No Deflationary Spiral Forthcoming

Submitted by Rich Toscano on January 22, 2009 - 3:36pm

Over at VoiceofSanDiego.org I've put up a two-parter explaining why I believe a protracted period of deflation is an exceedingly unlikely outcome.

No Deflationary Spiral Forthcoming, Part 1
No Deflationary Spiral Forthcoming, Part 2: Counterpoints

(These articles comprise a very slight retooling of the "US Government Won't Choose Deflation" piece linked to at the upper right of this page -- so if you've already read the original one, there's no need to slog through these too).

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Submitted by moneymaker on January 22, 2009 - 10:48pm.

Excellent articles! I never connected the deflation(economic) angle to the savers(political)agenda. My only comment is that trillions of dollars are on the sidelines right now and I think the threat of inflation will make them play again.

Submitted by stansd on January 22, 2009 - 10:54pm.

Great article, Rich...I've been having many of the same thoughts you have for some time, and you characterized them well. The one thing I think will be very interesting: monetary policy is a very blunt instrument with long lag times, and inflation indicators are often very much lagging.

I envision a world where deflation is the operative word through 1H09. This leads to a large policy response as you suggest. This stokes inflation, and eventually, you wind up with a Volcker like figure at the Fed to bring it back under control.

I keep thinking back to Bernanke's confirmation hearing. Fears that he was an inflation dove were paramount, and it's now clear that those were well-founded.

I also think deep down that Bernanke believes inflation is the answer. If you are an economist thinking positively (in the economic sense of the word), inflation might even be the preferred option to deflate the bubbles that still exist. On the normative side, you have to be willing to stick it to the savers and the prudent, but that seems to be something our leaders are more than willing to do.

I'm saddened by the state of this all, but fascinated to see how it plays out.

One last thought that I find interesting: In the end, saving is essentially an act to buy a right to consume future production. The world is aging, so the demand for assets that buy a right to this future production may exceed the ability of the world to produce them efficiently (either due to labor shortages, or resource limitations). The end result has to be a reduction of returns on assets (I'd argue we are seeing this earlier than I, at least, thought we would), or higher returns on labor.

I get the sense that the workforce will reap the benefits of the desperate need to consume the baby boomers will have. This will support wages, but place continued pressure on asset returns.

My thoughts on this aren't completely formed, so I'd love to hear what others think.

Thanks again,

Stan

Submitted by KIBU on January 22, 2009 - 11:25pm.

It's a great article with lots of things addressed, I learned a lot.

I have a few questions for clarification please if anyone would like to provide input. In the example for Alice, quote:

"In other words, no money has been destroyed -- it's just been moved around. There has been no change in society's aggregate ability to spend".

I believe no money has been destroyed but I am not sure yet about the strong linkage to "There has been no change in society's aggregate ability to spend".

1. I believe that "society's aggregate ability to spend" relate to more factors than just the money supply. One of them would be credits. For example, the guy who bought the stock from Alice didn't really have 3 millions. He borrowed part of it from some banking investors (before the crash he could borrow 3 millions, after the crash he could only borrow 2 millions). So he didn't really have 1 million extra and he couldn't borrow that 1 million extra.

The author did address in the paragraph about credit deflation that yes, in practice the banks could create lots of credits and magnify the effects of the money supply. However, my belief is that the capability to do it does not mean they will once again throw money and credits away to risky projects, assets in declining economy in a state of deflation. And as long as they do not find economically sound basis to invest, they would rather deleverage and ensure safety, decreasing others' ability to buy, borrow, invest..etc.

2. Second factor I was wondering about is the international investors in American assets. The reason for my question is that when we use the phrase "society's aggregate ability to spend", I keep thinking it's only our country here. But the price, money supply, credits supply, etc are significantly determine by world investors into America. So when they pull back because of a significant trust problem, even if our aggregate ability to spend could stay the same, it would still be a significant deflationary force IMHO.

