Dueling Reader Comments (And Damn That Economy): En Garde!

That’s an apples to oranges comparison. SF is different. All you haterz just wait and see.

That’s true although they did nationalize their banks back in the 1980’s. So in that respect they’re way ahead of us.

“down almost 10%”, I don’t think anyone sees this. Even “Plan A” hoods are down more than 10%.
With, of course, my typical comment: except fixers.

Darn, I did not expect to be asked to back up this post. But here we go.
Apart from my individual story, I have some stats to back it up. This is a PDF from the Paris “notaires” who collect all official resale prices:
http://www.paris.notaires.fr/UPLOAD/files/5a52f9ab485d28a4/historiquedesindicesdesappartementspararrondissementt22008.pdf
Each quarter is qualified as T497 or T106. It starts in 1991 (T291) though and not 1990 and ends in 2008 (T108). But it’s good enough.
Follow the column 10e (where I bought).
T391: 2735 E/m2
T394: 2232 E/m2
T198: 1626 E/m2
These are averages, not medians, by the way.
Locally, this was much more brutal in distressed neighborhoods. The 10th is very diverse and I was scraping the bottom of the barrel. I paid my place around 2150 E/m2 in September 94 (sucker!).
A neighbor moved in in the same condo layout 2 floors down paying 1200E/m2 in late 96 (a sweet deal, her mom being a Realtor 😉 ).
I bought my next condo in January 98 for 1000E/m2 from a capitulating seller (arm’s length deal). Her place had been stuck vacant for 6 years (yes, six years…) and needed work. She just gave up. Some sales at the time ranged between 1400 and 1600E/m2.
Anyway, Paris is different from SF, no question. But a 10-15% drop after a huge run-up is not always the opportunity of a lifetime.

It strikes me that the government is missing a valuable “teachable moment” here.
Instead of trying to reflate the housing bubble with loans to new buyers at 4%, why not condition the availability of federally insured mortgages to security (property value) calculated using the *income* method–i.e., net present value of rental income, or rental income x a multiplier derived from historic price/rent ratios for the property type in question–rather than the bubble-vulnerable “comparable sales” method. If the government wants to blow more money, it could also give a bonus (e.g., an interest subsidy) to buyers who transact at a price at or below the expected equilibrium value (i.e., the value determined using the income method).
This would do several useful things: (1) it would provide a “cue” to buyers about whether they are gambling on jurisdiction-specific appreciation (e.g., due regional economic changes, supply restrictions, etc.) at the transaction price; (2) it would help to keep prices from dropping below their equilibrium value (the overshoot problem with panic selloffs); and (3) it would (one hopes) encourage the private mortgage industry to come up with better, less bubble-vulnerable ways of valuing the assets on which they are making loans. (The secondary market is likely to be quite demanding vis-a-vis loans that are not “secure” at the income-derived property value that the gov’t is using.)

A bit of hope: This will be the biggest buyers market in decades. Prices are down almost 10% in most of [San Francisco]. We’ll never see this opportunity again. . With normal market appreciation of +7%/yr, you’re looking at less than a year for ROI.
I think this is so far removed from reality that it is not even worth commenting on.
When I put the numbers in the rent vs. buy NYT calculator, I would have to hold a condo for 25 yes for it wo be move financially viable than renting. ANy ROI whatsovever doesn’t look plausable for at least an 8-10yr hold

But, the amount of we have lost (dozens to hundreds of trillions) is greater than the amount we’ve created (a few trillion dollars). Combine the two and you have deflation.
Well, you could argue that it never really was “wealth.” Did someone who held GOOG shares at $700 “lose” over $400 since it’s tanked? Maybe. But what if they bought it at $100? They’re still up $200.
I would argue that it’s only real if/when you cash out. Of course, there’s the wealth effect, etc.
If you’re going to define deflation as a decrease in the money supply, I don’t see how a decrease in the stock market automatically leads to a decrease in the money supply, and vice versa. It MAY, but then again, it may not.

I’ve never understood the arguments that an appreciating FMV for an asset isn’t real money. Assume I buy a dairy cow for X. Assume that the next month, a virus kills a bunch of dairy cows and the FMV of my cow is now 2X. Further assume that, a few years later, a bunch of new diary cows are on the market and the value of my cow is now back at X.
Does that mean that the increased value of my cow wasn’t real? Of course it was real. It’s an asset. Had I sold it, I would have 2X.
How is the stock market different?
There’s an argument that it doesn’t apply to housing, since, for most people, housing is not a capital asset. But that’s an argument that real estate agents and I have never seen eye-to-eye, and I accept that most people on this blog have different opinions.

Yeah, that was probably a bait to get our blood pumping again. Even a giant slow-motion train wreck loses its entertainment value after the first 2 wagons have been crushed.
[Editor’s Note: We could care less about the “entertainment” value, it’s people wrongly thinking the wreck is over that we’re worried about.]

Inflation is primarily defined today as a rise in general levels of goods/services in an economy over a period of time. Increases in the money supply do create inflation, but most people don’t use the terms interchangeably these days.
The Fed is printing money like crazy today and putting all kinds of junk on its balance sheet. Will that cause the price oil to double next week? No, there’s a lag effect. But over time, all of this liquidity has a habit of finding places to go (other than treasuries and mattresses).
Inflation eats away the value of paper money, forcing people to spend or invest in assets. The fiscal and monetary stimulus on the horizon is pointing toward a coordinated, engineered decrease in the value of the paper dollar. Inflation typically finds its way into wages too. In the eighties, people routinely got 15% raises. If the Fed pumps enough paper money into the economy, unemployment and housing prices should stabilize, while (unfortunately) the price of everything else–bread, milk, rent, gas–will go up.

