Tag Archives: Deflation

quick update

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First, a few of today’s headlines to set the mood:

China factory sector close to stalling – Flash PMI
Europe Services, Manufacturing Weaken More Than Forecast
France’s Manufacturing, Services Growth Slows More Than Forecast
Trichet Says Risk Signals ‘Red’ as Crisis Threatens Banks
Italian Household Confidence Falls Amid Concerns on Growth, Jobs
U.K. Retail-Sales Index Declines to Lowest in a Year, CBI Says

Deficit-Cut Talks Hit Roadblock, Cantor Exits
Jobs Picture Grows Worse as Weekly Claims Post Jump
New US Home Sales Fall 2.1 Percent in May
Fed Slashes Growth Forecast, Sees High Unemployment
Oil Prices Plunge

It’s all unfolding like a slow motion train wreck.
The underlying deflationary forces were temporarily masked when QE2, under the misconception that it was somehow inflationary, caused global portfolio managers to exit the dollar, both directly and indirectly.

But now that psychology is fading, as the global lack of aggregate demand revealing the actual spending power just isn’t there to support things at the prices managers paid to place their bets.
And the next ‘really big shoe’ (as Ed Sullivan used to say) to fall could be China, as they move into their traditionally weaker second half.

Which looks to be closely followed by the US as some kind of austerity is passed by Congress, further supported by continuing austerity in the UK and the euro zone, and the setback in Japan and much of the rest of the world from the earthquake, and not to mention Brazil and India attempting to fight inflation.

Yes, the lower crude and product prices will help the consumer, but prices were lowered in reaction to a weakening consumer, so seems more likely they will slow the decline some rather than reverse it.

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State of the Union

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Some of the risks listed at year end seem to be coming on line, including slower growth out of China, euro austerity keeping a lid on demand in the euro zone, and US fiscal balance too tight for anything more than very modest top line growth, given current credit conditions and the negative income effects of near 0 interest rate policy and QE.

With crude oil continuing to soften, and Brent looking to close the gap with WTI by falling more than WTI, the dollar continues to gain fundamental support as it becomes ‘harder to get’ overseas.

And falling gold and silver prices, along with most other commodities, are showing a world that is sensitive to those indicators that QE2 doesn’t look to have been at all inflationary, leaving many people with positions they otherwise would not have taken (long gold, silver, commodity currencies, and other implied ‘short dollar’ positions).

The risk here is that the dollar gets very strong, and commodities very weak, which can lead to a US equity correction as well as a strong bond rally, all contributing to a deflationary malaise, as the theme remains:

Because we believe we can be the next Greece, we continue to work to turn ourselves into the next Japan

Which includes a misguided national effort to export our way to prosperity, which is likely to be featured by the President tonight.

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Fed Minutes

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The staff still expected that the pace of economic activity through 2011 would be sufficient to reduce the existing margins of economic slack, although the anticipated decline in the unemployment rate was somewhat slower than in the previous projection.


Karim writes:

Staff still forecasting above trend growth, though not as firm as before. Activity indicators coming in as expected, with financial strains in May and June the cause for the revision.

Table below is average of FOMC members, not staff, but appears to have similar profile. Average expectations for 2011 growth at 3.85% from 3.95% prior..

A few participants cited some risk of deflation. Other participants, however, thought that inflation was unlikely to fall appreciably further given the stability of inflation expectations in recent years and very accommodative monetary policy. Over the medium term, participants saw both upside and downside risks to inflation.


Deflation talk still seems contained to a ‘few’ members.

Members noted that in addition to continuing to develop and test instruments to exit from the period of unusually accommodative monetary policy, the Committee would need to consider whether further policy stimulus might become appropriate if the outlook were to worsen appreciably.


This was only mention of QE2 – not very extensive.

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EU Daily | Trichet remains confident in ECB plan

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The euro zone is standing on the deflation pedal hard enough to turn the euro northward when the portfolio adjustments have run their course, which could be relatively soon.

And the indications of growing exports are more evidence the currency could bottom and start to appreciate.

Like Japan, when relative prices get to where exports pick up it causes the foreign sector to get short (net borrowed) in that currency, which tends to cause the currency to appreciate to the point exports fall off.

The ‘answer’ is to buy dollars as Japan did for many years, and China continues to do. And note how strong the yen got after Japan stopped buying dollars- strong enough to keep a lid on exports. But the euro zone ideology won’t allow the ECB to buy dollars should the euro start to appreciate, as that would give the appearance of the euro backing the dollar.

