The Fed is fighting deflation, can it win?

Deflation has a bad rap.  I think deflation has a bad rap harking back to the gold standard days.
In those days, when deflation took hold, countries could NOT print fast enough to counter its effects.

In essence in classic deflation, people horde money and don't spend it.
That starves the entire economy, resulting in people working more for less in a never ending death spiral until the economic situation hits rock bottom.

In such situations, people with cash (banks, the rich) rule the world as they take control over much more pennies on the dollar.  If you seen the movie its a wonderful life, that is what a deflationary collapse looks like.

But like so many words, they can be used for many different things confusing situations.
Deflation can also be used to describe falling prices.  While that looks on the surface to be same deflation as I just described, it may not.

Take assets like stocks and houses.  If housing goes down by 90% in price, young adults can buy houses they cannot afford now.  In effect standard of living for buying assets such as houses goes up.  Who suffers are those who already own a house, their savings goes down.  In addition if houses have larger loans on them than the face value, banks will get stuck with the houses, causing losses not only for the home owner, but the loan holder.

Depending how you look at it, housing prices collapsing is very good for humanity, for more can afford with less.  But in production such as making good or houses, lower prices result in lower wages or fewer jobs to create the items for consumption.

As for houses, if USA didn't build an epic ponzi scheme since 2001 on real estate, I can say with confidence lower house prices is good for humanity.  The ponzi-like scheme we have built on perceived value of houses unfortunately, make it not as clear as what is the best thing for society.  Hence in comes the Federal Reserve bank where 'status quote' for the financial markets is of utmost importance.  For the Federal Reserve bank is a  PRIVATE institution with the health of the banking system front and center.

What we have seen since 2008 is an attempt to stabilize the prices and restore valuation before 2008 collapse.  As I have just pointed out, this is at a cost of the 15-35 year olds in society.  We can see the effect between jobs and living costs of that generation taking it square on the chin.

The question is, can this go on forever? The answer is simply, no.  There are two forces at work that will make the reality of housing go down, and with it other over-inflated assets.  The first and foremost is demographics.  as the 35 year olds become 40, 45, 50, etc the needs of the older will succumb to the younger.  The asset protection for the older simply becomes less important demographically as that generation dies off.  The fiscal balance sheet shifts not only in who owns the assets, but the overall support of the system as the older generation stops working and the younger force at a fraction of the income replace them.  Mathematically something will give.

There is a second force at work, technology.  I have posted about 3d printing of all shapes, including houses.  I read an article today bringing housing one step closer to a price collapse.
A 3d house printer can make 10 houses a day for cost of $5K each.  The house of course, is basically a concrete shed, hardly the American dream house.  But here is the rub, its 2014, what will that printer do in 2020? I am positive in 6 years for $5K not only will that house have more than 1 room but it will have plumbing and pipes to run wires to install electric, a fireplace, and other basic needs.  by 2030, it will print the american dream house for maybe $100K or less in today's dollars.

Once we can print as many new homes as you want at a fraction of what houses cost today, what will old houses go for? Sure, by location it will vary greatly.  Desired areas have value not because of the house build cost, but because your buying into a neighborhood.  But for many areas I predict a Detroit-like exodus issue as a potential.

Combine this with 3d printing as seen below you destroy the need for many objects to be made at all, and many made locally right in your house, destroying the needs for millions of cheap factory workers.

There is NO QUESTION, massive deflationary forces are at work, and the FED wants to keep the status quo, I predict it can't hold it forever, between now and 2017 the cracks will become apparent to all.

And the next currency must be deflationary matching the technology and demographic needs, not inflationary as current currency is.  I believe a virtual decentralized currency will meet that challenge.

Robotics, Demographics, and the changing landscape of employee skills

The bar will continue to be raised for all workers, as they will need to compete with higher skillset to add value.  I ran across a video that dives deeper into yet once again, how the baby boomer demographics will influence the rise of the robotics.  See my previous post on March of the Robots, Deflation for Decades on my view of the changing landscape.  The video below isn't from an economic perspective, but does a great job of capturing the technological landscape ahead.

March of the Robots, Deflation for decades

Many economic blogs for years have called for US Dollar inflation.  This has not materialized as a general event.  I have covered this on the blog before.  Credit = Money, and Credit is not expanding like it did into 2007.   High unemployment stagnates wages.   And as I have called for since 2008 natural resources would creep up in cost over time due to global resource competition.  Specifically as India and China grow wealthier, they will consume a larger chunk of the resource pie.

Another deflationary force is Technology.  Every year less people can do more work.  Technology does create new jobs, but typically for higher education at the expense of lower skilled workers.  The wages are higher, but there are net fewer jobs.

