ECON 06.04.12 Ambrose Evans-Pritchard Column indicates DEFLATION

[JohnGaltfla]

06.04.12 Ambrose Evans-Pritchard Column indicates DEFLATION

by John Galt
June 4, 2012 17:30 ET

Tonight, Ambrose Evans-Pritchard switches from the Austrian bugaboo view to the Keynesian “oh crap we are all going to die” point of view in his U.K. Telegraph column:

Global slump alert as world money contracts


What? I thought we were in perpetual expansion? The Bernank, Obama, the Demopublicans, Republicrats, and Eurocommies all assured us sheeple that the events of 2008 were a one off event and the probability of a repeat were as remote as an African native becoming President of the United States.

Er….uh…..

So what does he say different tonight? Maybe this tidbit should give my reader a taste of the nightmare upon us:

The latest data show that the real M1 money supply – cash and overnight deposits – for China, the eurozone, Britain and the US has been contracting since the early Spring. Any further falls risk a full-blown global recession.
​

Yeah, but, well, M1 doesn’t matter and the US stopped measuring M3. So who cares about M1? My readers should. Precious metals investors should. Sane people buying food and prepper supplies should. How bad is it? More from the article:

The world money data collected by Simon Ward at Henderson Global Investors show that real M1 for the G7 economies and leading E7 emerging powers peaked at 5.1pc in November and has since plunged to 1.6pc in April. The data explain why commodity prices are falling hard, with Brent crude down to a 16-month low of under $97 a barrel.

China’s money data are falling at the fastest pace since records began. The gauge – six-month real M1 – gives advance warning of economic output half a year ahead. “Europe needs to start quantitative easing [QE] immediately and China must ease policy,” said Mr Ward.
​

So much for the cure by Keynes. Rumor has it the Fed is floating a $451 billion QE 3. Considering the crisis is ten to twenty times that not counting the U.S. government debt debacle and all they are doing as all of us Florida natives did as a young child:

Peeing into the ocean when the tide goes out and saying “Look Mommy, I’m refilling the ocean.”

Good luck with that Ben.

 

[Kathy in FL]

So which is it? Hyperinflation or deflation? Or is it the same tune, just with different words?

 

[China Connection]

Deflation might occur as overproduction of stuff gets sold off by a firm to stay liquid but hyperinflation is down the road and not that far away.

Deflation is good for the general population as they retain the buying power of their savings. Now you have to be a nut to think todays governments will allow this to happen. On the other hand hyperinflation allows governments to pay off loans with devalued currency.

So expect food and energy prices to go up along with the cost of new goods. Expect luxery goods to drop in price for the short term. Second hand goods for the short term will go for very little but once hyperinflation kicks in second hand goods will be valuable provided they are practical products.

 

[JohnGaltfla]

So which is it? Hyperinflation or deflation? Or is it the same tune, just with different words?

Short term currency deflation with long term price/goods hyperinflation.

In other words, as I said here in 2006, you are toast.

 

[Be Well]

So instead of people pushing a wheelbarrow of money to buy a loaf of bread, a loaf of bread costs a wheelbarrow of money but no one has a wheelbarrow of money?

 

[JohnGaltfla]

So instead of people pushing a wheelbarrow of money to buy a loaf of bread, a loaf of bread costs a wheelbarrow of money but no one has a wheelbarrow of money?

WINNER!

 

[Be Well]

So the worst of all possibilities.

Crazy.

 

[raven]

i've tried to explain this so many times that i get a cag reflex and want to puke

it is both - you cannot get hyperinflation without deflation

 

[TerryK]

The Great Depression was deflationary.
Those who had debts lost everything. Those with money bought it.
If you had money you got some very good buys and came out on top.

 

[TorahTips]

Deflation is a natural event that happens sometimes before hyperinflation. Here's an analogy that might help.

In the Indonesian tsunami, all the water was "sucked" out to sea. That seemed safe so people ran out on the sand to see what had happened (deflation). Then, the monster wave came in and covered miles of ground in a short period of time (hyperinflation). This whole thing will end as an economic tsunami (deflation followed by massive hyperinflation - especially if we cover the Euro).

 

[knepper]

Those who had debts lost everything. Those with money bought it.
If you had money you got some very good buys and came out on top.
I'm trying very hard to knock out the rest of my credit card debt (thanks, ex!), but sometimes I think I'm a fool to pay it. If we do get hyperinflation, it will soon be worth much less in real terms. Oh well, you pay your money and take your chances.

 

[DHR43]

I've been expecting widespread deflation world-wide for years now. It's on schedule and is becoming obvious to some.

