Deflation Makes for Ugly Headlines

I wanted to take a minute and apologise to the readers. Last post I was a bit edgy, and I let my own frustrations bleed out into my writing. I think my post was still about where I wanted it to be, but if it was harder that usual I meant no offense to anyone. Of course there was plenty of debate and some great comments, including a personal response to my question put to Ilargi of the Automatic Earth, for which I am very grateful. Ok, back to the regularly scheduled programming.

You Know You Think About Economics Too Much When....
I have to admit that when I saw the pictures today of the balloon that was drifting across Colorado (and may have had a child inside; turns out he was hiding at home) a thought jumped into my head in about 5 seconds. First, the scene:

The first thought I had was:
-"Helicopter" Ben Bernanke has swapped his whirly bird for a balloon to drop billions in dollars across America. Not only will this be more random, it is eco friendly!

Discussion is a Good Thing
Plenty of discussion form last night! I really do love the comments section and I get plenty of ideas from the readers here and other stops on the blogroll.

First up, the author Ilargi made time to leave his answer to the question I posed last time out regarding his essay. His comment can be seen on that thread, and I will not repost it here. It was well thought out and well reasoned. My question perhaps was unfair, who can know the exact mechanism by which all the pretending will fall apart, assuming it does.

I will post a section from the latest missive at TAE, and the author I think answers my question the same way he did in the comments section:

Those who suggest that present practices of hide the baloney and have another trillion can go on for much longer seem to understand neither the costs incurred in doing so, nor the increasing instability of the underlying system.

It’ll take just a minor trigger, which could come from just about anywhere, including totally unexpected corners, to make investors lose their risk appetite faster than they can spell sell-off. That will force the hands of Washington all of them. Let them eat growth is not a slogan that wins elections when growth is nowhere to be found.

I agree, it is often small, seemingly inconsequential events that cause huge cracks to spilt. In this case it will be the "accumulation of hurt" from many small fissures that breaks the dam.

The pace of these things is what wears on me. I prefer to get things sorted out, deal with the pain, and move on. It seems policy makers are more than willing to roll around in their own slop, like pigs, and stay dirty. Sadly the people will accept what they can get out of this instead of taking what they deserve (not a call for arms, but by voting for reasonable candidates). Indeed it could be a long slow burn for the middle class.

As far as gold discussion goes, I am tapped out. I have stated my case for gold over the span of 2 years and cannot add anymore to that debate. For some recent items that I agree with in principle (the iTulip article is a bit too "inflationista" for me, but well thought out) about gold and what it stands for can be seen here:
Your dollars are just Monopoly money by Bill Fleckenstein

So What's Behind Moves in Gold? by Mish Shedlock

The Game - Part I: Queen of Hearts by Eric Janszen

While not gold specific, this story explains why confidence in the financial system (via extension, confidence in money itself) is struggling due to the clear corruption and lack of trust:
The Ongoing Cover Up of the Truth Behind the Financial Crisis May Lead to Another Crash by George Washington on Zero Hedge

And now onto tonight's main theme....

Deflation Makes for Ugly Headlines
When people that follow economics discuss inflation and deflation they understand basic concepts of money. Ask a hard core follower of monetary issues about "real returns" over time or "inflation adjusted prices" and you will see all kinds of strange things pop up. Take this strange tidbit (via Zero hedge):

While in absolute terms the Dow may cross whatever the Fed thinks is a necessary and sufficient mark before QE begins to taper off (Dow crosses 10k just as Treasury purchases expire), the truth is that over the past 10 years (the first time the DJIA was at 10,000) the dollar has lost 25% of its value. Therefore, we present the Dow over the last decade indexed for the DXY, which has dropped from 100 to about 75. On a real basis (not nominal) the Dow at 10,000 ten years ago is equivalent to 7,537 today! In other words, not only have we had a lost decade for all those who focus on the absolute flatness of the DJIA, but it is also a decade where the US Consumer has lost 25% of purchasing power from the perspective of stocks!

Very interesting. Everyday people are not aware and do not care about such things. To them a $10 bill is worth roughly what they remember it was worth in 1999.

What is curious is that inflation results in sexy headlines like "home prices double" and "Nasdaq 5000 last stop before 10,000" or what have you. Maybe slow theft of purchasing power has been pushed like a drug over time, yes?

Of course right now deflation rules the landscape. This is not helpful at this juncture because deflation headlines are not exciting. In fact, they will almost always mean less money coming your way. Some points just from the past couple of days.

