Deflation hedges

[petec]

You don't get much deflation from a consumer credit crisis. Because you can't fire your wife. You get deflation from business/financial credit crisis. During both the Great Depression and the Japanese credit crisis it was businesses that held huge debts. The deflation during the Great Depression was due to bank failures and businesses firing workers and lowering prices. This was explained competely by Irving Fisher.

 

Was it?  I've just finished reading Murray Rothbard's excellent book on the Great Depression which gives an entirely different set of explanations. 

 

I happen to disagree with everything you've said but I won't bore everyone debating line by line.  What I will say is that the economics world is largely in the grip of one set of ideas based on one interpretation of history.  That might be the right set of ideas and the right interpretation.  But there are other ideas, and other interpretations, that have been coherently argued by intelligent people (Rothbard being one, Jim Grant another in his recent book on the 1921 depression - I'd recommend both).

 

It is quite possible that in 20 or 30 years' time we will look back on monetarism and think it as deluded as most people now think pro-austerity Austrian-school economists are.  Only time will tell and in the meantime I'm with Munger: anyone who is intelligent who is not confused doesn't understand the situation very well.

[petec]

Wouldn't the retirement of baby boomers be deflationary?

 

No. People who retire spend, but don't work. They draw down savings and spend their pensions. This reduces labour supply much more than it reduces consumption. For instance a person making $100000 retires with pension of $20000. Lets say they spend $100000 when they were working and now spend $20000 in retirement. Retirement has reduced consumption by $80000 but reduced production by $100000. These assumptions of course are very conservative because typically people save money pre-retirement and spend down savings post retirement.

 

Baby boomers are not being replaced by new workers. This labour supply is going down. You can already see this occurring in the labour participation rate. Right now unemployment is 5.1. Wages will start rising. I expect profit margins will shrink and when they can't shrink any more inflation will start.

 

I haven't fully thought this through but I find this odd given that aging has often been cited as a cause of deflation in Japan.

 

If the labour force shrinks, then GDP will shrink unless there is productivity growth.  If GDP shrinks, and debts stay fixed, that will eventually be deflationary.  If productivity grows, then isn't your argument invalidated?  Because I would think growing productivity could offset the declining labour force, so spending would drop faster than production.  Again, deflationary.

 

Much more importantly, retirees spend savings.  Any savings in the forms of deposits are inflationary, as they boost the money supply.  As they get withdrawn, the money supply shrinks, and that is very deflationary.  The real drivers of inflation and deflation are changes in the money supply.  What matters is whether governments, desperate to keep the money supply up via fiscal and monetary means, will win their battle with the free markets, which seem to want to reduce the money supply by paying down loans.

 

[james22]

The world has been in a deflationary cycle since the collapse of Lehman Brothers Holdings Inc., evidenced by the euro, crude oil and a gauge of average commodities futures prices all peaking out in 2008, while risk-asset prices are merely buoyed by aggressive global monetary easing, Wakabayashi said.

 

As the accommodative policy has failed to end global deflation and artificially inflated risk-asset values are running out of steam, the dollar’s strength is reminiscent of the yen’s appreciation that hurt the Japanese economy during decades of price declines, he said.

 

“The U.S. will have to eventually resort to a weak dollar policy as deflation deepens,” Wakabayashi said.

 

The Federal Reserve has held rates near zero since December 2008 to boost the economy through the worst recession since the Great Depression.

 

“It’s obvious the U.S. is headed for deep deflation, hurt by the strong dollar,” said Wakabayashi, 72. “The Fed raising rates in this environment is not only ridiculous but harmful. U.S. stocks are plunging, not because of the prospect of a Fed rate hike, but to prevent it.”

 

http://www.bloomberg.com/news/articles/2015-10-01/strategist-known-as-mad-dog-says-yen-can-climb-to-100-per-dollar

[rb]

Much more importantly, retirees spend savings.  Any savings in the forms of deposits are inflationary, as they boost the money supply.  As they get withdrawn, the money supply shrinks, and that is very deflationary.  The real drivers of inflation and deflation are changes in the money supply.  What matters is whether governments, desperate to keep the money supply up via fiscal and monetary means, will win their battle with the free markets, which seem to want to reduce the money supply by paying down loans.

