Fleckenstein (and others)
State the Deflation Case
Mike "Mish" Shedlock
Aug 9, 2007
I was surprised to see Bill
Fleckenstein, a long time believer in inflation, state the case
for a Japanese style deflation in the US. But it's right here
in America
follows Japan's misguided path.
"....Given all our problems
related to debt, I thought it might be worthwhile, particularly
for new readers, to provide a brief history leading up to where
we are now.
Taking a big step back, the
Bank of Japan acted foolishly throughout the 1980s, which caused
that country to experience enormous real-estate and stock bubbles.
Japan's stock bubble was really a residue of its real-estate
bubble -- actually a credit bubble, as the banks lent money to
any corporation with a pulse. (Does that sound familiar?)
Then the institutions that
lent the money took forever to write off the bad loans. That's
why Japan's real-estate market, stock market and economy did
so poorly for more than a decade.
Free money exacts a price
After [the dotcom] bubble,
Greenspan took a page out of the Bank of Japan's book and lowered
rates to 1%. That helped precipitate the housing bubble here
that ended in 2005.
As to why the unwinding has
taken so long to commence, only recently has the cause become
clear: the mark-to-model fantasy employed by those who have bought
the sliced-and-diced mortgage paper.
But the fantasy is unraveling
as these structured-credit products are now slowly being marked
to market. Just as virtually every subprime-mortgage lender has
blown up, Alt-A lenders (the next rung up the ladder creditwise)
will blow up -- and, ultimately, many hedge funds will blow up,
though we're in the early days of that process.
In the years since our equity
bubble peaked, trillions of dollars' worth of debt have piled
up throughout corporate America. So now, as we enter recession,
we will experience not just a weak economy, real-estate market
and stock market, but the exacerbating effect of a mountain of
bad debt, completing the analogy to Japan of the 1990s.
Like it or not (and I suspect
he might not because he did not use the D-Word itself) Fleckenstein
described how and why a Japanese style deflation is headed for
the US.
Economist Paul Kasriel at the
Northern Trust also describes how a Japanese style deflation
can occur in the US. Please read Interview
with Paul Kasriel if you have not yet done so.
The D-Word
Two of my favorite professors
on Minyanville are
not afraid to use the D-Word (deflation). Point #1 in Kevin Depew's
daily dose of Five Things was FOMC
Preview: Their Greatest Fear.
"..... Stocks may still
be up but as Professor Bennet Sedacca noted on the Minyanville
Buzz and Banter this morning, financials rallied huge yesterday,
but what about corporate spreads, the true barometer of the health
of the financial industry? "Believe it or not, spreads on
brokerage and bank corporates are actually wider than yesterday
morning," Sedacca said. That means someone has it wrong.
Either equity investors haven't woken up to credit market problems,
or credit markets are overestimating the risk of owning corporate
debt. "My guess is the credit market has it right,"
he said.
This explains in part why it
feels so treacherous right now. If the markets have decided that
too much credit is too easily available, as it appears they already
have, then the Fed can simply lower rates to make credit more
available. Problem solved. But what if there are two separate
but related forces at work: tightening lending standards and
reduced credit appetites? Then the Fed has something more serious
on their hands.
The key in all of this is not
inflation, as most believe. The Fed says they are most worried
about inflation risks, but the reality is that they are most
worried about deflation risks. Always. Always deflation. The
Fed has no choice but to always remind us that the risks are
tilted toward inflation, just as the Treasury Secretary, whichever
one happens to be in office at the time, must always say that
the U.S. maintains a strong dollar policy, even if monetary policy
and fiscal policy are conspiring to devalue the dollar.
As for equities, when the dollar
begins to rise, and it appears the Fed finally will begin to
cut rates, as they inevitably must to try and sustain credit
consumption, then it's time to worry. That means deflation is
winning.
The Fed is Keeping the Top Spinning
One of the best articles I've
on the subject of deflation was Mr. Practical's (Professor John
Succo's) article today on Minyanville: The
Fed is Keeping the Top Spinning.
"The "strong U.S.
economy" has been pushed and pushed along by 25 years of
hyper credit expansion fostered by the Federal Reserve. When
witnessing the tumultuous results of just a slowing down of the
credit expansion, one can only imagine the problems that will
surface once credit begins to contract in earnest.
