Wednesday, Dec 17, 2008
It is deflation! The central bankers are very worried about it.
Telegraph: US interest rates: Mr Bernanke correctly judged the risk of deflation
The sort of deflation now spreading across North America, Japan, and parts of Europe is not the benign variety of the late 19th century when prices slid gently for year after year. Debt levels are much higher today, so the deflation effect is that much more dangerous. The danger is a self-feeding downward spiral as the `real’ burden of debt keeps rising into the slump, as Irving Fisher dissected in his great opus “The Debt-Deflation Theory of Great Depressions”. US inflation was minus 1.7pc in November, and minus 1pc in October. This entirely vindicates the brave decision by Ben Bernanke at the US Federal Reserve -- and our our own Mervyn King at the Bank of England -- to “look through” the oil spike earlier this year and keep his focus on the underlying forces at work in the global ecnomy
39 Comments
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1. drewster said...
Inflation vs deflation argument continues here
Ideally, Bernanke and King will print just enough money to keep their economies afloat; but not enough money to save the skins of BTL investors. Can they possibly hit that target accurately? Or will they err on the side of caution and print more than enough, thereby inadvertently saving the BTL parasites?
2. mountain goat said...
There was an interesting thread yesterday about red herring which I now can't find. Anyway, someone mentioned how with a printing-press/computer-keyboard you can make as much money as you like. So there is no reason to go into deflation - reduction in money supply. I find this a compelling arguement given also Bernanke's speaches in the past making it clear he will drop money from helicopters if necessary. So in some ways we are in a Brave New World where deflation incidences in history don't apply since there was a gold standard. Fiat currencies in the past have always failed miserably and really this is the first major test of our fiat currency system. I think we with no debts can sit back and enjoy the ride. Personally I am glad I have 30% of my savings in gold and silver, just incase this sucker is going down. 2009 should be another wild ride.
Not so sure about Mervyn King, but must concede that Bernanke did well standing his ground as the USD fell and oil went sky-high. Only for this to reverse later in the year. He did that like a market pro with balls of steel. Whether QE is right or wrong is another matter entirely, and I reserve judgement for a few years to see how this mayhem resolves itself.
3. flintster1994 said...
MG,
Japan didn't have a gold standard during their lost decade, did they?
4. mountain goat said...
Flinster - say more?
5. flintster1994 said...
MG,
I thought your points were sound until I remembered Japan. They were able to turn on the printing presses but this didn't stop them having a decade of deflation. If deflation was as simple to avoid as cranking up the money supply, how come the Japanese didn't manage it? Just a thought.
6. Gareth said...
Deflation is not a problem for those who haven't mired themselves in debt, and if having the value of money increase by 1-2% a year "wipes you out" because it makes your debts unmanageable then I would suggest you are an idiot for taking on such a huge burden.
We don't need Bernanke printing money to save every bankrupt bank, business and ponzi scheme in the world and thereby support house prices to just out of reach of the sane levels, what we could do with is a bit of Austrian economics, a gold standard for money and a world where a house is something you buy just to live in not an investment due to endless inflation giving the illusion of a depreciating asset going up in value.
7. mountain goat said...
flintster1994 - I know Japan had a decade of recession but I don't think it was deflationary?
A related point with regards to Japan is whether it is good to try stop deflation. Deflation cleans out the rotten companies leaving space for new vibrant companies to form. It always puzzled me why Japan and Germany, the two losers of WWII whose economies were trashed during the war, managed to become so economically strong afterwards. I think it is related to this. A fresh start leads to economic strength. Trying to prop up a failing economy with QE might stop a lot of suffering in the short term but it definitely prolongs the recession and hinders the recovery.
8. Stevo said...
mountain goat is right, the whole cycle of nature is growth death and decay, these crap banks and ailing companies, are the same as the big movie stars,got big and glamouros treat everone like shit, keep having plastic surgery, then realise they are done for, so stop proping them up gordon, somone else will move in,the money go round will keep turning
9. mrmickey said...
What I am not sure about is how you can have deflation and a crumbling currency as we are experiencing with Sterling the two don't seem to add up surely the currency should be appreciating if the money supply is shrinking, anyway went food shopping last night and was gobsmacked at the rises in prices.
