Inflation or Deflation? Marc Faber vs. Mike “Mish” Shedlock

Once in a while you can observe a few minutes where people on mainstream news speak the truth. I treasure these moments …

Part 1: Mish & Faber discuss market outlook and see value in Japan

Part 2: Mish & Faber on Inflation or Deflation

In case you care about my humble views in next to these two brilliant titans, read my Inflation & Deflation Revisited.

Part 3: Mish and Faber agree “It’s too late to fix things”

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Deflationary Collapse More Likely Now than in 2007

Janet Tavakoli makes some excellent points on how 2 years of endless money pumping, government bailouts, and stimuli and have accomplished the exact opposite of what was intended: Matters have gotten far worse, and the financial system is now in a much more explosive condition than back then.

Part 1

Part 2

Her book Dear Mr. Buffett sounds like a great read. I will definitely check it out.

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Consumer Price Index July 2009 – Real Prices Down 6.6%

The BLS reports CPI data for July 2009:

The Consumer Price Index for All Urban Consumers (CPI-U) decreased 0.2 percent in July before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Over the last 12 months the index has fallen 2.1 percent, as a 28.1 percent decline in the energy index since its July 2008 peak has more than offset increases of 0.9 percent in the food index and 1.5 percent in the index for all items less food and energy.

The official price decline over the past 12 months was 2.1 percent. That alone is unprecedented as far as I can tell. But let’s, as always, approximate real price declines:

Looking at the detailed table, one can see that owner’s equivalent rent (OER) went up by 1.7%. If we want to calculate the True CPI, we have to replace OER with the Case Shiller home price index, which most recently dropped by 16.8% over the year. If we do this, we get an overall price decline from 1 Year ago of 6.6%. (Last month’s release yielded a real price decline of 6.4%)

Not only are prices falling, they are falling at an accelerating pace. This a corollary effect of deflation, plain and simple. Some investors say we should expect inflation soon. Some expect it somewhere down the road and that it will me rampant. Most of them don’t dare use the D word, even though by all unconventional AND unconventional measures we are in the very midst of a massive deflation, not based on prices alone, most definitely not based on money supply alone, but first and foremost due to an ongoing and likely long lasting credit contraction:

total-credit-long-term
Click on image to enlarge.

Since the peak in October 2008, total credit and loans/leases outstanding have fallen by $725 billion, a 4.3% drop. And this doesn’t even take into account the decline in outstanding bond prices and unfunded liabilities. It is, indeed, tough to ascertain whether there is a decline in the net present value of unfunded liabilities. Thus we shall ignore them for now. However, bond prices have definitely declined across the board.

If we conservatively assume, for the sake of simplicity, that those bonds have contracted by about the same percentage since October 2008, this would give us a total credit contraction of around $2.15 trillion since the peak.

[smartads] On top of that, I don’t think that people are oblivious to the fact that there is absolutely no way that all social security and medicare benefits will ever be paid. Thus it would only be reasonable to conservatively assume that the present value of those liabilities has dropped by the same amount. This would almost double the total contraction to $4 trillion.

It is, on top of that, rather questionable whether all this credit is marked to market. I would say that all this number gives us at the moment is at the low end of the range. Meanwhile, the true money supply since then has grown by merely $170 billion.

Why is this so important? Because it shows us the magnitude of the deflation that we are in right now, a deflation with all its consequences on home prices, consumer prices, interest rates, and stock prices. And it gives us a solid foundation to understand why various investors and maintream journalists who continue to expect, fear, or hope for inflation anytime soon are way off base and will be proven wrong in the long run.

As far as a general mid-term trend one can expect based on this data, as far as certain asset classes are concerned:
Bullish: Treasurys, Dollar, Gold, (maybe) Silver
Bearish: Stocks, Corporate Bonds, Foreign Currencies (except for the Yen maybe), Soft Commodities

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Total US Credit and Loans – How Much Contraction Since Peak?

I have been trying to put together a complete picture of the credit situation in the US, in a historical chart on a weekly or monthly basis. The closest I have come is to take the St. Louis Fed’s figures for “Bank Credit at Commercial Banks” and “Total Loans & Leases at Commercial Banks“. Together they currently add up to around $16 trillion.

For a complete measure of total US debt it is still insufficient. The market for all bonds (public and private) comprises approximately $34 trillion (about $11 trillion of that is public federal debt). This, added to the previous $16 trillion, makes a total of $50 trillion.

