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Are you expecting inflation or deflation?


muscleman
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Prem Watsa has a big deflation bet while LUK is positioned for inflation. It seems to be like Prem is right so far. All commodity prices are down, but have they bottomed out?

 

The real question is housing. You won't see sustainable deflation/inflation if it's not reflected in housing as that's such a huge part of the CPI index - (around 1/3 if I'm not mistaken). If housing prices/rents start to flat-line/decline, you'll have your answer.

 

It's hard for me to make predictions without knowing what other "magic" the Central Banks will stir up in an attempt to pull forward demand and discourage savings, but I generally lean towards deflation being the bigger threat to developed markets in the near term. Debt is deflationary in a downturn (just as it's inflationary in an upturn) and we have more of it now than we've ever had in history.

 

 

 

 

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It is hard to say...

 

I wish the central banks would FIRE up the printing presses.  A lot of people have tons of debt.  Vast inflation would help them out.  Vast inflation would also help out real estate owners and natural resource companies.

 

If you at the price of education & health care, the prices have gone up tremendously.  Of course, these sectors have TONS of money available to them.  The amount spent on education is simply mind bending...

 

I would prefer inflation, but I'm afraid we are looking at more deflation...

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I don't see how inflation will help people's debt. If everything costs double and my salary doubles, my current expenses are the same. If my debt is variable rate it will just increase in cost. If it's fixed rate, perhaps there is some opportunity there for some saving but all this is predicated on debt remaining constant and earning power increasing faster than current expenses. I don't see how this happens for most people on average. Maybe there is another benefit to inflation?

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The retiring baby boomer generation, coupled with relatively rapid technological advancement (particularly in AI, automation, and energy efficiency) are structural factors pushing Western societies into a deflationary trajectory.  Loose monetary policy seems to be central banks' solution / band-aid for these structural issues to avoid the deflation bogeyman.  So with that in mind, I don't see inflation perking up until the Millennial generation starts to buy houses and have families in earnest.  In the meantime, I see our economy bouncing along with low inflation, low interest rates, and a shitty stock market.

 

My fingers are crossed that a lengthy period of time with low interest rates does not impair our banking system.  While there are many factors that have supported the rapid growth of the United States, I believe a healthy banking system and property rights are at the top of the list.  Low interest rates are causing some bankers to extend duration to keep NIM constant (or to slow the decline), or take on increased credit risk.  This may result in an unhealthy/impaired banking system.

 

In case it wasn't obvious, my view is US-centric.   

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stion is housing. You won't see sustainable deflation/inflation if it's not reflected in housing as that's such a huge part of the CPI index - (around 1/3 if I'm not mistaken). If housing prices/rents start to flat-line/decline, you'll have your answer.

 

Housing has a much bigger impact in the CPI index than just the rent itself.

 

Go to any region with sky-high housing and everything else is very expensive too.  Rents and paychecks feed off of each other.

 

A pool service guy who comes once a week is $75/month in the Sacramento region, but $160/month in Santa Barbara.

 

The pool guy needs somewhere to live, and he has to pay the high rents.  So he demands more pay too.

 

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I don't see how inflation will help people's debt. If everything costs double and my salary doubles, my current expenses are the same. If my debt is variable rate it will just increase in cost. If it's fixed rate, perhaps there is some opportunity there for some saving but all this is predicated on debt remaining constant and earning power increasing faster than current expenses. I don't see how this happens for most people on average. Maybe there is another benefit to inflation?

 

In times of rising inflation debt holders benefit.  The lender is screwed.  The lender is receiving fixed income and principal repayment later.  The present day value of the principal repayment and future interest payments goes down.

 

That's the reason why when inflation and interest rates go up, bond holders (which is the same as any lender) lose money on their bonds if they sold their bonds.

 

For new debt, in times of constant high inflation, the interest rate can be thought of as principle payment. But that is a side issue.