So right now a euro strong enough to slow exports would be highly problematic for a continent already in the midst of a deflationary spiral with its fiscal authority, the ECB, forbidden to offer the needed fundamental support.

The price of gold in euro could be the indicator of this turn of events. The portfolio shifting has driven up that gold price, and a downturn could be the indication that the portfolio shifting is getting played out.

But for you traders out there- I wouldn’t be early or try to call the precise bottom of the euro.

There’s no telling how much more portfolio shifting lies ahead.

Trichet remains confident in ECB plan
Trichet Says Greek Situation Resembled Lehman Collapse
Trichet: economy in deepest crisis since WWII
Stark Says ECB Measures ‘Only Bought Time’
Weber Says Crisis Response Must ‘Respect’ Policy Divisions
Stark Shares Weber’s View on ECB Bond Purchases, FAS Reports
ECB’s Nowotny Says Euro’s Drop of ‘No Specific Concern’
Lagarde Says Greek Debt Restructuring Isn’t an Option, FAZ Says
Berlin calls for eurozone budget laws
Schaeuble Has Plan to Stabilize Euro
Papandreou Says Greece Is a Good Investment, Handelsblatt Says
Spain puts labour reform on agenda
Italy to Make Extraordinaray Spending Cuts, Minister Says
April EU car sales fall as cash-for-clunkers fades

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Re: Tax cuts may heighten deflation risks – NY Fed study

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[Skip to the end]

(email exchange)

It doesn’t make sense in any model this side of sanity. Comments below:

>   
>   On Sun, Feb 22, 2009 at 7:47 PM, Steve wrote:
>   
>   Does this make sense in your model of fiscal policy?….interesting
>   counter intuitive argument…
>   

Tax cuts may heighten deflation risks- NY Fed study

Feb 18 (Reuters) — Cutting taxes to try to stimulate the economy could do more harm than good in a zero interest rate environment as it can heighten the risk of deflation, according to a recent New York Federal Reserve study.

Policies that are aimed at increasing the supply of goods can be counterproductive when the main problem is insufficient demand, New York Fed economist Gauti Eggertsson said in a research paper entitled “Can tax cuts deepen the recession?”

Increasing the supply of public goods is never contractionary. Though wise investment can bring down real costs and prices and thereby increase productivity and our real standards of living.

“The emphasis should be on policies that stimulate spending,” Eggertsson said, adding that his research found the impact of tax cuts is “fundamentally different” with interest rates near zero.

“At zero short-term nominal interest rates, tax cuts reduce output in a standard New Keynesian (economic) model. They do so because they increase deflationary pressure,” he wrote. Eggertsson’s study focused primarily on labor taxes and some sales taxes.

There’s the problem- the standard ‘new Keynesian model’ is garbage.

Cutting payroll taxes, for example, would create an incentive for people to work more. But if there are not enough jobs, this could have a negative effect: creating more demand for work and thus driving down wages.

Huh? First of all, for me personally at least, when my income is cut I tend to work more to at least try to make the same income. And when taxes are cut I certainly don’t work more. But that’s just anecdotal.

The main point is there are already millions of unemployed so even if somehow cutting payroll taxes so people struggling to make ends meet can better do so causes a few more people to seek work the pressure on wages can hardly go up.

And maybe the strongest point, these new people supposedly seeking work due to a cut in payroll taxes will only work at the higher wage as a point of this (convoluted) logic which is far different from a market and wage level pressure point of view than the millions of others willing to work at current wages who can’t find work.

Last, the notion that changes in payroll tax could measurably alter wage seekers is extremely far fetched at best and not statistically significant in any case.

And with interest rates near zero, the Fed cannot cut rates further to fight deflation.

As if cutting rates does or ever has fought deflation.

If anything the causation is reversed. The new Keynesian model has this all wrong.

President Barack Obama on Tuesday signed into law a $787 billion package of measures to lift the recession-mired U.S. economy that included about $287 billion in tax cuts.

Eggertsson’s findings counter the argument that cutting taxes to put an extra buck in consumers’ pockets will boost their spending. Instead, given the current economic backdrop, it is likely people would save money from temporary tax cuts,

Yes, this is likely, and not a ‘bad thing’ as it means taxes can be cut at least that much further and/or spending increased further.

given the recession and expectations that tax increases are inevitable in the future.