Pease explain why withdrawals from savings accounts will reduce the money supply?

[petec]

Much more importantly, retirees spend savings.  Any savings in the forms of deposits are inflationary, as they boost the money supply.  As they get withdrawn, the money supply shrinks, and that is very deflationary.  The real drivers of inflation and deflation are changes in the money supply.  What matters is whether governments, desperate to keep the money supply up via fiscal and monetary means, will win their battle with the free markets, which seem to want to reduce the money supply by paying down loans.

Pease explain why withdrawals from savings accounts will reduce the money supply?

 

D'oh - they don't.  Apologies - I wrote that when I was very tired and entirely failed to say what I meant to say, which was:

 

People heading for retirement pay down debt which reduces the money supply (all else being equal obviously).

 

[Guest Dazel]

http://www.telegraph.co.uk/finance/economics/11928178/Britain-falls-back-into-deflation-as-tumbling-fuel-prices-take-effect.html

 

 

so for all of you naysayers.....how do we like the UK deflation hedges?

 

:)

[giofranchi]

http://www.telegraph.co.uk/finance/economics/11928178/Britain-falls-back-into-deflation-as-tumbling-fuel-prices-take-effect.html

 

 

so for all of you naysayers.....how do we like the UK deflation hedges?

 

:)

 

Dazel,

you know I have never been a naysayer! On the contrary, I have always said I believe FFH’s macro thesis will ultimately be proven right.

I had sold some months ago simply because I think it is easier to make money selling smartphones, selling pharmaceutical products, selling software, or selling aerospace components… than making macro forecasts! Won’t you agree?

This being said, I have recently bought back a meaningful amount of FFH, because I think it might be a good idea to use it as “ready cash”, especially now that their macro thesis is beginning to be proven right.

 

Cheers,

 

Gio

 

[petec]

Won’t you agree?

 

 

These ways of making money are easier 99% of the time.  But the macro stuff is, very very very occasionally, the only way to survive.  Which is why I like the insurance of owning FFH (and I know you agree).

[petec]

http://www.telegraph.co.uk/finance/economics/11928178/Britain-falls-back-into-deflation-as-tumbling-fuel-prices-take-effect.html

 

 

so for all of you naysayers.....how do we like the UK deflation hedges?

 

:)

 

Inflation came in at -0.1pc in September.....oh the humanity. This thread is like CNBC when the market goes down. The world is ending because gas prices fell.

 

I know what you mean - it does make me laugh that this thread lights up whenever the market falls 5%.  But I do think that the world today looks like it needs more or less continual QE in order not to fall into deflation, which is interesting and worrying.

[TwoCitiesCapital]

http://www.telegraph.co.uk/finance/economics/11928178/Britain-falls-back-into-deflation-as-tumbling-fuel-prices-take-effect.html

 

 

so for all of you naysayers.....how do we like the UK deflation hedges?

 

:)

 

Inflation came in at -0.1pc in September.....oh the humanity. This thread is like CNBC when the market goes down. The world is ending because gas prices fell.

 

I know what you mean - it does make me laugh that this thread lights up whenever the market falls 5%.  But I do think that the world today looks like it needs more or less continual QE in order not to fall into deflation, which is interesting and worrying.

 

I think that's the crux of the deflation camps thesis. A lot of people seem to write off deflation as a stupid concern because we haven't had prolonged deflation in the Western world in decades, but I look at policy makers doing trillions in quantitative easing and trillions in deficits and still see deflationary prints and it makes me think that policy makers don't have anywhere near the control that most people thought they had in controlling the economy.

 

It's not so much that -0.1% is significant in and of itself - it's that we're getting -0.1% despite policy makers doing everything in their power to get to 2-2.5% and we're still getting deflation in return....

[giofranchi]

(and I know you agree).

 

Yes, I do.

 

Cheers,

 

Gio

[Guest Dazel]

 

 

 

 

Gio...I was kidding about naysayers!...all I care about is who is right...the money has already been made by those that believed like a few of us in the summer that things were "not' good...could not give a shit less about the headlines now....the market, bond rates...and now cpi will confirm what we were saying...no idea how far it goes and "no one does".