Of course, I'm a follower of Robert Prechter and have been for years. Consequently, I've made good money on his recommended asset classes over the years and avoided losses on other asset classes over the years. Because of his long track record (as I've followed and practiced it), he's earned credibility with me, so I'm a deflationist.

 

[China Connection]

Look China has been buying up raw materials for years and most of the population earn little so they are well set up for a war. The West in general has little back up on raw materials so when a war starts and supply lines get cut then costs must go through the roof. I can't see how you can have deflation if a major war starts.

Also your government has been borrowing to keep up on debt repayments. What happens when the lenders stop lending? There are huge dollar holdings being held around the world so if you have a big devaluation latter this year on the dollar then I expect a lot of this money to start madly hunting commodities. While money sits inflation stays in check but when governments want to get out of dollars then there are going to be a lot of dollars chasing physical materials, assets. So expect inflation.



.

 

[Double_A]

Is it possible you have that backwards? It seems to me that hyperinflation would come first and when the last of our money is spent on a single can of beans, we tip into deflation where nobody has any money left and while prices drop and drop still nobody has any money to buy.

Deflation is a natural event that happens sometimes before hyperinflation. Here's an analogy that might help.

In the Indonesian tsunami, all the water was "sucked" out to sea. That seemed safe so people ran out on the sand to see what had happened (deflation). Then, the monster wave came in and covered miles of ground in a short period of time (hyperinflation). This whole thing will end as an economic tsunami (deflation followed by massive hyperinflation - especially if we cover the Euro).

 

[China Connection]

Look the whole thing is rather confusing as when you have hyperinflation say in the US and your currency has become valueless within the US and the average person can't afford to sit down to a decent meal then a person from a country with a strong currency can visit with say travellers checks and buy stuff for peanuts in his / her own currency.

So the visitor buys for deflated prices while the local person is paying inflated prices. Now what do you have inflation or deflation?


So inflation is is a loss of buying power for a local person on what they used to be able to get in exchange for their savings. The local currency can be losing its buying power by the hour. Wages that are inflating from week to week usually only have reasonable immediate buying power. If you hold the money for a day of more you could be looking at loosing half of your buying power or more. A currency that is not hyperinflating has the same buying power from week to week more or less.

Now gold I have seen it go to over $900 and come back to $250 then back up to its current price. Now say country X is having hyperinflation does that mean that gold is hyperinflating on the world market? Sorry no it doesn't. In fact gold could be dropping strongly.

What can you bet on going up when you have hyperinflation in the US? Answer anything that is imported or dependent on something that is imported. Food will go up strongly in the US because everything to do with growing food and moving it about in the US is dependent on oil. What will go down in price? Local labor costs. Sure wages will go up but wages will buy less than before. So a foreign company employing Americans but exporting all its manufactured goods will find their labor costs are less in real terms in the US. Also rent and real estate will go down down strongly as the average person will not have the power to pay high rents or buy expensive homes in a working area.

Work bargining will probaly be brought in down the track. That means that you sign a contract where you agree to work for so many hours etc for so much. There will be no set wages and employers will be able to bargin stuff down in wages and stay within the law. That is how I work here in China. Back in Australia it is called work place bargining.

Secondhand things like antiques that do not have a real use will drop strongly in price. Things like tools, fishing gear, fertilizer, garden equipment will maintain value.

 

[China Connection]

Good Old Australia! Um, it used to be but not these days!


http://www.google.com/search?hl=en&...0.0..0.0...0.0.TepvQDywtOU&sa=X&nfpr=1&spell=

I will give a practical example of this government’s vision of fair bargaining and how it is occurring in practice. Morris McMahon is a company located in Arncliffe, New South Wales, close to my electorate. Australian Manufacturing Workers Union members were on strike from 13 March 2003 for 16 weeks. In some instances, both husband and wife work at Morris McMahon and both were on strike, so they had no money at all coming into their household. Most of the workers have children. Many of the workers live in my electorate and are of non-English-speaking background. There was a 24-hour, seven-day a week picket in place since the beginning of the dispute. The company manufactures cans and employs around 100 workers. The owner of the company also had her own legal firm, Beswick Solicitors, in Clarence Street, Sydney. The company refused to negotiate a certified agreement with the employees and tried to force its workers to sign individual contracts. Until the final days, the company refused to negotiate with the union and, when forced to speak with them, refused to discuss anything other than individual contracts. The company offered striking workers an upfront cash payment of $1,000 to return to work on individual contracts. Think about this: both parents were out on strike on a picket line. They are battlers, people who were being paid less than $12 an hour—and the bleating in the coalition party room over their super entitlements showed the comparisons that they were on about—yet there was systematic intimidation of these employees, with hired security outside the picket line.


