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Will the Lesser of Two Evils Prevail?
Submitted by Leo Kolivakis, publisher of Pension Pulse.
David Pett at the national Post reports that Euro worsens deflation risk:
Since the Great Recession, there have been fears that the U.S. economy would follow in the footsteps of Japan, where economic activity and investment have been stagnant for more than two decades.
More recently, however, prospects for recovery south of the border have improved and it is the European Union, struggling with a growing sovereign debt problem that could be headed for Japanese style deflation.
"The recent string of debt crises in Southern Europe has revealed the true financial frailty of the euro area economy," said Chen Zhao, managing editor, BCA Research Inc. " In fact, the economic snapshot of the eurozone looks very disturbing."
Over the past two months, markets around the world have been rattled by the growing unease surrounding Greece's well-documented debt woes, but also by other eurozone nations, such as Portugal and Spain, also burdened by highly levered balance sheets.
While the past few weeks has seen bond spreads fall and the euro rebound against the greenback on tentative plans for a Greek bailout, Europe's economy remains tenuous.
The OECD said growth in gross domestic product in the euro area slowed to 0.1% in the fourth quarter of 2009 and will expand by just 0.9% this year.
Mr. Zhao said the intense debt-deflation pressure being felt in Europe has many similarities to the post-crash environment in Japan in the early 1990s.
Even as the country's very own asset bubble was beginning to burst in 1989, Japan mistakenly believed the biggest risk to the economy was inflation, not deflation, and continued to raise rates until September 1999. Continuing to run a surplus until 1992, its fiscal policy was also a drag on the collapsing economy and it was not until 1995 that Japan's deficit hit 5% of GDP.
Similarly, the European Central Bank was slow to react to the recent global financial crisis, raising rates as late as July 2008 when stock markets had already fallen 30%. The implementation of a fiscal stimulus package was also late in coming.
Since then, Europe's monetary and fiscal policy has been much more aggressive and proactive than Japan's response, but Mr. Zhao said the recent collapse was also much more severe than the slump in the Japanese economy in the early '90s.
"So judging by the severity of the Great Recession, it is not obvious whether the stimulus in the eurozone has been aggressive enough at all," he said.
In addition to parallel policy responses in both episodes, Mr. Zhao said the strong euro has greatly increased the risk of weak economic recovery, price deflation and loss of competitiveness in Europe, as did the strong yen during Japan's post-crash struggles.
To make matters worse, the common currency makes it impossible for member countries struggling with excess debt to devalue their own currency.
Chen Zhao has always been one of the more interesting Managing Editors at BCA Research. When I was working there, I didn't know how he was able to constantly produce so many thought provoking pieces. Chen is a tireless workhorse who never shies away from making big calls.
I saw the slowdown in Europe coming when I visited Greece this past summer. There were hardly any tourists and the strength of the euro didn't reflect strong European fundamentals, but relatively weak US fundamentals at the time. One Greek cab driver told me: "we're going to starve this winter." They're not starving but Greece's fiscal woes are going to require some sacrifices ahead for most Greeks.
And risk of deflation are not just in Europe. In Japan, bonds advanced for a second day as concern deflation will deepen in the world’s second- largest economy boosted demand for government debt.
Bond futures approached the highest level this year as stocks slid worldwide after a U.S. report yesterday showed confidence among consumers declined to the lowest in 10 months. Consumer prices in Japan dropped for an 11th month in January, according to a Bloomberg News survey of economists before the government report this week.
“Given the huge slack in supply and demand conditions, Japan will be mired in deflation,” said Akitsugu Bandou, a senior economist at Okasan Securities Co. in Tokyo.
“This will make it easier for investors to keep spending money on bonds.”
The yield on the benchmark 10-year bond fell 1.5 basis points to 1.315 percent as of the 11:05 a.m. morning close in Tokyo at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The 1.3 percent security due December 2019 gained 0.130 yen to 99.869 yen.
Ten year bond yields at 1.35%! As bad as that sounds, it's better than the ravages of deflation, which wipes away returns from risk assets like stocks and corporate bonds.
In England, Gov. Mervyn King said on Wednesday that the Bank of England may still have to pump more money into Britain's fragile economy after the central bank forecast inflation standing well below target in two years' time.
