patrick.net

Honestly, I do not have a position on this yet. Anyone?

Please enlighten me. :)

Can't say I'm an expert on the subject of macro-economics, but what little I've read on the subject recently from those who are indicates that there's a wide range of opinions, but little consensus out there about impending inflation/deflation.

More significant for housing than the overall inflation rate is the yield curve, which is nearly flat right now (Alan Greenspan's "conundrum"). This, plus theose steady 1/4-pt. Fed hikes in the short-term/LIBOR rate, tends to be a good predictor of both recessions and higher long-term, rates (which will put pressure on even fixed-rate borrowers). Here are some good links:

http://tinyurl.com/8sdbx
http://tinyurl.com/bguw3
http://tinyurl.com/8ry6z

Marina, Oil money mostly goes overseas. To the domestic economy, won't it behave more like taxation? Oil can bring inflation only when producers have pricing power. Will they?

Monetizing debt (printing money to pay for debt) is highly unlikely, I agree. But I would not rule out debt deflation so soon.

can there be just inflation in oil and deflation in other commodities?

Absolutely possible. Oil production is declining. Even if demand fades, oil price may still go up in the long run.

Not so sure about growth dependent commodities like steel.

I cant argue with you until I actually KNOW what “monetizing debt” means! What does it mean when/if the government monetizes debt?

Jack,

Here's my non-expert/imperfect understanding of the “monetizing debt” concept.

1. Federal government realizes that current federal budget deficits are unsustainable at 6%+ of GDP (which combined over the years with interest, minus surpluses = the National Debt). Interest payments on the $7.8Trillion National Debt (http://tinyurl.com/ecpx) continue to eat up more and more of the budget. There are few new revenue sources to be tapped, and raising taxes on corporations or upper-income people is a non-starter (at least under the current Congress/Administration). Add to this a huge run-up in CONSUMER debt, a large % of which is housing, and you have a worrisome situation for policy makers. Whay to do...?

2. Government decides to "monetize" at least some the federal/consumer debts by deliberately inducing higher inflation (a.k.a. "currency debasement"). The Fed & Treasury hold most of the levers on the money supply, so can easily accomplish this, by lowering short-term interest rates to rock-bottom (again) and prining more dollars.

3. Double-digit inflation for several years gradually erases the value of federal & U.S. consumer debt, which are denominated in dollars or dollar-assets (MBSs & Treasuries for example). This "monetizes" it by reducing what those dollars & dollar-assets are worth. If inflation erodes the value of the dollar by say 50% over several years, then any pre-existing debt the government or consumers currently hold is worth half of what it once was.

Of course, the dangers of this strategy are many, which is why there's no hard consensus out there that this will happen. Will it trigger a "flight to quality" by Asian investors & central banks (to other non-dollar assets, like the Euro or Yen)? Will double-digit inflation trigger a nasty recession? Will other nations who hold large amounts of dollar-denominated assets and have trade surpluses with the U.S. retaliate in kind by pulling the "inflation trigger" as well (to try to nullify the impact of a falling dollar against their own currencies)?

Lot of questions, few easy answers.

The thing with "inducing inflation" is that the FED alone cannot control where the money will go. They will need to make the CPI even more ridiculous or any CPI-indexed liability will not shrink. Many retirees (read sizable political power) with fixed-income securities will be hurt.

I believe monetizing debt is quite politically infeasible.

...but I think many people will be very unhappy in the coming days. One way of the other.

Peter,

I too am not 100% sure that monetizing debt will be feasible --politically, or practically (see my caveats above). However, I don't agree that the government can't/won't make the CPI more "ridiculous" than it already is. See Bill Fleckensteins' excellent commentary on the subject:

tinyurl.com/9osq5

"However, I don’t agree that the government can’t/won’t make the CPI more “ridiculous” than it already is."

I know how that can do that. They can define CPI as the following:

"CPI index is the constant 2.0."

:)

Yes, we must exclude all those "volatile" commodities from the official index. Such as energy, food, clothing. education, housing and health care. Aside from those things, the core CPI has hardly budged at all!

Heck --have you seen how cheap plasma TVs & MP3 players have gotten lately? Why not run out and buy one --or buy two? Credit/cash-flow problems? Don't worry --it's "on the HOUSE!"*
*courtesy Rock Financial(tm) all rights reserved

If hyper-inflation is out-of-the-question is it safe to invest in commodities (GSCI or individual contracts) with USD payout? :)

If hyper-inflation is out-of-the-question is it safe to invest in commodities (GSCI or individual contracts) with USD payout?

