CFAH

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.

A bit of history:

I bought my first condo in Europe in 1994 in very very desirable Paris. Prices were 15% under the 1990 bubble peak. Great deal! By 1997, the price per square meter had lost another 40% and the economy was not down the toilet like today…

And a bit of a lopsided bout as far as we’re concerned, but what the heck…en garde!
U.S. Mortgage Applications Surge With Refi’s Leading The Way [SocketSite]

Comments from Plugged-In Readers

  1. Posted by Jimmy (Bitter Renter)

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

  2. Posted by cooper

    Well France didn’t have a fiat currency with seemingly unlimited printing presses behind it.
    If the government wants housing prices to be higher, nothing is gonna stop it.

  3. Posted by Jimmy (Bitter Renter)

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

  4. Posted by Jake

    My guess, and it’s just that, is that this is not a good time to buy in SF as the overall real estate market will continue to decline, up to another 20%. However, this will vary tremendously across the city as good areas retain more value and not so good ones retain less (duh). I’ve always been of the opinion that your personal residence is at best a mediocre/poor investment – point is, if you like something, want to buy it and can afford it, and don’t buy it as an investment but more like you would a car that you can afford (and it’s in a good area) go for it.

  5. Posted by plan C-sparky

    “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.

  6. Posted by tipster

    Japan tried reflating its bubble too – didn’t work, even with 2.45% 35 year fixed mortgages.
    Perhaps if we lower interest rates, people will buy pets.com stock too.

  7. Posted by San FronziScheme

    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.

  8. Posted by DataDude

    @ tipster re: Japan
    Good point–even with lower rates and longer mortgages, Japan still experienced the “lost decade” where real estate prices went down 60-70%.
    Fact: the number of SF buyers has shrunk. Anybody who has lost their job or down payment is no longer a buyer. Anybody who still has a job has lowered their compensation projections: bonuses are cut and stock options are under water.
    Have SF prices fallen only 10% since October? It will probably take a few months for us to know for sure, just because so few things are selling. One data point doesn’t make a market. But once enough new comps get established, sellers will have to pull their heads out of the sand, and lower prices if they are truly serious.
    Also, although San Francisco is a fabulous city, at some point would-be buyers will substitute for homes just outside the city that are already down 30, 40, or 50%. As buyers dry up in the City, prices will come down accordingly.
    Whatever home relief plan the geniuses in Washington come up with, it will be aimed at the 80% of Americans living in $200K homes, not the 20% of Americans living in $1 million or up.

  9. Posted by cse

    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.)

  10. Posted by "Dave"

    It all goes back to whether you believe we are headed for a bought of deflation or inflation. Everyone around here seems to think that deflation is in the cards. I’m not advocating that people go out and buy now, but I think inflation is what will actually happen.
    Comparing the current situation to LA or Paris or Japan in the nineties is not as relevant as it might seem on the surface. This is not your ordinary, regional business cycle. This is a worldwide economic crisis with significant over indebtedness. The only reasonable solution is inflation because the alternative is too scary to contemplate.
    Yes, inflation hurts the poor. Yes, it punishes creditors by repaying them with devalued currency. Yes, it dramatically damages the real value of real estate. But negatively impacting the real (as opposed to the nominal) price of housing is precisely what it would take to keep banks solvent and stabilize the housing market.
    Absent inflation, prices probably need to fall in the US by 15-20% more just to reach “affordability”. With inflation, you get to affordability without a further drop and without the psychological feedback loop of deflation, which will certainly cause prices to overshoot to the downside.
    All the actions you see now by helicopter Ben and now Paulson are inflationary. Obama’s fiscal stimulus–likely to be closer to a trillion $ by the time it’s implemented–will be inflationary.
    In normal times this would be suicidal to the currency, but the whole world (even China) is taking similar steps simultaneously. And, like it or not, we still have the world’s “risk free” standard of debt so our foreign creditors are not going away any time soon because (today) there is no alternative.

  11. Posted by spencer

    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

  12. Posted by D

    It all goes back to whether you believe we are headed for a bought of deflation or inflation.
    Headed? We have been actively experiencing massive deflation for the last year. Deflation is a decrease in the supply of money. Inflation is an increase in the supply of money. Over the last year, the stock market has dropped around 40%. Commodities have dropped by large percentages. Housing values have dropped by large percentages. Loans are being defaulted upon. Every one of these destroys wealth. Destruction of wealth is, by definition, deflation. Dozens, if not hundreds, of trillions of dollars have been lost.
    The US Government has been throwing money at the problem in the form of debt secured instruments. These increase the amount of money and are, by definition, inflation. A few trillion dollars have been created.
    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.
    Prices are not inflation or deflation. Prices are symptoms of inflation or deflation. Since we have deflation, we will see decreasing prices. This isn’t just theoretical. Gas prices, housing prices, energy prices, food prices, retail prices, etc. are all falling.
    The question for this blog is whether or not SF real estate will remain a pocket of inflated prices. Personally, I think not. Alameda, San Mateo, and Marin counties all start to look pretty good to an SF buyer when they are significantly cheaper.