 

 

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stion is housing. You won't see sustainable deflation/inflation if it's not reflected in housing as that's such a huge part of the CPI index - (around 1/3 if I'm not mistaken). If housing prices/rents start to flat-line/decline, you'll have your answer.

 

Housing has a much bigger impact in the CPI index than just the rent itself.

 

Go to any region with sky-high housing and everything else is very expensive too.  Rents and paychecks feed off of each other.

 

A pool service guy who comes once a week is $75/month in the Sacramento region, but $160/month in Santa Barbara.

 

The pool guy needs somewhere to live, and he has to pay the high rents.  So he demands more pay too.

 

Absolutely - furthering that idea, houses move faster as the prices rise. Higher housing mobility and higher sales feeds into increased demand for other products (paint, tape, tools, steam cleaners, etc. etc. etc.) as people repair, decorate, move in etc. You slow down the process of housing sales and you delay all that spending to some future date.

 

The raw weight is 30%, but it's impact on other industries brings it to a much higher figure. People also tend to spend more as housing prices are rising even if they don't sell so that helps too...

 

The virtuous cycle becomes a troubling one on the way down. I tend to be in the deflation camp, but don't expect to see it sustained if housing doesn't participate. I also tend to believe that housing will likely be the last shoe to drop this time around as opposed to the first largely because my thesis for housing rests more on demographics and housing trends than it does the economy.

 

 

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M2 Money Supply:

 

https://fred.stlouisfed.org/series/M2

 

Velocity of M2 Money Supply:

 

https://fred.stlouisfed.org/series/M2V/

 

I like what Francis Chou had to say about this .....

 

Deflation vs Inflation In the history of mankind, we have never really been in a kind of environment where one could make an equally strong case for deflation or for inflation. The arguments for both sides are quite compelling. If you believe in deflation, these are the points one could make: 1) China, the recent locomotive of global growth, is lurching ahead at an ever slowing speed. Its economy and financial markets in 2015 went through tremendous turmoil, affecting all markets worldwide. China has been a huge success story for the last 30 years as it was responsible for taking away large amounts of manufacturing jobs from developed economies. Its economy grew annually at a double digit rate and we thought this growth would not show any signs of slowing down appreciably in the near future. Even after the Great Recession of 2008, China's economy grew at a pretty good clip. However, most of the growth occurred not because of demand but due to enormous spending by all sectors of its government on unneeded housing and infrastructure. As a result, if one were to go to China now, he would notice a tremendous number of ghost cities with empty houses, empty highways and no people; 2) As shown by the weakness in commodity prices, it will take a while for demand to absorb all the excess capacity built up over the last 20 years; 3) Some sovereign bonds carry negative interest rates; 4) The recovery of the global economy from the Great Recession of 2008 has been sluggish at best.

 

On the flip side, one could make an equally compelling case for inflation to roar back some time in the future: 1) How low could interest rates go? At negative yields they can’t go much below zero; 2) Although the recovery has been anemic, at least in nominal terms there has been some recovery; 3) The velocity of money for M2 is at an all-time low. This can be further highlighted if we hypothesize about what would happen if M2 moved back up to the historical average. If a regression to the mean was to occur, the price levels could be 25% higher than what it is today. Carrying this logic one step further, with the current levels of money-printing growing at approximately 7.2% annualized, this could see a potential price level increase of 50%, if the velocity of money were to move back up to the historical average; 4) Normal market forces, the incessant balancing of supply and demand, will bring everything into equilibrium as the boom-bust cycle produced by artificial credit creation works itself out, but you cannot ‘un-print’ money. 95 The current situation reminds me of a story about an exchange between Winston Churchill and MP Bessie Braddock: At one time when Churchill was drunk, Bessie Braddock yelled at him, "Winston, you are drunk, and what’s more, you are disgustingly drunk." Churchill retorted, “My dear, you are ugly, and what’s more, you are disgustingly ugly. But tomorrow I shall be sober and you will still be disgustingly ugly.” That's how I feel about deflation and inflation (eventual consequences of printing too much money)

 

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