Perspectives on the global economic meltdown (Jan 26 2010)

[Sanjay M]

Look at UK's Cameron slashing his way through the state fat - Go Cameron, Go!

http://www.nytimes.com/2010/07/25/world ... itain.html

Obama with his healthcare plans are looking more and more like a Dinkins Presidency.
All his infamous comparisons with European social welfare systems are falling apart.
There's hardly any figleaf left for him now.

I think Cameron's poised to exceed even Thatcher's record on fat-slashing.
This is really going to be the Winter of Labour's Discontent.

[Sanjay M]

Was predicted... a big flight to safety.

There is no flight to safety. Its a term invented by the US media propaganda team at the behest of the American govt.

I'd like to invent a new term - "Flight from garbage"

There is a soon to come flight from garbage which will be a flight from equities and other bad investments like real estate. Flight from garbage may lead to the USD for those ex-garbage holders but only because that is the default option.

Flight from garbage does not equal to flight to safety even though the mid term outcome be the same.

"safety" vs garbage - it's all relative - glass half empty vs glass half full

you can still be 99% full of garbage, as long as the rest of the world is 99.1% garbage

capital has to go somewhere, lest it be confiscated - thanks to "institutions" like the Fed and their pro-inflationary politics

by not allowing the money mattress to compete in the fray, then garbage gets a free ride, to pass itself off as safety by default

[Neshant]

Prechter predicts gold could drop substantially since a) there are too many gold bulls and b) deflation will destroy the value of all commodities and equities. Preserve USD in the safest possible place for the buying opportunity of a lifetime when stocks and commodities (including gold) bottom out in 2014 to 2016 he says. I think he said gold will decline to $300 /oz or something ! He predicts private debt destruction will be much faster than bernanke can print and monetize the debt.

He states that in the long term however, gold will be the only money left standing as the federal reserve is run out of town. He advocates buying it at this upcoming bottom.

Personally I rather not risk it 100% on his strategy. We are definately going to move to some kind of new monetary system within the next 5 years. Its just a question of who is going to be cheated and left to hold the bag.

I'm determined that it not be me. I've put some of my money in gold (more than 99% of people on this planet will have). I"m also building up a stash of toilet paper known as fiat. If his prediction pans out, I'll swap the toilet paper for more gold at the bottom along with select dividend paying equities. And if not, i'll have my life boat when the titanic starts to spring a leak.

[Neshant]

Interesting prediction from March 2009 (the market bottom)

So far all of his predictions in this video are more or less bang on. Check it out. I think his 400 prediction might be coming up in the month of October, 2010. But I'm also sure the federal reserve will be rigging away to prevent a repeat of March, 2009 :

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[ShivaS]

The easiest way to restore intrinsic value of USD is to create deflation.
Since the world will continue clamor to export to uncle the downward adjustment to commodity prices is automatic. The losers again will be developing countries and fast developing nations (aka BRIC) unless they consume more domestically and export fewer raw materials to uncle.

This had been predicted very humble, by yours truly in a different era and avtar.

Equity loss to all the people who are paying mortgages sincerly is forgone and is sunk cost. SO thats one deflation point.
Banks holding defunt mortage instruments is another deflation point...
So the real purchasing power is already down for average joe so once the mid term is over the tightening of the money supply will further make it spiral towards deflation.

Also the trick is print money give to banks who in turn buy T bills instead from PRC, so the fake money is circulated like um um thermal runaway in a transistor ciruit.

[Carl_T]

I'm determined that it not be me. I've put some of my money in gold (more than 99% of people on this planet will have). I"m also building up a stash of toilet paper known as fiat. If his prediction pans out, I'll swap the toilet paper for more gold at the bottom along with select dividend paying equities. And if not, i'll have my life boat when the titanic starts to spring a leak.

This is a symptom of a bubble, when everyone starts buying the thing. Low interest rates are whats fueled this thing for the past 10 years, and IMO when the interest rates rise, this thing is going to come crashing down very badly.

I'm personally worried about deflationary pressure like what Japan had in the 90s, and I think gold will be the first victim as people will favor to sit on cash.


I think the US dollar will hold its value in the near term, but gold IMO would be a bad idea. It would have been a great idea in 2002.

[Neshant]

I've put some of my money in gold (more than 99% of people on this planet will have)

This is a symptom of a bubble, when everyone starts buying the thing. Low interest rates are whats fueled this thing for the past 10 years, and IMO when the interest rates rise, this thing is going to come crashing down very badly.

Its not difficult to have more gold than 99% or 95% of people on this planet because most people don't own any. Of those who do, most have very little of it. Others have it in paper (etf) not physical form with all kinds of counter party risks and misleading jargon to make them think have a claim on physical gold when they really don't.

Gold will certainly fall when interest rates are raised and money printing stops. But that would imply US intends to repay its debts. I don't believe there is any intent to repay the debt - certainly not at its current purchasing power.

If rates rise it will only be for a short while to sucker people out of gold and into paper before rates fall again. At 7% the interest payment on the national debt would be approx a trillion. The only way to meet that kind of obligation is with printing or massive taxing - and i don't think they are going to tax people who's lives are getting worse.