  13. Posted by anon

    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.

  14. Posted by Trip

    Even if we’re heading for a bout of inflation, WAGE inflation is not in the stars for us any time soon, particularly in this area with the mounting layoffs, recession, etc. That is what would further drive housing prices. So long term, it is certainly true that inflation (if it appears at all) would prop up SF housing values, albeit in less valuable dollars! But that will not happen before the next couple years of further price declines no matter what happens on the broader inflation/deflation front.

  15. Posted by D

    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.

  16. Posted by Dude

    I’m guessing this clown calling himself “Deal Master” is likely some under-employed, bored realtor. In any case, the comment was obviously placed to stir things up. I’m surprised the editor even turned this into a thread. Maybe to see if people call him out on his fictitious numbers?
    In any case, I only hope that other aspiring Trumps out there heed the advice and jump into this market with both feet. In a few months, when us bitter renters are priced out forever (again), you’ll look like geniuses. The worst is clearly behind us (again). So get after it.
    [Editor’s Note: Rest assured, there is a method (and point) to the madness.]

  17. Posted by San FronziScheme

    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.]

  18. Posted by anon

    I’ve never understood the arguments that an appreciating FMV for an asset isn’t real money.
    You were talking about the money supply. Unless the asset is exchanged for money, I don’t see how it affects the money supply.
    Your cow is only “worth” what someone will pay for it, and the only way to know that is to sell it.

  19. Posted by "Dave"

    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.

  20. Posted by San FronziScheme

    For now, that money printed out of nowhere is just filling a giant debt hole left by the simultaneous popping of the debt and RE bubbles. I don’t see it creating inflation, just preventing a collapse.
    Now would “stimulus packages” be a different story? I don’t think so. I think just as banks took the Fed’s money to shore up their distressed finances (with no result for the economy), I believe taxpayers will use the funny money from the Feds next year to shore up THEIR OWN finances.
    Times are tough. The tile countertop and white enamel appliances can last another 5 years. No need for granite or stainless steel. Not in this economy!

  21. Posted by "Dave"

    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…

  22. Posted by DealMaster

    Dude,
    I’m just relaying what I’m seeing in the market right now. Say whatever you want about Trump, the guy’s been “in the game” longer and better than all of us on this board. Anyway, sorry for stirring up a sh*tstorm. I just wanted to add my 2 bits. No worries about any future posts from me.

  23. Posted by anoncensorious

    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

  24. Posted by waiting2nest

    I understand The Donald’s Dubai tower on Palm Jumeirah has also come to a screeching halt (WSJ).

  25. Posted by DataDude

    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.

  26. Posted by ex SF-er

    Absent inflation, prices probably need to fall in the US by 15-20% more just to reach “affordability”. With inflation, you get to affordability without a further drop and without the psychological feedback loop of deflation, which will certainly cause prices to overshoot to the downside
    This only works if there is wage inflation. One thing that is ‘different’ this time is global wage arbitrage. it will be hard to get wage inflation due to the global wage arbitrage.
    one way it can be done is if we devalue our currency. the problem: all the countries are trying to devalue their currencies right now.
    due to Bretton Woods II it would be hard to achieve nominal wage growth in the US given this set of circumstances. We would either need to enact protectionist policies (to avoid the global wage arbitrage issue) or come to a new currency agreement by amending/altering Bretton Woods (which could easily be done).
    if you have consumer price increases (“inflation”) without wage inflation then you are in trouble, as the consumer will have less money at the end of the day. In that scenario you often get asset appreciation in the things you NEED, and asset depreciation in the things you WANT. (so food prices skyrocket while Harley prices collapse as example).

  27. Posted by tipster

    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.

  28. Posted by ex SF-er

    You were talking about the money supply. Unless the asset is exchanged for money, I don’t see how it affects the money supply
    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’ve written out how this works 10x and can’t make it make good sense in English. I will try later.
    but there is no question that asset devaluation affects money supply through the changes in fractional reserve lending in a fiat system.
    this would not be the case if we didn’t have fractional reserve lending.
    I’ll think of a way to answer this.