I am a member of the Australian Labor Party and I was proud to be on the picket line for two mornings with the workers who were `salt of the earth’ people. They showed great courage. The company threatened to terminate the union delegate’s employment. It sought damages of $700,000 against the AMWU. Workers were being forced to accept a roster of hours that they were not employed to work—five days work instead of four days work per week—the employer would not tell employees about the security of their entitlement and the company bussed in scabs using a professional strike-breaking company.


What did the workers want? They wanted, firstly, an end to six years of unregistered agreements; secondly, respect as workers and decent wages and conditions, as contained in the union agreement; and, thirdly, the right to be represented by their union. They were resolute in their commitment to achieve a collective agreement.


During the dispute Doug Cameron, the National Secretary of the AMWU, had a debate with the then minister, the member for Warringah, Tony Abbott, at Sydney University. Doug challenged the minister to come and talk to the workers. This is a minister who spoke all about choice—`We are all about choice and giving workers the right to choose.’ He went to that workplace and had to acknowledge that what they wanted was their right to bargain collectively. Yet they were not able to do so because of this government’s legislation.


The Hon. Justice Munro of the AIRC told the commission that he no longer had the power to assist in the resolution of the dispute but wished that he did. He said that the employer did not bargain in good faith. Eventually the matter was resolved and the employees went back to work. There are no individual contracts, the workers have a registered agreement and the union has been recognised. The employer won the worst boss for 2003 award from the New South Wales Labor Council. That dispute should not have occurred; there should have been proper and fair bargaining. That is not what this government is about. It is about taking away the rights of workers and handing all power to employers. That is why the Labor Party rejects the government’s industrial relations approach. We do not back away from our connections with the trade union movement. I have been a proud trade union member all my working life and will continue to be.

 

[Border guard]

No matter how you slice it, we're basically toast. - BG

http://theeconomiccollapseblog.com/...-crazy-summer-for-the-global-financial-system


21 Signs That This Could Be A Long, Hot, Crazy Summer For The Global Financial System


The summer of 2012 is shaping up to be very similar to the summer of 2008. Things look incredibly bleak for the global economy right now. Economic activity and lending are slowing down all over the planet, and fear is starting to paralyze the entire global financial system. Things did not look this bad back in the summer of 2011 and things certainly did not look this bad back in the summer of 2010. It is almost as if a "perfect storm" is brewing. Today, the global financial system is a finely balanced pyramid of risk, debt and leverage. Such a system requires a high degree of confidence and stability. But when confidence disappears and fear and panic take over, the house of cards can literally start collapsing at any time. Right now we are watching a slow-motion train wreck unfold and nobody seems to know how to stop it. Unless some kind of a miracle happens, things are going to look much different when we reach the start of 2013 than they do today.
The following are 21 signs that this could be a long, hot, crazy summer for the global financial system....
#1 There are rumors that major financial institutions are cancelling employee vacations in anticipation of a major financial crisis this summer. The following are a couple of tweets quoted in a recent article by Kenneth Schortgen Jr....

Todd Harrison tweet: Hearing (not confirmed) @PIMCO asked employees to cancel vacations to have "all hands on deck" for a Lehman-type tail event. Confirm?
Todd M. Schoenberger tweet: @todd_harrison @pimco I heard the same thing, but I also heard the same for "some" at JPM. Heard it today at a hedge fund luncheon.
​

As Schortgen points out, these are not just your average Twitter users....

Todd Harrison is the CEO of the award winning internet media company Minyanville, while Todd Shoenberger is a managing principal at the Blackbay Group, and an adjunct professor of Finance at Cecil College.
​

#2 The Bank for International Settlements is warning that global lending is contracting at the fastest pace since the financial crisis of 2008.
#3 Unemployment in the eurozone has hit a brand new all-time record high.
#4 The government of Portugal has just announced that it will be bailing out three major banks.
#5 Many U.S. banking stocks are being hit extremely hard. For example, Morgan Stanley stock has declined by 40 percent over the past four months.
#6 Yields on Spanish debt and yields on Italian debt have been absolutely soaring.
#7 10 year U.S. Treasury notes hit a record low on Friday because investors are scared and they are looking for safety. The following is from a recent USA Today article....

"Treasuries are at 1.46 because people are freaking out," says Mark Vitner, senior economist at Wells Fargo Economics.
​

#8 New orders for factory goods in the United States have declined three times in the last four months. That is a sign that the "economic recovery" in the U.S. has clearly stalled.
#9 U.S. job growth in May was well below expectations and the unemployment rate has increased to 8.2 percent.
#10 Economies all over the developed world are seriously slowing down right now. The following is from a recent article by Ambrose Evans-Pritchard....