 

The market was more hedged last week (thank you we went very long in the fear) then anytime in history...so whatever price people had for Fairfax CPI deflation contracts I would suspect they are higher...but the CNBC headlines will tell everyone that in month or so!!!!

 

50 cent...as long as you know where you sit at the poker table...I will gladly take your criticism!

 

 

;)

[Luckyone77]

 

 

"It's not so much that -0.1% is significant in and of itself - it's that we're getting -0.1% despite policy makers doing everything in their power to get to 2-2.5% and we're still getting deflation in return...."

 

That truly is the scary part of all this. What is real GDP around the world if you took the massive amount of QE by all parties out of the equation? Ray Dalio calls it beautiful deleveraging. Maybe he's right. Something, however, just feels very wrong about it all. Right or wrong, hence my investment in Fairfax. Protection.

[james22]

The velocity of money has turned lower… and since 2008 and 2009 when we started to see deflation, the Fed and other central banks have declared war, hell bent on wiping out deflation and foregoing debt deleveraging through massive QE.

 

As of last month, inflation is zero.

 

Some war!

 

http://www.businessinsider.com/us-on-fast-track-to-deflation-2015-10

[petec]

The velocity of money has turned lower… and since 2008 and 2009 when we started to see deflation, the Fed and other central banks have declared war, hell bent on wiping out deflation and foregoing debt deleveraging through massive QE.

 

As of last month, inflation is zero.

 

Some war!

 

http://www.businessinsider.com/us-on-fast-track-to-deflation-2015-10

 

Money velocity today is 1.5 - the chart in this link is a bit out of date.  Amazing that it's only been below 1.5 twice in 115 years!

[TwoCitiesCapital]

The velocity of money has turned lower… and since 2008 and 2009 when we started to see deflation, the Fed and other central banks have declared war, hell bent on wiping out deflation and foregoing debt deleveraging through massive QE.

 

As of last month, inflation is zero.

 

Some war!

 

http://www.businessinsider.com/us-on-fast-track-to-deflation-2015-10

 

Money velocity today is 1.5 - the chart in this link is a bit out of date.  Amazing that it's only been below 1.5 twice in 115 years!

 

The velocity of money has been my main indicator for the deflationary thesis - there are two pieces to this that we should understand though. GDP and the M2 monetary base. Theoretically, dividing GDP by the M2 monetary base gives you the velocity of money. ($17.9 T/$12.02 T = 1.49).

 

There is only 1 way for this ratio to fall - if the growth rate of the monetary base exceeds GDP growth. Generally, if there is more money to circulate, more money gets circulated and GDP increases at the same, or a higher rate, than the monetary base (because each $1 can be spent more than once). What we have seen over the last decade is that there is far more money to be circulated but we're generating far less activity with every $1 of it.

 

This is a fundamental change in consumer behavior. The M1 money supply has grown by about 1.65 trillion since 2008. The M2 money supply has grown by about 4 trillion since 2008. These figures do not count the reserves held by the banks at the Fed and are happening despite tighter lending standards which should constrain the money supply growth in a fractional reserve system. Individuals and companies are hoarding 2x as much in the way of demand deposits as they were pre-crisis. Including non-demand deposits (CDs, Money Market funds, etc.), we're holding 50% more than pre-crisis. People and companies are not spending money - they're "hoarding" it. Even when accounting for the demographic shifts of boomers who should be spending more of their savings.

 

Why they're hoarding it is anyone's guess. Companies may have been scarred by a near death experience in 2008. Those who experienced layoffs may have seen that their cash savings weren't adequate and are now changing their behavior to ensure it doesn't happen again. Investors may be scarred by the 50+% drop in equities twice in a single decade. Near retirees may realize they had been slacking on their savings to survive a 2% interest rate environment. The list goes on and on, but these types of economic occurrences scar people and change their behavior. There's a reason that depression-era grandparents have very different savings/spending attitudes than our parents. This is also why some forecast that a Depression-like economic scenario needs to happen once every 3 generations or so.

 

As they save more cash, people will be buying less as a % of their income. Until they hit that savings goal, as an aggregate population, we'll continue to see more money being withheld from economic circulation which means less purchases as a % of income which means we may need less capacity than we have traditionally needed which means that production should fall to balance demand or prices should fall to increase the demand - sometimes both.

