Deflation hedges

[wisdom]

http://wealthtrack.com/recent-programs/kessler-treasury-bond-contrarian/

 

good interview

[TwoCitiesCapital]

Deflation still very much a threat in Europe.

 

http://www.theguardian.com/business/2015/jul/14/zero-inflation-falling-food-clothing-prices

 

Just imagine if we get to a point where deflationary trends find their way into housing...

[KinAlberta]

ASIAN ECONOMY

Failing on Inflation, Japan Fudges the Numbers

14 JUL 12, 2015

By William Pesek

Excerpt:

 

"The slew of cheerleading reports BOJ officials have started issuing are a tacit admission that Kuroda's efforts at monetary stimulus have failed. The bank has even changed its methodology for measuring inflation so the data fit the BOJ's preferred narrative."

 

http://www.bloombergview.com/articles/2015-07-12/failing-on-inflation-japan-fudges-the-numbers

[kevin4u2]

While you do make some interesting points I would encourage you to think about one thing.  Over the past few decades has demand for computers decreased or increased.  Obviously increased, right.  Yet prices have steadily declined.  So deflation can occur even when demand is increasing.  This is totally counter to your earlier point that people don't wait for a cheaper tomorrow.  Perhaps demand has nothing to do with falling prices? 

 

I'm no expert when it comes to deflation but I don't understand why you would bet on it happening to a great extent. The definition of deflation is if prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases. But do consumers think this way? No. Who here has ever delayed a purchase because they think prices will be cheaper tomorrow?

I never have. For example, if you're hungry and in a grocery store and want to buy a sandwich, would you say, I'm not buying this because it will be cheaper tomorrow? Nobody would do that.

 

People buy cars, washing machines, refrigerators, computers, iphones, clothing, shoes because their existing ones have worn out.  They don't sit around like economists and make predictions about the prices of products. The avg. consumers has no idea where prices are trending.

 

Also, the world's population is still growing, so wouldn't there be more demand for products thus, increasing prices? Why would prices go down if the population is growing? Doesn't make much sense to me.

 

Just think about the computer business. How much did a computer cost in 1985? I don't have exact $ amounts in front of me but I would guess it was a few thousand. That computer was crap compared to a laptop today which you can buy for $500. A million times faster than the computer we all bought in 1985. Who in 1985 said, I'm not buying a computer for $2000 today, when I can wait until 1990 and buy one that is way faster and for half the price? Nobody does that because consumers don't think that way.

 

The PC market today is mature and prices are flat. How much lower can you go for a $500 laptop? Again, who here will delay purchasing a computer because I thought, well, if I wait another year, prices will be lower and the features will be better! Even though I know this would be the case.

 

Same thing with a video game system. I bought Nitendo, sega, playstation, and xbox growing up as a kid. Who here knows anybody that didn't buy a console because the next one would be cheaper and way better than the current system? Again. I know this is the case but it doesn't make me not purchase today's new console.

 

Maybe I'm wrong but betting on deflation happening to a great extent doesn't make much sense to me.

 

50cent

[ERICOPOLY]

While you do make some interesting points I would encourage you to think about one thing.  Over the past few decades has demand for computers decreased or increased.  Obviously increased, right.  Yet prices have steadily declined.  So deflation can occur even when demand is increasing.  This is totally counter to your earlier point that people don't wait for a cheaper tomorrow.  Perhaps demand has nothing to do with falling prices? 

 

I'm no expert when it comes to deflation but I don't understand why you would bet on it happening to a great extent. The definition of deflation is if prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases. But do consumers think this way? No. Who here has ever delayed a purchase because they think prices will be cheaper tomorrow?

I never have. For example, if you're hungry and in a grocery store and want to buy a sandwich, would you say, I'm not buying this because it will be cheaper tomorrow? Nobody would do that.

 

People buy cars, washing machines, refrigerators, computers, iphones, clothing, shoes because their existing ones have worn out.  They don't sit around like economists and make predictions about the prices of products. The avg. consumers has no idea where prices are trending.

 

Also, the world's population is still growing, so wouldn't there be more demand for products thus, increasing prices? Why would prices go down if the population is growing? Doesn't make much sense to me.

 

Just think about the computer business. How much did a computer cost in 1985? I don't have exact $ amounts in front of me but I would guess it was a few thousand. That computer was crap compared to a laptop today which you can buy for $500. A million times faster than the computer we all bought in 1985. Who in 1985 said, I'm not buying a computer for $2000 today, when I can wait until 1990 and buy one that is way faster and for half the price? Nobody does that because consumers don't think that way.