10. tyrellcorporation said...
Germany and Japan had millions and millions pumped into them after the war to rebuild their shattered countries and create stable political and economic frameworks. They also had no defence spending for decades and in fact defence facilities were supplied by the allies. On top of that Germany and Japan are naturally very inventive and are probably the best nations on Earth at mass production techniques. Add all this together and you get economic power-houses.
11. Boom_and_bust said...
The politicians are not doing what is good for the economy, they are doing what is good for them to be in power.
12. tyrellcorporation said...
The lost decade can really be attributed to a massive and pervasive loss of confidence in the future and the desire to preserve wealth at all costs. With real incomes plummeting in the West, this is a real possibility over here. I for one don't spend a bean other than rent, food, utilities, etc.
13. bellwether said...
Set your biases to one side guys. No-one wants to see the housing bubble reinflate and hyper inflation would have that effect.
That said there are myths that keep on being perpetuated by the anti inflationists, particularly (1) the gold standard and fiat currency are not incompatible, you can just devalue your currency against gold. Clearly.
FDR did it in 1933 - there has not been to my knowldge a true gold standard for centuries ie we have had fiat currencies for far longer than you are suggesting (2) Japan didn't print money as you infer during the lost decade and certainly wasn't chucking the yen out of helicopters. The Japanese have always had a secret fondess for keeping their currency strong, indeed it was that, that the principal reason for the lost decade.
14. bellwether said...
I would concede one thing though, if you are a small country then you probably have no choice but to keep your currency strong even going into a deflationary spiral becuase your currency will crumble and drive inflation from imports anyhow. If you are a large economy such hair shirt policies will look like the Great Depression or worse and drive the global economy down.
The question I guess therefore is whether the UK remains a large or small economy in relative terms, and whether our currency can tolerate the fiscal stimulus, time will tell but it is a gamble either way.
Everyone being oddly silent about significant Sterling rally against everything but the Euro - which is in mania bubble phase anyway
15. drewster said...
Japan had several important differences.
First there was the magnitude of their bubble. The Nikkei p/e ratio peaked around 80 (impossibly overpriced), and we all know the famous story about the value of land in central Tokyo being worth more than all of California. The 2007 bubble simply wasn't as big.
Second, despite the property bubble, most ordinary Japanese still had substantial savings. Politically, this made it impossible to just print their way out.
I'm no longer expecting another depression.
16. Pundit said...
Is there a danger in discussing the pros and cons of deflation vs inflation we are all being diverted from the real purpose behind the US interest rate cuts? The stage is set for hyper inflation.
The US should now be taking the honourable option and declaring bankruptcy rather than attempting to inflate its way out of the problem by turning on the printing presses. The US economic problems are too vast for QE to be effective; at best it can only delay the fateful day of bankruptcy. The zero interest rate suggests the US has chosen (hyper)inflation and anyone with savings is about to be annihilated. US national self interest is has taken precedence - the rest of the world can suffer the consequences. This is economic warfare on a global scale. In the UK we are standing shoulder to shoulder with our oldest ally (UK IR < 0.5% in Jan).
US bankruptcy and a fresh start would have been a better long-term outcome.
17. techieman said...
Bellwhether for what its worth here is my take on the currencies v £. The $/£ @ 1.55 is just in a counter trend rally, so yes we could have some more upside but then we have downside that takes out the 1.45 low. How much it gets taken out by depends on how far up this rally goes. ok GBP / Euro - 9300 looks a good upside target place and i will definitely be hedging some there, above that upside looks limited unless there is a blow-off.
18. Tenyearstogetmymoneyback said...
Mountain Goat @ 7
Have a look at
http://en.wikipedia.org/wiki/Japanese_asset_price_bubble
A few other facts about Japan's bubble from memory.
On a news feature shown just a few nights ago they were looking at a luxury Toyko appartment on the market for £1 million.
At the peak of the bubble it was worth three times that.
One of the reasons for the Japanese bubble was that companies were allowed to include the value of their land in their
balance sheets. So some of the most "profitable" companies were actually the least productive e.g. disused steelworks
with hundreds of acres of land.
