All money is born with an equal and opposite debt.
So if all debts are paid off there is no money. (other than the sum of previously wriiten off bad debts)
There is no floor.
Once develeraging starts what stops it?
What tools do governments have to break the vicious cycle?
What is the cost of employing these tools?
Prom
While demand may grow in the long term and we may or may not become conditioned to tolerate greater debt levels, these trends are clearly not with us in the short term.
Tomorrow there will be less debt in the world than today.
Tomorrow there will be less demand than there was today.
What i would like to know is when will these statements become untrue?
NED
One thing that has not held prices down has been low interest rates.
The whole purpose of having artificially low interest rates is to keep prices up and allow inflation targets to be hit, if trade deficits had been allowed to have their natural effect of raising interest rates and deflating prices then we wouldnt be in half the trouble we are now. (If trade surplus countries would also accept the natural lowering of rates and inflation of prices then we would be living in a beautiful new world)
Ok, I'm enjoying Barton Biggs in the FT... it allies nicely with my thesis that things aren't as bad as all that.
And the fabric for economic healing is developing. In the US average hourly earnings are rising at a 3% annual rate and the CPI is declining at 5% due to the fall in petrol, fuel and food prices, so average real hourly earnings are rising at a rate of 8%. The savings rate is rising. The sharp collapse in the price of oil, while hurtful to parts of the world, is very beneficial to the US, Europe and Asia.
He goes on to say that we are setting up for the mother of all bear market rallies.... maybe we'll see a 50% rise with some huge moves in small caps that are monstrously oversold...
By all accounts the Dow has had the steepest decline since the 1930s... is it as bad this time around? We shall see.
I think you would find it very hard to find many people who have had pay rises recently, the 3% figure is seen only in the rear view mirror.
None the less prices will certainly fall more than wages.
Higher purchasing power will not however lead to more purchases, as a greater proportion of wages will be saved.
This is not good for corporate profits and therefore not for stock valuations.
We may well be set up for an enormous bounce, the market bounced 50% after the 1929 crash only to plummet further later.
There are some important differences between the present situation and the 1930's:
Firstly energy prices did not impede growth in the 1930s ( Any economic rebound today may be immediately swatted by new highs in the oil price)
Secondly when we talk of the 1930s we are generally talking about the US, which had an enormous manufacturing base in 1930 and had accumulated vast wealth through running trade surpluses...this position is analogous to china's position today, the US's present position is however disasterously different, they are the greatest debtor nation ever and have watched their manufacturing base dwindle to nearly nothing. Not an easy position to rebound from...what exactly are they going to export?
...I am not even going to mention the UK...
Yes but the US has the greatest branded companies across the globe... and also some of the greatest services companies. These do count for a lot. There's a tendency amongst dollar bears to see the glass as half empty (or completely empty) regarding the US than seeing it as half full. I think most will be surprised by it's resilience over the next generation.
The US has shown remarkable resilience in the past, primarily due to sticking to their root principles of small government free market capitalism.
If they return to those roots and allow this crisis to prune the ecomony back then i have no doubt it will grow back stronger.
If however present trends of greater and greater government continue then I am much less optimistic.
As Mogambo Guru hilariously put it "the government has become the economy...and the economy must grow!"
I believe that even if we were not in a peak oil environment the US (and UK) would have to face the facts here and accept a massive reduction of living standards.
If trade deficits had been allowed to incrementally reduce living standards then we would be in much better shape.
Instead they replaced every dollar which left the country with a dollar of credit and thus delayed and delayed the reduction of living standards until the point where they have no manufacturing base left and now once the dollar goes will find they have nothing. Will they accept it, or will they throw a tantrum like Germany did and get the slate wiped clean?
dollar bears have a small advantage over dollar bulls.....the USDollar looks like the parrot from Monty Python....dollar resilience over the next generation? in this form it will do well to last 12 months - my bet is 9 months before we see wholesale debt default and/or hyperinflation. The current levels (and chart) of DXY is a stunning indictment of half baked investors failing to understand the nature of unbacked currency systems....death of the current dollar is guaranteed. if rather than when
also as for great services companies and brands - good bull market stuff!
So it seems that Mervyn King had to write to the Chancellor again to explain why CPI inflation is still more than a percentage point above target... seems that the dreaded D is not yet upon us... by all accounts according to the IC, companies don't tend to cut prices when demand slumps - inflation tends to bottom as the economy picks up.
It is my opinion that we won't see a negative CPI at all, but if it does happen it won't happen for quite a long time... with inflation still running on an annualised basis at 3%, there's a long way to go before we see sub zero.
Its all 'ministry of truth' stuff this CPI measure. John Williams at www.shadowstats.com has numbers run from the CPI measure from the Clinton era and also from 1980 and it tells you a whole different story. Strong recommendation for a visit to above website
great site ned... it just goes to show that the CPI is way above it's 'reported' level, and therefore that Deflation is still a remote possibility. I think it's important to distinguish between Credit Deflation, Asset Price Deflation, and Consumer Goods/Services deflation... while I agree that we have obviously seen deflation in the former pair, the last we haven't and wont.