I don't know if gold is going to be a good investment in the short to medium term. Certainly with attempts to pass on the useless banking & financial 'industry' losses to the public via huge taxation, it could fall sharply.

But I do know in the long term (5 to 10 years) many people will be wiped out in the fiat ponzi scheme. If this day of reckoning comes sooner than I expect, I'm prepared and if not, I'll use it as a buying opportunity.

Its crazy not to prepare for the coming collapse/reset of the fiat ponzi scheme in some way. If I'm wrong and gold craters, it won't worry me as I bought it as insurance - not a get-rich-quick scheme. But if things turn out the way I expect and I'm caught unprepared, I would never forgive myself. I'd hate to think I had sacrificed the best years of my life working for paper that gets devalued/inflated by some idiot, bribe taking politician and con artist central banker.

[Neshant]

now that the banking & financial BSing industry has offloaded its losses onto suckers, its time for the suckers to pay up.

gaming the system really pays.

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Obama Commission Will Call for Trillions in Tax Hikes

http://townhall.com/columnists/Floydand ... _tax_hikes#

Obama debt commission member, Republican Sen. Judd Gregg of New Hampshire, launched a scary trial balloon on ABC News. Gregg suggested the debt commission will likely recommend a massive $26.7 trillion tax increase.

[Neshant]

Bernanke has woken up to the horrific thought that if the stimulus spending ends, and the economy craters, Ron Paul might win the 2012 elections. If that happened, he would be out of a job.

So he needs the spending to continue and for the economy to hold up at least until then. Some clueless guy like Obama needs to be elected to office and guided by golman sachs type advisors planted around him. That will ensure huge taxes and banking losses can be passed onto suckers with ease.

---------
It's too soon for austerity, Ben Bernanke tells Congress
• Federal Reserve chairman spurns UK and eurozone approach
• Bernanke insists 'we should maintain stimulus in the short term

The head of America's central bank, Ben Bernanke, warned against immediate European-style budget austerity measures yesterday when he insisted that withdrawing fiscal stimulus was too risky for the recession-threatened US economy.

In a second day of testimony to Congress, Bernanke said the Obama administration should delay measures to reduce Washington's record budget deficits by cutting spending or increasing taxes.

"I believe we should maintain our stimulus in the short term," Bernanke said, as the latest batch of economic data from the world's biggest economy showed an increase in weekly unemployment claims, a drop in home sales and the second easing of activity in three months.

Bernanke's opposition to fiscal retrenchment until economic recovery has been assured is in contrast to the approach favoured by Britain (britain has again started talking about printing) and the eurozone countries, where governments believe action to reduce budget deficits cannot be delayed.

http://www.guardian.co.uk/business/2010 ... n-bernanke

[Hari Seldon]

^^^LOL.

Of course it's too soon for austerity. Aont it always??

Would Sri Ben rather have the khanomy dip to EU levels of debt-disaster-deleveraging-deflation-and-liability before the austerity imperative gate-crashes the kapitalist party?

Hearsay but TIFWIW.

A wag on the web I know reports that when Hungary, currently mortgaged to the IMF, sought to raise tax revenues by taxing bank profits - the IMF rushed in and said 'No.'

But, like a true sovereign nation with balls, Hungary went ahead and imposed the taxes anyway. Bravo Hungary. WOnder when Ireland and Latvia will see the light. Perhaps its remains on the PIIGS to blaze the ytrail before most of the rest of central and eastern oirope could follow.

IMO, the Iceland model is the way out. Jai Iceland!

[Sanjay M]

I thought Russia preceded the Iceland option by some years - and they've never had to look back.
(well, unless you count the crash of oil, when Putin had to hike the Gorshkov price on us)

[Neshant]

IMO, the Iceland model is the way out. Jai Iceland!

I believe if Iceland was a non-white country, their treatment would be a whole lot different.

[Neshant]

(well, unless you count the crash of oil, when Putin had to hike the Gorshkov price on us)

i believe they planned this low balling from the very start as they know Indians are easy to con and will pay when asked.

[shyam]

Many Bay Area homeowners in real estate limbo

Dunkin has plenty of company. An estimated 40,283 homeowners across a seven-county region spanning the South Bay, East Bay and the San Francisco metro area were at least three months behind on their mortgages but not yet in foreclosure as of April, according to CoreLogic, which tracks mortgage performance data. That's about 4.5 percent of total mortgages in those areas, and a drastic increase from 0.25 percent in January 2007. In the San Jose metro area in January 2007, only 513 loans were more than 90 days late but not in foreclosure. In April of this year there were 11,558. In the East Bay, the total grew from 1,435 in early 2007 to 23,155 in April.

[Hari Seldon]

Moody's Upgrades India Local Currency Rating

Lungi Dance time, folks!
/sarc off

Rating agency Moody's Investors Service raised India's local currency debt rating, citing the government's recent fiscal reforms and a strong economy.

The zero-cred rating agencies would do well to keep their lying traps to themselves for a while at least. I hope they realize that they will now on be liable for the ratings they give to bonds.

[Neshant]

The zero-cred rating agencies would do well to keep their lying traps to themselves for a while at least. I hope they realize that they will now on be liable for the ratings they give to bonds.