A few years into deflation the Japanese Government did actually try giving away money vouchers to try and get people to spend again.
The perceived problem with deflation is that everypone puts off buying things in the expectation that they will only become
cheaper.
We actually went to Japan on holiday two years ago. The BIG surprise was how cheap everything was, much cheaper than
you would pay in the U.K. The highlight was a 5 mile Rail journey across Toyko for 60p.
:- Duncan
19. uncle tom said...
The root problem that clobbered Japan was decades of exporting more than they imported - something they believed, at the time, to be a virtue.
UK, US and most of the eurozone has the opposite problem. A sound economy needs both a balanced trade position and a healthy element of self-sufficiency - too much trade is not a good thing, as it leaves an economy vulnerable to upsets over which it has no control.
The deflation argument is fundamentally flawed - until the trade positions get back into equilibrium, the western currencies will steadily fall against those of the rest of the world, pushing up the cost of imports. The spike in commodity prices has corrected - but supply and demand constraints will now propel them forward again.
Western wages, especially in the state sectors, have little history of contracting, and with so many households over-burdoned with debt, people will strike and riot before accepting a pay cut. Traders, meanwhile, have cut their margins a little, but have precious little scope for more.
Yes, inflation is falling, but it is a temporary phenomenon. Inflation was kept down for a decade by cheap imports - they ain't going to be cheap any more..
20. sceneclub68 said...
All this talk of quantative easing/ printing money raises, I think, an important question, and I'd be interested to know people's thoughts on it: how does the newly printed money make its way into the economy?
Clearly, you can't literally drop it out of helicopters, or allow people to take it from banks for nothing in return, as this would be grossly unfair and cause chaos. So how do you do it? In the Weimar Republic they gave it to factories and other employers to pay their workers.
I think I read recently that the Mervyn King proposal was to buy treasury bonds with it. What if the bondholders didn't want to sell? Would they be forced to sell? Another option would be lending to banks and forcing them to lend to punters. But what if the punters don't want to borrow? Force them?
All seems a bit more complicated than just hitting the 'print' button.
21. sold 2 rent 1 said...
As I said yesterday, this is one step closer to the end of money
The End of Money
http://www.chrismartenson.com/the_end_of_money
Nopensionnohouse pointed out yesterday that QE allows money to be created with no debt so the whole article is flawed as Chris states "all money is created as debt". I disagree that the article is flawed because of this. Here's why.
Under normal circumstances money is created as debt. QE is an exceptional circumstance and is very rarely used
Here are some figures of an example
Total US debt = $50 trillion
Total US M3 = $14 trillion
If QE were to be used to print $1 trillion, this isn't going to dilute the debt that much. If the QE causes inflation of prices to rise by 10pc, the debt as a percentage of GDP is not reduced by much either.
On the other hand we know from the "Money as Debt" video that $1 trillion of new money has the potential to created $90 trillion using the fractional reserve system. And this new money IS created as debt.
QE has seemed to work in the past after the debt implosion has happened (USA 1930s). It then kick starts the economy from a base level of debt. QE fails when it is used to prevent the debt implosion or before the debts have been expelled from the system (Japan 1990s)
The QE that is being offered now looks set to fail because they are trying to avoid the debt implosion which is impossible. All you can do is delay the debt implosion for another day. QE will blow the debt bubble higher and risk crashing the whole financial system at a later date.
22. bellwether said...
Thanks Techieman, sorry does GBP/E 9300 mean £1/.093 Euros or £1/1.075Euros?
I find TA interesting but don't know enough about it to rely so tend to focus on bigger trends eg there seems something compelling about parity with Euro now, the story almost has a gravity of its own, the ECB look like remain relatviely hawkish on interest rates and fiscal stimlus, good in short term for Euro but increasing risk of moneatry union cracking altogether and once the cracks are more visible people will start really worrying about that.
Agreed on the dollar/sterling, anticipation of jan BOE interest rate cut should kill that.