Final point, I think that deflation will not only come from our "aggregate ability to spend" but also from our "aggregate will to spend". For sure the govt is going to spend like crazy but I don't think any of my friends will be spending like crazy like the government regardless of my friend's "ability to spend". In a deflationary environment, my friends would save the money so that he could buy a bigger TV in the next couple month. Now, that's his belief, his will, actions, his logic, so it may have nothing to do with how successful the government will be able to engineer inflation.

My 2 cents just to add discussions for fun. Hats off to the author.

Submitted by ralphfurley on January 23, 2009 - 3:38am.

What do people think the deflation/inflation cycles predicted here will do to housing prices?

Maybe drop short term since there are too many downward factors contributing to a price decline? Then things stabilize in 2010-2011? Without inflation, I gathered (from reading stuff here) that we were in for a long slow price decline over the next five years or so.

Submitted by Fletch on January 23, 2009 - 9:58am.

I have the same question as Ralph.

Doesn't the rebound of the housing market ultimately depend specifically on wage inflation? Shouldn't this be the marker most directly correlated with a housing value turn around?

Since you described, Rich, a scenario where it's quite possible to have high inflation in the midst of a recession (with presumably high unemployment), my question, put another way is: will inflation only translate into higher housing values if it is accompanied by low unemployment and higher wages?

Submitted by Rich Toscano on January 23, 2009 - 10:06am.

Thanks everyone for the nice comments.

A couple thoughts on KIBU's post.

KIBU wrote:

I have a few questions for clarification please if anyone would like to provide input. In the example for Alice, quote:

"In other words, no money has been destroyed -- it's just been moved around. There has been no change in society's aggregate ability to spend".

I believe no money has been destroyed but I am not sure yet about the strong linkage to "There has been no change in society's aggregate ability to spend".

1. I believe that "society's aggregate ability to spend" relate to more factors than just the money supply. One of them would be credits. For example, the guy who bought the stock from Alice didn't really have 3 millions. He borrowed part of it from some banking investors (before the crash he could borrow 3 millions, after the crash he could only borrow 2 millions). So he didn't really have 1 million extra and he couldn't borrow that 1 million extra.

The author did address in the paragraph about credit deflation that yes, in practice the banks could create lots of credits and magnify the effects of the money supply. However, my belief is that the capability to do it does not mean they will once again throw money and credits away to risky projects, assets in declining economy in a state of deflation. And as long as they do not find economically sound basis to invest, they would rather deleverage and ensure safety, decreasing others' ability to buy, borrow, invest..etc.

I think you are conflating credit and money here. Outside the fractional reserve banking system, a credit transaction does not create any ability to spend -- it just transfers spending power from the lender to the borrower. Inside the fractional reserve banking system, a credit transaction CAN create the ability to spend -- but it does so by creating more money.

I believe you are saying that risk aversion will cause the banks to be less likely to lend, thus creating less money. And I agree with that. And money supply growth did flatline earlier in the year. But if you look at the monetary aggregates you can see that money supply is already rising quite rapidly, probably as a result of all the reflationary efforts.

KIBU wrote:

2. Second factor I was wondering about is the international investors in American assets. The reason for my question is that when we use the phrase "society's aggregate ability to spend", I keep thinking it's only our country here. But the price, money supply, credits supply, etc are significantly determine by world investors into America. So when they pull back because of a significant trust problem, even if our aggregate ability to spend could stay the same, it would still be a significant deflationary force IMHO.

Final point, I think that deflation will not only come from our "aggregate ability to spend" but also from our "aggregate will to spend". For sure the govt is going to spend like crazy but I don't think any of my friends will be spending like crazy like the government regardless of my friend's "ability to spend". In a deflationary environment, my friends would save the money so that he could buy a bigger TV in the next couple month. Now, that's his belief, his will, actions, his logic, so it may have nothing to do with how successful the government will be able to engineer inflation.

Here, you are basically talking about willingness to spend, not ability (in the parlance I was using -- but don't get too hung up on my turns of the phrase, I just kind of made them up).

The point I am trying to get across is that there are two things: ability to spend, and the will to spend. A major point of my article is to separate these two factors out to gain a better understanding of what's at work.