This recent ruling suggests they are not lliable for anything. Why does India allow these jokers into the country anyway.

--------------
Judge Throws Out Suit Against Moody’s and S.&P

A federal judge in Manhattan threw out a class-action lawsuit accusing the ratings agencies Moody’s Investors Service and Standard & Poor’s of defrauding investors about the safety of $63.4 billion of mortgage debt, Reuters reports.

The plaintiffs said the securities they bought were in fact “not of the ‘best quality,’ or even ‘medium credit quality.’” They said that, after being downgraded to junk status, the securities were worth far less than they paid.

Many underlying loans were made by mortgage lenders that later became distressed or defunct, including three of the largest: Countrywide Financial, the American Home Mortgage Investment Corporation and IndyMac Bancorp.

A spokesman for Moody’s, Michael Adler, and one for S.&P., Frank Briamonte, said their agencies were pleased with the ruling.

http://dealbook.blogs.nytimes.com/2010/ ... hoofinance

[Hari Seldon]

Neshant,

I believe if Iceland was a non-white country, their treatment would be a whole lot different.

One can only hope. The ever-benevolent n fair UKstanis invoked terrorism laws against Icelandic banks to seize their london ass-ets. Doesn't get more civil than that short of a shooting war.
Last I heard, TSP is a non-white country, despite their ardent TFTA pretensions.
And they're bankrupt like several score times over. And yet, they've been feted, fed and pumped with dollahs on and ever on....if only every bankrupt Des could hope for such benevolence....LOL

This recent ruling suggests they are not lliable for anything.

After that ruling, the so called fin-reform that passed does make the agencies liable. In fact, the SEC sorta gave the rating agencies a 6-month reprieve on poor ratings. The law is not effective retrospectively of course.

[Neshant]

And they're bankrupt like several score times over. And yet, they've been feted, fed and pumped with dollahs on and ever on....if only every bankrupt Des could hope for such benevolence....LOL.

The ones who think they will bleed us dry by propping them up will find they are themselves being bled dry.

After that ruling, the so called fin-reform that passed...

US govt shielded these snake oil salesmen from lawsuits. An attempt is being made to paper over the US govt role in preventing justice for the victims of these rating crooks. The message being put out is - now its safe to trust rating agencies.

Who in their right minds would trust a con man after being conned out of one's life savings the first time round. Only an idiot.

[ramana]

Neshant, Hari and Carl_T, You guys know some economics stuff. Can you please use simple sentences without jargon to lay out a few scenarios for ordinary folks to understand?

- Rising interest rates
- Inflation
- Trade flows
- Deflation

What will cause these and what will be the impacts and what is the hedge

And the probabilities.

Other wise this thread becomes a nukkad.

[aqkhan]

- Interest rates - Interest rates are a way of the federal reserve banks to control monetary supply to hit the sweet spot between inflation and deflation in an economy. If the federal reserve sets interest rate too low, the banks are flooded with money, so they can lend at low interests to people to stimulate the economy. However, there is also an increased risk of bad loans (and if there are a lot of them, banks can collapse). There is also a risk of inflation shooting through the roof (because if everyone earns a lot, prices can rise faster than average compensation of the general population). If inflation rises, Federal Reserve usually raises interest rates which means not everyone will be able to borrow, which will control the prices of goods and make it affordable to general population.

- Inflation - Inflation in simple terms is the increase in prices of daily goods. Inflation is good if compensation of the country as a whole outpaces the price rise. Inflation is bad if the price shoots through the roof and people struggle to buy simple daily usage items

- Trade flows - Trade flow is the flow of goods (raw materials, finished goods etc) amongst countries. Baltic Dry Index is a good measure of where the economy is headed (upwards/downwards) because it measures the shipping prices of goods across countries (If the trade increases, shipping prices go up, and vice-versa).

- Deflation - Deflation is when prices of commodities and daily goods fall. Deflation occurs when everyone starts hoarding money (due to fear of recession) and manufacturers then are forced to drop down prices to make them attractive to buy. Deflation is a blaring alarm for economists because if deflation occurs, then it means they have not done the job of oiling the economy well (suitable conditions for people to keep spending/investing).

I'll post a complete analysis of the current situation later in the evening when I go home.

[Suraj]

Another thing about deflation: Deflation is a 'return to the mean' after a period of overextending. It poses the added danger of a deflationary spiral if it continues for any significant length of time. Falling prices mean that consumers withhold purchases, since they feel they'll get a better price later. Manufacturers and service providers respond to loss of business by lowering prices, cutting capacity and laying off workers. In the process, people lose their jobs and stop spending. This further exacerbates the pressure to lower prices to move inventory, and the vicious cycle continues, as economic activity essentially unwinds; the actions of the seller in cutting prices ironically reinforces the buyers move to not buy.

The government frantically tries to stimulate economic demand by lowering the cost of money, i.e. interest rates, so that the buyers cost of buying is minimal. However, if the interest rates are already at rock bottom levels, they've essentially painted themselves into a corner. Throwing essentially zero-cost money will no longer work. Banks become unwilling to lend because of lack of return, and since deflation follows a period of overextension, they use the money to service their accumulated bad loans. They refuse to lend or act fast, as seen in the story of the bay area real estate scene - if they rush in and foreclose a lot of houses, they'll put more homes on the market, lowering prices across the board, tipping those underwater even further.

