The world is becoming desperate about deflation

Vitaliy Katsenelson's picture

The Great Recession may be over, but eight years later we can still see the deep scars and unhealed wounds it left on the global economy.

In an attempt to prevent an unpleasant revisit to the Stone Age, global governments have bailed out banks and the private sector. These bailouts and subsequent stimuli swelled global government debt, which jumped 75%, to $58 trillion in 2014 from $33 trillion in 2007. (These numbers, from McKinsey & Co., are the latest, but it’s fair to say they have not shrunk since.)

There’s a lot about today’s environment that doesn’t fit neatly into economic theory. Ballooning government debt should have brought higher — much higher — interest rates. But central banks bought the bonds of their respective governments and corporations, driving interest rates down to the point at which a quarter of global government debt now “pays” negative interest.

The concept of positive interest rates is straightforward. You take your savings, which you amass by forgoing current consumption — not buying a newer car or making fewer trips to fancy restaurants — and lend it to someone. In exchange for your sacrifice, you receive interest payments.

With negative interest rates, something quite different happens: You lend $100 to your neighbor. A year later the neighbor knocks on your door and, with a smile on his face, repays that $100 loan by writing you a check for $95. You had to pay $5 for forgoing your consumption of $100 for a year.

The key takeaway: negative and near-zero interest rates show central banks’ desperation to avoid deflation. More important, they highlight the bleak state of the global economy.

 In theory, low- and negative interest rates were supposed to reduce savings and stimulate spending. In practice, the opposite has happened: The savings rate has gone up. As interest rates on their deposits declined, consumers felt that now they had to save more to earn the same income. Go figure.

Some countries resort to negative interest rates because they want to devalue their currencies. This strategy suffers from what economists call the fallacy of composition: the mistaken assumption that what is true of one member of a group is true for the group as a whole. As a country adopts negative interest rates, its currency will decline against others — arguably stimulating its export sector (at the expense of other countries).

But there is absolutely nothing proprietary about this strategy: Other governments will do the same, and in the end all will experience lowered consumption and a higher savings rate.

The main point that investors must understand and remember: If the global economy were doing great, interest rates would not be where they are today.

So, how does one invest in this overvalued market? Our strategy is spelled out  in this fairly lengthy article.
 
Vitaliy Katsenelson is chief investment officer at Investment Management Associates in Denver, Colo. He is the author of “Active Value Investing” (Wiley) and “The Little Book of Sideways Markets” (Wiley). Read more on Katsenelson’s Contrarian Edge blog.

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doctor10's picture

Traditional currencies really aren't worth all that much in a surveillance society -which essentially all big governments are today. All opportunity for arbitrage is stolen by the sociopsyopaths pre-occupied with going through everybodies bank accounts, real estate holdings, telephone and email records, tax returns and health records seeking "opportunity".

Not much business can be done profitably. At the end of the day its why interest rates -at least in 100% traceable accountable taxable regulatable and ultimately takable currencies are basically 0% give or take a few fractions of a percent-worldwide.

FWIW if you want to borrow BTC now interest rates can be 12-13%!!

"value" is anonymity and privacy in conduct, thought and action-one of the consequences of which is enhanced ability to keep the fruits of your own labor. It also is the ONLY means through individual productivity can increase-thus extending across an entire nation. Electronic/digital currencies actually fulfilling those needs will be the most valuable-there is yet to emerge one that clearly does so.

Ask East Germany and the Soviet Union exactly how well a surveillance society worked out during the 20th century. The 21st is no different in that regard-except that surveillance is cheaper and more intrusive and consequently more deleterious.

my new username's picture

What deflation? Money is not gaining value, it is losing value. Oil is somewhere near its real market value, as OPEC has declined - this reduces prices. Rent, food, healthcare and travel all cost most much more.

Hubbs's picture

The word has so much debt, everything is now devoted to paying it , leaving nothing for purchase of anything else or productive enterprise start up. Debt, it would seem, has almost overtaken the fiat printing press.

 

My favorite analogy: You would think that  there is enough water (capital/money velocity) on the earth due to supposed global warming (fiat printing) to flood everything, but in reality, if there is an ice age (debt crisis), then all the water (money) is frozen (locked up in interest payments) and  the world has  become a very dry (deflation stricken)  place.

 

PS: I had a fantastic visit to Elephant Island, Deception Island, Point Lockerbee, etc in Antarctica.

juggalo1's picture

God forbid they resort to helicopter money.

cynicalskeptic's picture

BS

 

1) The Great Recession is NOT over.   Unemployment is at 23% in the US (shadowstats).  Retail is in freefall. 

2) Inflation is all too real - almost 6% by shadow stats, far higher in major urban areas.

You're seeing deflation in the things you DON'T need and inflation in the cost of the things you DO need. 

It's hard to have a higher savings rate if you're unemployed or, if employed. your earnings are stagnant or going down or if the cost of basics like food are going up

NumbersUsa's picture

Help Flush Down Brown !

Sign our petition to recall Jerry Brown:

  http://action.makecaligreat.org/flush_down_brown

BuddyEffed's picture

By definition or axiom, resource constraints that force real or true consumption declines are just raw facts and data about reality. Money and inflation / deflation perceptions are manipulated for reasons most appealing to the status quo top players.