Brazil wilted in the first quarter. India grew at the slowest pace in nine years. China’s HSBC manufacturing index fell further into contraction in May, with new orders dropping sharply and inventories rising.
​

#11 Stocks in Japan hit a 28 year low on Monday.
#12 Over the past five years, the stock markets of Greece, Spain, Italy, Portugal, Ireland and Cyprus have all fallen by more than 50 percent. Will we soon see similar results all over the rest of Europe?
#13 The Greek economy is literally shutting down. Just check out the chaos that unpaid bills are already causing....

And unpaid bills are now threatening Greece’s electricity supply. State-owned Electricity Market Operator (LAGIE), a clearing house for power transactions, hasn’t paid independent power producers for electricity it bought from them. They, in turn, haven’t paid their natural gas supplier, Public Gas Corporation (Depa), which now doesn’t have the money to pay its supplier. Payment is due on June 22. Alas, its supplier is Gazprom in Russia, and they insist on getting paid. If not, they will shut the valve, and Depa won’t get the gas to supply the independent producers, which will have to take their power plants off line, removing about a third of the country’s electricity production.
​

#14 It is estimated that there are 273 billion dollars of failed real estate loans in the Spanish banking system.
#15 In March, 66 billion euros was pulled out of Spanish banks and sent out of the country. That was an all-time record and that was before we even knew the results of the recent elections in Greece and France. The numbers for April and May will almost certainly be even worse.
#16 The unemployment rate in Spain is 24.4 percent and for those under the age of 25 it is over 50 percent.
#17 Former Italian Prime Minister Silvio Berlusconi is warning that Italy may have to take drastic actions if something is not done soon....

"People are in shock. Confidence has collapsed. We have never had such a dark future," he said. Indeed, the jobless rate for youth has jumped from 27pc to 35pc in a year. Terrorism has returned. Anarchists knee-capped the head of Ansaldo Nucleare last month. Italy’s tax office chief was nearly blinded by a letter bomb.
"If Europe refuses to listen to our demands, we should say 'bye, bye’ and leave the euro. Or tell the Germans to leave the euro if they are not happy," he said.
​

#18 It now looks like Cyprus is going to be the next European nation to need a bailout.
#19 Switzerland is threatening to implement capital controls in order to stop the massive flow of money that is coming in from banks around the rest of Europe.
#20 As I wrote about the other day, World Bank President Robert Zoellick is warning that "the summer of 2012" could end up being very similar to what we experienced back in 2008....

"Events in Greece could trigger financial fright in Spain, Italy and across the eurozone. The summer of 2012 offers an eerie echo of 2008."
​

#21 Germany’s former vice-Chancellor, Joschka Fischer, is warning that the entire EU could fall apart over this crisis....

"Let’s not delude ourselves: If the euro falls apart, so will the European Union, triggering a global economic crisis on a scale that most people alive today have never experienced"
​

When was the last time that we saw so much bad economic news come out all at once?
2008 perhaps?
We truly live in unprecedented times.
It will be exciting to watch what happens, but it is also important to keep in mind that the coming economic crisis will cause extreme pain for millions upon millions of people.
For example, the suicide of a mother and a son due to the deteriorating economy has absolutely shocked the entire nation of Greece....

A 60-year-old Greek musician and his 91-year-old mother jumped to their deaths from their 5th floor apartment, driven to despair by financial woes. This double death is the latest in a rising epidemic of crisis-induced suicides in Greece.
*Witness accounts vary – some say the mother, who suffered from Alzheimer’s, jumped first, screaming a prayer as she plummeted to her death. Other neighbors say the mother and her son jumped together, holding hands.
But the one thing everyone seems to agree on is that the family had been struggling for a long time. The night before, Antonis Perris posted a suicide note of sorts on a popular Greek forum, saying he had no way of resolving the family’s financial issues.
“The problem is that I didn’t realize that I would need to have cash, because the economic crisis came so suddenly. Even though I have been selling our possessions, we have no cash flow, we have no money to buy food anymore and my credit card is maxed out with 22% interest rate.”
Perris continued to say that both his and his mother’s health deteriorated, and that he saw no solution to his most basic problems – getting food and medical help.
​

This is why it is so incredibly important to get prepared.
You don't want something like that happening to you or anyone in your family

 

[Adino]

Is it possible you have that backwards? It seems to me that hyperinflation would come first and when the last of our money is spent on a single can of beans, we tip into deflation where nobody has any money left and while prices drop and drop still nobody has any money to buy.