For this spiral to break, re-employment needs to stabilize first, and then employment numbers need to pick up. Without a new industry generating real value, just throwing money at the current economy will result in all of it essentially ending up servicing the financial sector that overextended itself. There's a potential for a massive public works maintenance/renewal project to employ people - stimulus 1 already attempted it to an extent - but considering the logjam in DC, it's unlikely to occur on anywhere near the same level of urgency as the 1960s interstate highway building program.

[VikramS]

ramana:

Interest rates are set on a curve depending on the duration of the bond. The Fed controls overnight rates. The bond market controls all other rates. Right now the yield curve is one of the steepest since overnight rates are close to zero while 10 year rates are near 3% (near historic lows). This means that banks' (who can borrow from the Fed) cost of capital is almost zero while they can lend at higher rates. This low interest rate policy is there to encourage bank lending to stimulate the economy which unfortunately is not happening since credit-worthy borrowers do not want to borrow while banks do not want to lend to risky borrowers. It is also designed to help banks make a lot of profits to fix the capital hole in their balance sheets.

There is a risk that if US deficits continue to grow AND inflation rears its head, bond investors will demand greater yield and the US will not be able to finance her deficit at low costs. If interest rates (the longer term) rise, then bonds lose value; the Fed can not control those rates.
Best way to hedge this against this risk is:
-> Use a ladder of CDs/bonds (maturing between 1-5 years) and as each matures roll it over to 5 year bonds.
-> Buy TIPS which are inflation protected (though the inflation calculation is supposed to be rigged).


Inflation: Common sense definition is the increase of price of stuff (goods/services). Classic definition has to do with increase in money supply which creates demand which is greater than economic capacity, which pushes the price of production resources higher and hence the price of goods higher. Right now there is wage deflation (high unemployment, cheap Asian labor), over capacity in production resources but a chance of commodity inflation due to (a) Demand for India/China (b) Investor demand for hard assets to fight dollar cheapened by quantitative easing. Economists want moderate inflation since it allows asset back debt to be secure and allowing the fractional reserve system to work.


Deflation: The opposite of above. People do not spend because they expect lower prices and the downward spiral continues since demand dies. Biggest issue is that asset back debt goes bad since the debt is more than what the assets are worth.

TradeFlows: Creates a component of current account deficit. Right now the rest of the world gets USDs for the trade imbalance and either sells it (which lowers the value) or buys US assets (treasuries). If interest in US assets declines then USD will start falling if deficit is high. For the US to get out of the unemployment mess, the USD should devalue making US production more competitive which should reduce trade imbalance and make USD stronger.

How to handle it:
Diversify into different kind of resources with a bias away from US/European resources. Include Gold/Commodities. Focus on income producing investments (REITs, MLPS, high yield staple stocks). Be careful with the duration of the bonds you hold. Longer duration bonds will crash if long term interest rates rise; keep the duration limited to 5-10 years. Trade the US stock market; it is likely going to be range bound.

There might be a low slow grind down but the Fed will pump enough money to prevent a crash. So take Prechter et. al. with a pinch of salt.

[AkshayM]

I don't think ramana is asking for definitions of those terms but scenarios under which these may occur and ensuing impact.

- Rising interest rates

Easily not happening until 2012. I'm talking about Fed funds rate (the short term interest rate). Fed is allowing easy money for banks to recoup much needed capital they lost on bad loans. Most of the banks are accumulating easy 3% on treasuries while borrowing at 0.25%.

- Inflation

Consensus is that this is not likely happening. Consumer deleveraging is probably about 30% through. Until households deleverage demand will not return. There is complete collapse of consumer credit because no one wants to borrow. Also, Fed is pumping money via quantitative easing i.e. buying up all types of assets at who knows what prices. This new money is going to banks and other agencies and not ending up in economy. Unless new money directly results in new credit there is little chance of inflation.

- Deflation

Is what is playing out right about now. Deleveraging deflationary cycle is real possibility if not already underway. Private sector is hands down paying off debts, negotiating or defaulting. Consumer demand for everything but essentials is non existent. This may prompt QE 2 (quantitative easing 2) by the Fed and/or fiscal stimulus. The latter is going to be victim of Washington politics and may not happen until after mid-term elections.

Between unemployment, flat housing market, deleveraging by private sector, banks resorting to reducing loan loss provisions and moving it to income and demand collapse does not indicate imminent inflation.

[aqkhan]

What will cause these and what will be the impacts and what is the hedge

There are two scenarios under present condition that can cause havoc on the global economy:

Scenario 1:

US government decides that the tax cuts that were given during the Bush administration is not fuelling spending growth and decides to tax the families making upwards of $200K per year in order to get revenue to reduce fiscal deficit. Most small businesses are started by these families or a group of these families (which are a bit affluent but want to increase their wealth by starting their own small business). An estimated 20 million people in the US work for employers having less than 20 workers working for them and another 18 million work for employers with a workforce strength of 21-100. So approximately around 25-30% of the US workforce is employed in small businesses. If taxes increase, this could cause job losses for these small businesses (because profit margin in small businesses are low and small businesses cannot sustain huge losses). If the tax increase is substantial, this could also mean small businesses closing shops exacerbating the situation. The severity of the situation can be compounded if banks continue to hoard money due to uncertainty surrounding the value of USD and government policies. If this situation continues for 4-5 years, the big businesses will start feeling the heat and they will continue layoffs to please investors and shareholders. If they continue, the middle class erosion will continue, people will be unable to spend, there will be deflation and if the federal reserve (and the US govt) doesn't intervene then, there will be deflation, which if continues for a long period of time will result in a depression.


