Deflation hedges

[rb]

I have been thinking about this deflation debate in general and it seems to me that deflation is what would happen if the government didn't interfere.  In 08/09 it sure looked like deflation was going to happen and when it didn't the deflationists blamed it on government cronyism, can kicking, deficit spending, propping up failed banks, etc.  I think the deflationists were right on the theory but ignored that government wouldn't stand idly by.  That same issue will exist going forward.  It just seems governments have so many tools to fight deflation, they can run deficits, the federal reserve can print money, they can lower taxes, enact stimulus programs, etc.  All of these things are arguably bad in the long-run but I think we have enough evidence now that that is the way it will go.  If the government can just make money appear, is that not all inflationary and shouldn't that at some point push up prices?

Lunch,

 

I don't see why it's a shock that governments stepped in? They basically came it to prop up demand and smooth the deleveraging. What should they have done? Sit back and let their economies implode? Why was that a rational expectation? The fact is that the governments haven't done enough. They had all the data but determined that doing more was not politically feasible. That's either a cop out or a sad state of society.

 

Don't take this the wrong way because I've seen a lot of stuff you posted and you're a smart guy so don't take what I say to heart. The truth is that macro is hard. The idea that "All of these things are arguably bad in the long-run" is wrong. That was the liquidationist view of the 1930s which was the dominant view back then. The thinking was that the government shouldn't step in because negate the good work that depression do. That worked out brilliantly!

 

The thing is that the economics profession has learned a lot from the 1930s and we've (less Europe) been lucky enough to have people at helm that know those lessons. The downside is that the measures implemented have only gone half way because of political reasons. What is disturbing is that the reasons against government intervention today are the same as the ones that popped up during the 1930s and which have been proven totally wrong. But I think it could have easily been worse.

[rb]

It is for this reason that I believe the delation contracts market prices will differ from actual cpi numbers. why? Oil was $148 dollars and we had huge inflation in June 2008...only to see massive deflation in 2009!! It is not where we are...it is where we are going...No one's hedges worked even Ray Dalio got smoked in August...Einhorn, Ackman etc...so the interest in another way to hedge is certainly on the table globally.

 

We really didn't have massive deflation in 2009.  There was a spike up during 2008 of about 5%, which completely reversed by the end of the year.    2009 saw the CPI end within a fraction of a percent of where it started.

 

Here are the end of year CPI numbers for the US:

 

2007: 210

2008: 210.3

2009: 215.9

2010: 219.1

2011: 225.7

2012: 229.6

2013: 233.0

2014: 234.8

 

I guess I can't say with absolute certainty we won't have deflation but we really didn't have any sustained deflation during the 08/09 crisis and there wasn't any in japan over the past 20 years.  That is all I am saying, we have to really get speculative that this will happen.

There are some very good points here. In economics there is the headline CPI and Core CPI which is CPI excluding food and energy. In economics you learn pretty quick that for monetary policy reasons you discard CPI and focus on Core CPI. One of the reasons for that is that food and energy prices are really volatile. The other is that it would lead to bad decisions. From the point of view of a central bank to keep the economy humming and have smooth inflation at some target rate. If you have a big jump in the oil price that is a negative supply shock. But it will cause a jump in the headline CPI so if you were focused on that you'd raise rates and hit the economy with a negative demand shock. Great you've just battered your economy.

 

If you ignore headline CPI and look at core CPI you'd see that it didn't really go negative in 08-09 so it was a lot to do with the price of commodities. There is also the concept of sticky prices that everyone ignores around here. But the fact is that it's hard to break through the zero barrier of inflation.

[no_free_lunch]

The fairfax hedges are on the headline CPI so it is good to know that it is more volatile.  So this is slightly to fairfax's advantage I guess.  It is possible you could have some quick deflation before the fed can react.  However, if headline CPI dipped and fairfax didn't sell their options it could all disappear when the CPI reverts back up.  In 08 they probably wouldn't have made money because I don't think it fell enough that they would have sold.

 

I would prefer a fairfax that just equity hedges.