 

The PC market today is mature and prices are flat. How much lower can you go for a $500 laptop? Again, who here will delay purchasing a computer because I thought, well, if I wait another year, prices will be lower and the features will be better! Even though I know this would be the case.

 

Same thing with a video game system. I bought Nitendo, sega, playstation, and xbox growing up as a kid. Who here knows anybody that didn't buy a console because the next one would be cheaper and way better than the current system? Again. I know this is the case but it doesn't make me not purchase today's new console.

 

Maybe I'm wrong but betting on deflation happening to a great extent doesn't make much sense to me.

 

50cent

 

It would be very item specific.

 

You aren't going to wait to buy food even if you think prices will be down 50% next year.

 

Computers -- it will cost you in other ways if you try to go without one.  So I don't know how good that example is.

 

I'm not sure if anything I buy is driven by the expectation that the price will be higher or lower -- unless it's an investment item.

 

However if my income was suffering and I was budgeting I would be thinking different.  So perhaps during times like that (The Great Depression) people are closely watching prices.  So maybe it's a combination of weak buying power as well as oversupply that is necessary to drive deflation that leads to people putting off purchases.  Somebody flush with excess income isn't in the mindset to pay close attention.

 

 

[TwoCitiesCapital]

I've been thinking about this awhile and the only negative thing that I come up with in a prolonged deflationary scenario is you have fixed rate debt obligations - which every tax-paying American does on top of whatever we have individually.

 

The government has a massive vested interest in inflation, because we're already talking about the potential of it being broke under unfunded entitlements and that is before tax revenues start consistently shrinking. I think that there is the potential for seriously prolonged deflation though - it would take a massive change in political good will to actually enforce a policy that would be almost guaranteed to start inflation of some sort: flying around in a helicopter and raining down freshly printed dollars on the poorest of neighborhoods.

 

Of course, this wouldn't be productive inflation - simply goods inflation that would likely result in bubbles across different consumer products, but at least the government can start paying it's debts in devalued dollars, right?!?!?

 

 

 

 

[KinAlberta]

While you do make some interesting points I would encourage you to think about one thing.  Over the past few decades has demand for computers decreased or increased.  Obviously increased, right.  Yet prices have steadily declined.  So deflation can occur even when demand is increasing.  This is totally counter to your earlier point that people don't wait for a cheaper tomorrow.  Perhaps demand has nothing to do with falling prices? 

 

I'm no expert when it comes to deflation but I don't understand why you would bet on it happening to a great extent. The definition of deflation is if prices drop, people will stop buying, as they will see that prices will be lower in the future and thus delay purchases. But do consumers think this way? No. Who here has ever delayed a purchase because they think prices will be cheaper tomorrow?

I never have. For example, if you're hungry and in a grocery store and want to buy a sandwich, would you say, I'm not buying this because it will be cheaper tomorrow? Nobody would do that.

 

People buy cars, washing machines, refrigerators, computers, iphones, clothing, shoes because their existing ones have worn out.  They don't sit around like economists and make predictions about the prices of products. The avg. consumers has no idea where prices are trending.

 

Also, the world's population is still growing, so wouldn't there be more demand for products thus, increasing prices? Why would prices go down if the population is growing? Doesn't make much sense to me.

 

Just think about the computer business. How much did a computer cost in 1985? I don't have exact $ amounts in front of me but I would guess it was a few thousand. That computer was crap compared to a laptop today which you can buy for $500. A million times faster than the computer we all bought in 1985. Who in 1985 said, I'm not buying a computer for $2000 today, when I can wait until 1990 and buy one that is way faster and for half the price? Nobody does that because consumers don't think that way.

 

The PC market today is mature and prices are flat. How much lower can you go for a $500 laptop? Again, who here will delay purchasing a computer because I thought, well, if I wait another year, prices will be lower and the features will be better! Even though I know this would be the case.

 

Same thing with a video game system. I bought Nitendo, sega, playstation, and xbox growing up as a kid. Who here knows anybody that didn't buy a console because the next one would be cheaper and way better than the current system? Again. I know this is the case but it doesn't make me not purchase today's new console.

 

Maybe I'm wrong but betting on deflation happening to a great extent doesn't make much sense to me.

 

50cent

 

It would be very item specific.

 

You aren't going to wait to buy food even if you think prices will be down 50% next year.

 

Computers -- it will cost you in other ways if you try to go without one.  So I don't know how good that example is.

 

I'm not sure if anything I buy is driven by the expectation that the price will be higher or lower -- unless it's an investment item.

 

However if my income was suffering and I was budgeting I would be thinking different.  So perhaps during times like that (The Great Depression) people are closely watching prices.  So maybe it's a combination of weak buying power as well as oversupply that is necessary to drive deflation that leads to people putting off purchases.  Somebody flush with excess income isn't in the mindset to pay close attention.