I am a techie, I love tech.  I am not suggesting the world follow the Amish.
But I see technology efficiencies now biting into the technology world.  The area of growth for jobs is now also becoming a victim of the success of itself.

Pure capitalists state that if we freed the economy from the shackles of all government intervention, that the market will find optimal balance.     I question if that balance can ever equal full employment again.
People use history to project future events.  The capitalist 1800's and 1900's that yielded the middle class and a booming economy is not the same backdrop we face today.

The Western Baby boomers are aging, the younger generation have endured a decade of stagnant jobs.
And technology marches on.

What I think is happening is a shift in who is employable.   If you look at the industrial revolution, people shifted from agriculture to the urban centers to staff factories.   Those who did not adapt may have had to experience lower wage jobs in the fields relative to the new industry wages.

I think that is what we are starting to see now, the efficiencies of technology reaching deep into the economy to 'raise' the bar.   I have a couple of items for you to consider.

First, there is robotics.  This industrial industry has for the last decade taken a chunk out of the large manufacturing jobs.   Consider this, Apple is moving some manufacturing BACK to the USA from abroad.   Termed reshoring work.  But instead of 1,000s of factory workers, it is expected TOTAL employment, including the receptionist, to be 200.  Why? Automation.

Baxter, a robot targeting SMALL companies to replace 'expensive' workers at 9 bucks an hour is being marketed for a total of 22K per Robot.  In 18 months you can expect this robot to do much more than today, and every 18 months thereafter.  Dare I say the price will also steadily be reduced.
It isn't out of the question in 6 or 8 years that the Robot be under 10K. In a decade every McDonalds will have 2 people and rest robots running the operations.

Combine above trends with IT trends of eliminating IT datacenters and consolidating on the cloud, and we have massive deflationary forces at work.

Now for a quick higher level view of job facts.  Mish posted two images below about the US labor force over the last five years.  Considering the US government is spending 3.4 Trillion of a 15 trillion economy each year, the US is barely treading water.  Dare I say the forces I quote are hard to keep at bay. Simply look at industries hardest hit.  Those that can be automated or outsourced.

What does this amount to?  Well we are in interesting times in the years ahead.   There will be explosive new companies with tremendous growth as new areas continue to unfold.  Society is a bell curve of capability, and the bar for new jobs will continue to be raised.  I expect an ever increasing higher REAL unemployment rate. (if you don't ignore those who give up trying to work)  There will be continued deflationary forces between baby boomers retiring, technology, and overall unemployment.  And I still think natural resource contention as China kick starts their consumer economy along with India.

I do have optimism, to read that post, click here!

It's all about Oil

As I have posted before, I am a believer of peak oil.  Whether the peak has past or will past soon is immaterial.  In the scheme of 100+ years of oil use, we are about to hit the peak, and afterwards we will experience continued rising costs for energy.

Governments can and have been promoting green energy.  But the adoption rate is slow, but hopefully will accelerate with technology efficiency advancements.

The growth for energy in India and China is staggering.  The consumption monster drives all energy sources higher.  China has done much with nuclear and coal to relieve pressure off oil.  

So when resource costs are going higher, what can governments do?  Why a stronger currency helps offset these pressures.  Think of it this way, if the USD was worth 10x more than other currencies, oil to US Citizens would cost less than people pay in their countries.  The irony is governments are publicly advocating cheapening of the currency to make them more competitive (and help pay down debt cheaper, but that part they don't announce).  The act of lowering money's value is a tax on every single citizen, in higher expenses.

We may be seeing another round of deflation to start, to help kick resources down a few notches in cost.  And of course, sometime between September and February of next year, another round of loose money will hit the world.  But only after resource costs go lower.

To get an idea how expensive oil is, and remember, the US and Europe are experiencing weak economies, look at the graphs below.  The second one is important, it helps make the costs of oil reletive in current dollars. By any historical standard, oil is expensive.

From WebSufinMurfs FinancialBlog2

From WebSufinMurfs FinancialBlog2

US 30 year bond rate trend

Recently, the 30 year bond rates did break above the downtrend starting in 1987 to today. The rates are now falling. The key trend line now to watch is to see if the uptrend from 2008 can be reversed.

If rates do not resume downtrend, dare I say, inflation is here. So far, I can't make that call, and deflation is the word to use since 2008 primarily.

From WebSufinMurfs FinancialBlog2

Inflation, Deflation, and global currency wars

America is involved in many wars right now, lets list them shall we?

