patrick.net

@netdance,

The Weimar Republic did not have:
a) the world's reserve currency
b) a credible military

And come to think of it, defaulting on foreign debts and rearmament was exactly the way the Nazis solved Germany's Wiemar hyperinflation woes.

Tell me - how are we going to get widespread price inflation without wage inflation? Because wage inflation is certainly not going to happen.

Those $100k REIC credit cards I already mentioned? (not all that different from those 'Katrina' cards, just on a much bigger scale)
How about adding a zero or two to everyone's bank accounts, Brazil-style?

I suspect stalwart Deflationists like Mish are missing a salient point: we have a fiat currency that can be expanded at will by government in myriad different ways.

When government (made up of politicians who always think short-term and in their own interests) faces problems like $45 Trillion Medicare/S.S. unfunded future shortfall, $8.6 Trillion National Debt, consumer Peak Debt, etc., what other option is there really?

Because wage inflation is certainly not going to happen.

Why not? I thought they just recklessly increased the minimum wage.

When government (made up of politicians who always think short-term and in their own interests) faces problems like $45 Trillion Medicare/S.S. unfunded future shortfall, $8.6 Trillion National Debt, consumer Peak Debt, etc., what other option is there really?

I proposed abolishing Medicare/S.S.

My two cents on the Fed report is that it’s really not that important. It doesn't really reflect inflationary or deflationary policy at all, though the deflationists will surely argue that angle. The reduction in credit is merely a reflection of the lockup, and when FOMC woke up to the solvency risks of a declining RE market the Fed simply reeled back the lines. No big whoop.

This is not an indication of unwillingness to direct liquidity in other areas. The stimulus handout might even be viewed as an inflationary indirect Fed injection of liquidity into the system, and as obscene as it is maybe preferable to throwing cash at insolvent banks.

Some speculation, but my guess is they endeavoring to walk a middle ground between a long, dragged out Japan scenario and the rapid shock to the system. So, what do they do next? They are asking themselves how they inject liquidity directly where it is needed. This is piece that is maybe a bit scary.

Figure we've a Fed and "financial" team that is going to be much more proactive is staving off a depression this go around. If we are to assume that their two priorities right now are getting a solid floor under RRE and equity markets, what might they do? Could we see them actually directly buying equities in our markets? How about a massive purchase of RE, removing inventory from the market and providing a nice political win providing shelter for needful?

We are in a serious crisis, I'd not discount the possibility of our team doing unprecedented things. Netdance, you asked what ammo they have left? Well, I think a large inventory removal or stock purchase is possible. Huge government deficit spends will be inflationary. Massive government infrastructure spends. Along with tax cuts as the tax base crashes and deficits balloon. This is where we will likely see the inflationary policy take hold.

Tell me - how are we going to get widespread price inflation without wage inflation? Because wage inflation is certainly not going to happen.

@netdance,

As a simple textbook explanation, increasing wages is only one cause of price inflation, due to wage spiral effect and also demand-pull inflation:

http://en.wikipedia.org/wiki/Inflation#Causes

You need to also consider cost-push inflation, which we may very well be experiencing due to limited supply of certain commodities (oil in particular). Also, the Fed's rate cuts are very likely to fuel inflation expectations, which is a self-fulfilling prophecy kind of a problem.

All this doesn't even account for the possibility of stagflation, as OO mentioned.

Aha I see the world is still not ready for my "three ists" hehe. Oh well looking at the text up at the very top, yeah, this is a deflationary discussion thread, not one on how to actually solve it!

OK, so, there are places like Zimbabwe with a paper currency, shortages, that are experiencing a lowering standard of living and inflation. Weimar was of course another good example. But I dunno about the US, wages are so low for 3/4 of the population, that I really see deflation ahead. Wages especially aggressively lower when you're jobless and living in a tent city.

Could we see them actually directly buying equities in our markets? How about a massive purchase of RE, removing inventory from the market and providing a nice political win providing shelter for needful?