[rb]

The fairfax hedges are on the headline CPI so it is good to know that it is more volatile.  So this is slightly to fairfax's advantage I guess.  It is possible you could have some quick deflation before the fed can react.  However, if headline CPI dipped and fairfax didn't sell their options it could all disappear when the CPI reverts back up.  In 08 they probably wouldn't have made money because I don't think it fell enough that they would have sold.

 

I would prefer a fairfax that just equity hedges.

You're kind of on the right track on the CPI stuff. inflation in a rate of change so if you put the hedges at the right time and headline CPI drops because of a decline in oil (which would be a one time shock to cpi)  then you need to sell right after to get your gains otherwise the regular inflation takes you above the strike again.

 

So it would work if you were market timing commodities. They're not doing that though. So I don't see how that works well.

 

You do, but I also don't like the equity hedges - and those have been the bigger problem. That's also a market timing issue. Why focus so much on that instead of using your vast stock picking (or valuation) skills to build value? Do good underwriting, make money, invest that money - make more money and so on. Worked pretty well for Berkshire.

 

As I've said in another post between the equity and deflation hedges they booked losses equal to roughly half the book value of the company - most of that came from the equity hedges. They've argued that it was in order to protect the company. I'm sure that someone will come and explain to me how it's great that they've done so because we're about to have a nuclear winter. But booking losses that are worth half your book value doesn't seem to me like such a great thing.

[petec]

Don't take this the wrong way because I've seen a lot of stuff you posted and you're a smart guy so don't take what I say to heart. The truth is that macro is hard. The idea that "All of these things are arguably bad in the long-run" is wrong. That was the liquidationist view of the 1930s which was the dominant view back then. The thinking was that the government shouldn't step in because negate the good work that depression do. That worked out brilliantly!

 

The thing is that the economics profession has learned a lot from the 1930s and we've (less Europe) been lucky enough to have people at helm that know those lessons. The downside is that the measures implemented have only gone half way because of political reasons. What is disturbing is that the reasons against government intervention today are the same as the ones that popped up during the 1930s and which have been proven totally wrong. But I think it could have easily been worse.

 

Count me as a deep sceptic.  Jim Grant's book comparing the 1921 depression (government did not intervene, slump corrected itself in 18 months) to the 1929 depression (government intervened heavily, counter to popular wisdom, and it lasted a decade) is interesting.  What developed through the late 1920s and out of the GD was the idea that every mild setback should be met with ever easier money.  That has encouraged the accumulation of records amounts of debt.  Some say that does not matter.  Some say it does.  My point is, we do not yet know whether what we learned from the 1930s was how to avoid a crisis, or simply how to create a different kind of crisis.  I'm going to wait another 50 odd years before declaring victory for modern economics ;)

[petec]

I would prefer a fairfax that just equity hedges.

 

 

I'm the other way on.  The deflation bet is a cheap bit of insurance against an unlikely event that has disastrous consequences.  The equity hedge was an expensive bet against an unlikely event (markets were still cheap in 2010) that would have had disastrous consequences (for a levered insureco).

 

That said, I'm not in the camp that criticises them for the equity hedges.  Whether or not a nuclear winter is coming, they always had an offsetting long position so what they did was lock in alpha at a time when they were uncertain about the markets.  They were wrong.  But they run a highly levered company in a market where regulators and clients scrutinise capital levels carefully, and in which equity investing is not the prime value creator.  They wanted to minimise their risk and they did.  I don't fault them for that.

[mals]

Here is my view on why deflation is possible. I am no expert - just trying to see if I can wrap my arms around what is going on - directionally (not trying to predict timing).

 

I think that

Change in Prices to consumers are a function of change in

  a) RM cost +

  b) apportioned capital cost +

  c) labor component ( of mining/growing, manufacturing and transportation and retail) +

  d) return on capital (profit) +

  e) temporary / rapid currency fluctuations +

  f) money in circulation +

  g) unexplained factors  ;)

 

If I think about it in this manner, here is what I conclude (based on facts as I know them)

  a) is severely downwards - i understand that the input value in the overall consumer basket might be a smaller portion as basic RM goes through many value addition steps.

  b) if massively surplus capacity - then this should also trend downwards (production to cover variable cost?)

  c) labor component - US labor mildly upwards perhaps, the rest of the world not quite.

  d) if surplus capacity, then this should also trend downwards

  e) negative effect on all import prices - at least for the US and perhaps Europe also

  f) my understanding is that the increase in circulation is not quite happening - low velocity of money (as i understand)

  g) ??