Sure, maybe… Like I said, everyone around here seems to think we’re headed toward either Japanese-style or 1920-style deflation. It’s not impossible but I personally don’t believe it will come to that.
Europe is thinking about providing stimulus “coupons” to people (rather than stimulus tax rebate checks) in order to pump up the economy. Those would only be redeemable for purchases, not paying down your own balance sheet. It’s just one example, but my humble advice is, don’t underestimate the ability of a government to devalue its paper currency.
I also don’t think you can say with a straight face that banks shoring up balance sheets with free paper money had “no result” for the economy. Preventing a collapse is not “no result”.
Six months ago, everyone was screaming about inflation. Today, it’s deflation. In six months, I will not be surprised to see people squawking about hyperinflation and arguing to put us back on the gold standard…

If “The Donald” wants to continue being “in the game”, he could start by paying some of the outstanding past-due loans on the Trump Tower in Chicago.
http://www.nbcchicago.com/around_town/real_estate/Trump-Sued-Over-Chicago-Tower.html

Inflation occurs when too many dollars chase too few goods, sending prices up. You can’t have inflation with so much excess inventory–houses, new cars, airline seats–sitting in the economy.
Excess inventory dries up when one or more of the following happen:
1) Production stops (abandon new construction, shut factories, cut back on number of flights) or,
2) Prices go down (deflation) until consumers eventually buy or,
3) Consumers become more wealthy and buy
Production is already starting to slow down or has stopped (#1). Consumers aren’t likely to gain more wealth anytime soon (#3), and even when the government hands out checks, consumers exercise self interest and hoard the money. So the only reasonable thing left for the gov to do is let #2 take place. Literally: let #2 hit the fan!
People seem to think that nothing good came from the Depression, but I disagree. What emerged was a group of Americans who appreciated the value of money, who were willing to work hard and save, who never over-extended themselves or expected somebody else to clean up their mess.
What happens to society when the government prevents risk takers from failing?
When I was eight years old I did something really stupid on my bike and ended up getting my teeth knocked out and a broken arm. What did I learn from my mistake? Not to do stupid things.
The big tragedy here, in addition to wasted taxpayer dollars, is that nobody will learn any lessons. The cycle of stupidity will surely be repeated.

C’mon you guys. Inflation? Really?
Oil is down to $43 (Gas is now around its inflation-adjusted 1955 price!), gold is getting sold off, other commodities are down, and you can’t sell an interest in a hedge fund to save your life (Harvard tried, and got offers for 50 cents on the dollar).
Meanwhile nearly every tech company is announcing 10% layoffs in the first round. And the congress has no 60 vote problem to worry about, so I don’t see massive spending that exceeds the massive deflationary pressures.

You can’t have inflation with so much excess inventory–houses, new cars, airline seats–sitting in the economy.
Sorry, that’s just not true. If you print enough money, you can make inflation. Excess inventory is a direct result of the lack of demand. Inflation stimulates demand. (Why do you think we target 3% inflation in this country instead of 0%? Because when the value of your currency erodes over time, you are more inclined to spend.)
What emerged was a group of Americans who appreciated the value of money, who were willing to work hard and save, who never over-extended themselves or expected somebody else to clean up their mess.
Sorry, that’s a tad revisionist. What emerged was a government willing to run giant deficits, massively devalue its paper currency (punishing savers/hoarders), and finance a gigantic war that finally sopped up excess manufacturing capacity.
There are huge costs to “depression” that many seem to conveniently ignore, not just in terms of deflating asset prices but of idle productive capacity. Deflation is not just a sale at Macy’s, it’s not just a good lesson in fiscal responsibility, and it’s not just an opportunity for patient buyers to get into SF real estate. It’s a huge destruction of economic viability.
For one example, instead of paying workers to actually do something, you get massive unemployment. In the 20s, there was no safety net but today, we pay idle workers to sit around and do nothing via unemployment checks. At 10% unemployment, you’re talking about paying 25 million able-bodied people to do nothing. During the depression we hit 25%.
The big tragedy here, in addition to wasted taxpayer dollars, is that nobody will learn any lessons.
I agree with you 100%. You’re talking about moral hazard. At some point, you have to ask whether it makes sense to let your neighbor’s apartment burn up to “teach them a lesson” about leaving the iron turned on, especially as your apartment burns to the ground. We live in a democracy where nearly 70% of the country owns a home and is up to his/her eyeballs in debt. So you should ask yourself if the public will choose to be taught a deflationary lesson or opt for a few years of higher than normal inflation. You could be right but I’m betting on inflation.

You guys are all missing the point. This isn’t some esoteric formula. Prices are dictated by only a few variables: Supply and Incomes. Supply in S.F. of single-family homes is static (sure more are on the market but there aren’t any new ones being built on top of that). Supply of in S.F. of condos is high right now with a slow absorption. However, multiple new projects are on hold which means there may actually be a temporary supply shortage in a few years (unless the new construction fires up in a timely manner, but there is a drag time of course on new construction. Incomes, well that is another story. Incomes are flat and will remain flat for a while as job losses mount, incomes stagnant as employment demand outstrips employment supply. However, in two years (just as the temporary condo shortage comes to fruition) when incomes begin to creep up—guess what? You got it, prices in S.F. will begin to trend back up. 24 months from now, this board will be talking about price increases as a steady clip. I assure you.

