Today’s inflation surprised to the upside. I see almost no bright spots, inflation rose across the board, and only one component, recreation, has a trailing 3-month annual-adjusted rate below 2% – recreation price is growing at only 1.6% annual rate. On the other side transportation cost is growing at 22% annual rate.
Do we need a better illustration that people spend money on what they need and cut on things that they want but don’t need? Recreation business has absolutely no pricing power.
Whenever we speak about inflation we need to recall what great economist David Rosenberg said:
Inflation is first and foremost a lagging indicator
It means that today inflation is echo of last year economy. Today’s state of the economy has no effect on inflation whatsoever.
Inflation is impossible without solid growth of real income and/or borrowing. Nobody has any damn interest what the producer cost is, the only thing that matters for inflation is do people have money or not.
While income growth was good but not great the borrowing was still exceptional. Look at personal consumption expenditures: growth was choking in October and December. Look at the compensation cost data: the rate of growth is getting slightly slower. Look at MEW: people continued to tap the home equity at alarming rate in Q4′07.
Based on above my prediction about inflation is following. Take this graph of MEW from CR post:
Once this graph falls into normal historic range of 2%-3%, few months later all the inflation will be gone. Completely.
Another angle to look at the inflation is like that: inflation means money get cheaper. Look at today Russ Winter blog: the main topic of this post is that price of money is going up. Mortgage rate is up, the cost to insure mortgage bonds is up, cost to finance the car is up – i.e. there will be less money in the economy once all borrowers will have to scale down on how much they can afford to borrow.
I give inflation another year, and I think I’m very generous
Of course, if our government manages to completely debase the currency the inflation will not only increase but it will turn into hyperinflation. When I see that happening I will change my mind
February 20, 2008 at 11:37 am
Thanks for the analysis.
The notion that we have to have hyperinflation is a strawman. Even Weimar did not have hyperinflation but during few months. I see us kicking into an extended period of 10% inflation, lasting for perhaps 10 years.
The inflation has to be there. The federal debt and more importantly, the trade deficit demand payment. There is no way that our economy is geared to pay them both. All we have to pay our debts is monetary inflation. We tried debt inflation, and now we are getting debt deflation. The only cure for which is monetary inflation.
So no, I am not buying the hyperinflationary strawman.
February 20, 2008 at 12:31 pm
One comment was pending for moderation:
http://theroxylandr.wordpress.com/2008/02/15/who-will-pull-the-plug/#comment-28605
# nicknamed Says:
February 20, 2008 at 8:17 am e
Darth Toll,
sorry for coming back like 4 articles of this blog….here:
http://theroxylandr.wordpress.com/2008/02/14/where-is-the-money/#comments
I would like to know what do you think about this:
http://blogs.wsj.com/economics/2008/02/08/non-borrowed-reserves-false-alarm/
(I rewrote it here realizing you might not read it again back there)
February 20, 2008 at 12:51 pm
>>> We tried debt inflation, and now we are getting debt deflation. The only cure for which is monetary inflation.
For this to happen it needs to happen. The Feds are not printing money any faster than before. To be exact they are printing money at the speed 3.5% per year, which is not sufficient to offset the pop of the credit bubble.
What are you saying has yet to happen, so far there is no indication that it will
February 20, 2008 at 12:52 pm
Printfaster, one school of thought might be to engineer 10% inflation to wipe out the deficit, and thus shaft all foreign creditors, and then to return to business as usual.
For your sake I hope you get your wish, but I suspect the rest of the world might have other ideas.
February 20, 2008 at 2:50 pm
If artificially created inflation picks up I think it will derail the bond markets before it helps to fool foreign creditors.
There is a also few $ trillions of outstanding fixed-rate mortgages (7 to 30 years) at rates between 4.5% and 6%. Inflation will kill Fannie and Freddie who will be forced to collect interest below their own cost.
So, can inflation happen by its own? No, only Feds can create inflation, on purpose, and it won’t be easy to do. Do the Feds think that benefits of inflation may outweight problems? Maybe, but they have a mandate. If something goes really wrong they better have an excuse that they followed the mandate rather than not.
Another entity that can create inflation is Treasury dept. For that they need to hint that they are thinking about declaring a default on treasuries. Do you think they will do that? Not me…
February 20, 2008 at 3:02 pm
“To be exact they are printing money at the speed 3.5% per year, which is not sufficient to offset the pop of the credit bubble.”