 

So my question - is the above equation too simplistic or wrong? Are there a big factors i.e. g), that I have missed out altogether, and are they such that they negate the other factors for long enough?

And please note, this is without assuming major recessions or anything - just basing it on factors observed so far this year.

[petec]

I think generally that's a great framework - but I think (f) is the key and understanding 1) why fractional reserve banking isn't creating money and 2) what central banks can, and can't, do about that is key to the debate. 

 

I'd also add that (g) might be an unexpected asset price (stocks/bonds/houses) fall that makes people nervous.

 

 

[TwoCitiesCapital]

http://www.ft.com/intl/cms/s/0/18c672e6-5793-11e5-a28b-50226830d644.html#axzz3lFWM9CIY

 

Food Prices Record Largest Monthly Drop in 7 Years

 

The FAO’s monthly food index in August fell 5.2 per cent from the month before, the steepest monthly drop since December 2008. The index is now at its lowest level since April 2009.

 

So - it's just the drop in energy right? That's all that's driving CPI and inflation expectations? We can ignore the drop in nearly all global commodities and food as coincidence? I think it's more of the canary in the coal mine.

[mals]

I think badly that's a great framework - but I think (f) is the key and understanding 1) why fractional reserve banking isn't creating money and 2) what central banks can, and can't, do about that is key to the debate. 

 

I'd also add that (g) might be an unexpected asset price (stocks/bonds/houses) fall that makes people nervous.

 

  f) money in circulation

so money gets into circulation when somebody spends it. and people and corporations have not increased spending as much as in past such cycles. perhaps scared of debt, corporations cautious, or that demand elasticity is low in developed world (outside of luxury and entertainment).

 

g) other factors

stock market shock can indeed cause people to spend less - not so for Main Street though.

 

Anyhow, since there are many who believe deflation likelihood is low, would be great to hear their rationale as it might translate to this "Change in price = a + b + ... + g" framework.

[petec]

f) money in circulation

 

so money gets into circulation when somebody spends it. and people and corporations have not increased spending as much as in past such cycles. perhaps scared of debt, corporations cautious, or that demand elasticity is low in developed world (outside of luxury and entertainment).

 

 

Less to do with spending and more to do with borrowing.  Central banks create base money.  They (in simplified terms) deposit this with commercial banks.  When there is loan demand, it gets lent out, less a reserve that must be kept back.  As soon as it gets lent it gets deposited again, which means it can be lent again, and so on.  In other words, for any given amount of base money, the amount of money circulating can expand and contract hugely depending on the demand for loans.

 

The deflationists aver that the world has reached the end of a leveraging phase, and that it will start to de-lever.  Loan demand will fall, and therefore the amount of money in circulation will fall.  That means prices will fall (money gets more valuable as there is less and less of it).

 

The central banks are combating this by printing more money.  Since they can't force people to borrow, they are buying assets.  This puts cash into the hands of the sellers (largely governments but also private bond owners and, in Japan, private equity owners) and increases the amount of money circulating.  In theory they could carry on doing this until they own everything on earth, but that's politically impossible!

 

So far three things have prevented deflation, I would argue:

1. Central banks buying assets.

2. Governments borrowing faster, partly enabled by (1).

3. China and EM's in general borrowing *very* fast.

 

I think (3) is stopping.  Interesting to see whether (1) and (2) hit political limits.  If world debt stops rising, we get deflation.

 

On the reflation side of the argument, maybe US consumers decide they have paid down enough and start borrowing again.

 

But I do think the key driver is this factor, your (f).  Ultimately in inflationary periods consumers borrow to spend and producers borrow to expand capacity, and this creates a lot of money; when the process reverses, you get deflation.  It's all about the ratio of "money" to "stuff you can spend money on"!

