Saturday, October 25, 2008

Deflation, Bah Humbug!

"As U.S. credit markets continue to be rolled in chaos, some are bandying about the notion that American's problems resemble those of Japan in its deflationary 'lost decade' of the 1990s. 'Deflation looms. It certainly does loom,' said one functionary for a major international bank. 'The cycle in which debt destruction and asset price destruction reinforce each other clearly has a very, very, strong negative effect on the economy.' This analysis expresses a common fallacy that asset-price declines give rise to economic weakness, and the effect is therefore deflationary. But 'deflation' is not a synomym for economic contraction. ... Like inflation, deflation is a monetary phenomenon. There is no evidence that deflationary influences are now at work in the U.S. economy. ...In fact, the comparison should provide some comfort to Americans. U.S. monetary conditions are nearly the exact opposite of the devastating deflation that characterized the Japanese experience. ... Our bubble had it roots in the Fed's exceptionally accommodative monetary policy. .. But unlike the Fed, the BoJ turned toward tightness with a vengance, apparently with the objective--at least initally--of pricking the bubble", David Gitliz at the WSJ, 8 October 2008.

"The [Fed] threw open its coffers to strained overseas credit markets, taking further steps to stem the global financial crisis. The U.S. central bank said Monday it would provide unlimited dollars to the European Central Bank, Bank of England and Swiss National Bank, allowing them to relieve pressure on commercial banks across their regions. Dollars have become elusive in recent weeks as short-term money markets around the world deteriorate. ... The U.S. previously had extended $620 billion in currency swaps with foreign central banks, which provide the funds in exchange for collateral from commercial banks", WSJ, 14 October 2008.

"In a financial world gone haywire, market indicators often send mixed signals. ... One gauge of market inflation expectations reflects this new paradigm: The spread between yields on 10-year Treasury inflation-protected securities and the 10-year Treasury note has shrunk to less than one percentage point, the lowest since 1998", Mark Gongloff at the WSJ, 16 October 2008.

I agree with Gitliz who is chief economist of Trend Macrolytics.

Deflation, I just can't see it.

Haywire indeed. Is there anyone who believes inflation will average 1% for the next ten years?


Anonymous said...

The biggest problem is who decides and how the inflation rate is calculated. With government and the FED constantly changing the mix who in the hell nows. I did just get a notice of a 6% increase for electrify next year and a 5.5% increase for my health insurance. but gas has gone down from 4.35 to 2.62.

I also some what have to disagree that inflation is always a monetary phenom, physical policy has just as much to do with it. The inflation wave I see hitting will be due to a default by the US government on it's debt which will collapse the bond market, stock market and the currency which will drive the cost of necessities threw the roof. Don't cry for me Argentina as they simply steal the remaining wealth of the populace to pay the bills by raiding pensions retirement plans and cutting off SS and Medicare.
My outlook is 1 - 3 years.

Independent Accountant said...

On 21 October 2008 I posted on the US impending bankruptcy. You and I agree here. I disagree about inflation. Changes in relative prices are not inflation.
Will the US default on its debt? I expect so, either explicitly, or more likely implicitly through inflation.
As to statistics, I have a "Questionable Official Statistics" tab. One should be skeptical of any official statistic. John Williams at shadowstats has this covered.
I disagree that a US Government debt default will collapse the stock market. I think it will make stocks, except financials, soar as people see stocks are claims on real things, unlike bonds.
1-3 years is a reasonable time frame for the proverbial feces to hit the fan.

G.Kesarios said...

Deflation is not a monetary phenomenon any more but an asset based phenomenon.

Theoretically we cannot have deflation because the M'2 will never go down, but we can have deflation due to a credit crisis and due to deleveraging.

In other words, I think we have to redefine what we mean by deflation.

Blissex said...

Deflation or inflation? That has been the big question for a long while indeed. But I sort of agree that there is a chance of 1% average "inflation" (whatever that is) over the next 10 years.

Just an average: like 5-7 years of deflation and then "inflation" (whatever that is).

Right now the Fed and Treasury have put colossal amounts of purchasing power in the wallets of the financial sector, hoping that they use it to purchase new assets (loans) and restart the inflationary merry go round.

But just about everybody is sitting on their cash pile and so the velocity of "money" (whatever that is) has crashed to very low levels even as the quantity of "money" has increased enormously.

My impression is that there will be a long recession both because and contributing to the low velocity, thus with deflation, and when that ends, the enormously increased quantity will trigger runaway inflation, at least of assets.

Then there are the big questions about the Fed/treasury loans:

* Will the Fed and Treasury really manage to borrow an extra 2-3 trillions for free?

* Will the Fed and Treasury really manage to lend an extra 2-3 trillions quickly enough?

The basic problem overall of the USA economy is that several asset classes had paper/book capital price gains totaling around 10-20 trillions, and a large percentage of those paper gains has been monetized by borrowing against them, and now there is no chance of those large sums being paid back, unless hyperinflation lifts paper value up to the bubble level. Hyperinflation is not so easy to engineer *quickly*.