I would think that the Fed only plays a small part in inflation. consider:
1. US Federal Gov’t deficit spending was (probably still is) about 6% of US GDP.
2. US Trade deficits is also about 6% of GDP. When foriegners lend us money and sell us goods, the money supply is effectively expanded. All those central banks are holding on to trillions of USDs that they lent to the US. Its money that was created from debt and credit. Even though their was no money printed, it still can be spent if foriegners chose to spend it.
3. Energy and food prices are rising. In both cases supply is constrained forcing the prices of every to rise.
4. The dollar declined about 14% in the last 2 years.
My guess is that real inflation is probably running between 7% and 8%. I think will continue to see a period of asymetical inflation. Real estate, Auto, etc will deflate as credit availability declines and credit costs rise. But food and energy prices will either continue to rise or at the very least remain flat because of supply constraints, and as the dollar falls.
—
Right now I believe our credit is dependant on the GSEs, which have so far been able to artificial maintain low interest rates. Its just a matter of time before the GSEs start to show huge losses that will eventually force the US gov’t to bail them out. I think once investors see huge losses, that they will demain much higher interest for thier money. I think that when gov’t starts bailing out the bad debt, that they probably won’t be too egar to loan new money to the GSE to support new loans. That will be death funeral for the real estate market.
The biggest worry is if foriegners lose faith in the US, and the dollar takes a nose dive. I can’t say if foriegners will dump the dollar, but is certianly in the forefront of my thinking. If one Central banks starts dumping, its likely they all will since no one whats to be stuck holding a bag full of crap.
I don’t think that the gov’t needs to crank up the presses to create inflation. If foriegn investors dump the dollar, the gov’t would probably have to build a set of incinerators just to maintain inflation at 10%.
February 20, 2008 at 3:55 pm
nicknamed,
Yeah that’s a real Orwellian article. They are basically saying that the non-borrowed reserves are not an issue because the banks are getting the money from the TAF and therefore are OK(?!?!) This guys obviously has no clue what the TAF is. It is borrowed money, therefore how can it be reserves?!
I’m sure the conventional MSM explanation of this “technical anomaly” is that the TAF is lent out in exchange for collateral so therefore they are simply “trading” money for collateral in this case and the TAF is as good as actual cash bucks. LOL! What a load of crap.
What I would like to know is, what is the TAF actually accepting for collateral? A bunch of dodgy fictitious capital and Ponzi units, or good stuff? Who knows? What we do know is that there is no real price discovery and no mark to market so we can be pretty well assured that whatever is in the TAF isn’t worth what the banks say it is.
Also, since when is collateral the same as cash? That’s why there is a non-borrowed reserves category and kudos for the Fed for keeping things somewhat real (in this case.)
February 20, 2008 at 4:53 pm
TechGuy,
Don’t you think it will be exceedingly tough to bailout the GSE’s?
Here’s my thinking: if the GSE’s fold and the government does nothing about it, this will result in a RE catastrophe as prices would crater 50% or more from where they are as there wouldn’t be any securitization model left and getting a loan for any type of RE would be extremely difficult.
Conversely, if the government does bailout the GSE’s and takes on all of that bad debt, this will cause the TNX to skyrocket as the bond market would be able to smell any bailout coming. We may be seeing a foreshadowing of this in the ten year right now. This in turn would cause RE to crater 50% or more and would also crush the dollar and cause many other nasty problems.
What is the motivation for the government to bail the GSE’s when RE is cooked either way? Are they this stupid?
February 20, 2008 at 6:01 pm
In spite of what some are saying the government can bail out the GSEs. All it means that the same debt is moved to the treasury book. GSE debt is backed by real estate, some a bit dodgy, but largely whole.
It does not affect federal debt to any degree since the rest of federal debt is backed by taxes, while GSE is backed by RE.
It is panic mongering to deem a bailout inflationary. It is very mildly so, and frankly good for the markets and tax receipts which should reduce true federal borrowing.
February 20, 2008 at 6:15 pm
I found an article that says exactly what I did in my post but in more professional way:
http://www.minyanville.com/articles/index.php?a=15975
I agree with every single word out there.
February 20, 2008 at 7:13 pm
PrintFaster, you make it sound all very simple, but you’ve completely forgotten about private credit market crowding out that would occur in such a scenario along with the forward costs of servicing the GSE debt. This would likely cause mortgage rates to skyrocket, thus killing the RE market entirely. Perhaps the TXN is already getting a whiff of the bailout coming and doesn’t like it?
