[patience]

Stoneleigh, one of my all time favorite blog writers, has posted another incisive group of predictions. It's the best summary of what I've seen in various places, and, IMHO, sounds likely indeed.

Sample quote:
"Deflation is inevitable due to Ponzi dynamics (see From the Top of the Great Pyramid)

The collapse of credit will crash the money supply as credit is the vast majority of the effective money supply

Cash will be king for a long time

Printing one's way out of deflation is impossible as printing cannot keep pace with credit destruction (the net effect is contraction)

Debt will become a millstone around people's necks and bankruptcy will no longer be possible at some point"

It gets worse from there--be prepared for some serious doomer porn here.
Read it all and weep, at The Automatic Earth blog.

http://theautomaticearth.blogspot.com/2 ... -your.html

I would love to read responses here to her predictions. A lot of posters here have voiced many, if not all of these concerns, but I haven't seen them collected like this yet. One point struck me hard: "The essentials will see relative price support as a much larger percentage of a much smaller money supply chases them". That seems to me to explain what I think many here have either reasoned out, or intuited as the case going forward. Some state it as "deflation in everything you have, and inflation in everything you need", or similiar. We are apparently seeing this now, or at least the cusp of it.

Comments?

[Caffeine]

Wouldn't these constant bailouts of banks and corporations, as well as the possibility of foreign nations ceasing to use the USD, result in hyperinflation/currency collapse rather than deflation?

Example: A large percentage of US oil is imported from other countries. What happens if oil-producing countries were to cease accepting dollars for oil?

Other examples: imported rice, imported fruit, manufactured goods, etc.

I wouldn't be surprised to see deflation in the prices of "unnecessary" goods, but I would not be at all surprised to see food price inflation, as one example.

[Armageddon]

$this->bbcode_second_pass_quote('Caffeine', 'W')ouldn't these constant bailouts of banks and corporations, as well as the possibility of foreign nations ceasing to use the USD, result in hyperinflation/currency collapse rather than deflation?
Example: A large percentage of US oil is imported from other countries. What happens if oil-producing countries were to cease accepting dollars for oil?
Other examples: imported rice, imported fruit, manufactured goods, etc.
I wouldn't be surprised to see deflation in the prices of "unnecessary" goods, but I would not be at all surprised to see food price inflation, as one example.

[patience]

Caffiene,
(Inflation = larger money supply, deflation = smaller money supply.)
That's what she said, in the last thing I quoted-more money chasing the essentials-because people can't afford anything BUT essentials, in a time of scarce money.

Have to be careful with the terms inflation and deflation, which she is, indicating when she means PRICES changing, and why, vs a change in the money supply.

Stoneleigh says that the US dollar will collapse, but not for a while yet. First comes deflation--the DECREASE in the money supply from a lack of credit. No credit, no money to spend, for many people.

[DantesPeak]

I've seen some famous economists, and some posters here, state that without an increase in the money supply and use of the banks free reserves, there can be no inflation - just deflation.

That concept is totally wrong. As for myself, I am putting my money where my mouth is and heavily betting on high inflation.

Even though the banking system has accumulated $800 billion in free reserves, that new money created by the Fed is being spent. The Treasury issues debt, and the Fed buys it with fiat money. This creates the free reserves for banks when they don't lend it out. However that $800 billion is being spent by the federal government. So even though incomes may be falling, the extra federal spending actually results in an increase in total spending in terms of dollars. This extra spending is the force that creates inflation.

The US government can, and will, eventually create trillions $ in new money. Meanwhile the deflation myth never dies. Review the history of the US after Roosevelt became President in the 1930s and you will see the US attempted a hyperinflationary jump start even back then (a 75% devaluation of the dollar followed by a 75% rise in commodity prices). I only posted that history about 12 times at po.com and I don't feel like looking it up again at this moment, but search some of my older posts for that.

If there was no Fed or paper dollar, then deflation would result, but not with the present financial system.

[Armageddon]

If credit dries up , the money doesn't get into circulation. It only lines their pockets.

[cipi604]

$this->bbcode_second_pass_quote('', 'O')rdinary people are unlikely to be able to afford oil products AT ALL within 5 years

[odegaard]

I agree with DantesPeak.

//

Here's a wild card that I have noticed MOST people never thought of.
I call it the flooding dam analogy.
Imagine a dam that holds back a river and thus creates a large artificial lake.
If the dam breaks there will be a massive flood of water many times more than the regular flow rate of the river.
Getting back to money.

There's a lot of money parked into speculative over-inflated assets like the stock market and real estate.
If society completely losses faith in these "over-inflated assets" and instead decides to throw their money into the "real economy" then there will be a flood of money chasing after consumer goods.
What we will get is:
http://en.wikipedia.org/wiki/Biflation

bonds = down
real estate = down
stocks = down
commodities = up
everyday consumer goods = up

add on:
I'm betting commodities will go up
and yes.....I'm putting my money where my mouth is.