And here lies the crux of the
matter: what the Fed has done over the last 25 years is artificially
decrease the relative value of real money in the U.S. system
while increasing the relative value of debt. It has done so with
no concern for the level of income generated to pay that debt
back. The Fed through their hyper expansionary credit policy
and Wall Street through financial engineering have loaded the
system with debt not supported by a commensurate level of future
(present) income.
But the Fed has been able to
accomplish what it has only because investors, for the above
reasons, have lost sight of this hidden risk. The Fed doesn't
really have the power to create more and more of this artificial
liquidity called debt; they need investors to cooperate. Here
is why.
The Fed really only can do
two things (Prof. Succo has explained this situation, but let's
go over it again). [Mish comment: Prof. Succo's previous explanation
follows these excerpts]. They can lower margin requirements for
banks, the amount of capital they have to hold to make loans.
That it has already driven to basically zero. So the Fed cannot
allow banks any more "leeway" than it already has.
They can also perform open
market money operations like REPOS and coupon passes. The Fed
calls up big banks and buys their government bonds out of their
portfolio. But they don't buy them with real money; they buy
them with credit newly created just for that purpose. The big
bank can then lend that credit out in a much greater amount because
the Fed only requires them to keep a small fraction of that credit
to support whatever the bank wants to lend out. This is our wonderful
fractional reserve system. If everyone went to the bank to get
their "savings" at once they would find that they could
get out less than 1%.
But here is the key. The bank
must ultimately be willing to lend it and then find some investor
to borrow it. This has been no problem whatsoever over the last
several years. Now most investors realize that they have too
much debt, that their level of income cannot support it. Banks
realize this too and have increased their lending requirements.
The last borrower is always the most aggressive speculator.
So most market participants
are now looking for ways to pay back debt (deflation) just when
the Fed is desperate to get investors to borrow more (inflation).
The top is only beginning to
wobble. When people tell me "there is so much money out
there" I tell them that no, there is so much credit out
there. This will be a muli-year process of debt reduction and
deflation to correct what the Fed has wrought.
Best regards,
Mr. Practical
Those are small snips from
a great article. I recommend clicking on the link above and reading
the entire piece.
Money vs. Debt
As noted earlier here is Minyanville
professor John Succo on Money
vs. Debt.
"Mini-Minyan Mailbag
Minyan MC to Professor Succo:
I was given these general statistics
on U.S. circulation of dollars, and I was wondering if they were
somewhat accurate?
a
$2 trln was put in circulation from 1776 through 1990
$2 trln more was added and was put in circulation from 1991 through
2000 (for a total of $4 trln)
$2 trln more was added and was put in circulation from 2001 through
2003 (for a total of $6 trln)
$2 trln more was added and was put in circulation from 2004 through
2005 (for a total of $8 trln)
$2.8 trln more was added and was put in circulation from 2006
through 1st half 2007 (for a total of $10.8+- trln)
So, essentially, in the last
six and a half years, circulation of U.S. Dollars has increased
by 170% (10.8 minus 4.0 = 6.8 trln dollars added to the system).
And what do people say about free money?
What do you think?
Professor Succo to Minyan MC:
Minyan MC,
Yes, but it is not really "money". The stats you quote
are "debt".
There is no "money" any more.
The actual money used to be backed by gold.
Actual money stock is 0.001% of what people call the money supply.
The money supply is really the debt supply.
Thanks to Mr. Practical, Kevin
Depew, Paul Kasriel, and John Succo for helping explain how a
Japanese style deflation could hit the US. The key point is deflation
is caused by a massive increase in credit/debt not supported
by a commensurate level of income. In simple terms, there is
no way to ever pay back what has been borrowed. It's also critical
to understand the distinction between a hyperexpansion of credit
and a hyperinflationary printing of money. The former is what
caused the Great Depression (and is happening again now), while
the latter happened in the Weimar republic and is happening right
now in Zimbabwe.
Addendum
My friend who posts on Kitco
under the alias "Trotsky" just pinged me with
this comment: "absolutely correct - this at the root of
the misunderstandings out there. because credit is used as a
money substitute in the financial markets, it acts as an inflationary
force in the asset markets (and this spills over into the real
world as the imaginary wealth thus created leads to overconsumption
and malinvestments), but it is all ephemeral - in the end, it
is still credit, not money. as soon as money is
needed in lieu of credit, such as has now happened in the CMO
and CDO markets, it becomes clear that the money simply
isn't there."
Aug 8, 2007
Mike Shedlock / Mish
email: Mish
http://globaleconomicanalysis.blogspot.com/
321gold Ltd
|