Sure supply and incomes are pretty strong components. But this market does not exist in the void:
1 – The outside markets DO matter. The BART makes cheap CoCo very attractive right now.
2 – The rental market does have an influence, and right now, it’s more than 2 time cheaper to rent than to own. This is a huge price deflator. Fence-sitting renters will need a big incentive to complicate their lives with a mortgage.
3 – We had 12 years of continuous bubble inflation. I don’t think this will correct that easily and the powers that be are making sure this is going to drag longer than it should.
4 – Cash is a critical issue in the new era of 20%-30% down payments.
Oh, and did I mention that the median family income in SF is less than 70K? Everyone is overstretched. Rule of thumb wants houses to be worth 3-4 times annual salary. OK, SF is highly desirable then we’ll stretch this to 5 times. It does not add up to the current 700K even less than the 800K of the bubble days.

I’ll just post one more thing and bail on this… I do agree with some of you that prolonged deflation is possible. I disagree with anyone who thinks that it will be a “good” thing. For those who think we’re already there, I’m sorry, but you’re definitely wrong. We’re not there yet. (When you start growing carrots in your back yard, you and I both get fired, your landlord drops your rent by$500/month, and we hoard all our cash in the mattress, THEN we can talk about deflation.)
We are clearly not there yet but we are on the brink of the dreaded “liquidity trap” (see Paul Krugman for an accessible explanation). Solving that, IMHO, is what the future of the economy hinges upon. Can we break the liquidity trap via massive fiscal stimulus plus policies that directly target deflating asset prices (e.g. Fed buying Fannie Mae securities, Treasury subsidizing mortgages at 4%, FDIC modifying Indy Mac mortgages, etc.)? If not, we will be turning Japanese. I really think so.

http://market-ticker.denninger.net/
Debt as a percentage of GDP has not seen these levels since the Great Depression. (see graph in link above) Why anyone still believes that creating more debt will “save” this economy is bizarre.

How is the government protecting people from failure? Banks are going under and homes are being foreclosed.
Some things came from the Depression like banking regulations that held chaos at bay until they were finally completely dismantled many decades later, but the social changes were not so pure. Some people who would have made it failed, and failed hard. Other people got by any way they could and continued on afterward as they always had. Claiming the Depression brought some kind of purity is silly. It is especially important to recognize the gifts bestowed on those who followed. The kids who started just after the Depression were in a baby bust, had more resources, and experienced a boom just afterward. No one needed to be protected from failure so much because the economy had already burned to the ground.
Moral hazard is mostly an illusion at this point. The money was spent during the run up. Now the bills are due. Not Bernanke bombing the system would just push the economy down even more. You either stop the bubble up front, or you pay later. The idea that we should sit back and let people learn their lesson would do a lot of damage for nothing.

@exSF-er,
I enjoyed very much your contributions to this thread.
The inflation/deflation discussion is improved, I believe, if one specifies that inflation is an increase in the supply of either/both money or credit.
Ergo, when you write, “this is a complicated question, and I have a hard time answering it in regular English… but in a fiat based fractional reserve financial system assets DO affect money supply.” I largely agree. With some clarification.
If one assumes a closed theoretical economic island where the central bank doubles the supply of currency overnight, one would expect the price of (a relatively fixed supply of) goods & services within that island economy quickly to double.
In a real world economy, where assets enjoy price gains because of modest year-to-year inflation, those assets become available as collateral to pledge for the creation of additional volumes of debt. All it takes is a willing lender & a willing borrower to create from thin air the increase in credit made possible by your “fiat based fractional reserve financial system.”
Just sign on the dotted line.
We saw a lot of this sort of inflation during the Greenspan years: negative rates made borrowing rational, which triggered ahistoric increases in a specific asset (residential real estate), which made all such collateral money-good to lenders, which afforded all owners of the asset class to sign on dotted lines, thereby creating new debt out of thin air, substantiating prior asset price gains and credit-quality, in a “virtuous” cycle for the ages. (Doug Noland has documented this well for many years.)
Consequently, it is not “assets” per se that affect money supply, but rather, the leverage of them: increases/decreases in their value affords the opportunity for their leverage.
What we are seeing in the current Great De-Levering is that “virtuous” cycle running in reverse. The destruction of debt – through default – destroys the artificial and temporary increase in the clearing price assigned to the collateral. Simultaneously, access to credit (and therefore the mechanism of its creation – the willing lender) has been withdrawn, or at least, “repriced.”
As that debt is destroyed, the (false prosperity of) economic activity that was previously associated with and dependent on it disappears.
*Poof*
Gone.
The price of inputs for that (otherwise previously phony) economic activity (i.e., commodities, energy, wages) must surely plunge to reflect the evaporation of credit-creation that previously supported it. Because that credit creation was at the center of the global economy, the “virtues” of that “virtuous” cycle were spread far & wide. Hedge funds piled into the commodities play the past 5 years, levering their investors’ capital investment, thereby creating a patina of leverage on leverage directly associated with the industrial metals, crude, baltic dry freight, steel, copper, and all else that fed the (otherwise previously phony) economic activity.
It all must be delevered now.
All of it.
Of course, I expect the Mother of All Levered Participants to the Great Unwind to be the U.S. government. It is going to be the collapse of the U.S. Treasury market that distinguishes this episode from Japan 1930s. When wiling foreign lenders withdraw from Treasury auctions (as they already have from the purchase of agency debt), U.S. interest rates will soar, and dollar-denominated levered assets will take their next giant step south.
And it will be very, very, very ugly. I would guess mid-2009, but that is just a guess.
Have a nice evening.