The point is NOT to say that willingness to spend has not declined -- because I fully agree that it's taken a mighty swan dive. But many people are confusing this with the overall disappearance of money (which hasn't happened), and that's what I'm trying to get across.

BTW the great Jeremy Grantham just came out with his quarterly letter and he describes the issue in an interesting way:

During the market’s rise, I wrote about the fallacy of paper
wealth, particularly as it applied to houses. At three times
the price, they were obviously still the very same houses.
How could we kid ourselves that we were suddenly rich
and didn’t need to save for our pensions when we were
sitting in the very same buildings we bought in 1974?
With “wealth” built on such false premises, it is not
surprising that we come to grief from time to time. But
the good news is that, as we move back down to earlier
prices, they are still the same houses. We have not lost
wealth, but just the illusion of wealth. Illusions tend not
to have very long-lasting effects, but they obviously can
and do have very powerful short- and even intermediateterm
effects. This particular illusion, which applied to
stocks, real estate, art, and almost everything else, was
grand indeed, and it directly over-stimulated consumption
and indirectly over-stimulated imports. In the process,
it suppressed both savings and investments of our own
locally generated income.

Whole thing here: https://www.gmo.com/America/CMSAttachmen...

(You might need to register but it's well worth it).

Rich

Submitted by Rich Toscano on January 23, 2009 - 10:16am.

Fletch wrote:
I have the same question as Ralph.

Doesn't the rebound of the housing market ultimately depend specifically on wage inflation? Shouldn't this be the marker most directly correlated with a housing value turn around?

Since you described, Rich, a scenario where it's quite possible to have high inflation in the midst of a recession (with presumably high unemployment), my question, put another way is: will inflation only translate into higher housing values if it is accompanied by low unemployment and higher wages?

Good and, of course, relevant question.

I think that one of the big misconceptions that the mainstream has about inflation is that it is like someone spreading peanut butter over a piece of bread -- that it increases all prices more or less equally. This may be true over VERY long timeframes, but in the shorter term, inflation tends to seek out that which has the most limited supply or the highest demand.

As of now, housing is oversupplied, so it is unlikely to be a big beneficiary of inflation. But if the oversupply gets worked through at some point, that could change.

Generally I think you are right that wages are the most important fundamental for housing prices. If inflation does push wages up, that will help home prices, as wages are a huge source of "nominal" demand. In addition we will have "real" demand factors (population, housing supply, popularity of real estate buying) affecting homes prices.

One other factor is mortgage rates... if inflation drives rates up, that could reduce nominal demand by reducing the amount people can spend cashflow wise. But if Bennie keeps mortgage rates artificially low, this isn't a factor.

There is no clear answer to this one, as my ramblings indicate... I am just throwing out some thoughts.

rich

Submitted by Joseph Oppenheim on January 23, 2009 - 10:24am.

"The Window"

As this economic downturn continues, I think it is worth a comment about the recent, unexpected by most, dramatic drop in oil prices to as low as about $32/barrel, with other commodities also dropping significantly.

Plus, with the dramatic drop in RE prices and stock prices, much money, and debt, has been removed from circulation or debt burden or possible circulation or debt burden, in the near term. So, as the government is essentially printing money by the trllions of dollars in trying to stabilize the financial system, stimulate the economy, etc, we have been granted a "window" to allow the "printing of money and issuing debt" as long as it is wisely used - like for investment in our infrastructure, energy, education, healthcare, etc - things which will eventually return more than they cost plus create jobs as unemployment has been increasing significantly.

The stock market has already had about $7T vanish, and RE probably more if commercial RE is included. So, for now, the expansion of money and debt to the amount of even a few trillion dollars, I just don't see as inflationary or of imminent danger to our currency. Yes, we must also come up with a plan to begin paying down our budget deficits and the large national debt, but for now, we have a "window".

Submitted by Rich Toscano on January 23, 2009 - 10:55am.

The stock market has already had about $7T vanish, and RE probably more if commercial RE is included

$7 trillion has not vanished... this is discussed at length in the second article.

