Tag: deflation

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Harry S Dent: Why the Fed will fail

Harry Dent is always entertaining to listen to, but is he right about the link between demographics and inflation?

There is simply no way the Fed can win the battle it’s currently waging against deflation, because there are 76 million Baby Boomers who increasingly want to save, not spend. Old people don’t buy houses! At the top of the housing boom in recent years, we had the typical upper-­‐middle-­‐class family living in a 4,000-­‐square-­‐foot McMansion. About ten years from now, what will they do? They’ll downsize to a 2,000-­‐ square-­‐foot townhouse. What do they need all those bedrooms for? The kids are gone. They don’t visit anymore. Ten years after that, where are they? They’re in 200-­‐square-­‐foot nursing home. Ten years later, where are they? They’re in a 20-­‐square-­‐foot grave plot. That’s the future of real estate. That’s why real estate has not bounced in Japan after 21 years. That’s why it won’t bounce here in the US either. For every young couple that gets married, has babies, and buys a house, there’s an older couple moving into a nursing home or dying.

In my opinion there is a clear link between credit growth and inflation: the faster credit grows, the faster the money supply grows, and the higher the rate of inflation. Demographics are one of the factors that drive credit growth, but they are not the only factor. Interest rates are just as important: when interest rates are low we tend to save less and borrow more. And jobs, as the Fed discovered, are also important: if you haven’t got a job, you can’t borrow from the bank even when interest rates are low.

At present I would guess that jobs are the biggest constraint on credit growth. Later, interest rates will rise when employment recovers — as the Fed attempts to take some of the heat out of the economy. Only then may demographics become the major restriction on credit growth, with older households down-sizing outnumbering younger households up-sizing. But that is by no means definite: solving the jobs crisis alone could take decades!

Harry dent quoted from John Mauldin | A Decade of Volatility: Demographics, Debt, and Deflation (application/pdf Object).

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The Fed and the impact of QE

Unless the Fed announces a new round of quantitative easing before the November election, I do not see the S&P 500 this year advancing past its 2007 high of 1560.

The market generally overreacts to balance sheet expansion by the Fed, anticipating higher inflation. What it seems to overlook is the deflationary effect of private sector deleveraging which should enable the Fed to maneuver a soft landing.

The real impact of Fed policy is to subsidize debtors and starve creditors — private investors and pension funds — of yield. The net result is that investors are driven to higher yields — accompanied by higher risk — which is likely to cause more pain at the next down-turn.

The only way to compensate creditors would be to lower taxes on interest, but I question how high this would rank in either party’s priorities.

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Inflation/Deflation Face-Off: Harry Dent v. James Rickards

At the latest Casey Research conference, Recovery Reality Check, James Rickards, senior managing director of Tanget Capital Partners and author of Currency Wars: The Making of the Next Global Crisis, debates Harry Dent, founder and president of HS Dent Foundation, on the subject of which is more likely in the near-term economic future, inflation or deflation.

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German Adjustment – NYTimes.com

Paul Krugman: Germany believes that its successful adjustment was the result of its own virtue, but in reality it was successful in large part because of an inflationary boom in the rest of Europe.

And here’s the thing: the Germans are now demanding that the European periphery replicate its achievement (and actually surpass it, because the required adjustment is much bigger) without providing a comparably favorable environment — they’re demanding that Spain and others do what they never did, which is deflate their way to competitiveness.

This is a road to disaster.

via German Adjustment – NYTimes.com.

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Mark Carney: Growth in the age of deleveraging

Today, American aggregate non-financial debt is at levels similar to those last seen in the midst of the Great Depression. At 250 per cent of GDP, that debt burden is equivalent to almost US$120,000 for every American (Chart 1).

US Debt/GDP 1916 - 2011

…..backsliding on financial reform is not a solution to current problems. The challenge for the crisis economies is the paucity of credit demand rather than the scarcity of its supply. Relaxing prudential regulations would run the risk of maintaining dangerously high leverage – the situation that got us into this mess in the first place.