You can’t take on $2TR in questionable debt without having some kind of a negative effect on borrowing costs, ie treasuries. Let’s not get into a perpetual motion argument where you take all of this very bad stuff that is going on in the RE market and magically make all of the problems go away with no down side whatsoever. There is always a counter-party to every trade. What would they have to say about such a move? What would be the ability of this zombie bank to continue functioning? This is not a panacea.
A bailout COULD be done, but should it be? IMHO, a GSE bailout would be the beginning of the end of the economy.
February 20, 2008 at 8:19 pm
Troll
You are missing the fact that new originations would all be Ginnie Mae or private with all they entail. Old ones would not encumber the federal debt to any large degree unless they were done with extremely low down payments or assets.
Fannie and Freddie would be allowed to fail and all the preferred and common would be used to finance the absorbed debt.
Let’s see, $2T in questionable debt. How much would it have to be marked down? 100B? 200B? 1T? Over how long? Likely it would not be over 100B in losses to be absorbed. Even so, all Fannie and Freddie stock would be applied against the debt. This would only be a problem if there was mass deflation in real estate. More of a problem is the monoline guarantees applied to the loans with higher loan to value ratios.
Taking on 2T does not negatively affect Ts. It is now debt and will still be debt afterward. Debt remains debt. The government has not added to the total quantity of debt.
Still, I think that this guarantee is implicit in a GSE, even though it is not law. Please convince me that this is a bad idea. Letting Fannie and Freddie disappear is the right lesson. Taking on their debt is the right answer.
February 20, 2008 at 8:20 pm
Apologies to Darth Toll.
I read that as Darth Troll. Ooops.
February 20, 2008 at 9:24 pm
I guess Warren Buffet will create a GSE, that could be a kind of solution. That’s after he creates a bond insurer. Later on he will create one airline, one railroad, one automaker and so one …
February 20, 2008 at 10:02 pm
Eeek, another Buffet rumor. Find a disaster and Buffet becomes the savior.
Don’t get me started on Buffet and his financial alchemy. How can he take Dairy Queen for example and add value to it? The thing was publicly traded, and should be fully valued. What does Buffet know about ice cream?
Need to pump your lousy stock? Mention Buffet.
February 21, 2008 at 1:45 am
PrintFaster, no problem. Many make that mistake although my namesake is actually a parody of Robert Toll and his infamous statements that ultimately only the rich would be able to buy RE in the US (as in Europe.)
PrintFaster, in the end you may be right and you and I agree on much more than we disagree. One thing that you said that is right on is the lesson. FNM and FRE must disappear, and the sooner the better, although we may differ on the government assumes dodgy debt piece. I am not convinced that Ginnie Mae or private can pick up the considerable slack, due to crowding out.
http://en.wikipedia.org/wiki/Crowding_out_(economics)
This is a serious concern and would demolish the RE market for a long, long time. Crowding out can be avoided by printing, but this has many negative side effects as I’m sure you are aware. The last thing the RE market needs right now is much higher rates.
Why not let FNM/FRE implode naturally and not assume the debt. Sure the adjustment will be painful, but this may be inevitable. In time, the private securitization model would make a comeback and be a much leaner, meaner and efficient machine, quite capable of doing the job. Financial innovation got carried away to be sure, but is not totally worthless long term.
BTW, there is mass deflation in RE and there will be much, much more before all is said and done.
February 21, 2008 at 2:13 am
Toll
We do agree fairly well. For the government to take over or manage Fannie/Freddie debt I don’t think will matter much economically. You see crowding out, but if Ginnie takes it over, it is still the same amount of debt. Frankly when I did my mortgage, I couldn’t tell the difference between Fannie/Freddie/Ginnie. Same-o, same-o.
The government has to maintain credibility above all else. The rest is just money. Taking the debt over is more about credibility and the overall crowding out I see as negligible.
Where you should be worried about crowding is in the treasuries. The fed going out and doing 30s again should be a real worry to those getting mortgages. In the past if you wanted 30 year paper it had to be Fannie or Freddie with the implicit government guarantee. Now treasury is stepping on the toes of mortgage seekers.
This game of hide the sausage is turning out to be a game where everyone is holding sausage.
February 21, 2008 at 2:21 am
By the way on Toll’s statement only the rich will be able to *buy* real estate is true even today.
I know of almost no one who *owns* real estate. Everyone that I know is mortgaged. And certainly most of those who may own their property, did not buy it outright.
Ah to be rich enough to buy real estate.