This is the ‘Ricardian Equivalent’ argument put forth by some of the ‘new Keynesians’ and has largely been dismissed as nonsensical by most. The idea that tax cuts do nothing because people automatically expect higher taxes later as they ‘know’ the budget must eventually be balanced, taken to the extreme, means totally eliminating taxes does nothing for demand which of course is ridiculous.

He said that while a number of economists have argued that aggressive tax cuts are needed to revive the U.S. economy, policy-makers should “view with a great deal of skepticism” studies that use post World War Two data — a period characterized by positive interest rates.

Interest rates have nothing to do with the effect of tax cuts. And history (and all other theory) has shown that tax cuts add to demand, tax increases lower demand.

The best ways to stimulate spending, according to Eggertsson’s study, is through traditional government spending and a credible commitment to boosting inflation, creating an incentive to spend now before prices rise. (Reporting by Kristina Cooke; Editing by Diane Craft)

Good old ‘inflation expectations theory’ again from the new Keynesians, which is also nonsense. It’s a ‘plug’ due to no other theory of where the price level comes from, as they have yet to recognize the currency itself is a public monopoly, and monopolists are necessarily price setters.


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Deflation forecast

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This is the deflation argument.
(See below)

Never seen a split quite like this with calls for both accelerating inflation and outright deflation.

Which will it be?

My guess is inflation for the US as our friendly external monopolist continues to squeeze us with ever higher crude prices.

The political process is ensuring they will be passed through as sufficient government ‘check writing’ (net government spending) is sustained to support real growth.

(Bear Stearns, housing agencies, fiscal rebates, fiscal housing package, etc.)

And the dollar continues to adjust to the sudden, politically induced shift in foreign desires to accumulate USD financial and domestic assets.

Various private Q2 GDP estimates are now up to 2% – more than sufficient to support demand and pass through the higher headline prices.

Government is never revenue constrained regarding spending and/or lending.

The limit to government check writing is the political tolerance for inflation, which grows with economic weakness.

This inflation looks to me to be far worse than the 1970s.

Back then, we were able to muster a 15 million bpd positive supply response in crude that broke OPEC by deregulating natural gas.

We don’t have that card to play this time around.

From HFE:

July 14, 2008

WORLDWIDE:

  • Global Disinflation Is Going To Be The Next Big Move For The Bond Markets – Weinberg
  • Commodity And Oil Prices Cannot Rise Forever… There Is No Inflation – Weinberg
  • Bonds To Benefit – Weinberg

UNITED STATES:

  • STOP PRESS: Treasury, Fed To Make Credit Available To GSEs; Treasury To Seek Authority To Buy Their Stocks – Shepherdson
  • This Is A Lifeboat, Not a Bailout; Aim Is To Prevent Uncontained Failure – Shepherdson

CANADA:

  • We Cannot Rule Out A Rate Cut Tomorrow – Weinberg

EURO ZONE:

  • Core CPI Shows No Medium-Term Inflation Risks – Weinberg
  • Production Data Will Be Really Soft – Weinberg

GERMANY:

  • Core CPI Still Under 2% And Steady, ZEW At New Record Low – Weinberg
  • … Tighter Money Is Unhelpful Here – Weinberg

UNITED KINGDOM:

  • Starting Point For August QIR Forecasts To Emerge In This Week’s
  • Reports: Most Inputs To The Forecasts Will Be Stronger – Weinberg

FRANCE:

  • Not-Too-Scary Inflation Report Exported: Core Prices Are Steady – Weinberg

JAPAN:

  • Three Soft Report This Week Will Keep Investors Moving Out Of Stocks, Into Bonds – Weinberg

AUSTRALIA:

  • CPI Report For Q2, Due Next Week, May Rekindle Inflation Worries – Weinberg

CHINA:

  • Exploding Foreign Borrowing Diminishes Foreign Currency Reserve Adequacy; Trends Suggest Further Decay – Weinberg
  • GDP Will Be Below Recent Trend In This Week’s Report – Weinberg


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Central bank debate: Is it inflation or deflation?

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Here’s how the inflation can persist indefinitely:

  1. In addition to the India/China type story for resource demand, this time around nominal demand for commodities is also coming from our own pension funds who are shifting more of their financial assets to passive commodity strategies.