No TT had it right. Deflation 1st then hyper-inflation in the death throes of the currency in question.

As derivatives become excersizable they blow holes in balance sheets. The QE has been attempting to create enough $ to fill the tbtf banks balance sheets but not so much that the $ gets in circulation, which would cause rampant inflation.

That's why the banksters have been seeing the $ not Main St.

During the space of time that there are holes in tbtf bank balance sheets and the time they receive bail outs the banks are wont to lend. They can't lend because their "assets" have been gob smacked.

Lending would take them below required reserve levels.

So they don't lend. That means no "letters of credit" to conduct business. That means businesses can't obtain goods for sale. That means contraction of the whole business cycle and that results in deflation.

But, as mentioned above governments also need the system to work. So when the deflation cycle starts they go to the banksters and beg for more debt load.

If the banksters comply they inflate the money supply and inflation kicks in.

If they don't you get a 1930's deflationary depression.

If they inflate but do so too dramatically confidence in the fiat currency is lost and everyone tries at the same time to dump the currency for hard assets.

This "musical chairs" routine to NOT be the last one holding the bunk currency ends in hyper-inflation.

 

[Y6K]

We will NOT have hyperinflation unless we have significant wage inflation. Is there anything more clear than that after the last 4 years? I don't see it in the cards. Deflation will rule.

 

[China Connection]

Fun and games! It it is no worse than 2008 then there is hope. However 2008 had a recoverery to a fair degree. What is coving will leave 2008 for dead and there will be no recovery until the One World Government gains power and even then it will be short lived.

 

[Adino]

We will NOT have hyperinflation unless we have significant wage inflation. Is there anything more clear than that after the last 4 years? I don't see it in the cards. Deflation will rule.

When then do you expect tbtf bank and sovereign debt defaults?

The $ has not been in death throes. Yet. Its lined up for it. And if China did indeed give its banks the green light to openly dump $ it will be gasping in weeks. But we have not yet seen the the last breaths of the $.

Hyper-inflation is experienced in the the death throes of a currency.

But back to your assertion that deflation exclusively has the stage when are you projecting defaults?

In the US alone uncle has to rollover 2 trill in the next couple years. Without inflation on a large scale how will the tbtf banks and sovereign govs roll their expiring debt over?

Its one or the other. Default or inflate.

So since your crystal ball has given the stage to deflation when/who is the next big default?

 

[Beth]

What will happen to the Canadian dollar in relation to the US dollar? Anyone know?

 

[China Connection]

Beth all the magor currencies are linked in loans and exports. It is fairly much expected that if either the US dollar or the Euro goes then the other has to go. Now at a guess there is half of your export market. So say you loose 25% of your export market just with these two places but then other places you export to will be effected like you also and will reduce their buying.

Now lets say your exports drop by 50% overall. This means that millions of Canadians will have lost their jobs. Now these millions of Canadians normally employ millions of fellow Canadians in the service industry meaning restaurants, clothing and so on. So you have a roll on effect. Then you have a further roll on effect from the roll on effect and so on.

So what happens to your dollar? It drops but probally not as bad as the dollar however as you have less in cities.


.

 

[Warm Wisconsin]

US Economists Warn The Fed Is Setting Us Up For Deflation

Home prices are stagnant, crude oil is tumbling and copper has fallen to a seven-month low. Inflation is not the problem. What is the problem is inflation's evil twin, deflation.

And as good as today's beginning stages of deflation may feel, especially when filling up at a service station or shopping for a house, economists warn that there is a high price to pay down the road and that current monetary policy is only raising that price.

Of course, not all price reductions are created equal. A price drop that stems primarily from an increase in technological efficiency is not deflation; it's progress. Deflation is a fall in prices that stems from a shrinking money supply, just as inflation is a price hike that stems from an increase in the supply of money.

Deflation ramps up when people borrow to make a big purchase on the assumption that what they are buying will be worth more later. But if prices fall, the loan will have to be repaid in dollars that are worth more than the dollars they borrowed, making the debt more onerous. As a result, when people expect falling prices, they become less willing to spend, and in particular less willing to borrow. And when that happens, the economy may stay depressed because people expect deflation, and deflation may continue because the economy remains depressed. It's a nasty cycle and it can often be traced back to the central bank's balance sheet expansion.

"Deflation is the one thing that a leveraged economy can't handle," said Steve Blitz, chief economist at ITG Investment Research. "The implication on the whole economy is potentially ruinous. The idea that every time the stock markets have some kind of a hiccup and they [the Fed policymakers] need to rush in with some sort of quantitative ease is a dangerous road for them to go on."