Scenario 2:
US government continues the tax cuts for the tax brackets of families earning $200K and over in order to keep the small businesses running and the federal reserve keeps the interest rates low for a very long period of time, causing increasing deficits for a long period of time. Since the federal debt is already at 90% of the GDP and deficit is at 10% of the GDP, foreign government who buy US debt bonds will question the monetary policy of the US government and will refuse to lend any more money to the US, unless the fed and treasury pay more interest on the new bonds issued. In that case, the government has to either increase taxes (this time forcibly) to pay increased interest on their debt bonds or go for a devaluation. In either case the government has to renege on its obligations to the citizens like Social Security, Medicare, Medicaid etc because they simply cannot continue to give these benefits to their citizens because of an eroding middle class (culminating in lower taxes) and an ageing population. At this point, If the government keeps printing money by stacking up a debt of a trillion dollars a year, it will go the route of Wymar Republic i.e. hyperinflation (where the global market realizes that the dollar is not worth the current exchange rates anymore and people start dumping USD). If the government goes the way of deficit reduction, it will cause either a recession or at best, stagflation (zombie economy with no growth but no crash either).

So, in my view (and in most economists view) the US government is stuck between a rock and a hard place. Uncertainty still looms large simply because Keynesian theory predicts doom at the stage the US economy is at right now regardless of the option it takes, simply because the fed cannot fine tune the economy. They can only provide a coarse direction. And that coarse direction is not working. Interest rates are zero and big corporate profits are soaring but small businesses are struggling and unemployment is still rising! This is crazy! Also there doesn't seem to be any new industry on the horizon that could boost growth and provide employment at the same time. The best scenario I see for the US is stagflation (no growth but zombie economy for a continued period of time which is where Japan is currently). The innovative edge is also lost with countries like China/India/Brazil/Indonesia which provide competitive labor (even for R&D moving up the value chain) at a fraction of the cost in the west. At first, it was assumed in the US that low cost manufacturing would be replaced by white collar jobs in the US this opening up the trade with China, but even that got eroded when India stepped in to provide those white collar services at a fractional cost. In essence, I see US government and its population in general stupefied by the rising of the east. Unless the dollar is devalued, I don't see any permanent solution to the debt woes of the western countries.

And the probabilities.

No economist in the right mind can give probabilities to any scenarios mentioned above simply because the federal reserve is run by a handful of people who are controlled by the biggest banks of the west. One cannot predict the market, nor the response by the fed to it.

[ramana]

Great explanations guys. Thanks to all of you. Now will mull over and come back with hopefully more questions.

About probabilities, how do you rate Secanrio 1: low, medium or high?

And from above defns home RE is already in deflationary phase?

[arnab]

About probabilities, how do you rate Secanrio 1: low, medium or high?

And from above defns home RE is already in deflationary phase?

Scenario 1 (of aqkhan) confuses between an income tax (families earning over $200 K) and a business tax (they will stop hiring) - so is probably irrelevant.

My 2 cents:

Generally speaking, Governments have two broad policy options to control economic cycles – fiscal policy (through changes in taxes and subsidies) and monetary policy (through changes in interest rates). Prior to the GFC, fiscal policy was essentially ignored and the focus was broadly on monetary policy by controlling interest rates to stimulate or dampen economies.

Inflation is a measure of an increase in the general price level in an economy. The link between interest rates and inflation is that an increase in interest rates is supposed to reduce inflation because it dampens economic activity because businesses and consumers find it more expensive to borrow, so prices fall. The opposite is when the government (Federal Reserve) reduces interest rates – economic activities pick up because it is cheaper for businesses to borrow and for consumers to spend and prices rise. Thus the cycle continues.

GFC was / is a rule changer because the link between interest rates and economic activity has broken (at least temporarily and no this is not the first time this has happened) – This is because it is a crisis of confidence. Bankers are not willing to lend and employers /consumers are not willing to borrow because of future uncertainty. So reducing interest rates to near zero has still not led business to start borrowing (and by extension start hiring people for work). And interest rates can go no lower. This is what is technically known as a liquidity trap. So this is a case of ‘market failure’.

Hence governments took the step of attempting to stimulate the economy directly by spending copious amount of funds on infrastructure projects (to start economic activity) or even directly handing out money to citizens – to get them to spend, so that businesses keep on functioning. In the process governments have incurred huge debt, however it has not been able to stimulate business activity to the level that firms have started hiring people (so the unemployment rate continues to be high).