 

I'd also argue that asset price falls have a significant impact on Main Street spending on anything remotely discretionary, especially when Main Street has debt.

 

P

 

 

[petec]

I found this site which lists the CPI index in Japan.  Since fairfax is betting on CPI indices in US & Europe I thought this was relevant.  You will have to tweak the graph to get the long term numbers but except for brief periods there has been no deflation, as measured by the CPI, in Japan except for brief periods.  Certainly the type of decline that would be needed for the FFH CPI bets to pay off hasn't occurred.  So, we would need a deflationary event greater than what has occurred in Japan in order for these things to hit.

 

http://www.tradingeconomics.com/japan/consumer-price-index-cpi

 

Thanks for this - really interesting.  In one way it does actually tally with what Prem has predicted, which is 'bouts of deflation'.  But it doesn't tally with his 'cumulative 14%' deflation claim.

 

However, look at the GDP deflator graph on the same page.  That tallies perfectly: topped out at 110 and fell back to 95 (remember these are the absolute figures, not the rates of change).

 

So...this tests my knowledge of these statistics to their limits!  Does anyone know why the GDP deflator would differ so much from CPI?

[TwoCitiesCapital]

I found this site which lists the CPI index in Japan.  Since fairfax is betting on CPI indices in US & Europe I thought this was relevant.  You will have to tweak the graph to get the long term numbers but except for brief periods there has been no deflation, as measured by the CPI, in Japan except for brief periods.  Certainly the type of decline that would be needed for the FFH CPI bets to pay off hasn't occurred.  So, we would need a deflationary event greater than what has occurred in Japan in order for these things to hit.

 

http://www.tradingeconomics.com/japan/consumer-price-index-cpi

 

Thanks for this - really interesting.  In one way it does actually tally with what Prem has predicted, which is 'bouts of deflation'.  But it doesn't tally with his 'cumulative 14%' deflation claim.

 

However, look at the GDP deflator graph on the same page.  That tallies perfectly: topped out at 110 and fell back to 95 (remember these are the absolute figures, not the rates of change).

 

So...this tests my knowledge of these statistics to their limits!  Does anyone know why the GDP deflator would differ so much from CPI?

 

I thought through this and it seems that they should be measuring the same thing; however, a quick Google search does suggest there are some differences. The GDP deflator only measures domestic goods consumption and ignores the price differential of imports that are subtracted out of the calculation of GDP. Also, CPI only measures consumer prices (which is why we also have PPI). The deflator will capture both.

 

So the GDP deflator could drop massively and the CPI could remain the prices you had import inflation while the business investment/PPI falls off a cliff. The opposite could also hold true where the GDP deflator remains stable and CPI falls off a cliff if you import deflation via a stronger currency (the current situation of the U.S.).

 

In Japan's case, their currency appreciated massively between 1990 and 1995. Given that it was an export based economy - that is going to blow a whole in your business investment, CapEx for export purposes, etc. but it may not flow directly through to domestic consumer spending because that's not where the massive excess in capacity was targeted. Also, the "bubble" in real estate was largely contained to Tokyo - not a national trend. So the only part of CPI that would have been decelerating massively is the % of the entire index that went to housing further segregated by the % of that figure that is Tokyo. Most other assets, outside of stocks, were untouched by the disaster in 1990.

 

[wisdom]

http://video.cnbc.com/gallery/?video=3000419287

 

David Tepper had interesting stuff to say - there are about 6 or 7 videos.

[petec]

I found this site which lists the CPI index in Japan.  Since fairfax is betting on CPI indices in US & Europe I thought this was relevant.  You will have to tweak the graph to get the long term numbers but except for brief periods there has been no deflation, as measured by the CPI, in Japan except for brief periods.  Certainly the type of decline that would be needed for the FFH CPI bets to pay off hasn't occurred.  So, we would need a deflationary event greater than what has occurred in Japan in order for these things to hit.

 

http://www.tradingeconomics.com/japan/consumer-price-index-cpi

 

Thanks for this - really interesting.  In one way it does actually tally with what Prem has predicted, which is 'bouts of deflation'.  But it doesn't tally with his 'cumulative 14%' deflation claim.

