politics and geo-politics.  The dollar is strong because America is strong militarily, and vice-versa. 

1. How will we continue to pay for empire under your scenario? 
2. Which politicians will be elected under the banner of national fiscal responsibility and austerity?
3. Where will the money come from to pay for high unemployment rates that will occur under your scenario (on top of the already high percentage of non-producers living off the fat of the land, social security, medicare, etc) for the decades-long period of your scenario?  What happens politically if there is no money?
4. What happens to the USD if the U.S. military abandons (or is economically forced to abandon) its global power role?
5. How will we pay interest on the ever-increasing national debt?

Thank you in advance for your earnest replies.

[Anonymous]

The funding issuing for government borrowing in a deflationary environment MAY not be a concern as you have stated above because:

1) Deflation results in increased purchasing power in your currency, so people would actually want to hold more of your currency;
2) "Low interest rates" would look a lot more attractive to investors if it's compared to a negative return in other investments; and
3) With high unemployment rates, investors will become more risk averse, and thus allocate more of their portfolio to assets that are perceived to be less risky. So even though people will have less money to invest, a larger portion of their investments will be in treaturies.

[Apocalypse Now]

Despite any reluctance to accept this thesis provided an individual's portfolio positioning perhaps for inflation, the economic backdrop is spot on and exactly what every investor must come to grips with. 

You asked many good questions which could be controversial to reply to.  The dropping of the missile shield in Eastern Europe was done in exchange for something from Russia and also a recognition that we don't have enough funds to do everything we want - expect more of the same negotiation and tough choices.  How do we reduce many of our promised liabilities including medicare - perhaps the answer lies in national security healthcare.  Swine flu might knock out many unemployed and disadvantaged.  What happens to the US is it is absorbed into the world government and roles of the fed are assumed by the world bank and IFM (as is happening now with SDR's and counries purchasing IFM bonds - it will be the new black hole).  World deflation and the fed will continue to devalue the dollar.  Judging by the headlines on the Drudgereport we may be closer to a war with Iran and controlling the world's oil, another economic stimulus.

And in response to the first comment, check the performance of gold in Japan during their deflationary lost decade - it did well - it may be in the "Gold what's next" post.

[Anonymous]

SWR, everything you say is right and real, at least from the past is prologue point of view (economic perspective).

I ran various searches for goodwill, and the best was a 1994 list of the top 25. Not good enough to make a solid case, so going it alone.

(no, i'm not mish, but do adhere to most of that style of thinking).

The first idea is debt financing as tribute. The empire has very adroitly managed to plant it's coin in all foreign central banks. A floating exchange anchor, if you will.

Civil Disobedience,(poster on Mish) makes a good case that all floating currencies were tagged to the USD, which was "anchored" by gold. True or not, the sheep are led by the dog.

So the current situation is roughly all foreign banks hold various amounts of american tribute. Also, many foreign operating banks hold bad paper issued by american banks.

This is where the goodwill concept comes in.

The write-off of expected impairment need never happen. That is a huge idea.

Kicking the can up to the IMF (or new entities to be further kicked to) is easily accomplished.

Deflation can therefore run for as long as the illuminati (aka fat bankers) want it to.

40muleteam borax.

[SWRichmond]

Yes, so far the Fed has bribed foreign CBs with newly-printed USD, which the Fed of course retains the power to render worthless by doing what they've already demonstrated their willingness to do, namely print some more.  The only way the write-off of the impairments can be avoided forever under my scenario is for foreign lenders to actually forgive U.S. sovereign debt.  They could be motivated to forgive if the (geopolitical) inducements the U.S. offered were sufficient.

The level of global cooperation, or high-level capture (as the case may be) that is required to accomplish what you allege is monumental, and as far as I know unprecendented.  That is not to say it can't happen, and I'll grant that it is the only way for the status quo to stay the status quo and is what they are therefore trying to accomplish in some manner over the long term, though I still say the goal remains a slowly falling dollar.  I have noted elsewhere that the currency devaluations are obviously pursued on an alternating but cooperative basis rather than a competetive basis.  I don't think they can pull it off, it violates another of my closely-held convictions: government can be counted on to act stupidly.