1. Iraq
2. Afghanistan
3. Libya (See War Powers Resolution, and how law is ignored. )
4. War on terrorism (Bin-laden...recent military action)
5. War on drugs ( Mexico's border is flaring up badly )
6. Currency War
7. Arguably, a global simmering trade war

Wow, thats quite a bit of wars! The first three are relatively easy to grasp by most people. The countries involved are "over there" and we send military to change a political situation.

The next two are a bit more complex, as it is arguably everywhere in the world. The shape and form however to bubble to the forefront when clashes occur. It could be in the form of the bad guys killing people, or a counter attack by the good guys (USA). Again, within reason, graspable.

The last two are very subtle wars, Currency and Trade wars. Each take their own form and shape of political maneuvering, like a very big chess game. Spectators watching may not easily grasp all the various possible moves and 10 moves ahead the players are planning for.

The USA made some very shrewed policy changes in it's day, one of the least recognized is what Nixon was able to do. At that time, the US dollar was the defacto standard for currencies. However, the US dollar was convertible to gold. America had started accelerating it's budget imbalances, and other countries were asking the US for larger and larger gold conversions.

Nixon's administration assessed the situation and realized the world would have no choice, but to support the dollar even if it became a pure fiat currency. At that time, America was a manufacturing and military powerhouse. The shackles of money tied to shiny rocks was eliminated, and America could do what it wishes with it's currency.

The chess play here is simply this. Say, other countries want to trade with America. And lets say that America gives US dollars in exchange for goods at a rate that is "unfair" to the other country. Let's assume America isn't providing valuable goods back to the same country and the deficit is basically IOU's in the form of dollars.

Countries COULD turn around and dump the US dollars, in exchange for other goods and services from other countries. It could even invest that money back into the USA by purchasing assets. But if they did so, that would apply pressure on THEIR FIAT currencies to rise, as their currency would gain strength relative to the over-printing of US dollars.

This you would think is a good thing, and in many ways it is. But the net effect would be that countries exports would go up in cost relative to any other country that is prices relative to US dollars. Over time, as the US deficits spends more, their currency would rise high enough to cripple exports.

What to do? Simple, keep US Treasuries or cash and sit on it. Each year allow your holdings of US dollars to build. Since the global currency system is based on fiat currencies, each currency floats RELATIVE to each other. And since historically (since WW2) the trading patterns have been dependent on US dollars, the world has been forced, and WILL CONTINUE to be forced to finance the US over-consumption and lack of production.

Fast forward to today, and the US is deficit spending 1.5 trillion per year in ADDITION to the revolving bond debt that matures on the outstanding 14 trillion of debt.

Now, lets turn to China!

China's currency does not float, and China aggressively locks their currency to a very specific level to US dollars. So while other countries may somewhat try to keep their currency stable to US dollar trade, they do allow a bit of flexing to help ease economic imbalances. (think Euro hitting all time highs against USD).

China however does not. So what possible effect could this have? China's command economy dictates that politicians set policy to maintain the currency imbalance with respect to the USA. This has the unfortunate side effect of excessive credit and currency in their own country, resulting in inflation.

Inflation in China is high right now, and China has been fighting hard to keep prices stable for it's exports, including to the USA. This relationship has been maintained since Reagan, and is partially responsible for the US corporation exodus to China.

Well today, I see a crack in this relationship. China is allowing electric costs to rise. That will in turn force manufactures to charge more. That will result in prices from China to rise. (think Walmart, or Apple) Apple btw, to their credit is heading this off by diversifying suppliers. And despite the US economy being in a fragile state, we may see prices rise in stores, beyond the recent food and gas price surges.

The situation is of course, unsustainable. But that won't stop everyone from keep on doing what they are doing know. The US will continue to deficit spend high amounts. China will continue to try to keep it's currency stable vs the USA. But once rising prices start snowballing out of china, this game will change in shape, form, size, and velocity.

The global economy will take a turn for the worse as China tries to redirect rising prices back out to America and the world.

We live in interesting times.

Deflationary collapses, how quickly we forget!

WAY back in 2008, we had a market collapse followed by an economic collapse. In August of 2008, oil was spiking to 145 a barrel. All systems where go for a global economy on fire.

Then just 4 months later, oil was hitting 40 bucks a barrel. Amazing.

But what caused the collapse? The mass media did an utterly piss poor job explaining it.

Was it the fall of Lehman Brothers? Bear Sterns? Banks?

And how could a few companies failing be responsible for what turned into a global economic collapse? If they where to blame, holly hell, what where government regulators doing since 2001?

I'll ignore the corruption, the outright lies, and other main contributors for getting America to that fragile state.