Money Printing

"Deflation is always a risk if you engage in a policy of inflation," said Albert Lu, managing director and chief portfolio manager of WB Advisors.

The problem with the addiction to money-printing is that it can't stop without dire -- albeit in the long-term healthy -- short-term economic consequences, he said.

To jump-start the economy, the central bank would increase the money supply and bank credit to support certain sectors or projects. That's what the Fed did after the dot-com bubble of 1995-2000 burst. The problem is that once the Fed stops the infusion of additional credit and money, deflation rapidly takes hold. It then takes an ever-increasing amount of new money creation to achieve a temporary suppression of deflation's symptoms.

Inflation-sustained projects are unsustainable because the expansion rests on government fiat, not economic fundamentals like supply and demand. Take the government's determination to promote home ownership. That public policy was advanced with easy money, especially during Alan Greenspan's leadership of the Fed, compulsory lending to unqualified borrowers and Fannie Mae and Freddie Mac buying tranches of subprime mortgages. Home ownership boomed. And then it collapsed. Home prices still haven't recovered: U.S. home prices fell in March (the latest data available), ending the first quarter at the lowest levels since the housing crisis began in mid-2006, according to Standard & Poor's Case-Shiller home-price indexes. Prices are down roughly 35 percent from their peak in the second quarter of 2006.

"Essentially, as soon as the government stops the expansion, you are going to hit one of these deflationary corrections with all of the nasty business cycles that accompany it," Lu said.

And often how the government reacts to that is with additional stimulus. For a third year in a row, the U.S. is seeing an economic slowdown and in response, policymakers could be unveiling policy sequels such as: Fiscal Stimulus 4, Operation Twist 2 or Quantitative Easing 3.

"They are basically keeping the thing going by continuously adding money and credit," Lu said. "This is just delaying the correction we need."

"We've been prolonging the agony, and the final correction will be much worse than it had to be," Lu said.

Let Them Fail

The depression of 1920-21 shows why the Fed should sit on its collective hands at their June Federal Open Market Committee meeting.

From the spring of 1920 to the summer of 1921, nominal gross domestic product fell by 23.9 percent, wholesale prices by 40.8 percent and the consumer price index dropped by 8.3 percent. Meanwhile, unemployment topped out at about 14 percent from a pre-bust level of as low as 2 percent.

In response, the administration of Warren G. Harding balanced the budget and the Fed tightened money supply, pushing up short-term rates in mid-depression to as high as 8.13 percent.

Harding also decided to let the ailing businesses fail. Then something wonderful happened: The economy purged itself and by 1923, the nation's unemployment rate fell back to 3.2 percent.

There was no government bailout, no rock-bottom interest rates, no QE, no stimulus of any kind. Yet the depression ended.

"We actually need a deflation. Believe it or not, it's actually healthy," Lu said. "However painful it is, deflation is the natural consequence of prior inflation and is a necessary step in the economic recovery."

"Trying to avoid it through additional Fed action will prolong the depression," Lu said.

http://www.ibtimes.com/articles/348727/20120605/federal-reserve-qe3-deflation-risk-quantitative-easing.htm?page=all

 

[Warm Wisconsin]

I don't think people understand deleveraging

Can't out print deleveraging. JMHO

Guest Post: The Pernicious Dynamics Of Debt, Deleveraging, And Deflation\

The Pernicious Dynamics Of Debt, Deleveraging, and Deflation

At this moment, the news media is constantly clamoring about the "Three Ds" that are buffeting the markets: debt, deleveraging, and deflation. We intuitively sense that they're linked -- but how, exactly?

Understanding this linking is critical; as debt has fueled the global expansion, it will also dominate its contraction.
Debt and Deleveraging

To illustrate the forces of debt and deleveraging, let’s consider a home mortgage.

Suppose a buyer of a $100,000 home qualifies for a mortgage that requires only a 3% down payment in cash. The buyer ponies up $3,000 in cash and obtains a $97,000 mortgage. The cash collateral is thus leveraged about 33-to-1: Each $1 in cash has been leveraged into $33 of borrowed money.

Let’s say the owner wants to refinance at a later date, and to qualify for the new loan he must have 20% collateral for the new loan. (This is a simplified scenario; we will consider more complex examples later.) If the house value remains around $100,000, then the owner must boost collateral by paying down the mortgage $17,000. This boosts collateral to $20,000 (20%) while reducing the mortgage to $80,000.