[Anonymous]

We are on the same wavelenth. Governments acting stupidly is still a possiblity, but unlikey given the current and expected pressure for everyone to play ball. Taking your bat home at this point shuts down the stadium, and i don't believe anyone sees an advantage in causing the lights to go off.

We've experienced unprecedented for two years; just imagine the next ten. NWO is the goal, sadly but unavoidably.

40muleteam borax

[mrhonkytonk1948]

Uh, let me guess:  devaluation of the dollar?  You are right, of course, but the question to ponder is whether it will be a slow grind down or a black swan asteroid (sorry for the mixed metaphor) heading our way, when it will start, and what our national response/behavior will be at that time.

[Anonymous]

These were the thoughts drifting through my worried little mind while reading this article. The thesis of this article is essentially true. Deflation is in effect and will continue to pull us downward for some time. However, I feel the inflation thesis has been mischaracterized in this debate. My line of thought is not attached to run-of-the-mill broad consumer price inflation due to an overheating of the economy. This clearly isn't going to happen anytime soon. What concerns me is a currency crisis of mega-super-ultra-never been seen before proportions. The value of the dollar rests solely on its use as a globally accepted medium of exchange. You can buy oil, gold, and guns with greenbacks anywhere at any time. The idea of the USD as a global RESERVE currency is dead and has been for sometime. The USD is a either a casino chip or a way to access the guns, gold, and oil markets (pretty useful stuff). Thinking of the USD as a store of wealth is absurd. However, it remains a highly liquid form of global exchange, which is backed by the good might and avarice of the US Military industrial complex. If you try to trade oil in a currency other than the USD, you might get a knock on the door-

“Who is it?”
“It’s a carrier task force sir.”
“Just one second.” The defiant country opens the door.
“I have delivery for a Mister Aba-deena-aaaajaada…”
“What’s in the package?”
“Well it says here: A period of sanctions, a bouquet of cruise missiles, and a never ending occupation- just sign right here.”
“Are you sure this isn’t for one of my neighbors? They usually get packages like these.”

This is the true purpose of the US Military at this point- to enforce dollar hegemony. However, this cannot carry on for ever, and I feel there will be shift towards a new global reserve system. This may occur sooner rather than later. In fact, if you squint, you might be able to see the beginnings of this shift right now. This is the looming currency crisis. As a result of this currency crisis you might see something that looks a whole lot like inflation, even within a deflationary spiral. This is a different animal than we’re used to dealing with. This is our (America’s) great white whale.

[JR]

Absolutely true and wonderfully said.  The Federal Reserve banking cartel is a powerful monopoly— morphing into an even more powerful global economy monopoly.  It’s the force behind the G-20. It's armed to the teeth with American weaponry, using starvation sanctions instead of tommy guns. It’s the old mob extortion racket, just different players on a grand scale.

Front man Ben Bernanke never even needed to ask the Congress of the American people if it wanted to “transition to a new global economy” defined by the banking cartel--under its financial thumb, the IMF, the long-awaited world central bank.

As you say, these powerful oligarchs are using the offices of their governments to blackmail, threaten with force and even occupy other countries for their own economic advantage--hardly an environment one should call free markets.

Market economies, whether they operate in a small village or in a nation or in the world, are still best based on allowing each entity, whether it be individuals, corporations, or countries, to operate with as much freedom as possible to make their own marketing agreements where both benefit mutually. That is, if the common good is the goal. If a small village is controlled by two or three rich men who own most of the real estate and select the council, the mayor, and the sheriff, it's just as damaging to the market economy as powerful members of the G-20 making agreements that benefit only the most powerful elites using the lie of globalization as an excuse.