No cost of living increases in 2010, Social Security says
And you thought the health care debate got seniors mad, wait for this one!

Of course, any US administration (any party,anytime) would be terrified of the over-65 voter block and so on the same day the above hits the wires we also get this:

Obama calls for $250 payments to seniors
WASHINGTON (AP) - President Barack Obama called on Congress Wednesday to approve $250 payments to more than 50 million seniors to make up for no increase in Social Security next year. The Social Security Administration is scheduled to announce Thursday that there will be no cost of living increase next year. By law, increases are pegged to inflation, which has been negative this year.
It would mark the first year without an increase in Social Security payments since automatic adjustments were adopted in 1975.

Wow, not since 1975!

Of course I thought that a $250 is really not even worth the bother. By my back of the envelope account (I lied, I am using a calculator) this comes to a whopping $20.83 a month bonus per check for those that qualify. 20 Bucks! Is this where we are now?

Of course not everyone thinks a mere $20 is small potatoes. Later in the article we have this:

"The likelihood of losing an average annual COLA increase of about $200 to $300 in 2010 may sound like no big deal to some, but for millions of seniors who've already seen a third of their Social Security eaten up by health care costs, this proposed COLA relief could truly make the difference" said Barbara B. Kennelly, a former Democratic member of Congress from Connecticut who now heads the National Committee to Preserve Social Security and Medicare.

I stand corrected. I guess this kind of money is a big deal in these circles.

Mish has all the deflation headlines and they are all ugly. Consider:
Year-Over-Year CPI Negative for 7th Consecutive Month; Rents Decline First Time in 17 Years

So this is good, right? Paying less for things saves you money and lower rents may help struggling renters who have been ignored in the whole "save peoples homes" crusade. It is no less sad for a unemployed renter to be evicted from their home. They too may have to abandon pets, they too may have to take a credit hit. Of course, banks have limited exposure to renters, so the renter can go screw themselves as far as the government is concerned. Free markets are rough if you are in the wrong crowd.

So what is scary here you ask? Of course what kinds of things are tied to the CPI? We already saw that social security would get no increase (no matter, the government will give it to them anyway). What about the minimum wage? Uh oh! You mean people WILL BE MAKING LESS during deflation! This is a problem.

Now let me be very clear here. This is in no way what the government wants. They want a great CPI print of 2% plus. They want to pay out more. They want to get money velocity going. This is in no way, shape or form a way for the government to save money, and it is not their intention.

Deflation makes for ugly headlines because the hand out programs get smaller. Of course in time your paycheck will get smaller. With less on hand, the fear is of a deflationary spiral. Here I think things get twisted by definitions.

A deflationary spiral is thought of as a process where a person thinks item X will cost less money next week, or next month so they hold off on buying. This causes a feedback loop. I would argue that a real deflationary spiral occurs at the point of recognition (POR) that yes, item X will be cheaper next month, but I will be getting less as well, so I do not buy.

To me this is a key concept. Inflationists and Deflationists are so very close in end result thinking, they only differ on mechanism. Perhaps they only differ in terminology of the overall construct of the argument.

Is there a difference between:
-Money is worth less going forward and things go up in price so you cannot afford them

-Money is worth more and things cost less but you have much less money with which to buy them

Either way, you have a problem!

In closing, deflation is a real political problem. Headlines as we have seen today will garner negative feelings towards elected leaders. This is why deflation is enemy number one of the government.

Quantitative easing (QE1) on the Treasury buy side is done next week. How long until QE2 is opened up, making all the super smart bond types look like fools for defending FED actions saying "this is a one time deal" (you know who you are). The mortgage securities purchase program will end in March, but if you really believe that then you may need to think about step one, admitting you have a problem.

I hate the phrase "This time it's different" because it is used primarily as a crutch to hang an empty argument. I would submit that this juncture in time is different than any other. What would the Great Depression onset look like with both the internets available? Better? Worse? I have may own answer, but I would love to see reader answers to that one (hint, submit an answer in the comments!).

In closing, thanks to all for all the interaction. We need to keep thinking and we need to keep discussion going.

Also, I only have a few entries for "Friday Night Video Fights" so please get your fighters in. Poll results will determine winners each week.

Have a good night.

Mid Week Tensions

I am not sure if it is the weather (cold) or that the days are getting much shorter, but I find I am a bit on the edgy side. It could be DOW 10,000 plastered all over the place, rampant spinning of data, of just plain exhaustion at all things deflation/inflation debate related. As such, this post is an amalgam of various things, though they do share common ground in many ways.