The leverage has been slashed from 33-to-1 to 4-to-1: now each $1 of collateral leverages $4 of borrowed money. This is deleveraging.

Another common example is a margin stock-trading account. J.Q. Speculator can leverage his cash collateral 2-to-1 via margin: If he has $100,000 cash in his account, he can buy $200,000 of stocks. If (heaven forbid) the stocks he purchased decline in value by $50,000, then his collateral has shrunk to $50,000. Since margin accounts cannot exceed a 2-to-1 leverage, he must either sell enough of his portfolio to return the leverage to 2-to-1 (that is, $50,000 in cash value and $100,000 in stocks), or he must deposit another $25,000 in cash (that is, $75,000 in cash/cash value) to collateralize the $150,000 in stocks he owns.

When credit is cheap and abundant, prices of assets tend to rise in self-reinforcing bubbles. If J.Q. Speculator’s portfolio of $200,000 rises by 50% to $300,000, then his collateral increases to $200,000. This expansion of collateral enables him to buy another $100,000 of stocks, as $200,000 in cash value can leverage $400,000 in stocks.

The same mechanism enabled home owners to leverage up their rising equity to buy additional homes.

When the debt cycle turns and asset bubbles pop, collateral declines and lenders are stuck with losses as over-extended borrowers hand the keys to underwater houses back to the lenders. These losses are subtracted right off the bank’s own equity (cash reserves), which are typically a modest 4% of loans outstanding. That is, the bank leveraged each $1 of cash collateral into $25 of mortgages.

If mortgage losses eat away that 4% of cash, then the bank is technically insolvent. As a result, banks become wary of extending risky loans in eras of credit contraction: Their fiscal survival focuses their attention on dumping liabilities and building cash reserves (collateral). The credit spigot is turned off, and all those down the line who were counting on easy abundant credit to bankroll their leverage are left high and dry. As credit contracts, demand for assets and commodities contract, and a wave of selling begins as cash is desperately in demand.
Leverage and Derivatives

In an extreme example, if a bank has $1 million in outstanding loans and has suffered losses such that its cash has declined to $1, it is leveraged 1-to-1-million. It must liquidate enough liabilities and concurrently raise enough cash to restore its 1-to-25 leverage (i.e., 4% of the outstanding loans are in cash reserves).

The problem is that liquidating liabilities requires the bank to absorb any losses generated by the sale/write-down of loans. If the bank sells a house for $50,000 that carried a $100,000 mortgage, the $50,000 loss is subtracted from its cash reserve.

The bank has a difficult mandate: Get rid of as many liabilities as possible without incurring losses that will bankrupt the bank. The alternative strategy is to sell unleveraged assets to raise cash or slowly build cash by earning interest.

To restore the 1-to-25 leverage of its $1 million in loans, the bank needs to raise at least $40,000 in cash. It has two basic ways to reach this goal: Either keep all of the impaired loans it owns on the books at full value—in other words, ignore the declining market value of the homes underlying the mortgages—and slowly accumulate cash from deposits and interest, or sell non-leveraged assets such as gold, bonds, or property it owns free and clear to raise the $40,000. (Again, this is a simplified example.)

If the bank’s management is dominated by wise-guy “operators,” then it might pursue another strategy, selling derivatives against assets it doesn’t own. The derivatives are sold for cash and hedged against losses by buying derivatives covering the other side of the trade from another institution. The difference between the revenues from selling the derivative contract and the cost of the hedging contract is pure profit that bolsters the bank’s collateral.

If the derivative contract expires or executes as planned, the cash earned from the sale of the derivatives is pure gravy.

If the derivative contracts trigger losses, then the bank turns to the other institution that it bought the hedge from to make good the losses. If that institution fails to make good, or the losses of the bank’s derivatives are not fully covered by the hedge, then the bank must raise enough cash to pay the buyer of the derivative.

The need to raise cash by selling assets leads back to the original problem. Liquidating liabilities, such as mortgages, by selling the underlying assets (houses) forces the bank to book losses it is ill-prepared to absorb.
Deleveraging and Deflation

This example illustrates the pernicious dynamics of debt and deleveraging. The bank cannot declare the true value of its assets (houses that have fallen in value), nor can it sell the houses and take the resulting huge losses, as its cash reserve (collateral) is already at dangerously high levels of leverage (or even negative -- i.e., the bank has no real collateral at all and is insolvent).

Ascertaining the true collateral of any household or enterprise is straightforward. Sell all of the assets on the open market and pay off all of the liabilities. The cash remaining is the collateral.