Prices have fallen in $, Yen, Euros, Yuan or Gold. The fall has been masked by the currency movement.
Indebted, trade deficit countries must experience these falls of relative value in order to rebalance world trade.
It can either happen through a deflation of prices relative to the national currency, while that currency maintains its value internationally OR it can happen with stable internal prices but with the national currency dropping internationally.
What happens when investors dump the debt of countries like the UK, who are trying to inflate their way out of their debts?
Bear in mind how far below present values we must get to be able to compete. We will be in desparate need of foreign currency at a time when there is a great oversupply of goods. In order to build a factory which can profitably sell goods below the prices of an ALREADY BUILT factory in China is so so so far below current values that it is staggering.
You could buy a whole block of Berlin for one ounce of Gold in the 1920's.
enjoyed that rpc but disagree with him about the deflationary argument. Personally I think that which ever way you spin it the public will soon start to lose confidence in paper money and pile into 'real things' - which of course will lead to hyperinflation
Bonds are up, stocks are down, it is Friday and it is full moon.
Is fear returning? Is this the beginning of the next big wave (5) down?
Deflation is caused by a reduction in the supply of money available in an economy, relative to the goods and services available. This usually happens because of a combination of wealth destruction, credit contraction and excess production.
The most classic example of this is in Japan, which has experienced mostly deflation for nearly two decades despite, enormous efforts to combat it from the government. Many people believe that the U.S. is headed for a similar fate because of our housing and stock market collapse combined with the credit crisis.
Here is why that is not very likely to happen.
First, the Japanese government was very slow to respond to its deflation problem with zero interest rates, quantitative easing and massive government spending. By the time it did get around to implementing these policies, the psychology of deflation had already taken hold among the Japanese people and businesses.
In contrast, the U.S. government has moved forward with these anti-deflationary policies in short order. Although significant damage has been done to consumer and business confidence, the problem has not been going on for years as it was in Japan.
The Fed has already come out and effectively said that it is going to target and basically guarantee a certain level of inflation. If the Fed has credibility about anything, it should have it with respect to printing enough money to create inflation, if that is what it wants to do.
In just a few months, the Fed has effectively printed trillions of dollars and the Treasury has spent more than a trillion dollars trying to increase the supply of money. That should demonstrate their seriousness about preventing deflation.
Second, it is in the national interest of the U.S. and the personal interest of most American consumers to create inflation. The U.S. government owes trillions of dollars to foreigners. It has a strong financial incentive to destroy the value of the dollar in order to repay that foreign debt with cheaper currency. Similarly, most Americans are deeply in debt and would benefit from inflation that would effectively reduce that debt burden on their households.
In a social democracy like ours, people support policies and government implements policies that benefit most of the people. In Japan, most people were savers and didn't have much debt relative to Americans.
Japanese corporations and the government have a lot of debt, but it is all owned domestically rather than by foreign creditors. So from a political standpoint, destroying the currency doesn't really benefit Japanese society as a whole.
Third, Japan produces too much and consumes too little, relative to the size of its economy and its stage of development. This is exactly the opposite of the U.S. Here, we produce very little and consume way too much. That has been our economic model, based on borrowing money to spend and speculate, for decades.
An economy oriented toward consumption and away from production like ours is far less likely to fall into a long-term deflationary spiral because there are not likely to be too many goods and services produced relative to demand.
Also, since America imports most of what we consume, our declining currency will create even more inflation because the imported goods will become more expensive in terms of our dollars.
People should not confuse short-term declines in commodity prices and asset prices caused by a recession with long-term deflation, which is always a monetary phenomenon. After the economy bottoms out later this year, inflation is likely to resume even stronger than before because of all the excess money in circulation and also because of all of the productive capacity that will have been eliminated during the recession.
The only way deflation could have a chance of happening long term in America would be if our economy continued to shrink for many years. Somehow I don't believe that the government is going to allow that to happen because the American people would definitely replace that government in the next election. That is another difference with Japan.
The Japanese electorate has shown extraordinary patience with their government's mismanagement of their economy. Americans are notoriously impatient and quick to "throw the bums" out if we don't like the immediate results that we're seeing.
For investors, what this means is to avoid long-term Treasuries, which are assuming deflation or no inflation in the economy. It also means that gold and other hard assets are a good long-term value to protect your cash against future inflation.
On a relative basis, oil is probably the best value of any investment today, because it has collapsed down to unsustainably low levels and almost has to go up substantially over the next six to 12 months.
The best ways to play this rebound in inflation and in oil are to own U.S. Oil Fund ETF (USO Quote - Cramer on USO - Stock Picks) or ProShares Ultra DJ Crude (UCO Quote - Cramer on UCO - Stock Picks); both are for more aggressive investors.
Oil stocks are not as good, but investors could also benefit from owning Energy Select SPDR (XLE Quote - Cramer on XLE -Stock Picks), which has among its holdings Chevron (CVX Quote - Cramer on CVX - Stock Picks), Exxon (XOM Quote -Cramer on XOM - Stock Picks), Occidental Petroleum (OXY Quote - Cramer on OXY - Stock Picks) and Anadarko Petroleum (APC Quote - Cramer on APC - Stock Picks).