@ Debtpocalypse
Very well thought out and very clear. I agree that leverage and artificial growth got us to where we are today, and that we need to deleverage. I hope the unwinding isn’t as bad as you suggest.
Question: if foreign money stops buying US Treasuries, where will this money go? Germany? Japan? Gold? What will foreigners know in mid-2009 that they don’t know now that will cause them to invest elsewhere?
Thanks

very well written Debtpocalypse (not just the explanation, which was precise logical, and coherent, but the actual words. I especially appreciated your use of the word ‘patina.’ Antiques Roadshow would be proud).
I agree with basically everything you have said. I would take issue with only two things.
The ten year will go below 2% before it climbs (eventually) to well over 7%.
It won’t happen until well after 2010.
All of this presupposes that a major armed conflict does not break out (whose explosions would stop all of these implosions). Please note, I consider a major armed conflict to be even uglier (but sadly, not that much uglier than where we are headed…).
Consider this to be the calm…

@ Debtpocalypse
The problem isn’t leverage per se, it’s leverage that cannot be repaid.
I think what Paulson-Bernanke-Bair are attempting to do is replace bad debt with good debt. Then the US economy won’t have to go through this ugly de-leveraging process.
An example (posted earlier), the FDIC has restructured about 25,000 mortgages written by IndyMac by slashing interest rates to as low as 3% for five years, extending payments over 40 years and in some cases charging interest on only part of the loan balance. The FDIC is encouraging other banks to follow suit.
The question is will this bad-for-good debt swap work, or do we have to unwind the leverage? And of course, if the bad-for-good debt plan works, who pays and what are the byproducts?

“The problem isn’t leverage per se, it’s leverage that cannot be repaid.”
At 360% debt-gdp, isn’t the question academic?
It simply cannot be repaid. Even if the real interest rate required on the debt averages only 2% (and it’s certainly higher – junk credit for instance now trades at approx 20%), that would require 7.2% of real GDP just to service the debt. To repay it would require much more of course. But our economy can only grow at a maximum of 3% or so per year, and less and less as government increasingly gets into the business of misallocating resources and distorting capital markets.
The latest debt-gdp chart – which had been floated around on SS numerous times last year and earlier this year – is contained in Karl Denninger’s latest post:
http://market-ticker.denninger.net/archives/673-Are-You-Tired-Of-Your-Children-Being-Raped.html
Notice how the debt chart has to go parabolic? That’s because politically it is too tough to take our medicine and reduce living standards by diverting part of GDP into debt service, and so debt keeps getting added to the system. That is the terrible caclulus of a ponzi scheme. There is no way that this has not been obvious to the policy makers for at least since 1991.
I know some people think that the Fed will make it work just like Goldilock’s porridge. It will “engineer” inflation not too hot (say, 5-10%) to make the debt serviceable with depreciated dollars (without spooking the pool of real savings, ie, lenders) and not too cool (say, -5-0%) to make it too painful for the debtors. Throughout all of this, the Fed in its infinite wisdom will thread the needle between the demands of our foreign creditors to be repaid with real money and the demands of the population to keep borrowing to consume like foolish children without taking their medicine.
I think that is a fantasy. It should be obvious these guys can’t figure out what to do. I wouldn’t trust Bernanke to run a taco stand, let alone intermediate by fiat the pool of real savings and demand for productive investment.
It’s going to end in an ugly deleveraging, whether inflationary or deflationary. FWIW, I think when you are up at these debt levels, the inflationary path is worse. In any event, SF housing price will go down. A lot. Perhaps a little less so if we go the “mass inflation” depression route, but I wouldn’t count on it. Most people are paid in dollars, and lending gets very tight in high inflation environments.

This is pretty much a rehash of the same conversation I had with the same players a year or so ago Dave. They are suffering from some confirmation bias. A few months ago they were claiming that the credit markets were frozen and talking about overnight LIBOR. I notice they are now talking about something else, now that the LIBOR is back to normal.
I for one will be very happy to see these idiots running the Fed and the USG (and their economist enablers like Krugman, Setser, et al.) discover that they are no smarter than the policy makers of the 1930s. It should be obvious: if they were smarter, we wouldn’t be in this mess, would we?
Except people like Krugman and Setser have been ignored and the opposite of their advice followed for the last decade, as I am sure you know. The people who got us into this mess are out of power and we have a new crowd, much more willing to listen to economists. Whether that means they will do a better job remains to be seen, but I am cautiously optimistic. The biggest risk is a breakdown of the international system of co-operation, which has held up remarkably well so far. China, India and Brazil are still growing, proving the “decoupling” hypothesis, and will help drive a global recovery. As long as things don’t break down.
The inflation/deflation discussion is improved, I believe, if one specifies that inflation is an increase in the supply of either/both money or credit.
This is not what the definition of inflation is. An increase in money supply often does lead to inflation, but it is not inevitable. I would prefer that we use the standard definition:
“A persistent rise in the general level of prices over time.”

Hats off to D, you think cows should be marked to market. very funny.

NVJ:
always good to have a liberal Keynesian (I remember when that was a slur – now it’s a badge of honor – times sure do change – economics are like fashion, always returning to what used to be the fad, but always looking a bit dated when one digs a bit deeper) around to pick a few fights.
can we at least agree that ‘a peristent rise in the general level of prices over time’ is price inflation? or can you at least give some categorization of the prices that you are talking about? the price of gas? the price of food? the price of 2/2 1000sqft condos in the Tenderloin? The price of virtually any equity holding in the world? For those scoring at home – every single one of these is down. Yet, I won’t use this as evidence of deflation. Perhaps price deflation 😉
But no, the real thing is so much more grand. And so much more painful.
And happening all around us now.