[hironegro]

I don't think the blogger has factored in how break throughs in G.N.R will change the future.

[kjmclark]

Giant Necrotic Retardism? I.e. Zombies???

Number 4 is nonsense: "Printing one's way out of deflation is impossible as printing cannot keep pace with credit destruction (the net effect is contraction)" However, for quantitative easing to work, they have to find a way to get the money to the people who will spend it, which I'm not convinced the Fed and Treasury will manage. (They can try the helicopters, but I would expect the wealthy to pay off the pilot so the first, biggest drop is into the gated communities ) So it's possible to print your way out, but that doesn't mean they'll succeed.

10, "Real estate prices are likely to fall by at least 90% on average (with local variation)" isn't likely either. That's far outside the range of anything in Shiller's historical data. That's into World Made By Hand territory. It's probably possible, but I'd expect it to take a decade of off and on crashes.

And there are important corollaries of #33, "We are headed for resource wars, which will result in much resource and infrastructure destruction" I'm reminded that WWII was a resource war, and started about a decade after the 1929 crash (German invaded Poland in September 1939). War with China over the middle east could mean confiscation of private weapons and ammunition for the war effort, rationing, confiscation of vital resources (gold and silver being necessary for electronics, after all), etc.

I thought yesterday that their list was too dark. This morning I'm thinking that if we don't get our act together and deal with oil depletion, the only things wrong with their list will be the timeframe, and that only one line discussed war.

[kjmclark]

BTW, for the housing prices point, here's a 2005 NYTimes article on Shiller's housing prices index. It's a really good article, and check out the chart that accompanies it.

A nationwide average drop of 90% would mean an index value of around 18. World Made By Hand.

[patience]

Maybe we are all correct on the concepts, and vary on the timing. How about this:

1 Shrinking credit to the consumer reduces their spending (now).
2 Fed wildly increasing money supply to banks, where it does not get to the consumer (now).
3. Later, Govt spending does get this bank money into the economy through deficit spending, resulting in commodity price increases.
4. Meanwhile, lack of consumer spending further crashes credit-dependent items (housing cars, appliances, et al).
5 Govt is desperate to restart the consumer economy, yet can't sell enough bonds to do so, and prints cash with last-ditch abandon = great inflation/dollar devaluation. US consumer dies on the vine.

I see these things as overlapping events, only roughly in this order. I do firmly believe that govt will do their utmost to hold onto power, and with their backs to the economic wall, destroy the currency to inflate away their debts. As China now so broadly suspects.

As T. Jefferson said, first with deflation, then with inflation, they will destroy and impoverish the country. It's the whiplash reversal that makes it nearly imposssible to hedge. That's what I expect. I don't see a way to hedge this whiplash without PERFECT timing, which for me is impossible. And I think we are well on the way now.

[gnm]

I generally agree with DantesPeak. It certainly seems like we should be headed for hyperinflation. I am surprised we are not seeing more inflation right now although gasoline is certainly creeping up. What about the massive black hole of derivatives/CDS? Is that just swallowing all new money creation? The big money question for me is how long foreigners are going to float us credit. most of our trade deficit is energy. What happens when the .gov and the US in general is seen as a bad risk and we can't keep the oil flowing through trade deficit spending. Instant 75% collapse in available liquid fuels?

-G

[TreeFarmer]

In a time of tight energy supplies and huge debts with their associated evergrowing interest, we are in a very bad situation. Once a debt gets large enough, the effects of the compound interest on that debt is uncontrollable and I suspect we are close to that point.

I can't believe I'm say this but, this guy MIGHT have the only concept that will save us from a huge trainwreck. http://mikecane2008.wordpress.com/2008/ ... 0-427-777/

Yes, things look so bleak to me that a Jubilee year seems like a good idea. When we went to a FIRE economy we totally ignored what is captured in tthis quote from Mike Cane, "Economics is supposed to be about creating value, not cancerous debt."



TF

[DantesPeak]

Let me make it clear that I also think we will pass through downwaves in prices, etc., that will be called deflationary periods. Even the early stages of hyperinflation in Weimar Germany were marked by temporary periods where prices fell and the weimar mark rose in exchange value.

But looking at the bigger picture, one should not look just at the Fed. What about the trillions in mortgages now being made by Freddie and Fannie that don't appear in the budget? What about all the countires in the world pegging their currency to the dollar, and by doing so, they also have to undertake an inflationary policy to keep their currency from appreciating in value?

[Stoneleigh]

The money the US government is proposing to throw at this is a pittance compared to the scale of the losses, and much of what they are promising is meant as a confidence trick anyway - like Hank Paulson saying that if you have a bazooka in your pocket you won't have to use it. Unfortunately the market will call their bluff and push them to spend until the bond market has a seizure. Quantitative easing is the beginning of the end. The sucker rally (which we warned people was coming) has given them a 6 month reprieve, but they'll be right back to buying the long end of the treasury curve once the decline resumes. The massive back hole in the derivatives market is indeed swallowing the new money, and that's before we see a large-scale mark-to-market event. The CDS market alone is $62 trillion, and the counterparty risk is enormous as there was no capital adequacy regulation. A meltdown is inevitable, and no one has deep enough pockets to do anything about it.