 

However, look at the GDP deflator graph on the same page.  That tallies perfectly: topped out at 110 and fell back to 95 (remember these are the absolute figures, not the rates of change).

 

So...this tests my knowledge of these statistics to their limits!  Does anyone know why the GDP deflator would differ so much from CPI?

 

I thought through this and it seems that they should be measuring the same thing; however, a quick Google search does suggest there are some differences. The GDP deflator only measures domestic goods consumption and ignores the price differential of imports that are subtracted out of the calculation of GDP. Also, CPI only measures consumer prices (which is why we also have PPI). The deflator will capture both.

 

So the GDP deflator could drop massively and the CPI could remain the prices you had import inflation while the business investment/PPI falls off a cliff. The opposite could also hold true where the GDP deflator remains stable and CPI falls off a cliff if you import deflation via a stronger currency (the current situation of the U.S.).

 

In Japan's case, their currency appreciated massively between 1990 and 1995. Given that it was an export based economy - that is going to blow a whole in your business investment, CapEx for export purposes, etc. but it may not flow directly through to domestic consumer spending because that's not where the massive excess in capacity was targeted. Also, the "bubble" in real estate was largely contained to Tokyo - not a national trend. So the only part of CPI that would have been decelerating massively is the % of the entire index that went to housing further segregated by the % of that figure that is Tokyo. Most other assets, outside of stocks, were untouched by the disaster in 1990.

 

Great stuff, thanks.  Doesn't fill me with joy re: the deflation hedges.

[Guest Dazel]

 

http://finance.yahoo.com/news/u-consumer-prices-post-first-123518143.html

 

Now imagine a recession! Fairfax has good insurance here and that is all I am looking for...if we muddle along ...the operating companies will do extremely well and likely far out perform a windfall from the deflation hedges.

[Guest Dazel]

 

 

how does the insurance look now?

 

http://www.theglobeandmail.com/report-on-business/international-business/european-business/euro-zone-inflation-slows-raises-expectations-of-more-qe/article26376905/

 

http://www.theguardian.com/business/live/2015/sep/15/chinese-stocks-fall-again-uk-inflation-markets-live

 

[kevin4u2]

Interesting graphic, see below.  Something changed in China this year.  The steel picture looks the same. 

 

Food prices just saw there biggest one month drop according to the UN.  Every commodity seems to be in free fall, not just oil.

[gary17]

I would love it if we have a huge deflation in Vancouver real estate.

[beerbaron]

Interesting graphic, see below.  Something changed in China this year.  The steel picture looks the same. 

 

Food prices just saw there biggest one month drop according to the UN.  Every commodity seems to be in free fall, not just oil.

 

The graph has a truncated scale which gives the impressions that cement is almost zero. Actually cement is only about 75% of the peak of the last 4 years... I would not call this a free fall.

 

BeerBaron

[Guest 50centdollars]

 

Deflation is not a threat.  Why?  Because first, the vaunted "threats" from deflation are nonsense.  Second, deflation ain't gonna happen to any great extent, period.

 

Let's look at the first issue.  The people who talk about deflation say, "If prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases."

 

Really?  You think people really think that way?  In the supermarket, they are holding a loaf of bread in their hands and saying, "Gee, I think I will wait until tomorrow to buy this loaf of bread, as it will be cheaper then!"

 

This is a classic example of economic theorists who don't understand human nature.  If you are hungry, you buy a loaf of bread.  You are less concerned about the future value of bread than the fact you are hungry.

 

And this applies to larger purchases as well. People buy cars, washing machines, air conditioners, refrigerators, computers, or a pair of blue jeans because their existing product has worn out.  They don't sit around like economists and make predictions about the prices of products in the future for the simple reason that most people have no clue how prices are trending.  If your car needs an engine overhaul, chances are, you are in the market for a new (or newer) car.  You don't buy a car on the premise that you'd "better buy now because they'll be more expensive tomorrow!" and you don't throw a rebuilt engine into a junker because "you might as well wait, as prices will be lower tomorrow!"