Good question. Though Hyper-inflation might be unlikely, I don't think higher inflation is. Remember, we don't need Argentina(80's) or Germany(20's) scale of inflation to slowly monetize debt --just a level significantly higher than today's. And don't "misunderestimate" the government's ability to hide that inflation via accounting voodoo, much as the lenders hide/shift mortgage default risk via the GSEs/MBSs.

If you predict higher overall inflation (which would be my guess), then I'd avoid dollar denominated assets (most U.S. stocks, long-term Treasuries, and --need I say it?-- MBSs). The value of gold/silver or other traditional inflation-hedging commodities should stay above inflation, regardless of what currency is used to initially purchase them (this is of course, also assuming that demand for these metals won't fall in the event of a worldwide recession). You could also try hedging the U.S. dollar by purchasing international stocks --most of the big investment firms offer European or asian mutual funds. I'm doing a little of both.

Monetizing “slowly” seems like it would produce the least abount of fallout politically.

Bingo --I think you hit the nail on the head, Jack. That's my best guess as to what they'll try to do. It's kind of like the Fed's "hiss" vs. "pop" approach to the housing bubble (trying to deflate it slowly via gradual rate hikes). Keeping most real inflation "off the books" is probably the least politically damaging way to slowly monetize the unsustainably large national/consumer debts.

The average Joe will sense that his paycheck isn't carrying him as far as it used to, but won't be able to "prove" it. After all the official CPI is continuing to read "low & steady". Same goes for large foreign & domestic Treasury/MBS investors. The Feds are probably hoping that by the time anyone (important) notices, it'll be too late to matter. Problem solved!

Who knows --it just might work?
And btw, thanks for the book recommendation --sounds like a good read.

In a social democracy with a fiat currency, all roads lead to inflation.
tinyurl.com/7tzdp

NapoV -

Thanks for sharing your experience & stats from the Asian crisis with us.
It's interesting that, as I read the two different strategies used by the developed countries (HK & Singapore) vs. undeveloped (Indonesia), I found myself coming to the opposite conclusion with regard to the U.S.
I firmly believe that the U.S. government, if presented with a choice between currency debasement (inflation) and asset deflation, will invariably choose inflation (though not as extreme as Indonesia's hyper-100%/year variety).

A few years ago, right after the NASDAQ crash and just before the Fed dropped the prime rate to 1%, there as a lot of chatter in the financial press about the prospect of deflation. I noticed that most government & quasi-government officials (including Alan Greenspan) seemed to regard deflation (and a prolonged recession) with alarm, if not outright horror, as though this were the worst outcome imaginable. AG & Co. promoted loosening the credit spigot via ultra-low interest rates and increasing the money supply. Other non-public sector economists and free-marketeers seemed to prefer deflation to the potential market distortions (i.e. credit/asset bubbles) that flooding the world with cheap dollars might bring.

Guess which side won that debate?

Frankly, I just don't see Americans (and politicians) willing to accept the pain and recessionary effects that deflation would bring. Many are also afraid that, unlike HK & Singapore, allowing deflation to happen here could trigger a much longer-term price spiral in virtually all asset markets, similar to Japan's (15 years and still falling). I could also point out that, unlike HK & Singapore, the U.S. is a net importer of manufactured goods, not an exporter --and a very large one at that. How would dollar/asset deflation and the accompanying "lack of consumer spending" as you noted, affect that critical balance of trade (and repatriation of dollars from Asia via MBSs/Treasuries)?

It's all just opinion & tea leaves, but my money's still on inflation.

I am probably going to put my money on volatility. Risk premium is too low right now.

I lack the economic sophistication of many of you guys...HARM, Randy and Dipanjan - Wow! ...but to me it seems as if the Govt. will do everything it can to keep inflation low.

1) Inflation destroyed the political career of Jimmy Carter...no one will want to be on watch when it happens.

2) But it's even more risky this time. Cost of goods sold can go up, sure, but what about wages? We're a service economy. Higher goods prices don't translate into higher profits or higher wages for American firms. Workers just don't have the leverage anymore. Too many cheap workers overseas. Unions are falling apart.

3) As was noted, the Fed is horrified by deflation. I would think this is because deflation means the government's debt effectively grows. It also is a signal of recession...an overabundance of goods that have lower prices because no one can afford them...a win for 100 or so US savers and foreign banks but a loss for the entire American (voting) pulic.

So in the end, I guess as was already said, a slight, slow inflationary trend is their goal.

...though I suppose hyper-inflation might be interesting if we're worried about China. That would be an interesting game of economics 'chicken'.

I lack the economic sophistication of many of you guys…HARM, Randy and Dipanjan - Wow!

