More on Deflation - Daniel Gross

I like reading Daniel Gross, but he's been mailing it in for about five months now. Probably fatigue from peddling his book. But, now he's just getting sloppy.

Economists generally agree that deflation is a widespread fall in prices, as measured by the consumer price index (CPI).

That economists generally agree on anything is news to me. Deflation has many definitions. Some would argue that there are multiple species of deflation.

For example, there is the phenomenon of debt deflation -- where credit was extended far and wide without proper risk assessment. Always this leads to creditors chasing too many debtors who cannot pay. Always this chokes the supply of money from lenders to borrowers.

There is also the type of deflation referenced by Gross, whereby prices of things go down in a domestic market. Price deflation can result from innovation (things being made cheaper) or from oversupply. Price declines from innovation are different from price declines from oversupply. For example, precision machining may lead to fewer error rates in a manufacturing process, which benefits the manufacturer's bottom line by reducing the cost of production. Some of that savings is passed on to consumers. Some is gobbled up as profit, depending on the level of competition in the industry. Suppliers to the manufacturer see no net change, unless the lowered price leads to greater demand -- in which case suppliers may see a benefit to the innovation-driven price decline. Maybe jobs will be created.

Price declines from oversupply are a bad deal for the companies selling the product. For example, many areas have too many houses right now. This means homes can be bought for cheap (especially with interest rates set to prevent a worsening of the depression). It also means many sellers are taking a loss. It also means home builders have to build fewer homes than planned. This means the suppliers to the builders will take a hit. People will get laid off.

There are other forms of deflation, too, such as an insufficient level of money printing. Or the decline of derivatives creation.

My guess is that we are in a state of multiple layers of deflation. Debt deflation, price declines from oversupply, and a complete derivatives Armageddon. One could make the case that the printing presses are not running at capacity, either. I know DeLong and Krugman would agree. So would Martin Wolf.

As for price declines from innovation, this is where it gets tricky. A lot of the innovation we have seen in the past fifteen years has actually been a political and economic innovation: globalism. Really, shunting off manufacturing to Asia to take advantage of the low cost of labor. This will reverse itself to some extent as Asian populations demand a chunk of the consumer pie, which will send some portion of their colossal aggregate savings into merchants’ pockets. This increase in demand will lead to price increases for everyone. These price increases, given the tendency for things to fall to shit all at the right time, will hit us just as our debt deflation is the worst. Meaning, just when we can afford it the least.

Indeflation, or Indigestion?

Deflation is still real, thanks to European banks holding sketchy sovereign debt. The poor stock markets are getting battered as the carry trade reverses. How this works is simple: European banks borrow dollars or yen, then trade stocks with the borrowed money. Basically, the banks are playing with free money because the borrowing rates that big players enjoy are close to zero. Well, now the European banks don't trust each other's collateral so they need to be back in cash to fulfill their capital requirements and pay their bills. So, they sell their stocks, using the cash to make payroll or to buy safe US Treasurys (used for collateral for overnight borrowing). Plus, Treasurys and other US guarantees are trading for higher than book value, so banks can trade them out for a greater rate of return than they'd see in this stock market anyway.

Meanwhile the printing presses continue to work overtime. Why would they do that? Again, for a simple reason. Politicians have decided that is is more palatable to inject blood into zombie banks than to let them fail. The story is getting old, but we're not writing any new chapters. So we have simultaneous inflation and deflation. Indeflation.

Bilderberg Update

The Bilderberg Brahmins released their "agenda":

The Conference will deal mainly with Financial Reform, Security, Cyber
Technology, Energy, Pakistan, Afghanistan, World Food Problem, Global Cooling,
Social Networking, Medical Science, EU-US relations.

Here is what I expected they would discuss:

• Debt deflation
• Spain
• Greece
• Turkey
• Maintaining European competitive advantage against emerging economies
• Social decline of the west

I imagine "financial reform" is actually a cover for fiscal reform. Financial reform can be discussed openly. Fiscal reform, however, is a fertile soil for popular anger. "Security" is code for the ongoing conflict between the West and Islam. "Cyber technology" can only refer to China and its army brigades of hackers -- or perhaps the loose band of Russian nationalist hacktivists. And so forth.

The two topics that surprise me are "medical science" and "global cooling." To be honest, seeing these listed made my skin crawl. Why in the hell would these people want to discuss about medical science? I don't see it, unless it's in the context of health care costs and the untenable welfare state. And, global cooling? Is there something we should know?

I wonder who's job it was to explain Twitter to Henry Kissinger . . .

Bilderburg 2010

I'm not into the Alex Jones scene, believe me, but Bilderburg always gets me thinking. Based on the leaked attendees list, here is my take on the themes:

• Debt deflation
• Spain
• Greece
• Turkey
• Maintaining European competitive advantage against emerging economies
• Social decline of the west

Think I'm wrong? Then why did Niall Ferguson get the invite, but Krugman didn't? If I was in charge, I would arrange the agenda as follows:

• Debt deflation
• Russian integration into the European economy (you know, because the failure to do so allowed WWI to happen)
• Alternative energy, i.e., anything but Middle Eastern oil
• Finding buyers for European and American goods, i.e., JOBS!

PIMCO

Am I the only one who thinks that PIMCO is behind all the public debt hysteria? Like the the Rothschilds before them, PIMCO will make a fortune by convincing everyone that public debt must be reduced -- which would decrease the supply of bonds, which would increase their market price.

Two Simple Thoughts

If the economy is going to lag, then seeking dividends is the only sensible way to allocate capital.

If employment stays low, then interest rates will, too. That's how the Fed works. Thus, assets will re-inflate (cheap money is too tempting to pass up), which will set the stage for yet another burst bubble (a bank failure in Austria was the spark that ignited the Great Depression). If that's the case, the only risk-approved way to allocate capital is to invest in blue chip companies that have the power and resilience to weather another broad decline. If those companies have been shown to be favored by the government (ahem, big finance, automobiles, GE), so much the safer, right?

And one less simple thought. The economy has found its footing. The housing market has found its bottom nationwide (more or less, regions and neighborhoods have decoupled, which is a sign of fundamental strength). Greece and the other PIGS will find a bailout. China will allow its currency to float a bit. These are all very good signs, but the question remains as to whether the skeleton has healed. A human body in traction is fragile, even if you dress it in Armani. I still believe that America faces a necessary step backwards in its standard of living. My reasons for this are not motivated by envy of the uber-rich, or a loathing of materialism. My gut math just doesn't add up. I can't help but think that the American consumer has been the victim of a macro version of a pump-and-dump scheme. Multinational corporations invest in facilities where labor is cheap, then sell the manufactured crap to Americans. Once the cost of money stabilizes (in part the dollar's relative strength is a result of a lack of confidence in other people's money -- increasing lack of trust in the American system and the American fisc will bring the dollar down), the dollar will find itself extremely overbought. Then multinationals will dump their junk on the next round of suckers (India, Brasil, China?).

And what will Americans do for a living? Build more houses?

Home Prices: Or, Why We Hate Economists

Here is probably the most ridiculous evaluation of home prices I have ever seen. Seriously, I read better analysis in the comments below Tech Ticker postings on Yahoo! finance.

http://economix.blogs.nytimes.com/2010/04/06/why-your-houses-value-probably-wont-rise/

Of all the things that factor into a home's price, cost of construction is ridiculously inconsequential.