 

Basic economics. Lower the price and sell more.  That's bad for business though if you buy at a higher price and your inventory's market value falls before you sell it.  So with investments and investment like assets (homes etc) if you lower the price people hesitate to buy and banks hesitate to lend since someone is going to loose in the process. 

[petec]

 

Just imagine if we get to a point where deflationary trends find their way into housing...

 

+1+1+1

 

That is an absolute game changer.  The UK has 80% mortgage debt to GDP and it's all floating.  Base rates are at 0.5%.  Rates are expected to rise.  The links between rates, household cash flows, house prices, and household wealth are huge.  I think the Eurozone is different (more renting) and the US too (more fixed rate mortgages) but the effect is still there.  I think this is the key motivation for QE, actually, but I don't think that works forever.

[nwoodman]

Not a bad article for ZH. Does a reasonable job of summing up the deflation thesis

 

http://www.zerohedge.com/news/2015-08-03/largest-financial-departure-reality-human-history

 

Cheers

nwoodman

 

[james22]

Likewise:

 

"The Worldwide Credit Boom Is Over, Now Comes The Tidal Wave Of Global Deflation"

 

http://www.zerohedge.com/news/2015-08-03/worldwide-credit-boom-over-now-comes-tidal-wave-global-deflation

[ERICOPOLY]

People only post about Gary Shilling when he is saying something negative.  So nobody talks about him when he is less depressing -- why is that?

 

He started talking about a coming decade of deflation in 2003.  Too early -- then we almost got some deflation.  People posted his negative commentary and now that he's changed his tune, nobody posts about him anymore. 

 

Here are his latest comments:

 

Is the U.S. economy stuck in an endless loop of sluggish growth and high unemployment? Many distinguished economists think so, and there is some evidence to support them. But looking at much the same data, I come to the opposite conclusion: The U.S. could soon experience a period of strong economic growth once deleveraging is over.

 

http://garyshilling.blogspot.com/

[TwoCitiesCapital]

People only post about Gary Shilling when he is saying something negative.  So nobody talks about him when he is less depressing -- why is that?

 

He started talking about a coming decade of deflation in 2003.  Too early -- then we almost got some deflation.  People posted his negative commentary and now that he's changed his tune, nobody posts about him anymore. 

 

Here are his latest comments:

 

Is the U.S. economy stuck in an endless loop of sluggish growth and high unemployment? Many distinguished economists think so, and there is some evidence to support them. But looking at much the same data, I come to the opposite conclusion: The U.S. could soon experience a period of strong economic growth once deleveraging is over.

 

http://garyshilling.blogspot.com/

 

I think it's important to note that he does qualify that by saying "once the deleveraging is over." I don't even think it's really begun yet - all we've seen is a transfer of debt from consumers to national governments which deleverages some as the cost to carry that debt is reduced, but it's not a true delevering.

[ERICOPOLY]

all we've seen is a transfer of debt from consumers to national governments which deleverages some as the cost to carry that debt is reduced, but it's not a true delevering.

 

The last time I got a loan, they asked about my household debt outstanding but nobody put my government's debt outstanding into the underwriting equation.

 

You can stop working at 65 without worrying about whether you've paid off your government's debt.

 

Household debt is extremely different as compared to government debt.  IMO.

 

[Txvestor]

all we've seen is a transfer of debt from consumers to national governments which deleverages some as the cost to carry that debt is reduced, but it's not a true delevering.

 

The last time I got a loan, they asked about my household debt outstanding but nobody put my government's debt outstanding into the underwriting equation.

 

You can stop working at 65 without worrying about whether you've paid off your government's debt.

 

Household debt is extremely different as compared to government debt.  IMO.

 

Gov't debt creates a grey cloud, when it is excessive ala Greece. It can also lead to required cuts in gov't spending and all of this can be deflationary when it happens.

As to stop working when you're 65, even that can be negotiated!

[petec]

all we've seen is a transfer of debt from consumers to national governments which deleverages some as the cost to carry that debt is reduced, but it's not a true delevering.

 

The last time I got a loan, they asked about my household debt outstanding but nobody put my government's debt outstanding into the underwriting equation.

 

You can stop working at 65 without worrying about whether you've paid off your government's debt.

 

Household debt is extremely different as compared to government debt.  IMO.

 

I agree, and the end of WW2 supports this observation, in that government debt was very high but private debt was very low and you got a good boom.

