Deflation or Inflation – Is Public Credit Setting Off Contraction in Private Credit?

I want to follow up on something Marc Faber said the other day in the second clip.

He said that it is true that private credit is contracting, but it is being offset by a government credit expansion.

Let’s examine this suggestion a little more closely.

I regularly publish the total contraction of total private loans and credit:


This is, however, only a subset of the total credit picture. What is missing are things like corporate and government bonds, and probably some other non financial obligations.

The most comprehensive data on the total of pretty much ALL credit issued in the US is really the Federal Reserve’s Flow of Funds Report, in particular the subsection “Level tables”.

The current flow of funds report can always be accessed here and for March 11, the latest release shows us the following:


Based on these numbers we can see that total credit, when measured across all sectors, has indeed been declining throughout 2009, by roughly $466 billion, in spite of a massive ramp up in public debt.

This simply shows us the magnitude of the deflationary forces in action.

I would also add to this that we could easily double the total credit outstanding above if we included the federal government’s Medicare and Social Security obligations which nominally amount up to $43 trillion and will never be fully paid back. There is no official number to track for this since these obligations are not reported on any balance sheet and are not traded on any markets. Thus we can only assume that their present value is declining by at least the current rate of decline in the remaining credit volume (about 0.8% through 2009).

This would bring the total contraction in credit up to around $810 billion through 2009.

I’m also not sure to what extent other municipal and state pensions are covered in the flow of funds number, but I rather doubt they are included at all. A lot of those lavish union pension plans are going to have to cut back on their commitments soon, probably the next big events to shake the markets, along with commercial real estate defaults and property values declining.

And last but not least, it is rather unlikely that the current numbers are all marked to market. Government regulations across the board have ensured that banks and corporations can be rather creative in their reporting.

Either way, all this is a rather strong indication that Marc Faber’s assertion may not me correct.

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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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Bets on Inflation – Full Steam in the Wrong Direction

Bloomberg writes Jim Rogers Sells Dollars, Plans to Short Treasuries:

July 6 (Bloomberg) — The dollar and U.S. Treasuries are both likely to slide as soaring government debt in the world’s biggest economy undermines confidence in its assets, according to Jim Rogers, chairman of Rogers Holdings.

“The government is printing lots of money and borrowing even more; that’s not the basis for a sound currency,” he said in a telephone interview today from Singapore. “The idea that anybody would lend money to the U.S. government for 30 years at 3 or 4 or 5 or 6 percent interest is mind-boggling to me.”

Rogers, the author of books including “Investment Biker” and “Adventure Capitalist”, said he holds fewer dollars than a year ago and plans to “short U.S. government bonds someday.” A short bet involves selling a security you don’t own with a view to buying it back after the price has fallen.

A time will come when Jim Rogers, Peter Schiff, Mark Faber, and other hyperinflationists will have to come forward and tell their investors that they were plain wrong. The only other option they have it to continue to predict for years and years to come, in millennial fashion, that someday their prophecy of hyperinflation will become reality. It is not a surprise that a lot of the current phenomena are entirely confusing and mind-boggling to them.

I would advise anyone who is still listening to them on this matter to consider Inflation & Deflation Revisited, take a look around and see what is going on with grocery stores, commercial properties, credit card defaults, friends who are losing their jobs, the immense appetite for savings, etc.

Adjust your investment strategy accordingly, and cash in while hyperinflationists continue lose money.

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Inflation Fears Meet Reality

The Bureau of Labor Statistics reports that consumer prices fell by 1.3% over the past year:

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3 percent in May 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 1.3 percent. This is the largest decline since April 1950 and is due mainly to a 27.3 percent decline in the energy index.


As can be seen this CPI-U measure applies a rise of 0.5% for “Housing”. How realistic does this appear? It is obviously a mirage. It is a result of the fact that the so called owners’ equivalent rent (OER) has replaced real home prices in the index. It contributes 24.433% to the current CPI-U and is included as a component of “Housing”.

This prevented the CPI from raising red flags during the housing boom, and it is now skewing price declines significantly

When we replace OER with the Case-Shiller home price index, which most recently indicated a year on year drop of 18.7%, prices overall actually fell by 6.3%.