 

In fact, it works just the opposite.  During the last recession, when prices of cars were flat, and the prospect of higher prices seemed dim, people threw money at their older cars to fix them because they could not afford a new or newer car.  When the economy recovered, people bought new cars (and boy did they buy new cars!) because their old clunkers were really past their prime.  That is what drove sales, not some theoretical philosophy about price trending.

 

The idea that the average consumer can perceive price trends and then act in accordance with them is just nonsense.  People buy goods because they need them, for the most part, or they want them and believe they can afford them.  Future Values just don't register in their brains.

 

The second half of the equation is that deflation just isn't going to happen.  Yes, the cost of producing a lot of goods has decreased over the last few decades, thanks to China.  But the cost of energy has kept up with this pace, and as a result, prices keep going up every year.  And those folks in China, India, and other 3rd world (or 2nd or 1st?) countries who are working for low wages, are starting to demand increases and thus the cost of such goods cannot remain low indefinitely.

 

Yes, the growth in the population has slowed.  But it is still growing.  And that means that demand for every product, from corn to iPhones, is on the rise, which means that prices will continue to rise, albeit more slowly.  Deflation?  Maybe if a plague cuts the world population in half.  Maybe.

 

 

 

[kevin4u2]

Interesting graphic, see below.  Something changed in China this year.  The steel picture looks the same. 

 

Food prices just saw there biggest one month drop according to the UN.  Every commodity seems to be in free fall, not just oil.

 

The graph has a truncated scale which gives the impressions that cement is almost zero. Actually cement is only about 75% of the peak of the last 4 years... I would not call this a free fall.

 

BeerBaron

 

You are quite right, but cement has been almost straight line down since the start of 2014. 

 

How much are steel prices down year over year?  That isn't a rhetorical question.  The CRU number from today saw HR coil fall 15/ton week over week, absolutely huge.  New 52 week low.   

 

If it weren't for trade protectionism, there would be a US steel mill closing every week.  You can pretend like this isn't a big deal, that's fine. 

 

http://news.yahoo.com/world-food-prices-plunge-seven-low-fao-084147343.html

[kevin4u2]

 

Deflation is not a threat.  Why?  Because first, the vaunted "threats" from deflation are nonsense.  Second, deflation ain't gonna happen to any great extent, period.

 

Let's look at the first issue.  The people who talk about deflation say, "If prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases."

 

Really?  You think people really think that way?  In the supermarket, they are holding a loaf of bread in their hands and saying, "Gee, I think I will wait until tomorrow to buy this loaf of bread, as it will be cheaper then!"

 

This is a classic example of economic theorists who don't understand human nature.  If you are hungry, you buy a loaf of bread.  You are less concerned about the future value of bread than the fact you are hungry.

 

I have never heard that definition before.  Do you think FFH is investing hundreds of millions based on your theory of deflation?

 

Prices fall because of increasing supply or declining demand.  The prices for every commodity around the world is falling.  It appears that a lot of people have been putting off purchasing decisions.  I don't see huge investments in O&G, steel mills, precious metals, mines, potash, etc.  In fact, falling prices has caused a decline of incomes.  The aggregate decline in incomes represents a further decline in demand.

 

Rapidly increasing credit worldwide has kept demand robust, but that appears to be unwinding particularly in China.  Keep in mind that what is required to reverse deflationary pressures is increasing credit, but banks tend to tighten credit when unemployment is rising and asset prices are falling.  I can guarantee you there are a lot of O&G companies that don't want to talk with their banker this fall about the value of a their assets.     

 

Just as a side note.  I was talking with someone from steel tubing company a couple weeks ago and he was telling me how many companies in Alberta have gone to 3-4 day work weeks, while some have kept 5 day work weeks but at a 50% decrease in pay.  I wonder what the unemployment rate would be in Alberta if these partial layoffs were reported as full time equivalents.  He also expects a lot more to come near the end of the year as people throw on the long awaited recovery.  When I was there this summer, everyone was still in denial about how long the low oil prices would persist. 