Rich

Submitted by DWCAP on January 23, 2009 - 11:11am.

To the Window post:

First off, the stock market hasnt lost that much money. The value of stocks on the stock market may have fallen by $7T, but the money didnt go anywhere in particular. I have some stocks I bought years and years and years ago. They were worth alot more a year and a half ago, but I still own them. I havent gained or lost anything other than a sense of happyness when looking at the total value of my portfolio. The money is still out there, people just wont give me as much of it as they use to.

Second off, your window assumption says politically correct things like "infrustructure will return more than it costs". Says who? There are tons of boon-doggles that the government could pour money into that will never turn a great amount to society. Load these projects up with overpaid (union?) labor, tons of enviromental watch dogs, indicisive goals (your real goal is to create jobs right? Why finish the project and fail?) and general government ineptnes and alot of these projects could suck for a decade or more.

Or we could spend tons of money on schools, that is always politically popular. 'Invest in the next generation' (mostly by robbing them blind BTW). But that doesnt mean that the kids will be smarter, or that they will go farther in life. Ca has been pouring money into the school system for a long time, and our schools are no better or alittle worse. All the fancy Computer labs and sports facilities wont make kids learn a damn thing if they dont want to. What is the point of learning math if the only jobs are digging ditches for the Federal governmnet or filling them in for the state government?

Look, the point isnt that all projects are crap, cause some are needed. But saying that all the projects will return more to society than they cost is a no win statement. If it wasnt viable to build it before, why is it viable to build it now?

Submitted by peterb on January 23, 2009 - 1:29pm.

The US govt may want inflation, but I doubt they'll get it. The debt/credit markets wont let them. The employment markets wont let them. All they could do would be to monotize the debt and that's a currency collapse, not inflation. To argue that we have not seen price declines in vitually every asset class is crazy. We have seen huge declines. And credit, which is a form of money, has been decimated. These are all deflationary signs. The stock markets loss was calculated at $30T when I last read it. Add a few more trillion to real estate and you've got deflation of wealth as well as money. I dont see how this gets better with the govt spending $3T!?

Credit is constricting and value has been decimated. The wealth effect has been severly impaired. Remember, money saved or invested is a future call on it's use. That has been greatly devalued. Just ask someone with a 401K that's in their late 50's or early 60's. Or perhaps someone who's become unemployed. A paper loss is real in that it is opportunity or value lost that could have been utilized.

We're not in a deflationary spiral? Tell me what all the newly built cars are doing in the USA right now? How about home prices? Consumers are saving for the first time in many years. They're not spending for two reasons. 1)Unemployment is climing fast. 2) Prices are declining on most items. Deflation wont last forever, but it's got a ways to go. Production will be cut way back, more people will be laid-off and eventually we will hit an equillibrium level. But we're not there yet. This is global.

Submitted by DaCounselor on January 23, 2009 - 1:46pm.

KIBU, your final point is well-taken and it is the cornerstone of my own feelings on where we are and where we are headed. I believe it starts and ends with consumer behavior, including in great part consumer psychology. On that presumption, it really is neither here nor there whether wealth has in fact "evaporated" or merely been transferred. Trying to explain these concepts to the man on the street who has watched his 401K balance and home equity whither is not going to get you very far. The man feels much worse off, much less wealthy, and is almost guaranteed to be far more cautious with expenditures and taking on new debt going forward.

First and foremost, I see no significant and sustainable general inflation without corresponding wage inflation. It simply will not go without higher wages. I will take it one step further and add that job security/economic optimism is also a necessary component of such inflation. We're talking generalities as to inflation, of course, as we could go on all day breaking down inflation of particular goods/services.

I do think access to money plays a secondary role in supporting inflation, but due to the debt mountains now being faced and what has developed into a general aversion to more debt, I see access and availability playing a much more minor supporting role than if we were coming out of different debt-load history.