NVJ:
“The people who got us into this mess are out of power and we have a new crowd, much more willing to listen to economists.”
Who got Great Britain into their mess? They have the same mess we do. How did it work out that there are completely different players over there, but they have the same problems. Are you sure about the players who got us into this mess really were the responsible parties?
“And wages are still going up, for those employed, at least, so the standard of living is going up, quite a bit, for those employed.”
OMG are you out of touch. Anyone who gets laid off is lucky to find a job at 90% of their former pay. They are employed, but their wages are going down. Google is cutting back perks – people are still employed but they are getting less. We are hiring only to replace workers – at 85% of the old workers pay. They are employed, and yes, as they become more productive we will give them raises, but that’s a far cry from increases – we are paying more for productivity, but new hires are making less for the same work. That’s wage deflation. Same job at the same level of experience last year paid more.
“I am pretty sure $1T of stimulus will keep us out of it.”
$1T of stimulus can just take money out of someone else’s pocket, siphon off some for the government and hand it to someone else. That isn’t necessarily hugely inflationary. We build more roads but spend less elsewhere and so more people elsewhere get laid off. It depends on how it is paid for as to how inflationary it is.

NVJ:
I responded to your article about whether or not banks are still lending on the other thread if you were still interested.
a slightly briefer answer: I don’t recall ever saying that banks aren’t lending at all. that’s hyperbole used by manic govt officials and bloggers. Instead I’m claiming that banks are hoarding cash.
one can hoard cash and still lend. these thoughts are not incongrous. I will explain:
the chart you referenced shows that lending (actually “bank credit”) is plateauing now. but one must take that in reference.
the Govt just pumped $250B directly into the banks using TARP. That does not include the >$1T of various “lending facilities” that swapped junk for Treasuries (cash) and who knows what else support I’ve forgotten (like the $29B for Bear Stearns)
Thus, in just the last few months the banks have $1.25T (minimum) of extra cash given them by the govt.
if they were lending as they could, you’d expect at LEAST $1.25T increase in your chart. Given reserve ratios of 10%, they could have lent up to $12.5T of extra lending!!!! (using TARP funds alone they could have increasd lending by $2.5T)
But the chart is flat.
thus, the banks are lending just a wee bit of the extra cash they’re getting. in other words, they’re hoarding. I’m not saying that they’re wrong for doing it… they need to hoard to recapitalize since they’re utterly bankrupt and then need to pay themselves big bonuses! in fact, many of us expected this, it’s what is called “pushing on a string”
the problem is that because of the banks’ predicament they are unable to lend as is “normal” and thus the typical transmission mechanism from Fed to “real” economy is not working well… in other words, the velocity of money is slowing down.
which is why if the govt were serious about “fixing” this they would nationalize the banks and force them to lend $10 for every $1 used to bail them out. as I’ve said, it would ‘fix’ the problems we see now. it would add a whole lot more and could destroy our economy. but then again, our economy is in critical mode anyway.
but our leaders don’t want to do this. either they have some misplaced idealism of “free markets” (retarded in this era) or they want to continue crony capitalism so they refuse. my guess is they have blinded themselves thus now only see the banks as a solution and hence reverse engineer all bailouts using the banks as mechanism.
**as a corrolary:
the chief reason given by economists for NOT bailing out Detroit is that you only get a $1 bang for every $1 put into Detroit… but you get $10 bang for every $1 put into banking. But as your chart shows… this is not happening.
**second corrolary:
this is why I eventually see us rapidly tipping from monetary disinflation/credit deflation into monetary and credit inflation (perhaps hyperinflation). because eventually these banks WILL be able/willing to lend, and they will do so in force… so all that money sloshing around will suddenly be magnified 10x due to fractional reserve lending.

“This is not what the definition of inflation is. An increase in money supply often does lead to inflation, but it is not inevitable. I would prefer that we use the standard definition:
‘A persistent rise in the general level of prices over time.'”
This definition is only one of many, of course. FWIW, I infinitely prefer the definition of inflation/deflation that relates to the money/credit supply. Of course, there are measurement difficulties (what is the “true’ money/creit supply?) but these are less significant that the difficulties in measuring prices. Mish had a worthwhile non-technical piece a while ago:
http://globaleconomicanalysis.blogspot.com/2006/02/inflation-what-heck-is-it.html
In the end, I lean towards the “correct” austrian definitions 🙂 because I think they lead to better investment decisions and hence are more practical. As the most recent example, those who believed the price signals recently were led into buying oil at $100/bbl, trading their SUV at a loss for a small hybrid, shorting the long bond, etc.

Yes, things are looking up — not!
Gosh, what’s it going to do in November with this jobs report?
And I’m sure wall street bonuses in December will be strong — not.
Stop looking at charts and look around. Go to the malls and see if there are any lines at the cash registers. You can see a lot just from doing that.

I don’t disagree with the deflationists around here on most of the issues you argue. It is true that this is a deep hole. But what you all seem to ignore is that deflation will crater the banking system in the US entirely and make the US govt insolvent, i.e. unable to service its massive debt. So you can cheer as treasury yields go to zero, confirming your thesis, but inflation is the only way that the US govt will be able to rollover its debt and pay it back at all, in arguably lower value dollars. The alternative (deflation) equals insolvency.
If inflation occurs, you are right in assuming a gigantic bear market in US treasuries and sharply higher yields going forward, but that’s about the only viable option outside of deflation/insolvency. For all the arguments about how we get there, I don’t disagree that the monetary operations are “pushing on strings” somewhat but not entirely. The Fed has found ways to bypass the private banking sector entirely in recent days (see Fannie MBS direct purchases and/or guarantees, which actually worked–that was not pushing on a string). They are not sitting by idly and twiddling with target rates. You can bash Bernanke but he has opened the toolbox as much (or possibly more) than is politically acceptable. And will continue to do so.
I’m not saying that we thread any needles for some kind of soft landing. But I bet you dollars to donuts that we are “battling” (er, welcoming) north of 5% “headline” inflation within the next 18 months. If I’m wrong, I’ll see you in the bread line.

LMRIM: Is it possible to get into direct contact with you?