 

I think this is the main deflationary force at work - the change in consumer behavior. The velocity of money shows a non-temporary change in behavior that the CPI fails to capture. The Federal Reserve can't do much about the velocity of money because they can't force transactions. Even having a negative interest rate on consumer deposits would likely just mean people hoard cash in safes and remove it from the financial system - it doesn't mean they'd just go spend it all and jump start the economy. That being said, it doesn't guarantee deflation as we have seen by the CPI - what it does mean is that it's far easier to get a deflationary event in the past because people, whose transactions account for the majority of economic activity, have a much higher propensity to save and that can be accelerated by any hint of another downturn in economic activity.

 

At least, that has been my thinking for the past 2 or 3 years.

 

 

 

 

[gary17]

so instead of printing money they should consider printing pseudo monies with an expiration date -    let's give everybody $500 for the year 2016 and 2017 each to spend , but you must spend it within the calendar year...  :)

[petec]

There's a reason that depression-era grandparents have very different savings/spending attitudes than our parents....Until they hit that savings goal, as an aggregate population, we'll continue to see more money being withheld from economic circulation...I think this is the main deflationary force at work - the change in consumer behavior.

 

Completely agree.

 

Equally, if the change turns out to be temporary, we will get an inflation. 

 

Going to be an interesting 20 years.

[petec]

so instead of printing money they should consider printing pseudo monies with an expiration date -    let's give everybody $500 for the year 2016 and 2017 each to spend , but you must spend it within the calendar year...  :)

 

Works for buyers.  How do you persuade sellers that expiring money has value?  Recipe for a black market!

[TwoCitiesCapital]

There's a reason that depression-era grandparents have very different savings/spending attitudes than our parents....Until they hit that savings goal, as an aggregate population, we'll continue to see more money being withheld from economic circulation...I think this is the main deflationary force at work - the change in consumer behavior.

 

Completely agree.

 

Equally, if the change turns out to be temporary, we will get an inflation. 

 

Going to be an interesting 20 years.

 

Both measures have been declining for many years. I think we're well past the point of being able to call this temporary. The real question is when does the decline stop? When do we get to the point where people have saved enough to be comfortable to start spending a larger portion of their income again and the velocity of money stabilizes and/or grows again? That's the real question - as it stands, the increase in the M1 money supply over the past 7 years is "only" about $5,000 per person.

 

If you were someone who was long-term unemployed, you know that $5,000 doesn't necessarily take you very far if you have kids, a house, food, and a car to pay for. If you were someone who lost your house, $5,000 may not be enough for your next down payment. If you lost 50% of your home value, $5,000 probably isn't anywhere near enough to make you feel like you're getting back to positive equity (though rising home values certainly have helped here). Of course, this is obviously extrapolating using the average figure to individual cases which is mostly inappropriate to do. In reality, these are the people savings more than $5,000 while others are hoarding less, but I guess my point is that a $5,000 increase in savings really isn't that much in the scheme of things.

[Luckyone77]

Great post, TwoCities. Seth Klarman commented back in 09 or so that one of the reasons he was so skeptical on the market was because of the lack of the Depression mentality after such a market shock. Once the government stepped in and essentially put all the bad private debt onto the books on the government (instead of letting Capitalism do it's cleansing), people said..."Well, that was a bad few weeks. Carry on." Lesson not learned.

 

I can only speak for myself but the reason that I'm sitting on so much cash is simply because I don't trust this academic economic experiment of printing gazillions of dollars all over the world. Make no mistake, I've been wrong up to this point. I'm just not smart enough to know exactly when the music stops in this game of musical chairs. Maybe it never will but this paper currency in my wallet has to mean something. Just feel like the day of reckoning has been postponed not avoided. It's been an expensive miscalculation so far. For Fairfax as well actually. Let's see how the story ends.

[petec]

 

If you were someone who was long-term unemployed, you know that $5,000 doesn't necessarily take you very far if you have kids, a house, food, and a car to pay for. If you were someone who lost your house, $5,000 may not be enough for your next down payment. If you lost 50% of your home value, $5,000 probably isn't anywhere near enough to make you feel like you're getting back to positive equity (though rising home values certainly have helped here). Of course, this is obviously extrapolating using the average figure to individual cases which is mostly inappropriate to do. In reality, these are the people savings more than $5,000 while others are hoarding less, but I guess my point is that a $5,000 increase in savings really isn't that much in the scheme of things.