Simply stated I do not believe consumers can or will support higher pricing without wage inflation. And even with wage inflation, I think there will be a longer than expected lag until they will support higher pricing due to debt hangovers and concerns about economic stability. So I'm not seeing significant or sustainable inflation anytime soon as I'm not seeing wage inflation anytime soon, particularly in conjunction with strong feelings of job security. Just my thoughts.

Submitted by Rich Toscano on January 23, 2009 - 1:55pm.

The US govt may want inflation, but I doubt they'll get it. The debt/credit markets wont let them. The employment markets wont let them. All they could do would be to monotize the debt and that's a currency collapse, not inflation.

How is a currency collapse not hugely inflationary?

To argue that we have not seen price declines in vitually every asset class is crazy.

Nobody is arguing this, just to be clear. The closest I came was to point out the energy notwithstanding, the prices of goods and services really aren't declining all that much.

We have seen huge declines. And credit, which is a form of money, has been decimated. These are all deflationary signs. The stock markets loss was calculated at $30T when I last read it. Add a few more trillion to real estate and you've got deflation of wealth as well as money. I dont see how this gets better with the govt spending $3T!? Credit is constricting and value has been decimated. The wealth effect has been severly impaired. Remember, money saved or invested is a future call on it's use. That has been greatly devalued. Just ask someone with a 401K that's in their late 50's or early 60's. Or perhaps someone who's become unemployed. A paper loss is real in that it is opportunity or value lost that could have been utilized.

Comparing the amount of govt money creation with the amount of asset price declines is comparing apples to oranges. And the "opportunity" lost by the holders of now-devalued paper assets is offset by corresponding gains for everyone else. This was all addressed in the second article.

We're not in a deflationary spiral? Tell me what all the newly built cars are doing in the USA right now? How about home prices? Consumers are saving for the first time in many years. They're not spending for two reasons. 1)Unemployment is climing fast. 2) Prices are declining on most items. Deflation wont last forever, but it's got a ways to go. Production will be cut way back, more people will be laid-off and eventually we will hit an equillibrium level. But we're not there yet. This is global.

You are citing a lot of reasons why real demand is declining and may continue to decline, but the point of my article isn't to argue against that -- it's to argue that this will be offset by a decline in the purchasing power of the currency.

Thanks for the comments.

Rich

Submitted by Rich Toscano on January 23, 2009 - 2:01pm.

Trying to explain these concepts to the man on the street who has watched his 401K balance and home equity whither is not going to get you very far. The man feels much worse off, much less wealthy, and is almost guaranteed to be far more cautious with expenditures and taking on new debt going forward.

Once again, I never argued against that and as a matter of fact I made that same point in the article. The point of that section was to counter the oft-repeated argument that $10 trillion (or whatever) of asset price declines is equivalent to $10 trillion of money disappearing. It just isn't. Yes, people feel less wealthy, but no money has disappeared, as so many people are wont to argue.

I feel this is a key distinction because people are comparing the money supply growth to the amount of asset price declines, and these just aren't two things that bear comparing.

I am pretty much in agreement with your point on wage growth. I also think that there is downward pressure on REAL wages. Nominal wages is a different story.

As I mentioned in my response to Peter, people are really focusing on the determinants of REAL demand. This is important, but I think it's dangerous to treat dollars as a sound and consistent measuring stick. The Feds will see to it that the dollar loses purchasing power -- and if this is happening, nominal prices/wages/etc can rise even as real demand is declining.

Rich

Submitted by FormerSanDiegan on January 23, 2009 - 2:23pm.

DaCounselor wrote:

I will take it one step further and add that job security/economic optimism is also a necessary component of such inflation.

History disagrees.
Neither job security nor economic optimism were present during the period of highest inflation rates of the past half-century (late 1970's /early 1980's).

Submitted by Joseph Oppenheim on January 23, 2009 - 2:49pm.

Yep, money has vanished, multi-trillions of it.

If someone's stock holding was $10,000, for example, he/she could have sold it and collected that amount of money. So, the way our financial system works, is that is how many dollars in currency was backing the stock, whether or not it was actually called upon to be delivered. Believe it or not, our outstanding money supply is not just stacks of paper bills with pictures of George Washington, Lincoln, etc on them.