Housing Still a Problem, and a Warning to the New Age Speculator
By now you have read the headlines that the newest (what iteration is this now?) mortgage modification plan of the US Administration is looking to deliver up to 500,000 loan mods to help housing. Others have parsed the number, and real mods number less than 50,000 in all cases, or 1/10th the advertised amount. Still, advertising is all about packaging and a number like 500,000 is pretty big.

So what is the problem? You, the reader, are well aware of the major ones, but let's review just one that surely should have been thought about before the process got started (via OC Register):

No Income, No Loan Modification
Here’s a quote from John Courson, president of the Mortgage Bankers Association:

“You can’t modify someone if they don’t have income or a job. We have to be realistic going forward. If we are going to play a numbers game, we are going to see a smaller percentage of borrowers in default able to be modified. It’s an unfortunate and difficult fact we are going to have to face.”

Now I know this kind of out of the box reasoning is very difficult to understand, but indeed having no income and no job will limit any possible loan workout. Of course these things made no difference when the loans where made, but that was so yesterday.

Of course, some are trying to squeeze anything they can out of bad loans (why would they need to do this, being well capitalized and all?) and are looking to the past for a new future. Consider this item from Bloomberg:

JPMorgan Pitches Interest-Only Mortgages to Boost Obama Plan
Oct. 13 (Bloomberg) -- Banks will push the Obama administration to expand its mortgage-modification program to allow interest-only periods on reworked loans, seeking to bring more homeowners into the initiative while recognizing concern that it may only postpone defaults, according to JPMorgan Chase & Co...
...The benefit of allowing interest-only periods as well would be “a significant pickup in terms of mods being done,” because the current methods often fail to allow loans to pass required tests on whether modifications serve lenders better than foreclosures, said JPMorgan’s Potolsky. The New York-based bank uses interest-only periods in many of the modifications it’s doing outside of the U.S. program, he said.

These games are getting old, but with the future holding so much promise, why not?

Promise in the housing market? Indeed there is, but here is my word of caution for the future (via Calculated Risk):

House Buying Frenzy
The real estate market has gone crazy. At the low end we've been seeing many offers per house for some time, and recently agents have been telling me there is almost no inventory. Jim the Realtor has been reporting on this in San Diego, see: Hot All Over and The “Euphoria Express”

And from Diana Olick at CNBC today: Lunacy in Las Vegas Housing (ht Larry)

Olick include an email from a real estate agent to a client "Katie":

- This market is crazy and many things are just not going to make any sense.
...
- Properties are selling in the blink of an eye.

- Properties are getting multiple offers within a few days of being on the market, the most offers I’ve heard a house had recently was 44 offers (I know, crazy).
...
- 40% of all transactions are cash purchases, which makes it harder for the buyers who are financing to get their offers accepted.
- We have 1/2 the inventory we had a year ago and 4 times as many buyers as we did a year ago.

Please note the bold face section.

Investors with real means are buying these homes with cash. Can they rent them out on a cash flow positive basis? I have no idea, and really I could not care less. These investors are taking a monster chance here though:

-By buying with cash they are not going to hurt anyone (read banks) but themselves, so there will be no help forthcoming should this go bad.

When it is the banks with their behinds on the line, the taxpayer is there to help. If aggressive personal investors lose their shirts, well helping them would be a moral hazard. Vegas is the gambling capital of the US, so this is indeed fitting.

Have no fear fellow taxpayer, we will all still pay for plenty of this, from later in the CNBC Diana Olick article:

Oh, and by the way, a fun factoid on Katie's Realtor: She bought her brand new home in 2005 for $240,000. According to the comps she runs daily, she says it's now worth between $90-110,000. So in January she decided to stop paying her mortgage. No financial hardship, she just figured she was throwing money away. The bank hasn't gotten to her yet, so she's just been living there for free. At some point, she knows, her bank will foreclose, but she's fine with that. She says she'll do far better financially renting for a while.

Love it!

A Question
By know the readers know that I am daily reader of The Automatic Earth which really offers insight and perspective that I feel is unique in all the blogosphere. It is with rare occasion that I have a fundamental difference of opinion with the author Ilargi, but I find myself there tonight.

To start, to consider my question you will need to review the latest article "Chris Martenson, Stoneleigh, and Mish Shedlock" because there is plenty of material there which needs to be reviewed.