As a result of deleveraging, the global economy risks entering a prolonged period of deficient demand. If mishandled, it could lead to debt deflation and disorderly defaults, potentially triggering large transfers of wealth and social unrest.

Managing the deleveraging process

Austerity is a necessary condition for rebalancing, but it is seldom sufficient. There are really only three options to reduce debt: restructuring, inflation and growth. Whether we like it or not, debt restructuring may happen. If it is to be done, it is best done quickly. Policy-makers need to be careful about delaying the inevitable and merely funding the private exit.

……Some have suggested that higher inflation may be a way out from the burden of excessive debt. This is a siren call. Moving opportunistically to a higher inflation target would risk unmooring inflation expectations and destroying the hard-won gains of price stability.

…..With no easy way out, the basic challenge for central banks is to maintain price stability in order to help sustain nominal aggregate demand during the period of real adjustment. In the Bank’s view, that is best accomplished through a flexible inflation-targeting framework, applied symmetrically, to guard against both higher inflation and the possibility of deflation.

The most palatable strategy to reduce debt is to increase growth. In today’s reality, the hurdles are significant. Once leverage is high in one sector or region, it is very hard to reduce it without at least temporarily increasing it elsewhere.

In recent years, large fiscal expansions in the crisis economies have helped to sustain aggregate demand in the face of private deleveraging. However, the window for such Augustinian policy is rapidly closing. Few except the United States, by dint of its reserve currency status, can maintain it for much longer.

…..The route to restoring competitiveness [in the euro-zone] is through fiscal and structural reforms. These real adjustments are the responsibility of citizens, firms and governments within the affected countries, not central banks. A sustained process of relative wage adjustment will be necessary, implying large declines in living standards for a period in up to one-third of the euro area.

…..With deleveraging economies under pressure, global growth will require global rebalancing. Creditor nations, mainly emerging markets that have benefited from the debt-fuelled demand boom in advanced economies, must now pick up the baton. This will be hard to accomplish without co-operation. Major advanced economies with deficient demand cannot consolidate their fiscal positions and boost household savings without support from increased foreign demand. Meanwhile, emerging markets, seeing their growth decelerate because of sagging demand in advanced countries, are reluctant to abandon a strategy that has served them so well in the past, and are refusing to let their exchange rates materially adjust. Both sides are doubling down on losing strategies. As the Bank has outlined before, relative to a co-operative solution embodied in the G-20’s Action Plan, the foregone output could be enormous: lower world GDP by more than US$7 trillion within five years. Canada has a big stake in avoiding this outcome.

Mark Carney: Growth in the age of deleveraging.

Comment: ~ One of the most important papers I have read this year. Mark Carney, Governor of the Bank of Canada and Chairman of the Financial Stability Board — established by the G-20 in 2009 to further global economic governance — maps out the hard road to recovery from the current financial crisis.

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Fragile and Unbalanced in 2012 – Nouriel Roubini – Project Syndicate

The outlook for the global economy in 2012 is clear, but it isn’t pretty: recession in Europe, anemic growth at best in the United States, and a sharp slowdown in China and in most emerging-market economies.

……Adjustment of relative prices via currency movements is stalled, because surplus countries are resisting exchange-rate appreciation in favor of imposing recessionary deflation on deficit countries. The ensuing currency battles are being fought on several fronts: foreign-exchange intervention, quantitative easing, and capital controls on inflows. And, with global growth weakening further in 2012, those battles could escalate into trade wars.

via Fragile and Unbalanced in 2012 – Nouriel Roubini – Project Syndicate.

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Deleveraging is over — it’s time to cut the deficit

US commercial bank loans and leases bottomed in April 2011, after shrinking more than $1 trillion in the previous two years. The annual rate-of-change has now recovered to positive territory, relieving downward pressure on asset prices, including stocks and real estate. Deleveraging has come to an end and is only likely to resume if the economy suffers further financial shocks.

US Commercial Bank Loans and Leases (incl. Securitized Loans)

You would expect the gap between savings and investment to close when net debt repayments cease, but a significant shortfall between Gross Private Savings and Domestic Investment warns of continued instability.