Same with RE, commodities, etc. Plus, the same with debt. If a home is foreclosed, the mortgage is eliminated. The debt disappears. Plus, the bank or financial institution counts mortgages held as assets. If a mortgage is wiped out, the firm has less assets, hence less money.

So, yes, there is indeed a "window". Sure, the key is to establish a plan to begin reducing the deficit and national debt before that window closes. And, sure, more of that new money created should be used to invest in things which will return more than they cost. But, even if maybe half or so doesn't that is still OK, at least for now. Better to err on not spending enough right now, than not enough, while there is that "window". We need more money in circulation right now, currently too much is frozen. The only caveat, is that the spending plan should be structured so to minimize the amount of money leaving the country.

http://josephoppenheiminvesting.blogspot...

Submitted by peterb on January 23, 2009 - 2:50pm.

Time will tell as we are all talking about where this will go from this point in time on. But history suggests that a senior currency like the US$ will be stronger relative to other currencies for most of this business cycle. Wages are sticky, so they tend to resist declining in a recession. But that doesnt mean they wont. No one is arguing that assets have not declined thus far. Now the question is "How will this effect the economy?" The forces of the market and the govt are now at odds with eachother.

My contention is that "Feeling less wealthy", is not a luxury that someone who's been unemployed for 8 months or was hoping to retire in a few years really has. To those that are relatively young and/or safely employed, loss of wealth is more psychological since they have a reliable source of income to rely upon. Or, so they believe. This is not the case for the unemployed and near retirement crowd. I would consider that Baby Boomers fall into this catagory. And they're the driving demographic/econmic force of our nation. If they're scared, they will not spend nor will they borrow. If the govt manages to get them more money, I think they'll save it. Where is the demand at this point? Without velocity, how can money supply be inflationary? Without the multiplier effect or wage increases where is it going to be deployed to cause inflationary activity? Perhap the banking system and/or treasuries or gold? That's my bet. But that's not inflationary. Anyway, As the global economy constricts, where's the demand outside the USA?
I think the govt's attempt to regain inflation will be very difficult for them despite their best efforts. They'd need to ruin the US$ to do it. And it would take a while to get there as they'd try to do it in stages to avoid collapse.

Submitted by sdduuuude on January 23, 2009 - 2:58pm.

Rich. Your simple, clear writing style shines through in this article. Well done filling in alot of details.

The question I have whenever I hear "deflation" and "inflation" is this - exactly what is going to change ?

Lets say in 3 years, we have a significantly larger money supply, yet prices don't come up at all? Were you right in your inflation call ? That isn't a "lawyer question" (one to which I already know the answer). And how does one measure credit destructions. I'm not sure how one measures credit destruction so calls of inflation or deflation based on that credit destruction don't seem useful.

I think you are right in your prediction of how the Fed/Treas/Gov is going to respond to this situation, but I'm not sure it will have enough of an effect it will have on prices to bring a stagflationary situation.

You mentioned that inflation strikes the higher demand sectors the most. Thus, If there is little demand for anything, and people are saving and/or paying back debts, the price effects of monetary inflation are significantly reduced.

I've heard it said gold does well during inflation as it's supply is steady. I have also heard that gold does well during price deflation because it acts like money, which increases in value as the value of commodities drops due to lower demand. And during moderate deflation, it falls by the wayside, unnoticed.

Getting to the bottom line - where to put your money for the next year / few years?

Submitted by sdduuuude on January 23, 2009 - 4:02pm.

Another way to ask the question.

When you do a financial analysis to determine if an investment makes money, you always adjust for tax, and inflation. (Also, compare to alternative investments, which also need to be adjusted for tax & inflation).

So if I invest $100 for 1 year and it returns $110, and I pay 40% tax on the $10 gain, it makes me 6%. But if inflation is 5%, it represents a 1% increase in spending power.

Here, inflation means "what is my spending power?" which is really not a question of supply, but price.