In highly-leveraged households and enterprises, the impaired assets are held, as the sale of the underlying asset would force the entity to declare its insolvency. So homeowners who are “underwater,” i.e., their mortgage exceeds the value of their home, continue paying the mortgage because selling the house would require them to come up with the difference between the value and the loan in cash. The alternative is to declare bankruptcy and give up any hope of leveraging future income into new loans.

The same basic mechanism is at work in companies and banks.

Ironically, perhaps, the process of raising cash by selling assets inevitably places a premium on unleveraged assets such as precious metals, collectibles, Grandma’s house that is now owned free-and-clear by her heirs, etc. Everything that has been leveraged is held, lest its true value be disclosed by the market, while everything that has retained some measure of its cash value is unloaded to raise cash—either to pay the interest on debt or to recollateralize the entity’s shaky finances.

The key point here is that the outstanding debts far exceed the cash value of the underlying asset; selling everything including the kitchen sink doesn’t even come close to paying off the entire debt. Selling everything that isn’t nailed down simply maintains the much-valued illusion of solvency and puts the reckoning off for another day. The hope of course is that assets will reinflate to their old bubble valuations, but the forces of deleveraging outlined above power relentless selling that eventually overwhelms supply.

The market “discovers” price as demand transparently interacts with supply. When supply exceeds demand, prices fall. And since price is set at the margin, even modest imbalances of supply and demand can lead to cascading declines in prices.

For example, the value of a neighborhood of 100 houses is not set by the sale of all 100 homes; it is set by the last few sales. Thus the last five sales determine the value of the other 95 homes.

Deflation is simple to define: Cash buys more real goods and services than it did last year. Cash is what’s in demand, and assets that depend on credit are not in demand. Rather, they are being sold to raise cash. It’s simple supply and demand: Cash rises in value as it’s in demand, and assets decline as the demand is lower than the supply.

In Part II: The Deleveraging Pain Is Just Beginning, we look at how much longer the U.S. might need to recover from its long deleveraging hangover from multiple global asset bubbles, and why building cash (and cash equivalents) at this time is especially prudent.

Click here to access Part II of this report (free executive summary; paid enrollment required for full access).

 

[Warm Wisconsin]

Betting on QE3? Not So Fast…

The market’s Spidey sense seems to be tingling over the prospect for another round of Federal Reserve policy action. Exhibit A would be gold’s rise 4% rise recently, back above the $1,600 mark per troy ounce. Various market watchers are also chiming in with their expectations that the Fed is going to announce something at their June 19-20 policy meeting. Morgan Stanley economists peg the chances at 80%, writing in a recent note:

Slower employment growth, worsening strains in European markets, and a gloomier assessment of U.S. politicians’ ability to steer clear of the impending fiscal cliff makes it likely that the Fed will mark down its already tepid forecast. This should provide all the justification the Fed needs to launch further unconventional policy action via changes in its balance sheet.

Michael Feroli, J.P. Morgan’s economist puts the odds at 50/50:

We are closer to even odds on seeing more balance sheet accommodation, and if it were to happen we think the path to Twist 2 is easier than to QE3; and if there were another Twist we would see a mix of Treasuries and mortgages being purchased. The shelf life of this guess may be shorter than usual, as we will be hearing from several of the Fed’s key decision makers this week.

That’ll make Thursday a big day. That’s when Fed Chairman Ben Bernanke testifies before a joint economic committee in Congress. Markets are expecting that he’ll tip his hand as to what the central bank might do, says Joe LaVorgna, economist at Deutsche Bank.

Given Mr. Bernanke’s strong desire for policy transparency, investors believe the Chairman will effectively tell us whether the Fed is going to embark on an extension of “operation twist” or undertake QE3, when policymakers meet later this month. The consensus of analysts is for further easing, but we continue to wonder what this would accomplish.

Far be it for us to differ. But we would point out that one of the Fed’s favorite gauges of inflation isn’t yet tumbling to levels that presaged previous episodes of Fed bond buying.

Behold! We give you the “five-year, five-year-forward” break-even rate, which measures inflation expectations starting five years from now and running five years from that date. (This is the version published by Credit Suisse, on its Locus data platform.)

Credit Suisse

In the past, the Fed has been quick to act when it seems that the risk of deflation is growing. But in this chart it doesn’t seem like the market is pricing in much of a chance of deflation. So what gives?

Well, some folks say that inflation expectations have held up precisely because expectations are so strong that the Fed will launch some sort of new program soon. In other words, the markets are taking it for granted that the Fed would step in to push inflation expectations right back up if they started to fall, so it’s not letting them fall in the first place. To be sure, the recent collapse in futures prices for crude and gasoline don’t seem to augur any inflationary push anytime soon.