Of course they'll do that - that was done for both the Depression and the S&L crisis, so it's basically a given.

Not that it really helped either time.

Revengeofone - Flying has become a huge, huge PITA. The airlines are dying, just just don't know it/won't admit it yet. But we're years from a good domestic passenger rail service. So, in the meantime, you fly and hate it, or drive, or for some vacations you can rent an RV and have the driving, hotel, and fun like cookouts at campsites all in one package. It has to be carefully weighed. I've been on trips where we left the gas guzzler at home and rented a little car for the two of us, I can tell you, the V6 Neon is fun!

I brag about taking the train into SF, but if I had to take 3 friends, it would make more sense to drive the ol' Prius (if I still had it) even with the high parking cost. Because 4 people from Sunnyvale to SF on the train is like $50. And bus fares, etc corresponding multiplied.

This is another thing indicating a falling economy - I believe travel is down by a significant amount.

@Harm

When government (made up of politicians who always think short-term and in their own interests) faces problems like $45 Trillion Medicare/S.S. unfunded future shortfall, $8.6 Trillion National Debt, consumer Peak Debt, etc., what other option is there really?

Yeah man, thats it precisely.

Because wage inflation is certainly not going to happen.

Why not? I thought they just recklessly increased the minimum wage.

Beyond certain unknown bounds, that's already proven not to work - for example, imagine that they just increase the minimum to $100/hr. For incremental changes, it's effective, of course, but only to a point.

The problem is that as a country we no longer make *stuff*. We instead sell *ideas* - Hollywood, Silicon Valley, Wall Street, and *services* - RE, doggy day care, gardening services.

For stuff, we're mostly either doing Ag, and construction, both of which are in the crapper.

Anyone making something we can export is going to have to compete with world markets, and that means low, low wages, or unemployment.

Mandating good wages is the same as picking unemployment, so higher minimum wages are deflationary on their face.

Also, the Fed’s rate cuts are very likely to fuel inflation expectations, which is a self-fulfilling prophecy kind of a problem.

While expectations may arise, it's not very likely that any employees will be in a position to kick off a wage inflation spiral in a down market. They'll have to take their lumps and be thankful they still have a job.

The unemployment rate, as measured by the Nixon administration, is already over 8%, and that's not including the illegals - the numbers are pretty cooked nowadays. Between that and global wage arbitrage, noone's going to be seeing real salary increases for a long time.

My head is doing some serious spinning after looking at the Fed report from which the chart came:
http://www.ny.frb.org/markets/omo/omo2007.pdf
To me it seems pretty clear (as others have pointed out) that most of the cash that came in the door through Treasury redemptions (which decreased SOMA) went out the door through TAF (and to a lesser extent, with Repos). To that end: By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, the TAF is designed to help promote the efficient provision of liquidity.

I couldn't help but think of the Soup Nazi when looking at the section under C. Permanent Holdings and Operations -- "No liquidity... for YOU!"
This year there were no purchases by the SOMA account from foreign central banks or other international institutions that hold accounts with the Federal Reserve. Okay, not really a big deal, but it seems worth noting as they purchased around $10 billion domestically from primary dealers.

And Chart 13 under Collateral Distribution in Repurchase Agreements is also worth looking at for the marked increase of MBSes used as collateral for Repos (not that there's anything wrong with that!)
Okay, maybe I need to read tickerforum to see what I should have taken away from the report.

Unless we can turn our views into profits, all talks are useless.

@Ed S

I spent several months beating around China not too long ago, and was skeptical like yourself heading in. No longer. The scale of the place is remarkable, and the infrastructure in place and going up is breathtaking, even if the whole country looks like a big giant tile bathroom.

What I find a bit scary about the place is the Chinese people themselves. They are maybe the most racist people in the world, intensely nationalistic, and nearly completely controlled by the state. They take immense pride in their long history, and view the rest of the world with disdain. Westerns are dirty and somehow "less" than them.

When they experience the coming dislocation, and class tension really takes hold, that place has the potential to be a problem. I hope they revert to insularity.