February 21, 2008 at 9:12 am
Mind-blowing stat for the day . As per Boone Pickens- I’m paraphrasing here ( On CNBC – 8:10 am Thursday )…. 500 billion goes out the door for crude and gas every year.. over ten years that 5 trillion dollars and a lot of that is going to people that aren’t real friendly to us… that’s wealth transfer on a massive scale.
February 21, 2008 at 4:14 pm
Darth Toll Wrote:
“What is the motivation for the government to bail the GSE’s when RE is cooked either way? Are they this stupid?”
I can answer your question with a question: Since when has our gov’t made smart decisions?
Had they been sensiable, we would be in this situation in the first place. Consider that they just passed leigislation to permit the GSEs to take on Jumbo mortgages. If had any common sense they would have never permitted the GSEs to raise the limit from the ~$360K-$380 to $417K a couple of years ago. The GSE were set up to permit very low income (hard working folks) to purchase a home. Now we have millionares getting financing through the GSEs.
I expect that Congress will authorize a bailout as a knee-jerk reaction, and because the country was OK after the S&L bailout. Congress is all about short-termism. They will continue to make easy short-term fixes so public will pat them on the back for another term in office. The long term is irrelavant, as long as the politicians can get re-elected. What makes you think that Congress won’t bail them out?
—
Another comment I would like to add, if the GSEs do collapse and default it would definately create the next Great Depression (very likely worst than the 1930’s depression). The US would loose all access to credit, including both consumer and corporate credit. Unemployment would probably soar to at least 30%, and Its likely the US govt’ would default (paying benefits, FDR style Worker programs). I believe that the US economy is dependant on cheap and abundant credit.
fredw quoted:
“500 billion goes out the door for crude and gas every year.. over ten years that 5 trillion dollars and a lot of that is going to people that aren’t real friendly to us.”
Consider than they are friendly enough to let us consumer all that non-renewable energy, and for decades, the money that we spent on energy purchase was re-invested back into our country. “Let me get this straight. Your going to sell us energy that is absolutely vital for our economy and then your going to take that money,and reinvest it back in our country?”
The real threat is that when the fields in the Middle east water out, and they simply can’t pump out any oil to send to us. What’s Plan B?
February 21, 2008 at 5:42 pm
TechGuy,
It sounds like you see the same basic scenario happening either way, which is kind of how I see it as well. If the GSE’s do get a government bailout, much higher rates and the death of the RE market. You didn’t say specifically that this would result in GD2, although I’m extrapolating here that it must due to lack of cheap and abundant credit.
If the GSE’s default and don’t get a bailout, death of the RE market and GD2. Sorry to keep hammering on this but my sense is that the GSE’s are the center of vortex, so it’s imperative that one has a good understanding of the possibilities there.
February 21, 2008 at 8:08 pm
Here is your evidence that the feds will bail out our fannies:
http://www.reuters.com/article/bondsNews/idUSNAT00373420080221
The foreign banks buying Fannie and Freddie at this time? Either the foreign banks are planning to rescue Fannie and Freddie or they fully expect a complete federal bailout of Fannie and Freddie if default is being faced.
Conclusion: Treasury is backing Fannie and Freddie debt today. Period.
February 21, 2008 at 8:12 pm
Just to get back to the mkts..my numbers gave a hint..well more than a hint, but not a certainty that the second (third?) leg down is soon to start.
February 21, 2008 at 8:23 pm
OK Don
I admit ignorance in things timing and things market. Help me banish my ignorance and point me to ways that I can get to where you are.
No need to reveal your methods. Enlightenment does not come from mere light alone.
February 21, 2008 at 11:50 pm
I measure 9 different variables, each assigned a point value to total 100. Using this system I trade the QID and QLD. I never buy the QID unless we are in a Bear MKT and I never buy the QLD unless we are in a bull mkt. My system gave a sell (or out of mkt)signal on October 25 so I moved to cash as we were still in what my gig calls a bull mkt. My point value dropped to less than 40. that means out of the mkt. It gave a short signal on Jan 4th as we were in a bear mkt so I bought the QIDs at 43. Points dropped to zero. Currenty points are 45 but looks like it will hit zero again soon. Will elaborate more later as wife wants to check her email..gotta go
February 22, 2008 at 10:17 am
Don, I think it’s very conservative and prudent.
The other prudent system I know is based on Dow theory. The followers on that theory don’t trade, they go 100% long or 100% cash depending on buy-sell signal, which comes only once in several years. That produces about 15% average over many years – they way to go if you have a lot of money.