Finally, the jury is out on whether the US will escape deflation. Some people feel that deflation risks still exist in the US while others see bond trading reflecting two views on U.S. inflation:
Bond markets are jittery and investors have reasons to be nervous. The dcision last week by the U.S. Federal Reserve Board to raise the discount rate - the interest it charges on the emergency loans it makes to banks - suggests the days of easy money marked by the Fed's zero-interest rate policy are numbered.
The Fed raised the discount rate by one-quarter of a percentage point, to 0.75 per cent.
While that signals another step in the return of financial markets to a more normal state, given the weak economy it will likely be some time before the Fed begins to raise its key federal funds rate. That is the rate that helps to hold short-term interest rates down in order to stimulate economic growth.
And it is that policy that has bond investors antsy. The worry is that the continuing low interest rate and loose monetary policies of the Fed will fuel inflation.
So far, inflation pressures as measured by the consumer price index#001f5e ! important; font-weight: normal ! important; font-size: 100% ! important; text-decoration: none ! important; padding-bottom: 0px ! important; color: #001f5e ! important; background-color: transparent ! important; background-image: none; padding-top: 0pt; padding-right: 0pt; padding-left: 0pt;"> have been relatively tame, if rising gasoline and food prices are excluded. The U.S. core consumer price index (excluding food and energy) on a year-over-year basis was 1.6 per cent in January, compared with 1.8 per cent in December.
However, overall the annual inflation rate is 2.6 per cent, reflecting higher gasoline prices and the beginning of higher food prices resulting from the impact of the Florida freeze on fruit and vegetables, according to BMO Nesbitt Burns Inc.
Bond investors are being torn between the safety of holding U.S. Treasuries and the risk of seeing their savings eroded by inflation. Recent action in the bond markets illustrates the forces at work.
The short-term action has been dramatic.
The U.S. Treasury Inflation-Protected Securities bonds, or TIPs, are securities that provide a return tied to the CPI data, including food and energy. TIPs have experienced a sharp selloff during the past few weeks, after a year in which they outperformed conventional Treasuries by more than 10 per cent. The recent drop has lowered the out-performance to about 7.6 per cent.
"I have been aggressively selling TIPs during the past month, and have been selling since some time last year," said Mihir Worah, a managing director and head of the real return bond desk for Pacific Investment Management Co., or Pimco, the world's largest fixed-income manager.
A year ago, Pimco saw TIPs as an excellent investment opportunity because they were priced as if there would be deflation for six or seven years. "Let's hope this call is right, too," Mr. Worah said.
Let me repeat that given the choice between the lesser of two evils, the Fed will err on the side of inflation. There is a concerted effort to reflate financial assets which they hope will translate into "mild inflation".
Pension funds are betting trillions of dollars that inflation will ultimately prevail. Let's hope they're right on that call because if they're not, millions of pensioners will be feeling the squeeze of reduced pension benefits.
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rising prices in a fiat currency system just create the illusion of rising incomes for companies. the real value of the currencies in relation to precious metals keep going down as seen in the price of Gold today compared to 1971 when the dollar was taken off the gold standard. so going back to gold or better silver based currencies is probably the best way to find true value of any currency. it sure would knock a few zeros of today's fortunes if we look at the price of Gold in 1971. In today's world silver would be a good base for a currency as it is a precious metal that has industrial use. This means more people and organisations need it ensuring that countries that hold these deposits and less likely to be leave it underground as a bargaining tactic as they need it themselves and may not have the technology to get it out for their own use. I say this as deflation and inflation have to be judged against real value for us to have any use for that data. otherwise everything is just funny money
My apologies, I meant to write the lesser of two evils. Funny how views are so widespread here, in fact they are at opposite sides of the spectrum.
Face it Leo, no one (who isn't among the chosen oligarchs) has any clue whatsoever on the details of what Europe is facing.
Citizens in the US can't even see their own money, and we think that the euro trash isn't riddled with the same mafia infestation?
C'mon get real, this whole system is ashes and no one is allowed to go near it for fear of a single breath blowing it all away.
Saw on another post, get rid of Fraud Street, get rid of the leverage (bullshit) machine.
Everything else ends up far worse.
If it is up to "the Fed and other central bankers," who have thus far done a magnificent job of engendering this worldwide financial cock-up, deflation it is. As the song says, you can't always get what you want (and the world certainly doesn't need any more inflation).
Leo, There are two doors infront of you. Both of them open to deflation.
Inflation or Deflation at this point it does not matter the only way out long term is to push the rest button. The economy needs restructuring one way or the other it will get what it needs.