Even in light of increased money supply, I'm not sure I should be using a positive number in calculations such as this. I'm screwing with examples to understand this more. Back in a bit.

Submitted by sdduuuude on January 23, 2009 - 3:30pm.

peterb wrote:
They'd need to ruin the US$ to do it. And it would take a while to get there as they'd try to do it in stages to avoid collapse.

I think it's going to be like someone firing a gun that isn't working. They fire several times (over the course of three or four years) but nothing happens (prices don't inflate). Finally, in total frustration they load it up with extra powder, then look down the barrel while pulling the trigger to see what is wrong, and blammo.

Submitted by sdduuuude on January 23, 2009 - 3:33pm.

error - change
"during moderate deflation" to
"during moderate inflation"

Submitted by FormerSanDiegan on January 23, 2009 - 4:17pm.

Joseph Oppenheim wrote:
Yep, money has vanished, multi-trillions of it.

If someone's stock holding was $10,000, for example, he/she could have sold it and collected that amount of money.

But wouldn't that $10,000 have come out of someone else's pocket. Net change in total dollars is Zero.

Suppose your example then sold his stock when it dropped to $5000. Sure he came up $5000 less than he would have if he sold at $10K, BUT the buyer saves $5000 in this case by buying at a lower price. Net change in total dollars is zero.

Joseph Oppenheim wrote:

If a home is foreclosed, the mortgage is eliminated. The debt disappears. Plus, the bank or financial institution counts mortgages held as assets. If a mortgage is wiped out, the firm has less assets, hence less money.

But,isn't the debt from the former homeowner relieved, resulting in a net increase in his net worth. Again a zero sum game in terms of dollars in the system.

Submitted by Rich Toscano on January 23, 2009 - 4:32pm.

Lots of good comments, I'm going to answer some below. But first, a fellow writer at Voice wrote a pretty lengthy counterpoint, which i counter-countered here in case anyone is interested:

http://voiceofsandiego.org/articles/2009...

More comments below.

rich

Submitted by Rich Toscano on January 23, 2009 - 4:36pm.

Joseph Oppenheim wrote:
Yep, money has vanished, multi-trillions of it.

No, it hasn't. I wrote at length to dispel this myth, and also included charts showing that the money supply has increased, not decreased.

If you want to argue with me that "multi trillions" of dollars have disappeared as a result of asset declines, you have to actually address the counterpoints I've made to that argument. That's how this "debate" thing works.

Rich

Submitted by Rich Toscano on January 23, 2009 - 4:43pm.

peterb wrote:
Time will tell as we are all talking about where this will go from this point in time on. But history suggests that a senior currency like the US$ will be stronger relative to other currencies for most of this business cycle.

This argument is common. It reminds me of the "everyone wants to live in San Diego" rationale during the housing bubble. Sure, many people want to live here because it's great. But that doesn't justify infinitely high home prices.

The "senior currency" argument seems like the same logic. Yes, there are reasons that the US is the reserve currency and the world is certainly geared that way. But that doesn't justify an infinite amount of abuse and purposeful debasement of the dollar. Just like with housing, one day they will say "too much." My suspicion is that the government will not stop until it's hit or crossed that line.

Also, I reject the "US is bad but other countries are even worse" argument. (Not that you made it in this post, Peter, I just thought i'd mention it as it's similarly themed). I'm sorry, but it is our banking system that is the epicenter of this whole mess. It is our economy that became dependent on debt and exports and just selling assets to each other. There's no way we come out of this first. Our exporters might have to repurpose their means of production -- we have to build ours from the ground up.

Rich

Submitted by DaCounselor on January 23, 2009 - 4:46pm.

"History disagrees.
Neither job security nor economic optimism were present during the period of highest inflation rates of the past half-century (late 1970's /early 1980's)."
___________________________

Very true, FSD. I think the variables are so drastically different now, however, that a comparison to the late 70's is not going to be very instructive. It does not appear that we are going to see inflation fueled (at least in part) by low productivity/lack of goods as we saw in the 70's. Something is going to have to replace that driving force, in my opinion increasing job security/economic optimism will have to be the substitute in this day and age. And such optimism will have to be awfully stout and enduring to drive inflation beyond the goals of monetary policy. Assuming the Fed, unlike in the 70's, prioritizes restraining inflation to mild/moderate increases.