The debate now is – should governments cut their losses because high debt means future higher taxes or a spiral where government continues to borrow which would push up future prices (inflation) and raise future interest rates? Or what Krugman, DeLong etc argue that it is too early to fear any return of inflation so need to continue to stimulate the economy by higher govt spending is needed. This is because the cost of long-term unemployment of a large section of people is far greater in the future because they would lose skills, become dispirited and move out of the labour force.
Trade flows is simply the fact that the theory of comparative advantage argues that trade can make everyone better off because this leads to ‘specialization’ and nations can focus on their core advantages (resources, technology, services, agriculture etc). It is also a measure of how ‘open’ a country is to trading. The more ‘open’ a country is, the more vulnerable it is to external factors. But on the other hand, openness allows countries to access a much larger market and build up skills because of increases in competition. In times of crisis, typically nations become ‘protectionist’, because they want to ensure survival of local industry. They do this through tarffis or quota. Typically this is seen to be inimical to world peace and prosperity (one of the causes of the 1929 depression and subsequent world wars), so have set up a multilateral institution like WTO to ensure that no countries unfairly manipulate trade through creating tariff walls or manipulating the exchange rate. In practice, many countries do manipulate trade flows to benefit local industry (e.g China through currency, and India through tariffs and other non-tariff barriers)

Deflation of course is a fall in the general price level. The key word is ‘general’. The fact that house prices have fallen does not mean that it is a deflation. This is a scenario where prices of everything fall. It is good if you are employed and bad if you are retired and an asset holder and live primarily off asset incomes.

The real problem that developed nations face is the ‘structural’ nature of their expenditures due to aging population. This means that developed nations have little room for reducing ‘discretionary’ expenditures. Defence is the easiest discretionary expenditure to tackle for the US. This means that US defence manufacturers would over-time look at other markets and preferably ones that the US govt does not have any issues in dealing with. The other option of course is to raise taxes on consumption or on income. The third longer-term option is to offset the aging demographics by providing incentives to increase birth rates (like paid maternity leaves) or to increase net migration.

[aqkhan]

Scenario 1 (of aqkhan) confuses between an income tax (families earning over $200 K) and a business tax (they will stop hiring) - so is probably irrelevant.

I agree with the rest of your post except this. You have never started a small business I assume. Small businesses (except in tech and that too only of a new promising technology) don't start off with simply with VC money. They have their hard earned money invested in their small businesses. Any increase in personal tax will effect their small businesses as will an increase in small business tax. They are very tightly coupled.

And from above defns home RE is already in deflationary phase?

Residential RE is in a deflationary rate because the middle class is eroding in face of stiff competition from the east. As long as there are job losses, the residential RE will continue its downward spiral. If the spiral continues for an extended period of time, eventually prices across the board will continue to fall thus culminating into a deflation.

[arnab]

I agree with the rest of your post except this. You have never started a small business I assume. Small businesses (except in tech and that too only of a new promising technology) don't start off with simply with VC money. They have their hard earned money invested in their small businesses. Any increase in personal tax will effect their small businesses as will an increase in small business tax. They are very tightly coupled.

This doesn't make sense - if their hard earned money is invested in their businesses - then it is an investment not an income. So the higher income tax does not impact them at all. Unless you are saying most small business owners actually continue to 'earn' their money somewhere else and then open a business to further augment their earnings or earn tax breaks (and hire people to run this business). I would really like to know what proportion of business do this (where running their business is not their full time occupation).

[Carl_T]

Rising interest rates is not a realistic scenario. The Fed raising interest rates raises the cost of borrowing (may also raise the profits from lending but we won't go into that ), and thus raising interest rates reduces lending activity, which in turn reduces the money supply because the movement of money through the economy slows down. When the movement of money slows down - less people are borrowing and lending, it means the economy is slowed.

We're at a point in which the economy is slow, AND the cost of lending is very low, so the fed cannot really use the interest rate wand to spark the economy. What to do onlee?

Government then either borrows or taxes people to get money and reinjects it into the economy....problem is it is just redistribution.


I feel it is better if the federal gov forgot about making the economy grow and focused on reducing taxes ---> giving people more money to spend instead of the government taking it from them and spending it.


Oh but why can't we lower taxes? A few wars and universal healthcare and medicare etc. Might be a good time to get out of those wars, reduce taxes, and down the road we may see growth.

[Neshant]

Jaguar Inflation

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[Hari Seldon]

U.S. may face deflation, a problem Japan understands too well (LATimes)
For those of faint of heart, you are warned that you will get a picture of Sri Bernake upon clicking on the above link.

Economists worry that America could be edging closer to the trap that cost the other nation more than a decade of growth.

Tell me about it.

Reporting from Washington — The White House prediction Friday that the deficit would hit a record $1.47 trillion this year poured new fuel on the fiery argument over whether the government should begin cutting back to avoid future inflation or instead keep stimulating the economy to help the still-sputtering recovery.

But increasingly, economists and other analysts are expressing concern that the United States could be edging closer to a different problem — the kind of deflationary trap that cost Japan more than a decade of growth and economic progress.

And as Tokyo's experience suggests, deflation can be at least as tough a problem as the soaring prices of inflation or the financial pain of a traditional recession.

When deflation begins, prices fall. At first that seems like a good thing.