Thanks, Matt, but I don't think we deserve such lofty praise!
After all, most of the Bubble Posse are *gasp* RENTERS. I mean, none of us even comes close to the sheer financial genius that Sauce obviously possesses. ;-)

Seriously, none of us are economics experts, least of all me, or we'd all be working for the Fed by now. I think you made some very good points about why a prolonged inflationary period might be *different* this time vs. the 1970s, especially point #2:

Cost of goods sold can go up, sure, but what about wages? We’re a service economy. Higher goods prices don’t translate into higher profits or higher wages for American firms. Workers just don’t have the leverage anymore. Too many cheap workers overseas. Unions are falling apart.

I think Peter's also brought up this point before --and it's one I agree with. However, I don't see this as an obstacle to gradually higher inflation. Wage erosion, after all, does not hurt the asset-rich (and geo-politically aware) upper classes the way it impacts the working class. And what do most working class people know/care about a little "off-the-books" inflation? What was the deciding issue in the last election among working class people? The trade deficit? The National Debt? The housing bubble? I don't think so...

As was noted, the Fed is horrified by deflation. I would think this is because deflation means the government’s debt effectively grows.

Excellent point --one that further reinforces my belief that the Fed is trying to engineer a period of moderately higher inflation, not deflation. I see the Fed/Treasury continuing to play a game of CPI statistical voodoo, while manipulating interest rates and the money supply so that true underlying inflation slowly creeps up. The aim is to gradually erode those twin mountains of government & consumer debt before most of the key players catch on to what's really happening.

Again, just opinion & tea leaves. TWIT...

TWIT, remember they were still playing violins when people were told to evacuate?

They’ve already shown that they can’t control what happens after they perform their tricks (i.e., when they print money they didn’t want to create a housing bubble, but they did)...
Nature has to run it’s course. There is nothing that AG or the Feds can do about this, short of making it worse. They’re just bailing.

Agreed. The Fed smay or may not still be trying to engineer that "soft landing" in the housing market, but I believe we're well past the possibility of that now. Way too many over-leveraged speculators and marginal buyers out there who can't even handle a plateau, much less a sharp drop in prices.

The big questions for me are, (a) Can (or will) the Fed continue to stave off the threat of long-term deflation/recession via low rates & printing dollars? and (b) Can they successfully monetize the Twin Debts without inflation getting completely out of their control?

Quite a balancing act... Glad I'm not AG's successor.

It is very difficult to swing from deflation to hyperinflation. In fact it is very difficult to just escape deflation. There is very little risk of hyper-inflation in this country for the foreseeable future. The availability of goods from the low cost providers of the world will prevent any serious run-up in prices here. They may experience strong inflation in their own counties, but the effect exported to us will be small.

If monetary policy was the cause of the recent asset bubbles then we would have serious inflation today, like we had in the 1970s and 1980s. The cause of the asset appreciation is the shift in valuation caused by the confluence of rising income/profits and lower cap rates (in a lower interest rate world) being accentuated by market psychology (exuberance).

It is very difficult to swing from deflation to hyperinflation. In fact it is very difficult to just escape deflation. There is very little risk of hyper-inflation in this country for the foreseeable future. The availability of goods from the low cost providers of the world will prevent any serious run-up in prices here. They may experience strong inflation in their own countries, but the effect exported to us will be small.

If monetary policy was the cause of the recent asset bubbles then we would have serious inflation today, like we had in the 1970s and 1980s. The cause of the asset appreciation is the shift in valuation caused by the confluence of rising income/profits and lower cap rates (in a lower interest rate world) being accentuated by market psychology (exuberance).

Asset pricing swings are a normal pert of economic cycles. To focus monetary policy on this would be destructive to other important elements such as employment and general price stability. The Fed is right to let the asset prices do what they may.

It is very difficult to swing from deflation to hyperinflation. In fact it is very difficult to just escape deflation. There is very little risk of hyper-inflation in this country for the foreseeable future.

A classic straw-man argument. No one here was arguing that there may be HYPER-inflation, merely HIGHER inflation than the "official" CPI is showing.

If monetary policy was the cause of the recent asset bubbles then we would have serious inflation today, like we had in the 1970s and 1980s.

We DO have "serious inflation" today. Only this time, it's not a broad-based inflation impacting all sectors of the economy (including wages), as was the case in the 70s & early 80s. As Peter P likes to say, "inflation is not a single variable."

Asset pricing swings are a normal pert [sic] of economic cycles. To focus monetary policy on this would be destructive to other important elements such as employment and general price stability. The Fed is right to let the asset prices do what they may.

*Ahem*, pardon me, but the Fed is mainly RESPONSIBLE for CREATING the housing Bubble in the first place. They did so by lending to member banks at negative real interest rates for 2 1/2 years, which flooded the mortgage market with liquidity. this may not have been their intention, but that's exactly what happened. If they are targeting this particular "asset price swing", then perhaps it's because it's THEIR MESS in the first place.