 

Once again I agree with the thinking - although I need to think about the validity of equating M1 with savings in a QE environment.

 

That said, there seem to be the green shoots of wage growth and that might be the start of an acceleration in confidence/money velocity/inflation.  I have a huge deflation protection position in FFH (which I also expect to compound healthily in the long term regardless of whether the deflation bet works) but it's protection, not prediction.

[TwoCitiesCapital]

 

If you were someone who was long-term unemployed, you know that $5,000 doesn't necessarily take you very far if you have kids, a house, food, and a car to pay for. If you were someone who lost your house, $5,000 may not be enough for your next down payment. If you lost 50% of your home value, $5,000 probably isn't anywhere near enough to make you feel like you're getting back to positive equity (though rising home values certainly have helped here). Of course, this is obviously extrapolating using the average figure to individual cases which is mostly inappropriate to do. In reality, these are the people savings more than $5,000 while others are hoarding less, but I guess my point is that a $5,000 increase in savings really isn't that much in the scheme of things.

 

Once again I agree with the thinking - although I need to think about the validity of equating M1 with savings in a QE environment.

 

That said, there seem to be the green shoots of wage growth and that might be the start of an acceleration in confidence/money velocity/inflation.  I have a huge deflation protection position in FFH (which I also expect to compound healthily in the long term regardless of whether the deflation bet works) but it's protection, not prediction.

 

You can correct me if I am wrong, but I was pretty sure that excess reserves, which is where most of money from QE has gone, are excluded from M1 and M2 measures which should just be physical currency, demand deposits, and time deposits (maybe a few other knick-knacks here and there). So realistically, M1 and M2 should both be a measure of cash savings with M2 reflecting the larger cash positioning of a lot of investments accounts and large corporations regardless of what the Fed is doing with QE since little of that money is even finding its way into the real economy.

[petec]

 

You can correct me if I am wrong, but I was pretty sure that excess reserves, which is where most of money from QE has gone, are excluded from M1 and M2 measures which should just be physical currency, demand deposits, and time deposits (maybe a few other knick-knacks here and there). So realistically, M1 and M2 should both be a measure of cash savings with M2 reflecting the larger cash positioning of a lot of investments accounts and large corporations regardless of what the Fed is doing with QE since little of that money is even finding its way into the real economy.

 

Yes, that sounds right.  Although (separate discussion) I questions whether investments accounts and corporations are *net* cash-heavy.  A lot of the evidence I have seen suggests otherwise. 

 

My other point would be that clearly bond, equity, and bull markets will make people feel they have 'saved' more than the cash figures alone suggest.  Problem is, that can reverse.

[TwoCitiesCapital]

 

You can correct me if I am wrong, but I was pretty sure that excess reserves, which is where most of money from QE has gone, are excluded from M1 and M2 measures which should just be physical currency, demand deposits, and time deposits (maybe a few other knick-knacks here and there). So realistically, M1 and M2 should both be a measure of cash savings with M2 reflecting the larger cash positioning of a lot of investments accounts and large corporations regardless of what the Fed is doing with QE since little of that money is even finding its way into the real economy.

 

Yes, that sounds right.  Although (separate discussion) I questions whether investments accounts and corporations are *net* cash-heavy.  A lot of the evidence I have seen suggests otherwise. 

 

My other point would be that clearly bond, equity, and bull markets will make people feel they have 'saved' more than the cash figures alone suggest.  Problem is, that can reverse.

 

Absolutely. I think we're on the same page then. People have been saving way more heavily than they were pre-crisis. This makes the economy deflation prone. There is the possibility for a correction in financial markets, or in real economic activity, that could exacerbate the issue.

 

I would also add that growing debt levels could hurt as well given that increased debt could lead to increased debt service with any appreciable rise in rates. It's certainly been an interesting decade and I think it will only get more interesting. I'm expecting one more large correction to shake out the excess and to really set the mood for the next generation.