The issue was simply LEVERAGE! If the US Financial system had no fractional reserve lending policy, it would in effect have no systematic leverage. What would happen is for every dollar a bank lent....a dollar must exist! Then if a dollar was lost, the existing dollar would pay for the bad loan.

In such a world, its hard to get into trouble, since, there is deposits that could pay off bad loans. Further, even when loans go bad, a percent does, not all loans do. So a 10% haircut may be painful, but a company would easily be able to survive based on it's remaining assets.

But thats not the world we live in. The world we live in is 100 deposited dollars can be leveraged to create a total of 457 of deposits, with 357 in loans, and a bank requirement to keep 89 dollars in reserve. (click for Wikipedia details)

So as you can see, if a loan goes bad, the "reserve" can be used quite quickly, leaving no reserve for remaining outstanding loans.

This my friend, is at the heart of a deflationary collapse. Once started, it can snowball into a cascade collapse. Banks and other institutions must dump assets to gain cash to maintain reserves. The system makes for some GREAT bull market runs and makes it easy for private institutions to fund growth. So when things are going good, the marketplace and business world is flush with liquidity (money) to finance business.

But if a tipping point of selling occurs, usually because of bad loans, a cascade failure can happen.

In 2008, the Federal Reserve, to its credit (its rare I complement them), acted quickly to stop the chain reaction to prevent a full all out collapse.

Unfortunately, the lesson learned was, lets do it again, but this time, lets press harder and involve the federal government directly. With governments involved, what could POSSIBLY go wrong?

For an example, lets take a look at Greece. That countries debts and financial situation is at a point of implosion. Greece will likely be the first country to be asked to leave the euro, and it won't be the last. (Spain, Portugal, Ireland) Once any country is asked to leave, it will make it easier to ask for others.

The question is, why is the European Union fighting so hard to prevent this from happening? Do the Germans, French, and other European nations love Greece for its art, food, and vacation spots? Is it they are really nice and like to lend money to others in a time of need?

I am of the belief that the European banking system is about to experience what America already endured, a deflationary collapse due to bad loans, fractional reserve lending.

Don't believe me? Lets see what a former European Central Bank Economist has to say about Greece.

“I’m skeptical about Greece,” said Former ECB Chief Economist Otmar Issing, who joined the ECB a year before the euro’s inception in 1999 and stayed there until 2006. “Greece is not just illiquid, it’s insolvent.”

This statement comes after many of the blogs I read have painfully detailed out that Greece is insolvent, while the European Banking system says otherwise. Mish has a great post of the quote above, and full detail of the pending Greece implosion.

In 2008, America took the hit as directly causing the financial collapse. 2011 will mark the rest of the world causing the next leg down. The European Union, and very likely, China. America's financial markets will get hit, and you can be sure that companies like Goldman Sachs will get caught in the "credit default swap" market losses it was a party to in Europe.

For since 2008, Credit Default Swaps which dwarf global output, ranging in the 55 trillion dollar liability range, with near zero regulation still!

So those looking for hyperinflation, think again, a little country like Greece may be the start of the great unraveling, and that is a deflationary event.

The currency debasement I fear will come AFTER this event. I still think currency debasement with hyperinflation is possible, that years off at earliest 2015-2017.

Inflation, Deflation, What's going on?

I really hate people trying to categorize our global economic system state and USA's economic situation as buzz words like inflation and deflation.

Oversimplifying complex situations creates false impressions of the reality that faces all of us.

I started a series of posts to explore money, and inflation and deflation topics. If you haven't read it, you can do so by starting with the first post "what is money".

For this post, I WILL oversimplify and focus on what people do tend to notice, and that is rising costs to consumers. We have recently seen some decent spikes in commodities, especially some foods such as corn. Other obvious price rises is gold hitting all-time highs, and oil rising.

At the bottom is a video from Walmart CEO starting to see cost increase creep. Welcome aboard! I have been stating this since 2008 as a result of our poor economic and political decisions. Its pretty much at the stage of destiny, but I try to leave some hope.

Some other notable recent articles, from ZeroHedge.com

Goldman Sachs raises corn price forecast by 30%

Inflation expectations 2010-2011

Philly Federal Reserve president's speech "inflation may require aggressive policy action".

Brent Oil hits 119 a barrel

Wal-Mart US CEO To America: "keeping eye on Inflation"

Ben Bernanke is wrong at every turn

The Federal Reserve Bank, a private institution, is lead by the Federal Reserve Board of Governors. The leader of the board is Ben Bernanke.

He follows in the footsteps of his predecessor, Allan Greenspan.