As I said 11 days ago:

…this is not the stuff from which inflations are made.

I expect a reversal of market data to adjust to real conditions sooner or later. I think Treasury Notes will be a good call. The dollar should start to rise again against other currencies. I think gold is likely to do fine. It is merely back to where it was before the inflation fears began. Silver’s excessive gains, however, may have partly been fueled by these inflation expectations. I would advise caution here. It may be time to ring the register on some silver gains and buy at another low.

Treasuries have rallied since then. Stocks have fallen. The dollar has gained, albeit rather moderately. Gold saw a minor drop while silver fell by about 6%. Virtually all inflation expecation indicators that I posted in that article have begun to change direction. I expect this to be a pervasive and extended trend over the next weeks and months with gold beginning to bounce back stronger than silver. Whenever expectations are so out of whack with reality, a market correction tends to be due … time will tell.

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Inflation Fears vs. Reality

Markets everywhere are unanimously heralding a return to dollar inflation


Inflation expectation is up:
Click on image to enlarge.

Stock markets are up (S&P 500 below):
Click on image to enlarge.

Treasury yields are up (10 year Treasury Note yield below):
Click on image to enlarge.

Spreads between Treasury Inflation Indexed Securities and regular Treasuries have widened significantly:
Click on image to enlarge.

The dollar is dropping against major currencies:
Click on image to enlarge.

Recent news are screaming Inflation:

Gas prices above $2.60:

Gas prices have been steadily rising since early December, when the national average was around $1.60 a gallon. But despite the recent rise, gas prices are still well below year-ago levels of $3.986 a gallon and last year’s all-time high of $4.114 a gallon.

But some are concerned that prices will continue to rise. Part of that has to do with the usual increase in demand for gas during the summer months.

In addition, rising hopes of a U.S. economic rebound have helped push oil prices higher as the dollar has weakened against other currencies. A weaker greenback tends to push up the price of oil since oil is traded in dollars around the world.

Dollar’s wounds reopen:

Emerging market indexes and commodities are surging as investor wealth pours in once again. Profligate US spending and skyrocketing deficits, hyper-loose monetary policies in this crisis, and collapsing confidence that the Fed will actually be able to withdraw such policies and excess liquidity when required, are all causing dollar inflation expectations to become deeply rooted in investor psychology.

The overpowering perception on the part of global investors that the Fed, Treasury and Administration are losing control of the US fiscal position, and that inflation (more likely hyper-inflation) is virtually becoming inevitable is threatening to wreak irreversible harm upon US finances and upon the dollar itself.


Actual market data, however, tells us the following:

Credit is imploding across the board…

Consumer Credit:
Click on image to enlarge.

Commercial Bank Credit:

Industrial and Commercial Loans:

Loans and Leases at Commercial Banks:

Real prices are dropping at unprecedented rates:

Case-Shiller-CPI (CS-CPI) vs. CPI-U

click on chart for sharper image.

See CS-CPI Negative 5.0% Third Straight Month for more details.

Greenspan ignored the effects of asset bubble like housing, by failing to take into consideration housing in the CPI. Real interest rates were -5% in mid-2004 and stayed that low for quite some time, spawning the biggest credit boom the world has seen. Now in spite of a Fed Fund’s rate that is zero, real interest rates are +5%.

Home prices continue to decline:

Click on image to enlarge.

According to the new Case Shiller report nationwide home prices dropped by 18.7%.

Top 3 annual declines:

1. Phoenix, AZ: 36.02%
2. Las Vegas, NV: 31.23%
3. San Francisco, CA: 30.06%

Top 3 monthly declines:

1. Minneapolis, MN: 6.25%
2. Detroit, MI: 4.85%
3. Phoenix, AZ: 4.52%

…this is not the stuff from which inflations are made.

I expect a reversal of market data to adjust to real conditions sooner or later. I think Treasury Notes will be a good call. The dollar should start to rise again against other currencies. I think gold is likely to do fine. It is merely back to where it was before the inflation fears began. Silver‘s excessive gains, however, may have partly been fueled by these inflation expectations. I would advise caution here. It may be time to ring the register on some silver gains and buy at another low.

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