 

That said, if his claim is true that private debt/income peaked at 130%, and is now 100%, vs. a long term average of 65%, we may only be halfway there.  And that's vs. the average, not the bottom of the leverage cycle.  Things are very odd at the zero bound, so who knows what it all means, but I can see deleveraging pressures continuing awhile yet.

[frommi]

I really doubt that the US will go into a long phase of deflation, but in the short term its always a possibility. As soon as the market drops the FED will turn around and anounce the next round of QE. And that is necessary until the deleveraging is over. Since the FED will then own most of the government debt its just an accounting number that the government can easily erase if it chooses to. They can simply print a trillion dollar coin and give it to the FED and the debt magically disappears. Thats the beauty of having full control over the supply of money.

 

EDIT: This was not possible in the 30`s, since the currency was gold backed, so it was a totally different situation.

[wisdom]

Does it really matter how we get there?

 

What matters is that no one knows what to expect. This will lead to volatility as adjustments happen = opportunity.

 

Was reading a article on real estate being 15% of Chinese GDP. Used to be 4% before the boom began.

 

US was around 5 or 6% before it crashed in 2008. Canada peaks at 7%. Canada is there.

 

According to Barclays, 50% of Chinese debt is backed by real estate - i recall, Chinese bank assets are at $25 T.

 

The margin of error is getting smaller for governments.

[TwoCitiesCapital]

I really doubt that the US will go into a long phase of deflation, but in the short term its always a possibility. As soon as the market drops the FED will turn around and anounce the next round of QE. And that is necessary until the deleveraging is over. Since the FED will then own most of the government debt its just an accounting number that the government can easily erase if it chooses to. They can simply print a trillion dollar coin and give it to the FED and the debt magically disappears. Thats the beauty of having full control over the supply of money.

 

EDIT: This was not possible in the 30`s, since the currency was gold backed, so it was a totally different situation.

 

Japan doesn't have a fixed currency either and they've suffered from deflation for the last two decades. Secondly, QE isn't inflationary for anything but risk assets which has the potential to transcend to the greater economy - but generally doesn't since most of the risk assets are owned by a handful of the wealthy that don't typically spend the money unless if they just bought a Picasso.

 

The majority of the money has been stuck as bank reserves and isn't loaned which is why after 4 rounds of QE we have paltry growth, record low monetary velocity, and had headline deflation in the first quarter.

 

There could be a real argument made that QE has been absolutely pointless except in potentially driving asset bubbles and monetizing the government debt.

[petec]

I really doubt that the US will go into a long phase of deflation, but in the short term its always a possibility. As soon as the market drops the FED will turn around and anounce the next round of QE. And that is necessary until the deleveraging is over. Since the FED will then own most of the government debt its just an accounting number that the government can easily erase if it chooses to. They can simply print a trillion dollar coin and give it to the FED and the debt magically disappears. Thats the beauty of having full control over the supply of money.

 

EDIT: This was not possible in the 30`s, since the currency was gold backed, so it was a totally different situation.

 

Not *totally* different - they changed the gold price, devaluing the currency vs. gold by 41% in 1933/4.  It wasn't a very solid gold standard!

[petec]

I really doubt that the US will go into a long phase of deflation, but in the short term its always a possibility. As soon as the market drops the FED will turn around and anounce the next round of QE. And that is necessary until the deleveraging is over. Since the FED will then own most of the government debt its just an accounting number that the government can easily erase if it chooses to. They can simply print a trillion dollar coin and give it to the FED and the debt magically disappears. Thats the beauty of having full control over the supply of money.

 

EDIT: This was not possible in the 30`s, since the currency was gold backed, so it was a totally different situation.

 

Japan doesn't have a fixed currency either and they've suffered from deflation for the last two decades. Secondly, QE isn't inflationary for anything but risk assets which has the potential to transcend to the greater economy - but generally doesn't since most of the risk assets are owned by a handful of the wealthy that don't typically spend the money unless if they just bought a Picasso.

 

The majority of the money has been stuck as bank reserves and isn't loaned which is why after 4 rounds of QE we have paltry growth, record low monetary velocity, and had headline deflation in the first quarter.

 

There could be a real argument made that QE has been absolutely pointless except in potentially driving asset bubbles and monetizing the government debt.

 

Agreed.  It might even be *de* flationary if it a) drives the building of over-capacity (look at Chinese PPI), and b) encourages money to be destroyed (bridges to nowhere, asset bubbles).

 

Then again, if we are starting to see wage inflation (WMT, minimum wages), then...

[ERICOPOLY]

Things are very odd at the zero bound, so who knows what it all means, but I can see deleveraging pressures continuing awhile yet.

 

Yes, the zero bound is a very different picture.