Everyone seems to be leaving out the possibility (likelihood IMO) of major armed conflict long before things like a default on SS happen. Americans are entitled to a higher standard of living! God says so!
I kid, but I see armed conflict as a real possibility if things like hyperinflation and high long term unemployment do happen. As LMRIM says, the USD may be “toast”, but we still have one of the most resource-rich pieces of land in the world, a large educated population shown to be willing to attack other countries, and the biggest military in the world.
If we didn’t learn anything from the 30’s, did we learn anything from the 40’s? I’m not convinced.

Volker is also 81 years old. Let’s hope he’s charging on all cylinders for another 5-10 years. If not, maybe we can clone him.

ex SF — there’s always money in the banana stand 🙂

“there’s always money in the banana stand :)”
Especially when you simply print it and give it to your best bankster customers 🙂

But sometimes the idiots burn down the banana stand . . .

Along these lines, from today’s WSJ;
“Air May Be Going Out Of Deflation Risk
Falling oil prices and declining mortgage rates could pack a potent, one-two stimulus punch. Combined with the flood of government bailout programs, they could yet knock deflation from its perch as the market’s biggest worry.
Granted, shell-shocked investors are still in a safety-first mindset. And the Federal Reserve’s plan to buy Treasurys could keep a lid on historically low yields for a while. But the possibility of an inflation snapback could mean Treasury Inflation-Protected Securities, along with hard-hit corporate bonds, may prove a more profitable play for investors.
Oil and mortgages are key factors. Between July of this year and next, falling gasoline prices should pump more than $200 billion into the consumers’ pockets, estimates Citigroup economist Steven Wieting. That is a huge, direct cash injection, and it may grow since oil is now within striking distance of $40.”
http://online.wsj.com/article/SB122851068095183729.html?mod=djemheard
Seems like we hear all this scary deflation talk every couple of years, and it hasn’t panned out. I’m going to go out on a limb and suggest that the world economy is so complex, that no-one, not even the posters here, understand it well enough to predict what will happen.
2004
2002
2001
1998
etc…

NVJ
“U.S. Mortgage Applications Surge With Refi’s Leading The Way”
from Dec 3rd.
I rehashed most of the argument above anyway… and I won’t be “plugging in” this weekend anyway…
have a great weekend all!

I think this thread is dead but one last comment:
Deflation makes it easier for government to roll its debt. -LRMIM
I agree with a lot of your commentary but this is absolutely backwards. Nominal debts in the face of consistently declining GDP and a shrinking tax base is a recipe for default, no rollover. You end up not only in a liquidity trap but a debt deflation trap.

@ Dave
I can see how deflation would lead to default for the normal bond or annuity issuer. For instance, under deflation my Mom’s fixed annuity payments will actually increase her purchasing power each month (provided the underwriter doesn’t default).
But when it comes to treasuries, instead of defaulting, wouldn’t the gov just turn on the printing press? Wouldn’t this ultimately lead to inflation?
(I very much appreciate your well thought out responses)

I don’t agree with you TinyTim on what the cause of true inflation is. Friedman said:
“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
And he is basically right. The corollary of this is not true however, in that an increase in money supply inevitably leads to inflation. I will let LMRIM explain in further detail, as I am sure he is itching to do so.
A lot of anti-government ideologues like to claim that Social Security is “bankrupt” and that the “trust fund money isn’t there” and all other sorts of nonsense. Social Security is fine under most projections, even the pessismistic ones have 75 cents on the dollar of projected benefits paid off. And you have to remember that Social Security payouts go up with increases in wages, not inflation, so even in the pessimistic scenario, you will end up getting more real dollars when you retire then you do today.
Parenthetically, I should note that after you retire your benefits go at the rate of inflation, just so no one is confused by what I just said. While you are still working, future Social Security benefits get increased by the rate of increase in payrolls. Which is higher than inflation, or at least has been so far.
The medical system is another problem entirely and it is true that with the current rate of medical cost inflation projected into the future, we will end up spending impossible percentages of our GDP on health care. This is not particularly a problem with Medicare per se, but a general economic problem. In some fashion, health care cost inflation will have to be reigned in.

Let’s say money supply doubled and all of the increase in money went into something economically useless, like Tulip Bulbs. Does it make sense to call this inflation? I don’t think so.