  29. Posted by "Dave"

    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.

  30. Posted by ex SF-er

    C’mon you guys. Inflation? Really?
    Tipster: there is no inflation at this time partly because the Fed has been sterilizing its activities (as Satchel used to talk about) and also because the transmission system is “broken”.
    The Fed and govt are creating money, but the banks are not lending it fast enough so the velocity of money has slowed way down. thus we have disinflation, or deflation if you count the destruction of the various credit instruments.
    however, if the banks start lending again (through force or through coersion) then you could see inflation rapidly again.
    google the “Ka-POOM” theory. it will discuss how/why we can have massive inflation here with or without our Fed “printing”.
    one way as example:
    if our leaders borrow too much then the central banks may decide that they no longer want to hold dollars. they can then sell those dollars (repatriate them back to the US). that’s trillions of dollars that would flood back into the US. basically, US inflation due to unwinding of global monetary positions.

  31. Posted by Grubber

    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.

  32. Posted by "Dave"

    Prices are dictated by only a few variables: Supply and Incomes.
    That might hold true if we weren’t dependent upon credit to purchase homes AND we weren’t standing on the precipice of deflation. For one, you need not only income but also access to credit (unless you make $800K/year) AND you need confidence that you’re not throwing your money away on a sure-to-be depreciating asset. If prices drop 10% this year and you expect them to keep dropping 10% every year, you will never make a purchase no matter what the level of inventory or income. And lastly, you need to factor in the cost of substitutes (i.e. renting).

  33. Posted by San FronziScheme

    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.

  34. Posted by EBGuy

    Anyone want to comment on this note in the latest Fed H.4.1 release. Is the Fed setting a floor on some of these AIG CDO’s and then forcing the counterparties to settle up?
    Note: On November 25, 2008, the Federal Reserve Bank of New York (FRBNY) began extending credit to Maiden Lane III LLC under the authority of section 13(3) of the Federal Reserve Act. This limited liability company was formed to purchase multi-sector collateralized debt obligations (CDOs) on which the Financial Products group of the American International Group, Inc. (AIG) has written credit default swap (CDS) contracts. In connection with the purchase of CDOs, the CDS counterparties will concurrently unwind the related CDS transactions.
    Payments by Maiden Lane III LLC from the proceeds of the net portfolio holdings will be made in the following order: operating expenses of Maiden Lane III LLC, principal due to the FRBNY, interest due to the FRBNY, principal due to AIG, and interest due to AIG. Any remaining funds will be shared by the FRBNY and AIG.

    Toxic what? We don’t need no stinkin’ TARP…

  35. Posted by "Dave"

    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.

  36. Posted by spencer

    It looks to me like supply is increasing, demand is decreasing, and buying power (credit and jobs) is dramatically decreasing.
    Anyone who sees a steady clip of increases (in 24 months) in home values with these things in mind, must be one-handed typing from their laptop on 6th and Market with a crack pipe in the other hand

  37. Posted by anon94123

    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.

  38. Posted by Fundy Mental

    Ha!
    I friggin LOVE the “DealMaster”, but no one really thinks this person’s sincere do they? No one thinks those cute little cartoon character thoughts.
    For Instance:
    “Levitz furniture or not, this place has massive potential. It may not go this month, but it will certainly get bites in Jan. I’m lovin’ it!”
    another:
    “Fluj, December is looking to be a monster month for us. I can’t believe the number of buyers we have that are making legitimate offers on houses right now. I’m not confident enough to call the bottom, but it’s looking pretty good on the sales front right now. Glad to hear you’re seeing the same trends.”
    Well played DealMaster

  39. Posted by Mole Man

    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.

  40. Posted by DataDude

    How is the government protecting people from failure?
    For instance, 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 says this is “a model it hoped other banks and collection companies would adopt to stem a wave of new foreclosures in the nation’s weakened housing market.”
    Even before the FDIC stepped in, many markets had already dropped 40-50% and were experiencing increases in sales activity and inventory reductions. This suggests that the market is capable of bottoming out and correcting on its own, without help from Washington.
    Which is the better scenario? FDIC assistance attempting to keep prices artificially high, or let markets bottom out on their own and eventually find buyers with incomes to support the mortgage?

  41. Posted by Debtpocalypse

    @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.