@netdance,

Back in the 1930s, the U.S. was a major net creditor and exporting nation with a positive saving rate and no Medicare/S.S. "Great Society" programs to fund, vs. the opposite case today. The USD was also still on the gold standard.

While specific commodities and bubble-inflated markets will see significant nominal deflation in the years to come (RE being one of them) I just don't envision any likely scenario whereby broad-based deflation will be allowed to take hold here. It's both financially and politically untenable.

@netdance,
I don't think anyone here is really arguing that wage inflation is likely. Rather, there are other factors that can lead to price inflation beyond a wage inflation spiral scenario.

In fact, you're right. Among the onslaught of bad economic news is a definite uptick in bad employment info, from the cooked data from the government to stories about layoffs (Yahoo, Morgan Stanley, or for that matter most financials), buyouts (GM), and the like.

BTW - if it sounds like I'm trolling, I'm not. I'm enjoying the discussion, and hope you are too. Learning a few things, too.

Stagflation:

I mentioned that obliquely as part of the Ka-poom idea. Prices of imports go up, the country goes into a deflationary spiral (which mostly effects locally produced goods and services), and then the rest of the world comes along for the ride, which drops prices on everything.

That intermediate step would look a lot like Stagflation, but it would be different from last time, since it wouldn't just be energy-based products going up in price.

But I'm not so sure that we'll be able to devalue the dollar as much as you think - everyone else has fiat currency too, and they're not dumb.

The Euro is unlikely to survive the next decade for instance - look at Spain for why.

And as I mentioned earlier in this thread, thinking that China is going to be able to keep making all the junk we need is wishful thinking. Their cities are going to be under martial law before this is all over - it won't take much, I've been there - once the gov't breaks their implicit "put up with our corruption and we'll make you rich" contract, it's game over. But at least that will (eventually) let wages inch up here once it happens.

How to profit from all this? I have no idea, except for shorting the market in the next year or so. Most of my ideas revolve around saving up enough cash to own my own place outright once the SHTF, and coming up with a small business idea to keep food on the table.

Everybody is about to get poor, one way or the other. My goal is just to be less poor than everyone else.

The Euro is unlikely to survive the next decade for instance - look at Spain for why.

Absolutely. I doubt the European Union can survive in its current form.

Everybody is about to get poor, one way or the other. My goal is just to be less poor than everyone else.

This is completely unacceptable. If we do not seek to thrive, why survive?

netdance,

(Let's try this on for size, hmm?)

THE HOUSING BOOM NEVER HAPPENED!!!

I know, I know...but,

Let's go back before we forever and irrevocably screwed ourselves and the balance of the planet!

Will we, can we, EVER look back and say that "something" ANYTHING good came of it?

China will contribute massively to inflation AND deflation of the world.

1) Chinese has overcapacity of almost everything that can be produced by man, from cars to toys. China's growth in the last decade, apart from export, was mainly driven by fixed investment. If you have ever toured China, you know what I mean by rows and rows of empty buildings wherever you turn.

2) Chinese population pyramid will start to reverse in about 12-15 years. China started one-child policy in 1978, despite scant efforts in the rural areas to reproduce more, the urban areas (about 20% population back then) have strictly enforced this policy. After 30 years of development, about 60% of the country's population now reside in urban areas, thanks to freedom of movement for farmers and urbanization, and these population start to take after the lifestyle of urban residents - have fewer kids, or none at all. So, excess cheap labor in China will start to disappear in 2020 or so. Can India take up the slack? I don't know.

At the same time, there has been substantial loss of farmland to industrialization, urbanization, weather changes and pollution in China. That's why China turned from a net food exporter 30 years ago to a net food importer.

At the same time, rapid urbanization also means more and more Chinese have higher expectation of their lifestyle that mimic ours one way or another. The worst of all is, their main usage of oil switched from industrial production to transportation in 2004, although the per capita consumption is still only 1/14 of ours.

So, what does it mean for us?