Then there are unfunded social security and medicare obligations of about $43 trillion according to the Treasury’s own Financial Report for 2008:

The SOSI provides additional perspective on the Government’s long term estimated exposures and costs. However, it should be noted that the Government’s financial statements do not reflect future costs implied by any current policy, such as national defense, the global war on terrorism, and disaster relief and recovery. Table 3 shows the Government’s estimated present value of future social insurance expenditures, net of dedicated future revenues for the programs reported in the Statement of Social Insurance (SOSI), projected to be $43 trillion as of January 1, 2008 for the ‘Open Group’6. While these expenditures are currently not considered Government liabilities, they do have the potential to become liabilities in the future, based on the continuation of the social insurance programs’ provisions contained in current law.

A liability, or debt, is simply “the obligation of one person or group to provide future goods to another person or group.” Thus, for the discerning economist, it is rather irrelevant if the government “considers” or “officially calls” them liabilities. As far as their impact on human action is concerned, and thus all that economics cares about, they are debts. This brings the total US debt up to around $93 trillion (with total public debt at around $54 trillion).

It is reasonable to also include stocks in the overall credit picture. In fact, if we want to be consistent, and really measure the total amount of credit, meaning claims to future money at the expense of present money, we have to include them. This may appear unconventional as far as our common understanding of credit is concerned, but it doesn’t change the praxeological nature of stocks and thus their fluctuation’s effects on human action.

According to this post, total stock market capitalization is around 35 trillion, with about 30% of that being US equities:

This implies that total stock market capitalization is currently at around $10 trillion in the US, which pushes total credit in the US up to around $103 trillion.

Stocks have, on the net, remained about flat since October 08. But all other credit classes have dropped. I haven’t found detailed monthly figures for the total bonds and the unfunded liabilities. Thus we have to stick with the figures on bank credit and loans/leases from the St. Louis Fed in order to infer from that the overall credit trend:

total-credit-long-term
Click on image to enlarge.

Since the peak in October 2008, total credit and loans/leases outstanding have fallen by $725 billion, a 4.3% drop. And this doesn’t even take into account the decline in outstanding bond prices and unfunded liabilities. It is, indeed, tough to ascertain whether there is a decline in the net present value of unfunded liabilities. Thus we shall ignore them for now. However, bond prices have definitely declined across the board.

On top of that, I don’t think that people are oblivious to the fact that there is absolutely no way that all social security and medicare benefits will ever be paid. Thus it would only be reasonable to conservatively assume that the present value of those liabilities has dropped by the same amount. This would almost double the total contraction to around $4 trillion.

It is rather questionable whether all this credit is marked to market. I would say that all this number gives us at the moment is at the low end of the range. Meanwhile, the true money supply since then has grown by merely $170 billion.

Why is this so important? Because it shows us the magnitude of the deflation that we are in right now, a deflation with all its consequences on home prices, consumer prices, interest rates, and stock prices. And it gives us a solid foundation to understand why various investors and maintream journalists who continue to expect, fear, or hope for inflation anytime soon are way off base and will be proven wrong in the long run.

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Deflation Continues in Germany

Deflation is and has been a global phenomenon for a while now. Germany, too, is not exempt from it:

Consumer prices in Germany, Europe’s biggest economy, posted their first annual decline in 22 years this month largely as a result of lower oil prices, preliminary government data showed Wednesday.

Prices were down 0.6 percent on the year in July — the first fall since March 1987, when they declined by 0.3 percent, the Federal Statistical Office said.

It said the decline was fueled by sharp year-on-year declines in energy and fuel prices, which peaked in July 2008.

Germany’s inflation rate hit zero in May and edged up to 0.1 percent last month. Several other European Union nations have reported a fall in prices this year.

Contrary to what the article goes on to assert, deflation is of course a desirable phenomenon that restores balance and sanity.

As I explained recently, regarding deflation in Japan:

Two fallacies in common reports in the media:

1. That there is a possibility of an impending deflation. – The truth is: Deflation is here and now, has been for a while, and will be for a while.

2. That we have to “fear” deflation. – The truth is: Deflation is a good thing, as I pointed out a couple of times:

Deflation is in essence a correction of the previous misallocations created by inflation.

What turns deflation into a bad thing? When the government tries to stave it off by spending billions and trillions of dollars, thus prolongs the correction, continues the misallocations, and increases the debt burden on the taxpayers. If you want to get an idea of the long term outlook for the US economy, look at Japan. The credit and stock bubble there burst in 1989, and has been deflating on and off since then.

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