I think I will switch to Dow theory model once I reach retirement and start depending on my investmenst
February 22, 2008 at 6:08 pm
Darth Toll Wrote:
“If the GSE’s do get a government bailout, much higher rates and the death of the RE market.”
I think a bailout will happen as knee-jerk reaction in a vane attempt to avoid interest rates for both consumer and commerical loans from soaring. If the GSEs are not bailed out, interest rates would soar. Probably in the 15% to 25% range, since it means there are no guarentees, and because the GSE’s have an enormous amount in loans. All that bad debt would saturate the market for a very long time.
On the flip side, a bailout would also mean that the gov’t would effectively have to print money for the bailout in order, which will likely cause the value of the dollar to nose dive. For the dollar not to go bust the Fed would need to raise the rates, and congress would probably have to double the tax rate to pay for it. Of course that medicine results in a the patients death, since in both case you end up with higher loan rates.
I guess it like choosing how you want to go to hell. Your options are: A. in a handbasket, or B. without a handbasket. If they do bailout, those with cash will be left holding the bad along with everyone else. I would perfer if we went the deflation route since my cash would retain value. With a Bailout I am screwed like everyone else. In the past I was really hoping the the high networth group would pressure the gov’t not to print money, since even the rich have exposure. Unfortunetly I haven’t see any signals that they are turning up the heat.
Darth Toll Wrote:
“my sense is that the GSE’s are the center of vortex”
I think so too, because the GSE’s are the backbone of the Mortgage market. The implied Gov’t guarentee permited fixed mortgages to go very low. From what I can tell, they are the only open lender now. Virtually all the banks are funneling new loans through the GSEs since Banks can’t take on new loans (no capital reserves) and they can’t sindicate them by selling bonds as the did in the past since, since they burn investors by selling subprime mortgages as AAA. If the GSE’s fall, its GD2 for sure.
FWIW: I have a family member that works with a former aid (recent college grad) who worked with the economic group in the White House. The White House Economic group expects GD2 within the next five years. I’ll see what more information I can get using this source.
PrintFaster Wrote:
“Conclusion: Treasury is backing Fannie and Freddie debt today. Period.”
I am not sure I would reach that same conclusion. Its plausable, but I wouldn’t bet money on it. It could just mean that they believe that the Gov’t will guarentee them. Keep in mind that China and other Asian and Middle Eastern nations have been buying GSE bonds for a very long time. I think this is more likely that they are just following their normal business. Like everyone else is, they may be just chasing higher bond yields.
Also consider what happens to the dollar if they bail out the GSEs by printing money?
The Central banks are still holding the bag when the dollar takes a nose dive. Its a bad investment decision whether the go’vt has promised them a full guarentee or not.
{joke}:
Unless China is really planning to take owership of all these defaulted mortgages and send us millions of chinese to come live in the US to deal with thier over-population problem:
afp.google.com/article/ALeqM5hyMhwroFlOgzPE61X3P0AVEmxCHA
[1973] Chairman Mao proposed sending 10 million Chinese women to US: documents
After reading that news article, all I can say is that truth truely is stranger than fiction. I wonder if there are Nixon audio tapes of this discussion.
February 22, 2008 at 10:34 pm
TechGuy
You said:
“I think this is more likely that they are just following their normal business. Like everyone else is, they may be just chasing higher bond yields.
That is the point of my conclusion. You don’t chase higher yields at a time when there is more doubt as to payout. I see this as reassurance being conveyed to those buying to “keep the faith”.
As for causing inflation by taking over the GSEs, I don’t see it. They won’t print money. They won’t even have to issue tax backed debt to cover it.
Remember the distinction: Tax backed debt is only needed if very substantial amounts of the GSE debt are not recoverable. I still see the amounts to be backed by taxes as small. The rest will be RE backed.
Remember, Weimar drove out of inflation by backing the currency with RE. Maybe if the treasury gets enough RE bankruptcies, they can sell the RE to pay off the federal debt. Insert smiley with tongue sticking out straight.
February 22, 2008 at 10:38 pm
TechGuy:
“Unless China is really planning to take owership of all these defaulted mortgages and send us millions of chinese to come live in the US to deal with thier over-population problem:”
This is already happening and has been happening a long time. We talked to a waitress in a Chinese restaurant a while back and she said that because of Chinese family planning rules, she had been exported. Her family would be fined or jailed if the government found out.
Think of them as womb bombs.