Mr. Bernanke's opinion and approach to finances was well documented by himself, in a college thesis paper. In that paper he described how the Federal Reserve could have minimized the Great Depression through additional actions they failed to take.

What we have been witsnessing since 2002 is Mr. Bernanke following his own playbook he started when he was in college. The problem I have with this approach is, he somehow knows better than the rest of the world, and has a "Secret sauce" to save the world economy.

Mish has a post that is exceptional reading (click). Mish starts with looking at Mr. Bernanke's own words issued in 2002 on how he would minimize the deflationary forces.

I do take one noteable issue with Mish's generalist view he presents of deflation will win over inflation. The US is tied to China like it or not. China's economy, although full of asset bubbles, is generally acknowledged to be growing. And assuming China will continue to grow over the next decade, it will surpass the US as the economic powerhouse.

What is perplexing is Mish acknowledges this as a possible outcome, in this post here. So I am at a loss on how he presents a world where deflation across the board "wins". So while I agree with Mish about Greenspan, and deflationary forces, I am in disagreement that his typical post view does not illustrate the resource calamity we all face from China's growth.

What it will be is USD devaluation, and should not be confused with economic inflation, with respect to natural resources and Asian currencies. American's (and all western countries) will face is a lowering of standard of living even more, as most wages remain depressed, but costs increase.

I hope Mish is right and I am wrong, but I am hedging my bets.

Mish has a great post explaining all the differing sources of information and opinions he either draws from, or disagrees with titled Straight Talk" with Economic Bloggers. I encourage people to read it and seek other perspectives.

Inflation vs Deflation continued

On Wednesday I posted that I am listening to great audio series of prominent inflationists and deflationists to understand US Dollar issues. (Sept 5th through Oct 3rd) No matter what you think of the economy direction, the policy of the US printing large sums of money, and the huge destruction of credit, are at the heart of the future of the US dollar.

Much smarter people than myself on this series are making compelling arguments for either camp. Mish(Video), Robert Precter, Mark Faber(Video), Peter Schiff (Video), Daniel R. Amerman, and Harry Dent.

For me to make sense of this, I need to break down the components, building a case of my thoughts of each topic, to culminate into a view I can make sense of. In the end, NOBODY can know the outcome, since, the outcome is dependent on what people do in the future. However, it is possible to make an educated guess based on the typical decision making pattern of the big powers involved.

My first post in this long series of Inflation vs Deflation, will be what is Money. The outcome of inflation or deflation, which is a fancy way of saying the US dollar retains/appreciates value vs moves towards being worthless, is critical to ensuring keeping wealth.

The Financial Sense News Hour posted their conclusions from both sides on October 3rd, which I will get to listen to this week. I am going to sketch out my thoughts before listening to their conclusions, then revise for my posts. I encourage you to listen to all the information presented in this series, the valuation of the USD is the elephant in the room during this crisis.

What is Inflation and Deflation, and what wins?

After doing this blog for over a year, it has been interesting to me to see how my own viewpoint changes on what is the "big issue" the US faces. By correctly identifying the US's most major risk, the idea is, you can minimize risk by recognizing and reacting to the US financial landscape changing.

What everything boils down to is US Government credibility. And US government credibility is reflected in the valuation of US dollars and interest rates foreign entities are willing to lend money to the USA.

Let me explain how I can make such a bold statement. The US has many "priorities" it is trying to address, but the bottom line is the US needs financing to operate, just like any government, corporation, or person. If the US citizen profile resembled Japan, the US could finance any issues using their own people's savings as collateral.

But the US is a debtor nation, with about 12 trillion in outstanding debt, trillions more in "implicit" debt from the US backing other companies, and yet over 60 trillion more with promises to pay Social Security or Medicaide benefits. With GDP at 13-15 trillion, the US debt has serious consequences.

The most serious is, at some point of debt, the US creditors will demand more interest to lend to finance all the spending.

With large borrowing, and spending, combined with the Federal Reserve and US Treasury creating "large amounts of money out of thin air", people are concerned how will this change the value of money.

There are two camps, people for an INFLATION result and those with a DEFLATION result. Some people go as far as to see the USD total collapse, and replaced with a new currency.

A reader, Ryan Swan, gave me yet another useful link from a podcast that is running a great series on inflation & Deflation arguments. I am in the middle of listening to this series, and plan to post a series of blog entries to explain my thoughts.

In the mean time, you can listen to this series on the blog site called "Financial Sense Newshour"m and start from September 5th, and listen to current. For those who use itunes, you can subscribe at Financial Sense Newshour itunes podcast.

I'll elaborate more on inflation, deflation in future posts