Gross Domestic Private Investment and Savings

The Investment – Savings gap is reflected by strong, negative Net Private Investment on the chart below. If it were not for the fiscal deficit, the US would risk a significant contraction in national income.

Net Domestic Private Investment and Fiscal Deficit

For the benefit of those who may have missed my earlier coverage of this issue:

Debt repayment after a financial crisis/balance-sheet recession creates a gap between savings and investment that has serious implications for the economy. The resultant shortfall between spending and income risks a sharp contraction in national income. The gap may be relatively small but, like a puncture in a car tire, the impact can be huge. It only takes each of us to withhold 2% of what we earn (e.g. to repay debt) for a gap to appear between spending and income. A for example may earn $1.00 but now only pays 98 cents to B, who will pay 96.04 cents to C, who will pay 94.12 cents to D, and so on through the entire supply chain. By the time we get to L, they will only earn 80 cents where they previously earned $1.00.

The solution, as Keynes pointed out, is for government to offset the shortfall by running a fiscal deficit. The chart above shows that Treasury has been doing exactly that — spending more than they collect by way of taxes — in order to prevent a contraction. The problem is that continual deficits have two serious side-effects. The first is a loss of investor confidence as the ratio of public debt to GDP rises. The second is inflation — if private investment recovers and starts competing with government for ever-scarcer resources. By inflation I do not just mean an increase in the CPI, but also rising asset prices as experienced in the 2004 to 2008 housing bubble, when government ran a deficit while net private investment was positive.

As the chart shows, the fiscal deficit is being funded by net savings (plus a little help from China). So what would happen if we cut the deficit?

  • An optimistic view would be that cutting the deficit would restore confidence and encourage more private investment, shrinking the savings – investment shortfall.
  • Pessimists, however, would warn that private sector balance sheets have been impaired by falling asset prices and investors are reluctant to borrow even at current low interest rates. A shrinking deficit without a counter-balancing rise in investment would send the US back into recession.

The truth lies somewhere in between. Corporate balance sheets are generally in good shape while small-to-medium business and home-owners have suffered significant impairment. And one of the major factors inhibiting investment is the uncertain political/economic environment.

Deleveraging has ended and the time has come to start cutting back the government deficit — but cautiously. Cutting the entire deficit in one hit would be more of a shock than the economy could bear, but setting out a four-year plan to cut the deficit by say 2 percent a year would do a lot to restore confidence and set the economy on a path to recovery.

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Roubini: Moving From the Post-Bubble, Post-Bust Economy to Growth | Credit Writedowns

It is not only the U.S. economy that is in peril right now. …Europe is struggling to prevent the sovereign debt problems of its peripheral Euro-zone economies from spiraling into a full-fledged banking crisis… Meanwhile, China and other large emerging economies… are beginning to experience slowdowns…Nor is renewed recession the only threat we now face. Even if a return to negative growth rates is somehow avoided, there will remain a real and present danger that Europe and the United States alike fall into an indefinitely lengthy period of negligible growth, high unemployment and deflation, much as Japan has experienced over the past 20 years following its own stock-and-real estate bubble and burst of the early 1990s.

via Roubini: Moving From the Post-Bubble, Post-Bust Economy to Growth | Credit Writedowns.

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The Sceptical Inflationist | Steve Saville | Safehaven.com

The reason we are in the inflation camp is that the case for more inflation in the US doesn’t depend on private-sector credit expansion; it depends on the ability and willingness of the Fed to monetise sufficient debt to keep the total supply of money growing. A consistent theme in our commentaries over the past 10 years has been that the Fed could and would keep the inflation going after the private sector became saturated with debt.

Up until 2008 there was very little in the way of empirical evidence to support the view that the Fed COULD inflate in the face of a private sector credit contraction, but that’s no longer the situation. Thanks to what happened during 2008-2009, we can now be certain that the Fed has the ability to counteract the effects on the money supply of widespread private sector de-leveraging. The only question left open to debate is: will the Fed CHOOSE to do whatever it takes to keep the inflation going in the future?

via The Sceptical Inflationist | Steve Saville | Safehaven.com.

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