@LMRIM,
“rolling” over the debt (which requires low interest rates) and “repaying” the debt, which requires massive inflation. There is no question that the end game will be default through mass inflation, and perhaps selective repudiation … actually, both are practically guaranteed IMO
I don’t think either the “Great Contraction” of 1930-33, or the Japanese experience of the last two decades bears this out. Generally speaking, it’s not appropriate to look at something like Debt/GDP and assume that that total debt needs to shrink, or that inflation is necessary to reduce the ratio. The vast majority of this debt is owed to ourselves, not foreigners — external debt was at about 7 trillion, last I checked, and can wholly be accounted for by printing on the part of Japan and China — e.g. compare M2/GDP for China (160%), Japan (130%) and the U.S. (45%). Net external debt is about half this amount. If the U.S. were to raise M2/GDP to say, 90%, we could fully retire the full external debt and instantly become one of the world’s largest creditors. Even at this level, M2/GDP would be less than our primary trading partners.
It is generally impossible to get out from a high Debt/GDP by means of liquidation, as the denominator shrinks faster than the numerator if the ratio is above 1. Moreover, there are multiplier effects, such that, in the Great Depression, a 15% debt reduction (which was all that occurred, and debt began to grow again from 1933 on) was achieved at the expense of a near 50% (nominal) GDP contraction. The result was a 60% increase of debt/GDP.
So, if the high Debt/GDP was a cause of the contraction (1930-33), then how did a 60% higher Debt/GDP not prevent the expansion of 1933-36? (Recall that by 1936, output returned to 1929 levels.)
At least from my reading of history, high Debt/GDP only decreases as the result of denominator growth during a period of low or modest inflation and falling asset prices.
This was certainly the case in the U.S. from 1933-1940 — we did not “inflate” or “re-flate” our way out of the debt/GDP burden — GDP quadrupled in a period of low CPI (actually 0% total inflation from 1929 to 1940), low asset returns, moderate debt growth, and a huge expansion of GDP, base money, and living standards.
How to achieve GDP growth with a high debt burden, and without spurring inflation?
Debts are assets — claims on future growth. You rightly point out that future growth cannot provide reasonable asset returns — the returns will be flat or negative. Hussman points out the same thing, but low asset returns do not necessitate liquidation, and in fact Japan has experienced low asset returns in an environment of low unemployment, low inflation, high base money growth, and decent (0.2% less than the U.S per capita) real GDP growth. The U.S., from 1933-1940 also experienced low asset returns and robust growth. Again, the key point is to avoid liquidation, and limit the “Depression” to one of asset prices (a la Japan) rather than one in the underlying economy.
In this case, the only solution that works (again I’m happy for counter-examples) is to lower the rate of return so that debt service is manageable, and there is room for future debt growth. Debt began to grow again by 1933, surpassing 1929 levels by 1936, but the ratio was tumbling quickly and asset prices were in a period of secular decline as asset returns were low.
When the government swaps a treasury for a CDO, or buys a bank loaded with CDOs with money obtained from selling treasuries, or just prints money to buy mortgages, the government is in effect substituting a risky higher yielding asset with a safer, lower yielding asset. By doing this repeatedly, asset yields and default risk can be driven down to the point where the debt is serviceable by GDP growth, and investors have sufficient certainty to invest in production. This is what Bernanke means by operating on the “asset side” of the Fed’s balance sheet. Moreover, rather than “crowding out” investment, this re-financing allows for further private sector investment, in just the same way that a bankruptcy and re-financing debt does not “crowd out” investment in the new enterprise.
Now, if say, in asset boom times, the government started universally confiscating assets for X principle amount yielding a 5% return, and replacing them with cash for the principle, yielding 0% returns, then a crowding out would occur. But, in a deflationary panic, just as in a bankruptcy proceeding, the exact same operation is viewed as a bailout and is welcome by investors — no crowding out — in fact, investors now have cash to invest in future productive operations. The risk is only of inflation.
But in a deflationary environment, this re-financing has historically not caused inflation — again, a historical counter-example would be welcome. If you believe that debt is a form of money — then substituting a lower yielding debt (even printed cash) for a higher yielding debt does not add to the total supply; the money supply was already increased when the risky debt was issued. In other words, we already experienced the inflation for the printing that we are about to do. And unless we actually print, deflation will set in. But the printed money needs to be directed in such a way as to reduce the rate of return of the existing asset pool, rather than used to buy up goods and services. The latter is a fiscal issue for dealing with the real economy, while the former is a monetary issue in which the government (once again) cleans up the massive mispricing of assets that is the inevitable output — and some would say raison d’etre — of financial markets.
As an aside, in a real market, people can price goods because they can meaningfully determine the utility of a given consumer product. However, investors in financial markets are attempting to predict the future. There is absolutely no reason to believe that humans, in aggregate, are able to predict the future, or to value a given future stream of income. The information coming from such prediction markets is not as valuable or meaningful as the information coming from a consumer market, and these markets are generally a colossal and ineffectual waste of human capital, as paraphrasing Marx, the bankers periodically emerge from their slumber to ravage the productive industries.

Since inflation properly defined means inflation of the money supply, an increase in the money supply always leads to “inflation”. See how easy it is when we get our definitions straight?
I assume you mean money supply + credit here, not just money supply. Since we can’t measure this value and don’t even attempt to, it is a pretty useless definition to boot.
Price level is completely independent of money supply, in other words
Do you have any references to back up your claims about the velocity of money and pricing TinyTim. I have to say, this is the first time I have ever seen anyone state something like this. I am not saying that is it entirely illogical, but I have my doubts.

Incidentally, a rise in prices without a rise in wages is NOT true inflation, though it shows up in CPI. The reasons is that this situation is self-limiting. If prices go up but wages don’t, then spending must drop, which tends to hold prices in check
Tim you argue back and forth with yourself. First you claim that the “money supply” definition is silly because it can never be measured, and then you show how the CPI is useless to discuss your so-called “true” inflation. in other words, there is no way for you to measure your “true inflation” either.
I would also like to discuss your particular quote here. Did we not see poor wage growth for some time with sky-high price inflation (especially that of housing), that went on for YEARS? with the advent of credit and international trade it would seem that an area can indeed show price appreciation (or as you call it, “true inflation”) without wage hikes. at least that’s what the last 8 years have shown us.
even with the latest bit of price depreciation the average joe is spending much more on life today than 8 years ago, despite little to no wage growth.