 

Today's 30 yr amortization schedule mortgages on the books will run-off at an accelerated rate due to the fact that a low-interest loan has a very high principle component.

 

Take a loan at 4% with a 100,000 initial balance.  It's first monthly payment has a $144 principle component and a $333 interest payment.

 

Compared to a loan at 8% with a 100,000 initial balance.  It's first monthly payment has a principle component of only $67 and an interest component of $666.

 

So the debt runs off at twice the pace in the beginning days of a mortgage.

 

So the household expenditures to service the debt today are night and day apart compared to those historical periods when the household debt to GDP was lower.

 

Most of the household debt out there is mortgage debt. 

 

Not only are the household debt service ratios at historically healthy/normal levels today, but the absolute amount of the debt (which is historically high) is running off at a historically high rate.

 

It's not anywhere near as simple as looking at a chart.  The charts don't tell us how fast the debt is running off vs other periods in history. 

 

 

[frommi]

Japan doesn't have a fixed currency either and they've suffered from deflation for the last two decades. Secondly, QE isn't inflationary for anything but risk assets which has the potential to transcend to the greater economy - but generally doesn't since most of the risk assets are owned by a handful of the wealthy that don't typically spend the money unless if they just bought a Picasso.

 

Japan has not really printed that much money until the start of Abenomics?

 

There could be a real argument made that QE has been absolutely pointless except in potentially driving asset bubbles and monetizing the government debt.

 

When too much debt is the problem, QE is the only workable solution isn`t it? They have to print enough money to offset the negative money velocity. And ideally the government spends more money financed by the FED. That way you simply can`t have deflation. At the moment the FED is not printing money and the government is spending less, the outcome of that is what we see at the moment.

 

 

[Crip1]

Things are very odd at the zero bound, so who knows what it all means, but I can see deleveraging pressures continuing awhile yet.

 

Yes, the zero bound is a very different picture.

 

Today's 30 yr amortization schedule mortgages on the books will run-off at an accelerated rate due to the fact that a low-interest loan has a very high principle component.

 

Take a loan at 4% with a 100,000 initial balance.  It's first monthly payment has a $144 principle component and a $333 interest payment.

 

Compared to a loan at 8% with a 100,000 initial balance.  It's first monthly payment has a principle component of only $67 and an interest component of $666.

 

So the debt runs off at twice the pace in the beginning days of a mortgage.

 

So the household expenditures to service the debt today are night and day apart compared to those historical periods when the household debt to GDP was lower.

 

Most of the household debt out there is mortgage debt. 

 

Not only are the household debt service ratios are historically healthy/normal levels today, but the absolute amount of the debt (which is historically high) is running off at a historically high rate.

 

It's not anywhere near as simple as looking at a chart.  The charts don't tell us how fast the debt is running off vs other periods in history.

 

 

I'm in the industry and know that our group has seen a higher percentage of new originations being 15 or 20 year compared to the more traditional 30 year. Again, the 30 year amortization schedule is still the norm, but 15's are gaining popularity in our shop. Project that over the industry and the run-off rate to which Eric refers is amplified.

 

 

-Crip

 

 

P. S. Seeking to see what I can get for a more holistic view of this.

[ERICOPOLY]

Today's environment in the US is one of:

 

A:  Normal household debt service ratios

B:  Existing debt running off at an accelerated pace

C:  Reasonable lending standards that suggest the economy is not being supported by a credit-driven boom 

 

Oh well.  I know it won't convince anyone looking for grey clouds in the household debt to GDP numbers.

 

Recap:

1)  Rapid legacy household debt growth created a boom that already busted. 

2)  Unwinding the remaining debt is sustainable (normal debt service levels)

3)  There isn't currently a boom in new credit (reasonable current lending standards)

[petec]

Today's environment in the US is one of:

 

A:  Normal household debt service ratios

B:  Existing debt running off at an accelerated pace

C:  Reasonable lending standards that suggest the economy is not being supported by a credit-driven boom 

 

Oh well.  I know it won't convince anyone looking for grey clouds in the household debt to GDP numbers.

 

Recap:

1)  Rapid legacy household debt growth created a boom that already busted. 

2)  Unwinding the remaining debt is sustainable (normal debt service levels)

3)  There isn't currently a boom in new credit (reasonable current lending standards)

 

I'd add the beginnings of wage growth to this picture.  I don't need a lot of convincing.

 

Against that, I'd pitch:

1. rising inflation (not in CPI but that's a very doctored measure)

2. totally abnormal interest rates (which distort your "normal debt service levels".

 

But it isn't the US I worry about.  I worry more about places where the bubble hasn't bust yet (EM), or where consumer debt is floating rate (UK) or where currencies are fixed (EU).