Another choice is Oil Services HOLDRs (OIH Quote - Cramer on OIH - Stock Picks), which holds shares in Halliburton(HAL Quote - Cramer on HAL - Stock Picks), Baker Hughes International (BHI Quote - Cramer on BHI - Stock Picks) andSchlumberger (SLB Quote - Cramer on SLB - Stock Picks).
Gold could be owned efficiently through SPDR Gold Shares (GLD Quote - Cramer on GLD - Stock Picks) or PowerShares DB Gold Double Long ETN (DGP Quote - Cramer on DGP - Stock Picks); again, both are for more aggressive investors. However, gold is overvalued right now relative to other commodities, especially oil. It may be a good idea to wait for a pull back in gold before buying.
Another way to benefit from future inflation is to take advantage of low-interest rates and lock in long-term financing to buy income property such as apartments in supply-constrained markets that will benefit from future inflation through increased rental rates and higher cash flow to the owner.
Do not believe the hype about deflation. It could be dangerous to your financial health. Right now is the best time to start hedging against future inflation because most people don't believe it's going to happen. Now is the classic time to buy a straw hat in winter, because people are just giving them away.
I'm a bit late to this discussion but must contest RPC's statement. All money is not born with equal and opposite debt, but rather equal and opposite assets. The fed usually issues money backed by treasuries, as an asset, but it could equally be gold or in the new world, dodgy asset backed securities through quantitative easing. One other caveat about gold - if you buy gold as a hedge against risk of US default, it doesn't help that SPDR Gold is backed by gold held in vaults in the US. Remember Argentina - locals bought dollars to protect against sovereign default, but then the government levied a 20% tax on all onshore assets, so the only ones who we protected had 3rd part monoline insurance from overseas and the Argentine government is still trying to tax those offshore gtees... This partly explains the premium you pay for physical gold coins, which have zero credit risk, but do have burglar risk.
The other thing about the inflation deflation argument is inflation is measured from consumer prices (in the UK the government took all housing costs out of the calc when the housing market started to take off 10 years ago) but the deflation problem is about asset prices and the erosion of savings (ie house prices and investment portfolios.) Cutting interest rates is primarily about trying to stabilise asset prices. I've done a lot of work on index linked products over the years and we calculated that the overall cost of living in London increased by more than 10% per annum, ie doubled over about 7 years, regardless of the price of a basket of goods chosen by the government - but in the UK, this is why the government loves the big supermarkets as they keep the price of the goods in the basket low (and call them loss-leaders) but more than make it back on the other things.
I heard an excellent explanation for the US fiscal stimulus - the credit crunch made people realise that all these ABS etc was actually ghost money, so the government decided to make lots of new ghosts to make the old ghost seem more real....
True Gradders, the monetary base is real. A discussion about the expansion of the monetary base and its implications was what i was trying to provoke here.
My thoughts on the subject are that as there is $52 Trillion of domestic debt in the US and many Trillions more dollar denominated liabilities internationally that the Fed's expansion of the monetary base from $800 Billion to $2 Trillion is pathetic.
There are 152 million working Americans so $52 Trillion equates to $346,000 of debt per job in America, which is clearly madness. A managed inflation is the only option. I dont think Bernanke is up to the job. "Helicopter Ben" couldnt inflate a balloon!
Incidentally, in terms of "managing" an inflation, i read at the end of last year that the fed was applying for congressional approval to allow it to issue its own debt.
This would presumably be a mop up tool allowing it to print in earnest to buy assets all over the place then issue debt to soak up the excess funds once things are stabilised.
All this interest rate setting open market operations stuff is of course the root of the problem. There should be a free market in money.
The problem with the inflation route is that all the idiots who lent money to people who couldnt pay it back, and all the idiots who over-borrowed are not the people you want owning and managing assets once we start growing again. They are proved incompetents. It is those who are prudent and saved, those who managed their affairs well and did not overstretch...those who are solvent...they are who you want in charge for the next growth phase.
But inflation will reward the idiots and destroy the savings of the prudent and we will still have morons in charge.
The issuance of Federal Debt is an interesting one and I am not sure of the purpose. Essentially, they are writing a cheque to cover the cheque they owe you, so it is the ultimate in money from thin air. Perhaps it is in preparation for a US national default and their handing over management of the mighty dollar to China?
I do think the US can resolve its issues without total collapse. Huge swathes of the "debt" is for keeping diabetic behemoths alive, so just by getting the fat fu**ers of the sofa and stop them eating junk and you reduce billions of healthcare costs, which have all been included in the figures. The tax cut from higher earners ($250k plus) that Bush gave will roll off in 2011, which would have raised about $600bn per year, but may be less in current economy. Cut back on a few wars here and there and it's looking almost manageable. The overall cost will require them to sell actual assets, as Britain had to do as the Empire came to an end in the 19th C, and adjust their relative economic standards compared to the rest of the world, but that's not a bad thing given how they have overindulged. Then we can get back to worrying what the Chinese are up to....