Submitted by sdduuuude on January 23, 2009 - 4:54pm.

Yes, prices can inflate during times of economic contraction.

So, why can't prices deflate during times of monetary inflation ?

--

Lets say the Fed writes everyone a $1000 check, and everyone sent the check to the bank to buy down debt that was printed into existence.

Is this inflationary, deflationary or neutral ?

Submitted by Rich Toscano on January 23, 2009 - 4:51pm.

Rich. Your simple, clear writing style shines through in this article. Well done filling in alot of details.

Thank you sir!

Lets say in 3 years, we have a significantly larger money supply, yet prices don't come up at all? Were you right in your inflation call ?

I would say no. Though my main argument is that prices of SOME stuff will rise, maybe a lot.. prices of other stuff may still decline. More below. But generally, if the prices of stuff that people need are down in 3 years in dollar terms, I would look back and say mine was generally speaking a bad call.

You mentioned that inflation strikes the higher demand sectors the most. Thus, If there is little demand for anything, and people are saving and/or paying back debts, the price effects of monetary inflation are significantly reduced.

But see, there is demand. Are people going to stop buy food? Gas? Etc? We are in a severe economic slowdown right now but I still get caught in traffic and have to wait at restaurants. There's still people at the malls, though buying less. Demand is declining, and I believe it will especially decline for discretionary goods and stuff bought on credit (to the extent credit stays tight). But demand hasn't disappeared by any stretch. Not to mention that we are vying for many things (food, energy, industrial materials) on the world stage, and unlike us, a lot of those people have savings they can dip into.

To avoid compliance hassles I am going to steer clear of all questions about how this pertains to investment strategies... sorry bout that. (Email if you want).

Rich

Submitted by Joseph Oppenheim on January 23, 2009 - 4:53pm.

But wouldn't that $10,000 have come out of someone else's pocket. Net change in total dollars is Zero.

Suppose your example then sold his stock when it dropped to $5000. Sure he came up $5000 less than he would have if he sold at $10K, BUT the buyer saves $5000 in this case by buying at a lower price. Net change in total dollars is zero....

But,isn't the debt from the former homeowner relieved, resulting in a net increase in his net worth. Again a zero sum game in terms of dollars in the system.<<<<<<

No.

1) the buyer needs less money to buy the stock. 2) the homeowner is net negative (equity lost - if was negative equity then the actual amount of money had already vanished) and the bank is out of an asset (the mortgage - if mortgage more than value of home - if home worth less than mortgage, that asset, the mortgage, had already evaporated some value - ie. money).

During this deleveraging and devaluation of assets, new money is worth more - it can buy assets cheaper and labor cheaper, at least during this "window".

Submitted by Rich Toscano on January 23, 2009 - 4:55pm.

DaCounselor wrote:
I think the variables are so drastically different now, however, that a comparison to the late 70's is not going to be very instructive. It does not appear that we are going to see inflation fueled (at least in part) by low productivity/lack of goods as we saw in the 70's.

Something is going to have to replace that driving force, in my opinion increasing job security/economic optimism will have to be the substitute in this day and age. And such optimism will have to be awfully stout and enduring to drive inflation beyond the goals of monetary policy. Assuming the Fed, unlike in the 70's, prioritizes restraining inflation to mild/moderate increases.

The 1970s inflation was driven by excessive growth in the money supply, as are all long-term inflations. And we've got plenty of that right now, so there is no need to replace any driving force.

Also, imho restraining inflation isn't a high priority for the Fed... as long as long bond yields stay low they really don't give a rat (as evidenced by their rate slashing even as CPI was up 5.6% yoy). And that was then -- now they are truly panicked and they don't want to make the "policy error" (as Bernanke puts it) of raising rates too fast, as they feel happened in the Depression and Japan.

Rich

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