You cannot print your way out of deflation. If it were that simple there would never be deflation and depression. Do we really think we are so much smarter than our ancestors that we see an obvious answer when they couldn't? That is far too facile. It gives others far too little credit and reflects our modern hubris. Once a ponzi scheme has been fully inflated, the next step is implosion, like Enron only on a vastly larger scale. Every bubble there has ever been has ended this way, with the aftermath roughly proportionate to the scale of the preceding excesses. Given that this is the largest bubble ever, and by quite some margin, it is safe to say that the aftermath will be devastating.

Once the bond market has been pushed too far, we will see interest rates spike and a tsunami of debt default. People and companies will cut way back on spending because they will have no choice. Credit will dry up, jobs will be lost, businesses will close, demand for raw materials and finished goods will crater. People will hoard cash and sell whatever they can for pennies on the dollar. The velocity of money will plummet once the rally is over. How does anyone think we 'll get a wage/price spiral out of that?

[DantesPeak]

Not only can you print your way out of deflation, but the US sucessfully did this in the 1930s following the 75% devaluation in the dollar by Roosevelt and massive increases in the budget deficit:

$this->bbcode_second_pass_quote('', 'P')rice rises in such great world staples as wheat, cotton, rubber and copper have been as thoroughly publicized as the Roosevelt bull market. But the world is full of a number of things just as important to industrial civilization as staples. For a broad view of commodities the businessman leans on the big wholesale price indices, typical of which are those computed by Dun & Bradstreet, the Department of Labor and the Annalist, financial weekly published by the New York Times. Last week a 23-year picture of these indices looked like this:

1914 1920 1925 1933 1937

Jan. Jan. March March Jan.

Dun's . . . . 124 247 202 128 207

Annalist . . 98 233 161 82 139

Labor . . . . 60 158 104 60 85

Over long periods these indices reflect the totality of commodity price changes, but they often lag in revealing price trends over periods of less than a year. For daily distribution by the United Press, a more responsive index is compiled by Dun & Bradstreet from the spot prices of 30 basic commodities. This roster of prices (with 1930-32 as 100) was at 68.51 in March 1933, at 129.96 last October, and by last week was up to 144.62. The Associated Press compiles its own index of 35 commodities for its member newspapers. From a depression low of 41.44 (February 1933) the AP index last week had risen to 90.42.

[Stoneleigh]

A simple dollar devaluation does not equal inflation. Inflation would require the expansion of money and credit in comparison with available goods and services. If credit contraction far outweighs the effect of dollar devaluation, then the net effect is still contraction of the effective money supply. Credit only functions as a money substitute during expansion. It's evaporation once this expansion ends is what leads to money supply collapse.

IMO we will see beggar-thy-neighbour devaluations in many places, and the floating currency regime will dissolve into chaos. Before that we will see the dollar appreciate as dollar-denominated debt deflates. As there is more dollar denominated debt than any other kind, its deflation will force the dollar up temporarily (perhaps for another year).

People associate unaffordable prices with inflation, but deflation can produce the same result far more abruptly, as purchasing power falls faster than price, meaning that prices rise in real terms.

[mattduke]

$this->bbcode_second_pass_quote('Stoneleigh', 'A') simple dollar devaluation does not equal inflation. Inflation would require the expansion of money and credit in comparison with available goods and services. If credit contraction far outweighs the effect of dollar devaluation, then the net effect is still contraction of the effective money supply. Credit only functions as a money substitute during expansion. It's evaporation once this expansion ends is what leads to money supply collapse.

IMO we will see beggar-thy-neighbour devaluations in many places, and the floating currency regime will dissolve into chaos. Before that we will see the dollar appreciate as dollar-denominated debt deflates. As there is more dollar denominated debt than any other kind, its deflation will force the dollar up temporarily (perhaps for another year).

People associate unaffordable prices with inflation, but deflation can produce the same result far more abruptly, as purchasing power falls faster than price, meaning that prices rise in real terms.

[Stoneleigh]

M3 hasn't fallen, but credit is contracting as assets markets have frozen over. We still have mark-to-make-believe, but at some point there will be a large-scale mark-to-market event that will reveal the price of those 'assets' to be pennies on the dollar at best. The collateral underpinning much of the derivatives market is almost worthless.

As for bonds, I am expecting credit spreads to widen dramatically once the rally is over. Eventually we will see a bond market dislocation even for high quality debt, but we are not there yet. When it does happen, the collapse of that debt market under high interest rate conditions will be highly deflationary. Purchasing power will collapse, prices, especially for essentials, will rise sharply in real terms while falling in nominal terms. The effect will be catastrophic.