UT, an interesting perspective on balance of trade, just don't buy the notion of the western currencies falling against other currencies because I can't see what currencies that would be. A depression as I have argued at othertimes would likely be significantly worse for emerging countries who rely on exports and who economically for all recent growth remain relatively small. All countries are part of a global bubble it is not just a western phenomenon
23. bellwether said...
S2R1 - agreed that nothing can increase exponentially, a macabre thought but even cancer unstopped kills the host in the end.
I don't think that an exponential expansion is what we are looking at as the current crash is going to a collapse that movement - because as you point out the debt is so momentous. There is going to be deflation, it is just a question of how much and whether it will take a live of its own and drive tendnacy towards exponential growth into some sort of reverse.
There is a huge problem with money but then it is one of the best inventions we have and if it didn't exist we would make it up again. You touch on the problem with reserves - that i suspect against a growing population is the ultimate problem
24. sold 2 rent 1 said...
It is unlikely that $1 trillion of QE money would create the full $90 trillion (theoritical maximum based on 10pc fractional reserve).
It could easily create $5-10 trillion of debt-based money though.
Who would be borrowing $5-10 trillion in times like these - homeowners? - not likely
IMHO when the commodity and oil prices start shooting up again, hedge funds will be borrowing like crazy to buy them.
25. jackas said...
There are two theories of liquidity.
Conventionally, theory goes that the central bank has a lever that it can pull using its institutional lending rate and open market operations (buying securities with printed money/reserves) that controls liquidity in the system. Clearly there is substantial evidence that this lever has become ineffective. ("The nasty banks won't pass it on etc")
An alternative theory of liquidity that is more relevant these days is "appetite for risk". This expains Japan's problems, and also explains why central banks seem to be impotent right now. The theory takes a more pragmatic and common sense look at the act of lending. If the lender doesn't see decent returns (too many bad loans, yields too low) then they won't lend. If the borrower doesn't see decent returns from investing the proceeds of the loan (lower incomes, falling asset prices, lower confidence in future returns) then they won't borrow. Plus a lot of the lending that was taking place prior to the crunch was in the "shadow" banking system - not credit backed by debt savings, but credit created through securitisation, hedge fund investment, and alternative investment vehicles, all of which are now defunct.
The government will continue to pull the broken lever and will destroy the currency in the process. They will print money. I have set up a google news alert for the phrase "quantitative easing" and I'm watching the number of alerts grow and grow. It will continue. If I could buy that index, that would be where I would put my money right now.
26. drewster said...
sceneclub68 (new user?),
You're quite right, the big question is how to deliver the newly printed money to the economy? Ideally it would be delivered in a way that can be clawed back if or when credit growth returns.
Japan's trick was to give money to the banks and make them lend it out. The result was housewives taking out loans worth millions and gambling on the carry trade (borrowing cheaply at 0-1% in Japan, then saving the money in countries like New Zealand at 7-8% or the USA at 5%). Some economists blame the Japanese central bank for the US housing boom.
The other obvious option is big infrastructure projects. Everyone's a winner: workers get jobs, travellers get new roads or railways, the economy moves again. However Japan also tried this, with little success in boosting the economy.
Of ourse it could be that Japan's crisis would have been far worse if it hadn't embarked on those measures.
27. bellwether said...
S2R1 the money is not in the form of debt, it really is just handed away - that is essentially what devaluation is and gift is how it gets into the system.
Drewster on that basis the money is not clawed back at all, it is used to write down debt not increase it.
The risk is that s2r1's exponential function kicks in which of course is what hyper inflation is about.
28. drewster said...
bellwether -
The central banks have a printer. They also have a shredder.
Infrastructure spending can be clawed back if it is undertaken as government debt, rather than printing. The only difference is that instead of government borrowing money from the markets (gilts & treasuries), it just borrows money from the central bank's printer at 0%. When/if good times return, the government can pay it back (from tax revenues) to the central banks who will feed it into their shredder.
If I tell you that Japan's public debt exceeds 170% of GDP, you can see how this panned out. They haven't seen the hoped-for recovery yet; the shredder at the Bank of Japan is gathering dust.
Of course, any government faced with the choice between spending tax revenues today or feeding it into a shredder to fend off inflation will almost certainly choose the former. That's democracy for you.