But soon, lower prices cut into business profits, and managers begin to trim payrolls. That in turn undermines consumers' buying power, leading to more pressure on profits, jobs and wages — as well as cutbacks in expansion and in the purchase of new plants and equipment.

Also, consumers who are financially able to buy often wait for still lower prices, adding to the deflationary trend.

All these factors feed on one another, setting off a downward spiral that can be as hard to escape from as a stall in an airplane.

But the Fed's chief, Ben Bernanke, appears to think deflation fears are overblown. During his semiannual testimony to Congress last week, he told senators that he didn't view deflation as a near-term risk.

In the Fed's latest forecast, core inflation is projected to stay at the current pace this year, then gradually rise toward 1.5% in 2012.

Should deflation occur, the central bank has the tools to reverse it, he said.

But many question whether the Fed can do much more, given that it already has pushed interest rates to historical lows and pumped more than $1 trillion into the financial system.

Also, Bernanke said, America's economy is more vibrant and productive than Japan's was, and its labor force isn't declining, whereas Japan's has been for much of the last decade. Japan also was much slower in addressing problems with its banking sector than the U.S., he said.

Japan's aging population and rigid business and political systems have clearly contributed to the country's long economic malaise, which began in the 1990s. But there are some notable similarities with America's latest economic slump.

Read it all only.

[arnab]

Reminds me of that old joke. Politicians don't like inflation. They don't like deflation. What they would want is flation

[Neshant]

politician, banks and other assorted crooks love inflation.

The fiat money pyramid scheme depends on it. Its set up such that those at the top of the pyramid enjoy the full purchasing power of the printed up money as they receive it first. As it rolls down the pyramid to the people, its value is destroyed (inflated) so the people down below don't get the full purchasing power that they earned.

Works good if you are a banking crook at the top of the pyramid. Not so good if you are doing real work at the bottom of the pyramid - especially with fake statistics cooked up by crooks at the top about how fast the fiat is becoming worthless.

The good thing about deflation is it turns this pyramid scheme upside down. Naturally the chief crook at the top is alarmed and wants to right the pyramid back on its base. That system of easy theft of other people's earnings for doing jack sh&t is important to the scheme. Otherwise, banking and financing con men might actually have to find real jobs.

[Hari Seldon]

Fake £1 coins rising in circulation, figures show (BBC News)

Packees expolting their, ahem, talents in oiroland these days or what?

[ShivaS]

Fake £1 coins rising in circulation, figures show (BBC News)

Packees expolting their, ahem, talents in oiroland these days or what?

from the above report

Key signs of counterfeits include a poorly defined ribbed edge or an indistinct design of the Queen.

Is it a sign of Republicans hinting to do away with the queen?

or a finding of compromising position of queen on the coin by Paki design?

[Hari Seldon]

Awrite, janta. aaj ka must-read (imvvho, of course)

The Death of Paper Money
By who else but our favorite resident alarmist allah-ram-ist, sri sri AEP!

The crucial passage comes in Chapter 17 entitled "Velocity". Each big inflation -- whether the early 1920s in Germany, or the Korean and Vietnam wars in the US -- starts with a passive expansion of the quantity money. This sits inert for a surprisingly long time. Asset prices may go up, but latent price inflation is disguised. The effect is much like lighter fuel on a camp fire before the match is struck.

The message in deep red font is worth digesting phurst.

People’s willingness to hold money can change suddenly for a "psychological and spontaneous reason" , causing a spike in the velocity of money. It can occur at lightning speed, over a few weeks.
The shift invariably catches economists by surprise. They wait too long to drain the excess money.

"Velocity took an almost right-angle turn upward in the summer of 1922," said Mr O Parsson. Reichsbank officials were baffled. They could not fathom why the German people had started to behave differently almost two years after the bank had already boosted the money supply. He contends that public patience snapped abruptly once people lost trust and began to "smell a government rat".

OMG - for whom does the red font toll?? All of us, I shudder to disclose....

As it happens, another book from the 1970s entitled "When Money Dies: the Nightmare of The Weimar Hyper-Inflation" has just been reprinted. Written by former Tory MEP Adam Fergusson -- endorsed by Warren Buffett as a must-read -- it is a vivid account drawn from the diaries of those who lived through the turmoil in Germany, Austria, and Hungary as the empires were broken up.

Near civil war between town and country was a pervasive feature of this break-down in social order.Large mobs of half-starved and vindictive townsmen descended on villages to seize food from farmers accused of hoarding.

The diary of one young woman described the scene at her cousin’s farm.

"In the cart I saw three slaughtered pigs. The cowshed was drenched in blood. One cow had been slaughtered where it stood and the meat torn from its bones. The monsters had slit the udder of the finest milch cow, so that she had to be put out of her misery immediately. In the granary, a rag soaked with petrol was still smouldering to show what these beasts had intended," she wrote.

OK, take sri AEP's exaggerated sesked up gore with some salt.

Grand pianos became a currency or sorts as pauperized members of the civil service elites traded the symbols of their old status for a sack of potatoes and a side of bacon. There is a harrowing moment when each middle-class families first starts to undertand that its gilt-edged securities and War Loan will never recover. Irreversible ruin lies ahead. Elderly couples gassed themselves in their apartments.