Should we look closely into aggie commodities?

China will contribute first to the inflationary pressure of food and energy commodities, but deflationary pressure to all other "made in China" items. However, when their population pyramid turns upside down, they will contribute to inflationary pressure of wages and therefore manufactured goods, and deflationary pressure to basic commodities.

And this is just one part of the equation. We don't know what India is going to do in the meantime.

Grant it, right now India doesn't have a fraction of China's reserve, and lacks a solid industrial base except for service outsourcing. Nevertheless, its population size will surpass that of China soon, and if it follows the same path of development as China, they will represent a formidable force in determining inflation or deflation for the rest of the world just like China in the next decade.

One thing for certain, the world is overcrowded.

When one looks at the Japan-style deflation, one must also take into account the rise of China as an industrial base. Japan's depression coincided with hallowing out of its manufacturing industry (not as much as ours) and outsourcing to China. If Japan was a closed system, will deflation be as severe as history has shown is debatable.

However, today the US is facing a different environment. We already have nothing left for manufacturing. Everything that can be outsourced is already outsourced. Whether China will deflate further on certain manufactured goods depends on the share of material cost in total production cost. China will keep deflating on factory buildings, already installed equipment, labor (reaching the absolute bottom labor cost pretty soon), or even utilities cost, but one thing that is completely out of its hand is material cost. If raw materials cost accounts for a big part of the finished goods, China won't be able to deflate further.

One thing about India - you can see people starving to death in the streets of any (almost) city. And most of their arable land is rapidly being converted to desert. Check out before and after pictures around Puna if you don't beleive me - never mind Rajastan. And most of their non-service economy is housing driven, if you can beleive it. Nope, they're screwed. Not as bad as China or us, but not good. Their first instinct will be to retreat to a protectionist socialist state when things to sour.

No, if you want to see a possible third world success story, I'd look to Brazil, or any of the petro-states (like Russia). Brazil because the have a LOT of land that's still useful, lots of natural resources, and they're going to be the first energy independant non-petro-state. (Not that I know that much about Brazil...)

I think Russia and Brazil will be the big winners for the next two decades. There are a couple others which will probably not suck, like Australia and Canada, but I wouldn't count on them growing exceptionally, either. They're resource-based economies without enough industry. But if Canada can get its oil sands act together...

Which is a pretty good idea for investments, now that I think of it. Of the ones mentioned, I'd go with Brazil - they're less likely to do a massive nationalization of private industry. And maybe Canada if you beleive in oil sands...

Thoughts?

If raw materials cost accounts for a big part of the finished goods, China won’t be able to deflate further.

Don't forget shipping costs. Bunker fuel may yet be outlawed by treaty - it's the dirtiest crap you can have that still burns.

HARM Says:
I suspect stalwart Deflationists like Mish are missing a salient point: we have a fiat currency that can be expanded at will by government in myriad different ways.

The problem is that the monetary base is a miniscule portion of the notional value of credit and its derivatives. Deflation, if it happens, will be caused by the unwinding of credit - and the F'ed is powerless to stop that. As it is, they are unable to get banks to lend (as is clear from the o.p.)

Bunker fuel may yet be outlawed by treaty - it’s the dirtiest crap you can have that still burns.

Gas turbine combined-cycle marine systems are much cleaner, but they emit more CO2! What should we do? :roll:

The whole world is leaning so far left that the planet may just fall off its orbit.

I would argue that India will never be capable of organizing in a fashion that is in any respect comparable to China over the past 25 years. The disparate culture, poor infrastructure, and stifling bureaucracy would combine to make this impossible. I don't see India ever competing at scale as a global manufacturing exporter. Probably global market growth will not happen in time to allow this scenario to develop.

OO, good stuff on China. :-)

A successful nation puts economics in front of culture.

Deflation, if it happens, will be caused by the unwinding of credit - and the F’ed is powerless to stop that. As it is, they are unable to get banks to lend (as is clear from the o.p.)