Our system does not work long term. And because of this, every now and then we need a reset.
In our current system, if everyone was disciplined and saved and invested in the stock market, we would be seeing socialized profits. That does not sit well with power hungry capitalists.
But this would never happen anyway because only a fraction of the economic activity is reflected in public equity. So if everyone saved adequately and bought equities, we'd have a bubble anyway because we'd have 100% of people investing in a small percentage of the economy. Question: Why should public servants get top notch pension funds investing in public equity when they don't work on the private side?
Our system is screwed up but worked as long as we had a population pyramid that was triangular. Now that there is a bulge, we are going to get a reset.
No matter what we do or change, the reset is coming. Deflation or inflation, a shakeout is coming. And those who suffer most in those times are those who can't work.
There is nothing that the fed can do to stop deflation. Just go an interview or ask 20 homeowners and find out what they wish they could right now financialy. Most will say pay off their home. This takes money out of circulation and creates deflation.
US taxpayers saving money and paying off debt is deflationary.
Buy TLT, it will be one of the best performing funds for 2010.
nicasurfer.blogspot.com
Let's solve this right now....
Rule number 1
It is not up to government as to what prices should be....
Guess who decides....the market....
.............................
ie
If 5 years ago....you gave me credit for $40,000 for a car as long as I paid up front $2000....and now there is no credit....what price can I afford to pay for my next car ?
If 5 years ago....you gave me credit for $500,000 to buy a house for 5% down.....and did not verify income.....knowing that just one foul it appraisal in one neighborhood can take all prices down....and now the source of that credit has been eliminated....how much am I going to pay for my next house....and how far down can the current house price go ?
....................................
Right now ......what is the proper price for a car ?
$7000 ?
Right now....what is the proper price for a house ?
$50,000 ?
......................................
That is all folks....
...................................
Now what good is fabrication of money....when the sources of credit do not change ? Jobs get more scarce ?
Does fabrication make matters even worse ? Absolutely ....
Does fabrication save the debtees or the debtors ?
.....................................
What good does it do for the government to borrow money that it does not have....when it is the market that decides price ?
Nada
.....................................
No matter how smart you are ....you will not escape the above...my friends....
The market decides...
................................
What would change the picture would be to change the tax structure to a sole 15% consumption tax....
This would have the desired effect the govt. seeks....
What are the govts. doing now ? Just the opposite...cutting down more orchard trees and expecting more fruit....
Utter nonsense....
How can this be explained ?
Go check the wiki bio of any of your favorate politicians....
Most all of them are not qualified to run a lemonade stand....
And no....this is no joke....
Check it out for yourself....
Deflation, due to a credit collapse cannot exist without some form of bubble. Fractional reserve lending is a great evil that has unstoppable destructive power once abused.
double post
Fractional reserve lending cannot exist without some form of inflation. Deflation, due to a credit collapse, is a great evil that has unstoppable destructive power once loosed. It has political ramifications - as observed above, a stable, employed Joe Sixpack is essential to a stable civil society. The notion that it's tough, deflation is good, and Joe Sixpack will just have to tough this out so that the "haves" of this world do OK and buy stuff cheap will not fly - it's called a "let them eat cake" policy and the heads of the haves roll eventually with that sort of thinking. Not my policy, just my observation.
And without inflation, those USTs will never be paid.
Where have u been for the last 12 years ??
I fully agree, mild inflation is the desired outcome. The reason why deflation is the worst possible outcome is the enormous indebtedness of the country. In a deflationary environment, the tax revenues will not cover the debt, deficits will continue to rise, forcing interest rates on debt higher, leading to stagflation. The problem with hoping for mild inflation is the limited tools available to the authorities. Measures such as QE, negative real rates etc cannot force money into the pockets of the wider public, nor can they force lending to increase. Therefore the tools available for increasing the velocity of money are similar to trying to pull a brick out of a wall with a piece of elastic. It will require a huge force to get the brick to loosen, but when it does, it is liable to fly out and smack you in the face. So, as others say, the two likely outcomes are either stagflation or hyperinflation, i.e. more than 20%. My view is the authorities will be aiming for the latter, hoping that the tools they can employ when this happens can bring it under control, as Volker managed in the 80s. The biggest difference between then and now however is the lack of large reserves of cheap oil. This will be the one thing they can do nothing about.
a) "Ten year bond yields at 1.35%! As bad as that sounds, it's better than the ravages of deflation, which wipes away returns from risk assets like stocks and corporate bonds"
Stocks returns have been wiped in Japan and rightly so. There is no god given right for risk to attract return, even on a long term basis. When investors, particularly pension funds, will accept that they are not entitled to real returns, sanity will finally be back in the financial system.
b)"Pension funds are betting trillions of dollars that inflation will ultimately prevail. Let's hope they're right on that call because if they're not, millions of pensioners will be feeling the squeeze of reduced pension benefits."