LMRIM,
I’m at work and don’t have too much time. As you say “focus on maintaining employment” 🙂
1) Agreed. Base money grew throughout (even 1930-1933), and the growth accelerated for a number of factors, including gold repricing, subsequent gold inflows from Europe, etc. I wonder if you’ve picked up a copy of Bernanke’s “Essays on the Great Depression” — there some good stuff in there. I think this supports the points I was making; I didn’t include a discussion of it, though.
2) Depends — equity prices really were ridiculously low at the bottom, a panic bottom, even given the existing macro environment, so they *had* to correct upwards. If you zoom out a bit, it’s a different story, but yes, the volatility is high. There are also issues such as measuring the debt market by aggregate bond prices, or the aggregate indebtedness, etc.
3) Agreed! The point is that debt deflation can occur via liquidation or re-finance. The former takes a big chunk from GDP while the latter allows for growth, if it is done on a large enough scale to make debt service and new debt assumption possible. You may find this paper interesting: http://www.bis.org/publ/work176.htm (I like all of his papers).
4) Yes! Everywhere in my post “debt” should be interpreted as total debt, both government and private. Total debt, by my calculation, did not decrease after 1933, and decreased only by about 15% during the contraction. The ratio of Debt/GDP decreased from 1933. I agree that the curve is not monotonic. Look at the Comstock graph of Debt/GDP, and notice how it shot up from 1929 to 1933, hovered a bit, and then began to decrease. By 1936, it is still higher than 1929, but GDP is about the same. You’ll see that the shape of the graph is controlled by the denominator — there was no real debt deflation, in aggregate, except a small amount that cannibalized GDP during the spike upwards from 1929. The point is that if we can avoid the liquidation, then we avoid the GDP collapse, while having a high ratio, as happened from 1933 on. The Japanese did avoid liquidation, preferring zombie banks and the like, and were mostly spared the GDP shrinkage. Admittedly, data is hard to come by here (for me; I’m just an tech worker bee trying to understand what is happening), and there are differing accounts, but the rough outline should be correct.
Recession of ’37: Indeed, it was severe, I’m talking about annualized GDP growth over the larger time period. As you know there are many debates about ’37, with the Keynesians seeming to have a good point here, as is often of the case in this time period, but perhaps not for the longer term.
Intrepid Market Pricers vs. Wise Fed Solons:
The problem is that accumulation of capital leads to supply gluts and aggregate demand failures, and is dependent on an expanding money supply. This goes back to Malthus, and was Marx’s insight in his criticism of Say’s law, and was picked up on by Keynes. Both realized that as more money is devoted to capital allocation (e.g. the financial markets) versus the real markets, then the instabilities magnify, for the reasons I cited previously. Look at the recent Rogoff paper (“This time it’s different: A Panoramic View of Eight Centuries of Financial Crises”), in which they show how increasing capital mobility is often followed by a string of bank failures. The same paper shows that defaults and inflation are common, but hyperinflation is rare. Also, the key point was total debt, not just external debt.
Now, you add leverage to the mix. Don’t you believe that leverage distorts people’s time preference? I just don’t understand why de-regulation in financial markets is often advocated by the same people who want deregulation in real markets. To their credit, the Austrians wanted 100% reserve ratios and golded back money, which is a lot more strict than even the fiercest regulator today. There may be a zero sum of financial flexibility and real market flexibility, in some sense.
I favor efforts designed to limit the total size of financial markets, as a fraction of the economy (i.e. total leverage). I don’t have a specific number in mind, but the point is that total leverage needs to be penalized in some way. Business can still live and die based on how well their products are received in the real markets, and investors would still need to allocate capital effectively to reap a return, only the return may not be 20 to 1. As an aside, total leverage is not the same as total debt, since there is netting, but it does add instability, so I would prefer to look at that figure.
Finally, large financial markets have their own distortions — have you ever read Doug Henwood’s “Wall Street”? I remember, in the late 90’s, that he showed that compensation of the FIRE workforce amounted to 40% of domestic investment. There is anecdotal evidence that bank efficiency falls as the balance sheet increases, etc.
End Game:
The Rogoff paper suggests what I believe as well, that hyperinflation is unlikely, but some form of sovereign default or rescheduling is likely. Hell, if we don’t do it soon, we’ll look like outcasts 🙂
Frankly, my main concern is the erosion of social capital. I think a current account balance and ending of reserve currency status would help a lot. More immigration would also help a lot. I would favor inflation in order to get there, but Warren Buffet’s Certificate Idea is also interesting. If I think I have meaningful data, I’ll pipe up.

They want to reinflate housing because housing is the collateral behind most debt (and debt is really money). That part of the money supply, while fiat like everything else, relies on the collateral as a kind of hard reserve until the loans are paid off. While there are concerns about the dollar, the Euro is the only barely viable alternative at this point and until the union resolves the debate over whether the future is treaty or constitution there is a political shadow that prevents the the Euro from prevailing.

“Am I incorrect in assuming that your base case outlook is mild CPI-type de- or in-flation against the backdrop of a sustained period of zero to low real growth (but no collapse) and deflation in asset values?
This is my base forecast, if a hope can be called a forecast. I haven’t convinced myself that we can really pull it off. I’m waiting for the next flow of funds report and GDP results, and will try to figure out what debts are shrinking (mortgages are certain to shrink) and look at the effects on GDP components. A large contraction is not off the table, but my gut says it is more likely to happen after the Fed has printed much more. The final chapter on Japan has not yet been written, either. ”
Even though I understand a tiny percentage, I love wading through these long technical threads and usually find a nugget or two. This right here fit the bill… thanks guys.

I would be happy to change my terminology to “increased money supply” and “price inflation” if that made you happy. it’s just words, and I’m not a word snob… but we do need to make sure we differentiate the two because otherwise economic analysis is difficult to argue.
in general, this is why I try to write “monetary inflation” and “price appreciation” in order to make myself clear.
Sheesh, no wonder we are having such a tough time coming to agreements, we aren’t even using words the same way. Okay, I will use the words “money supply” to mean money supply and CPI for consumable goods price increases and “asset price increases” for when the price of investible things goes up and “wage increases” for when wages go up. Not that the latter is going to happen anytime soon.

@SFS: Wow. I wonder how much more of this there is out there? Leverage is a fantastic tool for executing a Ponzi scheme, if you were so inclined.
Has anybody on this thread (Satchel/LMirm?) ever met this fellow? Brief reading suggests he was respected!