  42. Posted by Laughing Millionaire Renter in Marin

    I don’t disagree with most of what you wrote, Debtpocalypse, and the potential for a catastrophic unwind of the USD as reserve currency (and associated low rates) hints at my only substantive disagreement with ex SF-er these days: what is coming will not be a political decision.
    The economics will force the issue, as it usually does. Watch for an increase in US rates by the Fed sometime next year (almost certainly the second half) and fiscal restraint. IOW, a repeat of October 1931. 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?
    Don’t count the USD out just yet 🙂 but it is getting worrisome. Depression is assured IMO regardless.

  43. Posted by DataDude

    @ 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

  44. Posted by condoshopper

    the scenarios described above are downright scary to read, if i’m even understanding half of what’s being said. so for an average joe worker like myself, what’s the best course of action? have some savings, no house.

  45. Posted by poor owner living in potrero

    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…

  46. Posted by Melinda

    A couple of other issues, I think, that also fueled the latest boom, that are unrelated to asset prices.
    1. The “bucket laws” passed after the crash of 1929 were repealed in the very last session of the very last congress of Bill Clinton’s term. Congress passed a law barring states from regulating credit default swaps under their gambling and “bucket shop” laws. This set the stage for the market in “financial derivatives” that are a big part of what is causing the economic meltdown today.
    2. the bankruptcy reform bill of 2005 also removed the “risk” from the “risk/reward” equation. By preventing more people from declaring bankruptcy there was no natural incentive for lenders to curtail lending to sub prime borrowers.
    So, while an asset bubble was clearly in the works in the late 90s/2000, these two laws essentially opened the floodgates for greed and corruption.
    I’m a libertarian by philosophy but even I think capitalism needs to be saved from itself by careful, thoughtful regulation.

  47. Posted by DataDude

    @ 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?

  48. Posted by ex SF-er

    the potential for a catastrophic unwind of the USD as reserve currency (and associated low rates) hints at my only substantive disagreement with ex SF-er these days: what is coming will not be a political decision.
    The economics will force the issue, as it usually does.

    LMRIM: sadly, we even agree on this point. I’m going to have to find something to argue with you about now!
    I just think in the short to medium term the decision making will be (and has been) primarily political in nature. eventually the economics will force the issue.
    which is why I wrote this:
    if our leaders borrow too much then the central banks may decide that they no longer want to hold dollars. they can then sell those dollars (repatriate them back to the US).
    debtpocalypse: excellent post. you wrote it far better than I could have. bravo.

  49. Posted by Laughing Millionaire Renter in Marin

    “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.

  50. Posted by Laughing Millionaire Renter in Marin

    “I’m going to have to find something to argue with you about now!”
    Well, we could argue when we passed the point of no return (we’re well past it now). Because I’m an avowed Hayekian, I of course think it happened in the 1930s (if not 1913), but if you really pressed me I think it could have been averted as late as August-October 1998.
    I was working at a hedge fund literally within 200 yards of those yahoos at LTCM, and we all interacted professionally a bit, and when Greenie forced the bailout and cut rates to “save” the equity markets (which were about 20% higher than when he made his irrational exuberance remark two years earlier), you could just sense the collective relief in Greenwich, CT. True masters of the universe, with all the levers of power.
    I NEVER imagined that it would get so out of hand, but it should have been obvious. The career regulators never stood a chance. I had to give a talk at a treasury-sponsored gathering in 1996, and there were some IMF, World Bank-types, treasury and fed staff, etc. (That’s when I met Summers and actually talked a while with him). I gave out my card to a few people. By the time I got back to my desk (in London at the time), I must have had 100 resumes and 25 messages – every one looking for a job or offering their inside knowledge of Washington as a “consultant”. What a joke.
    When do you think we passed the point of no return, ex SF-er?

  51. Posted by NoeValleyJim

    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.”

  52. Posted by anonconfused

    Denniger’s Debt chart is not adjusted as a fraction of GDP. If one were to take GDP, wouldn’t it be more like the lower chart shown?
    http://en.wikipedia.org/wiki/Image:USDebt.png

  53. Posted by joe shmoe

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

  54. Posted by NoeValleyJim

    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.
    No, it is a little more complicated than that. What Bernake, et al. are trying to do is keep the debt level the same. They are doing this buy guaranteeing private debt with government debt. Denninger’s chart is not government debt, it is all debt, private and public. Public debt is much lower, as pointed out by anonconfused.

  55. Posted by poor owner living in potrero

    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.