Foreigners with dollars, pounds, Swiss francs, or Czech crowns lived in opulence. They were hated. "Times made us cynical. Everybody saw an enemy in everybody else," said Erna von Pustau, daughter of a Hamburg fish merchant.

Great numbers of people failed to see it coming. "My relations and friends were stupid. They didn’t understand what inflation meant. Our solicitors were no better. My mother’s bank manager gave her appalling advice," said one well-connected woman.

"You used to see the appearance of their flats gradually changing. One remembered where there used to be a picture or a carpet, or a secretaire. Eventually their rooms would be almost empty. Some of them begged -- not in the streets -- but by making casual visits. One knew too well what they had come for."

OMG. Terrible indeed. This was the misery that was visited on Russia in the late 90s though the ruissian khanomy was more basic and hence more robust to disruptions of this nature.

Who were the 'winners' in this sordid saga though? And wo were the soon-to-be losers, besides?

Corruption became rampant. People were stripped of their coat and shoes at knife-point on the street. The winners were those who -- by luck or design -- had borrowed heavily from banks to buy hard assets, or industrial conglomerates that had issued debentures. There was a great transfer of wealth from saver to debtor, though the Reichstag later passed a law linking old contracts to the gold price. Creditors clawed back something.

A conspiracy theory took root that the inflation was a Jewish plot to ruin Germany. The currency became known as "Judefetzen" (Jew- confetti), hinting at the chain of events that would lead to Kristallnacht a decade later.

While the Weimar tale is a timeless study of social disintegration, it cannot shed much light on events today. The final trigger for the 1923 collapse was the French occupation of the Ruhr, which ripped a great chunk out of German industry and set off mass resistance.

Wonder what the trigger event will be this time...

More terror...

The Carthaginian peace of Versailles had by then poisoned everything. It was a patriotic duty not to pay taxes that would be sequestered for reparation payments to the enemy. Influenced by the Bolsheviks, Germany had become a Communist cauldron. partakists tried to take Berlin. Worker `soviets' proliferated. Dockers and shipworkers occupied police stations and set up barricades in Hamburg. Communist Red Centuries fought deadly street battles with right-wing militia.

Nostalgics plotted the restoration of Bavaria’s Wittelsbach monarchy and the old currency, the gold-backed thaler. The Bremen Senate issued its own notes tied to gold. Others issued currencies linked to the price of rye.

OK, why this walk down history lane? How does it relate to 2010 AD you ask??

This is not a picture of America, or Britain, or Europe in 2010. But we should be careful of embracing the opposite and overly-reassuring assumption that this is a mild replay of Japan’s Lost Decade, that is to say a slow and largely benign slide into deflation as debt deleveraging exerts its discipline.
{I'm hoping and praying for a slow, managed decline for the paschimi powers. Sadly, all bets are off once the law of unintended consequences takes off. }

Japan was the world’s biggest external creditor when the Nikkei bubble burst twenty years ago. It had a private savings rate of 15pc of GDP. The Japanese people have gradually cut this rate to 2pc, cushioning the effects of the long slump. The Anglo-Saxons have no such cushion. {And that after centuries of looting and milking other lands dry, is saying something}

There is a clear temptation for the West to extricate itself from the errors of the Greenspan asset bubble, the Brown credit bubble, and the EMU sovereign bubble by stealth default through inflation. But that is a danger for later years. First we have the deflation shock of lives. Then -- and only then -- will central banks go to far and risk losing control over their printing experiment as velocity takes off. One problem at a time please.

Read it all.

[ShivaS]

The above narration conjures up the vision of the (flopped) movie Robinhood *ing Russel Crowe and Cate Blanchett. After the failed expeditions during the times of crusades people looting produce and cattle

[Neshant]

Should deflation occur, the central bank has the tools to reverse it, he said.

The tools.

Don't you just love the fancy terminology banking con artists come up with for money printing.

Make sure you tuck your tools safely away in your trousers in 'Mind the Gap' brand kacha.

[aqkhan]

This doesn't make sense - if their hard earned money is invested in their businesses - then it is an investment not an income. So the higher income tax does not impact them at all. Unless you are saying most small business owners actually continue to 'earn' their money somewhere else and then open a business to further augment their earnings or earn tax breaks (and hire people to run this business). I would really like to know what proportion of business do this (where running their business is not their full time occupation).

Higher income taxes stifle their ability to expand their businesses or even close it down if it starts being infeasible. There is only so much of hard earned savings that people would like to take risk with. While they can recuperate part of their losses by showing it as an investment loss, its only a fraction and the business and jobs associated with it are lost forever.

[aqkhan]

The good thing about deflation is it turns this pyramid scheme upside down. Naturally the chief crook at the top is alarmed and wants to right the pyramid back on its base. That system of easy theft of other people's earnings for doing jack sh&t is important to the scheme. Otherwise, banking and financing con men might actually have to find real jobs.

Actually, the people at the top of the pyramid still come out on top even if there is a deflation. They have RE investments around the globe, they invest in stocks and currencies around the globe by paying their investment managers a fat salary, so they are still kings, whether there is a rising inflation or deflation. The people at the bottom always suffer.