 

So, when CNRL cuts wages 10% across the board, what is the effect on the unemployment rate?  What is the effect on the economy? 

 

To answer your straw man, yes people will buy bread but why are grain prices at seven year lows, falling over 5% last month, if demand is so inelastic as you seem to think? 

 

Where is the demand response to falling prices?  To QE infinity and beyond.

[TwoCitiesCapital]

 

Deflation is not a threat.  Why?  Because first, the vaunted "threats" from deflation are nonsense.  Second, deflation ain't gonna happen to any great extent, period.

 

Let's look at the first issue.  The people who talk about deflation say, "If prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases."

 

Really?  You think people really think that way?  In the supermarket, they are holding a loaf of bread in their hands and saying, "Gee, I think I will wait until tomorrow to buy this loaf of bread, as it will be cheaper then!"

 

This is a classic example of economic theorists who don't understand human nature.  If you are hungry, you buy a loaf of bread.  You are less concerned about the future value of bread than the fact you are hungry.

 

And this applies to larger purchases as well. People buy cars, washing machines, air conditioners, refrigerators, computers, or a pair of blue jeans because their existing product has worn out.  They don't sit around like economists and make predictions about the prices of products in the future for the simple reason that most people have no clue how prices are trending.  If your car needs an engine overhaul, chances are, you are in the market for a new (or newer) car.  You don't buy a car on the premise that you'd "better buy now because they'll be more expensive tomorrow!" and you don't throw a rebuilt engine into a junker because "you might as well wait, as prices will be lower tomorrow!"

 

In fact, it works just the opposite.  During the last recession, when prices of cars were flat, and the prospect of higher prices seemed dim, people threw money at their older cars to fix them because they could not afford a new or newer car.  When the economy recovered, people bought new cars (and boy did they buy new cars!) because their old clunkers were really past their prime.  That is what drove sales, not some theoretical philosophy about price trending.

 

The idea that the average consumer can perceive price trends and then act in accordance with them is just nonsense.  People buy goods because they need them, for the most part, or they want them and believe they can afford them.  Future Values just don't register in their brains.

 

The second half of the equation is that deflation just isn't going to happen.  Yes, the cost of producing a lot of goods has decreased over the last few decades, thanks to China.  But the cost of energy has kept up with this pace, and as a result, prices keep going up every year.  And those folks in China, India, and other 3rd world (or 2nd or 1st?) countries who are working for low wages, are starting to demand increases and thus the cost of such goods cannot remain low indefinitely.

 

Yes, the growth in the population has slowed.  But it is still growing.  And that means that demand for every product, from corn to iPhones, is on the rise, which means that prices will continue to rise, albeit more slowly.  Deflation?  Maybe if a plague cuts the world population in half.  Maybe.

 

You're missing the second side of the equation - too much supply. There's a pretty good argument to be made that 20 years of excess supply in credit inflated people's consumption abilities which leads companies to over-invest in capacity which is a major problem when the credit stops flowing and people have to consumer below their means as they delever. 

 

Capacity utilization in the U.S. is still running below it's 40-45 year average. This is 6 years into a supposed recovery where tens of trillions have been spent globally on stimulus, we have "normalized" unemployment rate, and the consumer balance sheet has healed due to a transfer to the public balance sheet.

 

Also, you have to consider that if China/EM is really going down hard, which appears to be the case, that people will flee to safe haven assets denominated in USD, euro, and yen. As the USD appreciates, all imports get cheaper. For an economy that is a net importer, that is deflationary in and of itself. Every 1% tick up in the dollar brings down inflation readings by some fraction of that. A slow, sustained rise in the dollar brings a slow, sustained, deflationary pressure on top of the of the excess capacity which will result in companies cutting prices to get rid of inventories.

[Guest Dazel]

 

 

Does anyone have access to a pricing quote for the deflation contract or one similar to what Fairfax holds?

I don "t really care about the economic theory  I do care what the contracts are worth...and we know the value is going up. Fairfax has called what is happening...and bought insurance. What is the price of that insurance now? I am betting a lot of companies would like to purchase it as a hedge...