29. bellwether said...
Drewster but it is Japans reluctance to use the printer that has been the problem, their taste for a strong currency is the issue - bizarre for a non consuming exporter .
30. drewster said...
Interesting article in the FT today, touching on much of what we've said above:
31. drewster said...
bellwether - yes, from the FT article above, "the Bank of Japan did not wish to take such drastic measures"
I understood (and I may be mistaken) that they did start to print money around 2002-3, but the money just wound its way overseas through the carry trade, inadvertently fuelling a worldwide property bubble.
32. bellwether said...
Don't everyone ruish and assume this means the enf of the dollar unless they can think of a viable alternative. The status of USD as reserve currency is only based on relative strength - ie it continues if there are no viable contenders, and China will welcome the US spending again and soon beg for it
Ulitmately underpinning the USD as reserve currency are (1) ihistroy and relative size of economy (2) innovation - it continues to have world leading corporations even recent technology is dominated by us companies from IBM through Microsoft to Google and (3) Military capability - if you are looking of the dollars demise it will be when this happens and critically only then!
The lack of military power is amongst a host of other things an issue for the Euro
33. sold 2 rent 1 said...
"The status of USD as reserve currency is only based on relative strength"
Agreed.
IMHO the USD will get an extra boost when/if the EUR implodes.
According to my interpreation of Calleman's model this should happen in autumn 2010.
34. sold 2 rent 1 said...
"the Bank of Japan did not wish to take such drastic measures"
Like almost all central banks the BoJ is under control by the Power Elite.
This was obviously an order from the top brass.
35. Mark Wadsworth said...
@ drewster, I understood (and I may be mistaken) that they did start to print money around 2002-3, but the money just wound its way overseas through the carry trade, inadvertently fuelling a worldwide property bubble.
Exactly! That's an excellent potted history of the global economy over the last ten years or so.
36. spencer234 said...
The politicians and bankers keep trying to raise a "spectre" of deflation.
Yes house prices are falling, as are the costs of imported non-essentials. But add sterling devaluation into the mix, the ensuing high cost of essential imports, and that the printing presses about to be cranked up, and we will soon see inflation going up - not falling. OPEC today signalled a very drastic cut with the hope of getting pil up to at least $75 to $85. The energy companies are refusing to pass on cuts, council tax is going to go massively above inflation, food is going to go up...
The threat of deflation is being spun to justify drastic action in the form of quantitive easing - a last desperate attempt by a god-awful government. When QE doesn't work, savings values are massively eroded, there'll be some equally ludicrous spin being spun. By then this country really will be screwed.
37. wealthyvagrant said...
There is no denying the power of the deflationary force/weath destruction cycle currently occuring, remember much of the wealth being destroyed never really existed in the first place, so in theory we can go a lot lot lower...
...but a determined central bank can ultimately "print" there way out of it if they are determined (although I don't think the current amounts are enough yet) but to then expect a uniform increase across all asset prices when different players have different access to capital and interests to protect I think is unrealistic, hence biflation.
http://en.wikipedia.org/wiki/Biflation
From wikipedia - "Although there is an increase of money in circulation, fewer people have access to the money to make purchases. As a result, a greater percentage of individual wages is directed toward purchasing commodities and less is utilized for purchasing non-commodity items."
Factor into the mix that the US doesn't want to terminaly weaken the $ or strengthen commodity producing nations (Russia, Iran etc) as we saw earlier in the year and you have an interesting puzzle :)
38. sceneclub68 said...
Drewster @ 22
not so much a new user as a very occasional one! Thanks for the Japan example. I reckon it may be difficult for governments to provide such an incentive as the carry trade in a situation when most of the other important world economies are in recession. As for lending against houses, the idea is dead in the water. Gordo might be able to force nationalised banks to make more lending available, but I reckon that even the most incorrigible Location Location Location addict is going to think twice before taking such a loan when house prices are plummetting. So perhaps they'll favour the public infrastructure project approach. Or, when Mandelson has decided which non-financial companies he wants to nationalise, pay their employees with the newly printed cash...
39. bellwether said...
Interesting post @32