    Pension funds contributions have traditionally been invested primarily in financial assets, making them ‘unspent income’ and therefore ‘demand leakages.’ Other demand leakages include IRAs (individual retirement accounts), corporate reserve funds, and other income that goes ‘unspent’ on goods and services.

    Supporting these demand leakages are all kinds of institutional structure, but primarily tax incentives designed to increase ‘savings’.

    These come about due to the ‘innocent fraud’ that savings is necessary for investment, a throwback to the gold standard days of loanable funds and the like.

    A total of perhaps $20 trillion of this ‘unspent income’ has accumulated in the various US retirement funds and reserves of all sorts.

    This has ‘made room’ for the government deficit spending we’ve done to not be particularly inflationary. In general terms, the goods and services that would have gone unsold each year due to our unspent income have instead been purchased by government deficit spending.

    But now that is changing, as a portion of that $20 trillion is being directed towards passive commodity strategies. While the nature of these allocations varies, a substantial portion is adding back the aggregate demand that would have otherwise stayed on the sidelines.

    That means a lot less government deficit spending might be needed to sustain high levels of demand than history indicates.

    And, of course, the allocations directly support commodity prices.
  1. We are faced with the same monopoly supplier/swing producer of crude oil as in the 1970’s.

    Back then the oil producers simply accumulated $ financial assets and were the source of a massive demand leakage that caused widespread recession in much of the world. And didn’t end until there was a supply response large enough to end the monopoly pricing power.

    But it did persist long enough for the ‘relative value story’ of rising crude prices to ‘turn into an inflation story’ as costs were passed through the various channels.

    And a general inflation combined with the supply response served to return the real terms of trade/real price of crude pretty much back to where they had been in the early 1970’s.
  1. This time around rather than ‘hoard’ excess oil revenues the producers seem to be spending the funds, as evidence by both the trillions being spent on public infrastructure as well as the A380’s being built for private use, and the boom in US exports- 13% increase last month.

    This results in increased exports from both the US and the Eurozone to the oil producing regions (including Texas) that supports US and Eurozone GDP/aggregate demand.

    At the macro level, it’s the reduced desire to accumulate $US financial assets that is manifested by increasing US exports.

    (This reduced desire comes from perceptions of monetary policy toward inflation, pension fund allocations away from $US financial assets, Paulson calling CBs who buy $US currency manipulators and outlaws, and ideological confrontation that keeps some oil producers from accumulating $US, etc. This all has weakened the $ to levels where it makes sense to buy US goods and services – the only way foreigners can reduce accumulations of $US is to spend them on US goods and services.)

    The channels are as follows:

    1. The price of crude is hiked continuously and the revenues are spent on imports of goods and services.
    2. This is further supported by an international desire to reduce accumulation of $US financial assets that lowers the $ to the point where accumulated $ are then spent on US goods and services.

    For the US this means the export channel is a source of inflation. Hence, the rapid rise in both exports and export prices along with a $ low enough for US goods and services (and real assets) to represent good value to to foreigners.

  1. This is not a pretty sight for the US. (Exports are a real cost to the US standard of living, imports a real benefit.)

    Real terms of trade are continually under negative pressure.

    The oil producers will always outbid domestic workers for their output as a point of logic.

    Real wages fall as consumers can find jobs but can’t earn enough to buy their own output which gets exported.

    Foreigners are also outbidding domestics for domestic assets including real estate and equity investments.
  1. The US lost a lot off aggregate demand when potential buyers with subprime credit no longer qualified for mortgages.

    Exports picked up the slack and GDP has muddled through.

    The Fed and Treasury have moved in an attempt to restore domestic demand. Interest rate cuts aren’t effective but the fiscal package will add to aggregate demand beginning in May.

    US export revenues will increasingly find their way to domestic aggregate demand, and housing will begin to add to GDP rather than subtract from it.

    Credit channels will adjust (bank lending gaining market share, municipalities returning to uninsured bond issuance, sellers ‘holding paper,’ etc.) and domestic income will continue to be leveraged though to a lesser degree than with the fraudulent subprime lending.

    Pension funds will continue to support demand with their allocations to passive commodity strategies and also directly support prices of commodities.
  1. Don’t know how the Fed responds – my guess is rate cuts turn to rate hikes as inflation rises, even with weak GDP.
  1. We may be in the first inning of this inflation story.

    Could be a strategy by the Saudis/Russians to permanently disable the west’s monetary system, shift real terms of trade, and shift world power.
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