Inflation will reduce the purchasing power of the nominal commitment that Pension funds have undertaken. In ANY case, "millions of pensioners will be feeling the squeeze of reduced REAL pension benefits."
Brokers, Bankers, Pension funds "consultants" can't create returns out of thin air. Only scientists, engineers, geologists, etc... do, and only at a paltry rate, because creating real wealth is much harder that shuffling it around in nominal terms.
Inflation my ass. The consumer is so much in debt and there's so much debt in the system resultant from the mortgage delusion that deflation will win this one easily.
Leo, the two evils are deflation and hyperinflation. You cannot have inflation in this environment. The only way to defeat deflation is by helicopter, but this will mean hyperinflation like in weimar germany.
Leo,
if I get you right you state that with (moderate) inflation pensions will be paid but with deflation they will have to be cut.
What is the difference in purchasing power?
Inflation only makes sense when the economy runs better then without it.
Huh?! Inflation is NEVER desirable. Period. Any inflation at all punishes the frugal and rewards the gluttonous and profligate...even among retirees.
Any inflation at all "punishes the frugal and rewards the gluttonous"
Can you say bailout, bonus, bullshit? The "gluttonous rewards" runneth over.
Hopefully not - the lessee of the evils would be pretty upset...
Or perhaps you meant lesser...
I'm so sick of this BS, the lesser of two evils is deflation NOT inflation. Ask Joe Six Pack, what would he rather have falling prices or rising prices? Myself, as a business owner I prefer falling prices to rising prices too. The only people who like inflation are people in debt and the people who have access to the money first.
If deflation gets too low, the real return people get out of holding cash makes velocity dro pthrough the floor. Everyone becomes a saver. Joe Six Pack loses job. Since everyone is hoarding cash in the mattress, there is no transfer payments for Joe Six Pack. Joe Six Pack starves out in the street.
The is how life was for centuries or longer. Not saying it will happen, but have a little respect for deflation.
You may not like Ben and banks, but there are issues that they are grappling with you aren't appreciating.
Oh, I fully appreicate it.
I've studied history quite extensively and deflation was quite common before the Federal Reserve was created and it was not as bad you claim. Sure there were booms and busts, its a natural occurence of the economic cycle, but its nothing like what we've experienced the last 30 years. The Fed's serial bubble blowing over this time period is going to make this go around of deflation severe, but that's only because the market has not been allowed to clear the malinvestments.
If you do not think people can lose their jobs and starve out in the street during inflationary times you need a reality check. The Weimar Republics hyperinflation was much worse than our Great Depression with nearly 50% unemployment, leading to the destruction of Europe killing millions:
http://mises.org/daily/3661
Do you mean incompetent self-preservation??
The only issues they are grappling with is how a sound monetary system was infiltrated, hijacked and looted -- all in the light of day by big business, Congress, and oh yeah "gods people"
Quit being such a coward, and start demanding transparency and accountability.
Stand up for yourself, do not wince and become complacent for fear of the middle ages. You dont need money, you only think you do, a lot has changed in the last 50 years.
Do you mean incompetent self-preservation??
The only issues they are grappling with is how a sound monetary system was infiltrated, hijacked and looted -- all in the light of day by big business, Congress, and oh yeah "gods people"
Quit being such a coward, and start demanding transparency and accountability.
Stand up for yourself, do not wince and become complacent for fear of the middle ages. You dont need money, you only think you do, a lot has changed in the last 50 years.
yeah and unlike the 30's Joe Sixpack has no chickens in the yard no idea how to gut a pig and only about a 2 day supply of shit paper.
"Pension funds are betting trillions of dollars that inflation will ultimately prevail."
And gov'ts are willing to spend our last tax dollar to force inflation. How nice that gov/pension-funds are aligned.
But when they are done pushing on a string, we'll have no money and no way out.