My favorite theory is that they're not lending for two reasons:

1) They don't have much money free (reserves - TAF = negative number right now)
2) They "know" that some of them are already insolvent, but because of zero transparency, they don't know who. I wouldn't lend any non-FDIC money to them right now either. (Hello, Countrywide? WAMU? Citi?)

Default risk is rather high right now, isn't it? I think once the monolines are downgraded, the banks that survive will be happy to lend money to those with decent collateral :-)

Couple important and often overlooked facts about the US economy.

The US is currently the world's largest manufacturer. Larger than China, Japan, Germany, and everybody else. Nobody seems to talk about this anymore. Another is the US has lost far more jobs to information technology productivity gains than to offshore outsourcing and manufacturing. I think its important to keep this in perspective when endeavoring to understand macro inflationary and deflationary issues.

NVR, OO, Netdance:

Thanks for the comments and input on China. As I said, I think that I'm definitely at the end of the information food chain. Not too take this thread too far off topic, but with my EXTREMELY limited knowledge of China, I've always thought that the long periods of chaos and instability have had a tremendous influence on domestic Chinese policy.

To that end, I really wonder what will be the reaction of the CCP to any hints of turmoil? Will the CCP do almost anything to keep people employed and peaceful. So will the Chinese vendor financing scheme to the US continue no matter how much the dollar depreciates? IOW, if the alternative is substantial civil unrest, how will they react?

Deflation, if it happens, will be caused by the unwinding of credit - and the F’ed is powerless to stop that. As it is, they are unable to get banks to lend (as is clear from the o.p.)

I don't think the Fed is "powerless" --not all-powerful, either, but far from powerless. And Congress has shown great willingess to lend its own virtually unlimited powers to the "cause" (propping up lending bubbles and asset prices) whenever the banksters whine loudly enough.

If it if becomes necessary, they could simply conjure electronic money out of thin air and deposit it into member banks. An extreme solution to be sure, but don't think it can't/won't happen. For now, all I see modestly depreciating houses, while the cost of virtually everything else is spiralling upwards. Classic stagflation.

Deflationists: 0
Stagflationists: 1

waiting2buy has a good point- you had to buy in 2003 or earlier to 'get out alive'.

I look at all the sales in my local MLS (1 sale per day for an area with 800k population so it doesnt take long)

there are two types of sales
1. bought LONG time ago so can afford to slash price and not bring check to closing
2. short sale/REO sale - both must be bank approved.

the #2 are growin in share monthly its about 45% of sales now last I checked that is 45% of sellers who got WIPED OUT.

but the REAL trend is NO SALES.....I did some numbers checked 2 months ago and looked at a ton of listings from early 2007 and only 1 in 3 ended up being 'SOLD' the other 2 were expired or cancelled listings..... I then compared this to 2004 sample...9 out of 10 listings ended with SOLD status....

If you have MLS access you know what I mean, its a absolute epic disaster right now, a once in a lifetime shift change from biggest bubble evar to biggest crash evar. And STILL the dream price listings are dominating! hilarious waste of time for a realtor. So would take a listing when only 1 in 3 actually sell and the rest cost you money? not me..... but working with buyers is the same....they lowball and the seller wont take it - no sale.

Keep in mind the years 04/05/06 were all record years in terms of sales volume AND refi/cash out....so ALL these people have neg equity which is #1 default reason....50% off peak price is now a conservative estimate IMO. Even in your fort or whatever city that is in SF.

the mls data is a goldmine....in august 2007 the sales volume 'shut off' overnight....I called the mls to ask if they system had been down there were so few sales, no joke, it had no down time....8/07 was 'end of the world' when light switch flicked and music stopped.

Will the CCP do almost anything to keep people employed and peaceful.

Most definitely YES.

northernvirginiarenter:

You have a cite for that statistic? Google fails me here, and I'd love to see numbers.

All the numbers I've seen show us with the largest trade deficit - larger than all others combined.

So if we're making so much, where's it going?

Like I said, I'd love a cite.