The G-20, strong-armed by internationalists such as Goldman and JP Morgan, does not intend to service Main Street, USA. Representation by these central bankers simply means more secrecy and more market interventionism to benefit the bankers and monopolize world power. It has not and will not prove beneficial to Main Street.

As Ludwig von Mises pointed out in “Human Action, money can never be neutral or impartial:

“Whatever a government does depends necessarily upon the rulers’ personal value judgments. It also furthers the interests of some people at the expense of other groups. It never serves…the public welfare… Money is never indifferent. It determines the course of the cash-induced changes in purchasing power. The question is only who should make the choice: the people buying and selling on the market, or the government?”

We’re not talking here about some current, impartial economic dip. We’re talking deliberate policy that has destroyed America’s middle class—“the stuff which above all others makes a great people…the middles classes (the petit bourgeois, the epicier) that do three-quarters of the work of the world’s work and keep the machine going and the working man in a job…” (Buchan, Huntingtower)

We’re talking about people losing their homes, suicide, divorce, the destruction of a child’s future, erased jobs and careers, the inability of a man to provide for his family, severe debt, economic entrapment, ravaged self esteem. We’re talking about the loss of American opportunity, of life and death. And it just keeps going on, and on. I ask you, where is my benefit, or your benefit, from the bailouts of the TBTF bankers? Where is the nation’s?

Lately, says Ron Paul, the free market “has been wrongly accused of doing so many things it just doesn’t do, that are really the fault of crony corporatism and convoluted government policies that brought on the crisis. Too many people equate the free market with big business doing whatever it wants, but that is not the free market. Unconstitutional taxpayer-funded bailouts are what allow giant corporations to run roughshod over the economy. The free market is what puts them out of business when they misbehave.

“The free market is about respecting property rights and contracts. It is not about building up oligarchs and monopolies and confiscatory tax-theft…”

They, the socialists and their media, accuse the free market of what they do.

[George Washington]

Nope, not Mish ...

If currency goes Zimbabwean, we may get inflation quickly.

[jdun]

Zimbabwean hyperinflation is cause by government mismanagement. Basically the government destroy their entire agriculture infrastructure. Zimbabwean was known as the bread basket of Africa. When Robert Mugabe took over he kicked all the white farmers out and the rest is history.

[kita27]

Lets not blame Mugabe for removing the white farmers. He was not stupid, he new that they were keeping his country afloat. Yet the blacks supporting him demanded they go and he could not reason with them. Albeit he did get rid of them, but it was the vast black constituency that forced his hand.

He could either keep the whites and lose his power, but know that at least he tried to do the right thing by his country, or, he could get rid of the whites, remain in power, and preside over the clusterfuck that is now zimbabwe. Of course, he is a politician, and he made a politicians choice (grudgingly).

[jdun]

How the hell could he lose his power when the whites' power has been declining. They weren’t a threat. It’s bunch of stupid non-sense.

Mugabe mismanaged his own country. He is a power hungry two bit dictator. How long has he been in power? 20 years? 30 years? He murdered his own people. He murdered those that opposed him. Don’t make a thug look like a saint.

[i.knoknot]

ZH has so many great 'rest of the stories'...

i love this place

[Anonymous]

"...and yet there will be no sovereign debt trap leading to a default / currency crisis."

I don't see why this negates the fact that we're in a deflationary environment. Unless, I missed something, the original poster isn't claiming that such a crisis isn't coming, just that we have deflation right now. I agree with him, and I think a default crisis may well be coming. They aren't mutually exclusive.

[Anonymous]

Yo Sherlock, I believe that was addressed to citing Mish (approvingly?) when he derisively said:
"chanting that pending hyperinflation or massive inflation is coming right around the corner".
I think the salient point is that deflationists will only grudgingly admit that a currency fire is in the mix. Crushing, epic deflation is only a precursor. We can not muddle our way out of this one like the Japanese.