My question that I submitted to Ilargi follows (as in the comments section over there):

Ilargi,
very thoughtful post. I had one question which I did not really find a clear answer to in Stoneleighs writings. You had written:
"My initial reaction was that Martenson is better at gathering data than at drawing conclusions from them. And that stands. Then Mike Mish Shedlock tackled the one hand issue (see below), and concluded: "Pretending that defaulted debts do not exist is itself the "Sound of one hand clapping". Which is what I said: assuming that a central bank and Treasury, of any country, can keep losses hidden forever, means not understanding the dynamics at play."

I have to admit, I guess I do not understand the dynamics at play. The banks have indeed covered over losses and still refuse to recognize them, one better, they are writing UP the value of these instruments as of late. For over a year they have hidden them, why not 2 years? Why not 3? With a fully compliant government admitting this is policy prescription number one, I think the dare would have been called by now. What would be the trigger event?

Sorry for the question, but this gamesmanship by the Banks/Government is really starting to wear me thin.

So my question boils down to this:
-The banks have covered up losses, refused to write down loans, and have explicit backing of the US government to do so
-This has been ongoing for over 1 year
-What would change this a year from now? 2 Years from now? 5 years from now?

I am sure I am missing something here, but I cannot pin down what it is. I will return to this item if there is follow up.

Golden Conspiracies, and Metal Out performance
Last night I had written a small link about possible gold bullion problems with physical delivery. Loyal reader Stagflationary Mark had plenty to say, much of which I agree with. Of course there was some I did not.

Mark argues, and I think correctly, that gold price conspiracy is a pretty weak line of argument. I would submit that suppression of gold overall is no conspiracy, but governmental policy. There are many instances of FED minutes where Alan Greenspan clearly is concerned with gold prices and what that means for fiat currencies. IMF and central bank gold sales (except for the UK) are often used to lower gold prices. If the only use for gold was high end electronic contacts and jewelry for India, why on earth would the FED be even the least bit interested in gold prices?

Mark offers this as well about inflationary hedges:

Once again, aluminum is the SAME price it was 5 years ago. If hyperinflation was just around the corner (as implied by the movement in gold's price), then why aren't more people willing to hoard aluminum? I certainly don't have a problem hoarding aluminum foil. I don't see much harm in locking in the price. In fact, the higher the price of gold goes, the better aluminum looks to me and the worse gold looks to me. I'm a cheapskate.

Aluminum was certainly a good thing to hoard in the 1970s. So why isn't it now? Why isn't aluminum pricing confirming the gold story? Why isn't toilet paper pricing confirming the gold story? Seriously. I'd really like to know. Aluminum is a VERY useful metal. While it is true that aluminum is VERY common (roughly 8% of the earth's crust), this was also true in the 1970s. The same can also be said of toilet paper. The stuff practically grows on trees. ;)

Here I think we are talking about very different things.

In Marks comments he cites Mish many times, and thus I am sure he is aware of the times that gold had done well during inflation, and poorly during inflation. Gold has done well during deflation, and poorly during deflation. Mish has laid this all out before.

Surely Aluminum and toilet paper are not corroborating the gold price rise in terms of a framed idea of hyperinflation. I would add that neither is platinum, or corn, or soybeans.

I have written extensively about the repudiation of US financial engineering. When I started buying gold related assets in the early 2000's, it was due to an inflationary stance. After watching a cooked CPI basically kill off any real way to catch inflation via gold, I was a bit disenchanted. Then the credit bubble came. The housing bubble as well and the stock market blow off top in 2007. All through this I watched the gold (and silver) related buys rise higher, even as inflation was low or low historically.

Surely the rise in price of gold from 2002 until now is not based on inflationary expectations. If it is, then yes, things are wrong. Gold to me is a rock against which to hold against the massive issuance of money and credit. When it became clear the house flippers the world over would never be paying back any of their loans should house prices fall (I figured they had to) then the very meaning of money would fall into question. We saw that at the height of the crisis of late last year and into March this year, the very underpinnings of the banking system were called into question. In a twist, gold and silver were hammered in price during this time! Shows you what I know!

I think the questions still remain, and now that operators can be calm, gold becomes very appealing. We have been and are in deflation right now, and yet the dollar is lower and gold is higher. Another panic may be in the works and I think investment demand for gold serves this need for real assets. If money is not money (Think QE2), gold is always money and a great way to store portable value which will be accepted all over the world.

Of course you could do this with toilet paper, but getting 2 metric tons of toilet paper over a border may be an issue, while a few ounces of gold can fit in your wallet.

As always I could be wrong (very likely) and non of this is personal investment advice. Just my 2 cents as usual.

Have a good night.