  56. Posted by NoeValleyJim

    Oh, I am not trying to claim that we are not in deflationary environment, I can see that we are. I just don’t want to muddle the discussion by confusing the terms “money supply” and “inflation.” They mean different things and it is hard to have a discussion if you can’t even agree on the terms.
    I tend to think that CPI-U is the best value of inflation to use, since it tends to track the things most people care about over time. Asset bubbles come and go, but they don’t tend to swamp CPI-U. I know there have been some fiddling with it using “hedonic adjustments” and even worse, the geometric weighting, but it is still the best value we have of how inflation is effecting the average consumer.
    Deflation is running … what.. about 1%/yr right now? 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. We are not in a deflationary spiral yet and I am pretty sure $1T of stimulus will keep us out of it.
    2009 will certainly be interesting.

  57. Posted by tipster

    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.

  58. Posted by anon

    “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.”
    I agree with tipster, in relation to the current environment, this is one of the most preposterous statements I have ever read.

  59. Posted by ex SF-er

    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.

  60. Posted by ex SF-er

    When do you think we passed the point of no return, ex SF-er?
    I disagree strongly that it could have been in the early 1900’s. even with the oh-so-hated Federal Reserve system. Volker showed we weren’t past the point of no return in the 1980s. (IMO)
    I have 2 dates in mind.
    second place:
    October 1987, when Greenspan “saved” us from Black Monday. I think it changed market psychology to the Fed being “all powerful” and able to save us. It also changed Greenspan himself into believing the same. I think this day was more important than LTCM in 1998.
    first place (symbolic more than “real date”):
    1999 with the repeal of Glass Steagall. as I’ve said before, I think that the thing that’s “Different” with this downturn is the importance of the shadow banking system. Obviously, the shadow system and the breakdown between investment/commercial banks started prior to Glass Steagall passing, but to me the date of passage was symbolic that the game was done-that we as a society had embraced a new (erroneous) way of thinking.
    In theory, without the shadow banking system we could do another Volker.
    There are 2 problems with the shadow banking system. First: the nobody has “control” of it (also a good thing of course). but this makes intervention difficult, as our leaders are finding. for instance: who is responsible for AIG? nobody.
    second: too much is unknown and unknowable. For instance, Lehman was allowed to fail. who would have guessed that it would cause AIG to fail? Nobody. Or that it would cause the largest money market fund to break the buck and a run on the money market funds? few to nobody.
    thus, we are now trapped. All medium to large sized firms are too big to fail due to systemic intertwining through the shadow banking system, and it is completely opaque.
    on a side note to this: I’ve heard that there are a lot of CDS contracts on Ford and GM (unconfirmed, how can we confirm? it’s unknowable!). if true, there will be unforeseen major failures if they go BK based on their CDS contracts. the CEO’s are idiots for not mentioning this (unless they’re doing it behind closed doors).

  61. Posted by Laughing Millionaire Renter in Marin

    “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.

  62. Posted by NoeValleyJim

    Preposterous or not, that is what the data is telling us, Tipster (and anonymous critic):
    http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm
    (Sorry I don’t know how to make permanent links to the BEA website, so this will grow stale over time)
    Some tidbits:
    October 2008
    Personal income increased $42.4 billion, or 0.3 percent, and disposable personal income (DPI)
    increased $45.1 billion, or 0.4 percent, in October, according to the Bureau of Economic Analysis.
    Personal consumption expenditures (PCE) decreased $102.8 billion, or 1.0 percent. In September,
    personal income increased $8.0 billion, or 0.1 percent, DPI increased $11.6 billion, or 0.1 percent, and PCE decreased $33.7 billion, or 0.3 percent, based on revised estimates.
    Real DPI increased 1.0 percent in October, compared with an increase of less than 0.1 percent in September. Real PCE decreased 0.5 percent, compared with a decrease of 0.4 percent.

    Personal income, which had been going down over the summer, has turned back positive and pretty strongly so, if you use -1.0% as the deflator. Of course, if you think deflation is higher than that, then incomes are rising even faster. And this is *total* national income. Since the number or unemployed is up, those employed show an even stronger increase, since it is fewer workers dividing a bigger pie.
    Now this could easily be some kind of statistical glitch but it looks like the bottom for incomes was June 2008 and real income has been slowly increasing since then.

  63. Posted by tipster

    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.

  64. Posted by NoeValleyJim

    Of course, there are measurement difficulties (what is the “true’ money/creit supply?) but these are less significant that the difficulties in measuring prices.
    It is impossible to measure credit supply, at least in the current economy. Does anyone know how many CDS are outstanding and what their true value is? If the various swap and derivative markets were brought into a regulated market (not a bad idea) we might have some hope of it. There would still be a lot of unmeasured credit creation, but I think we would start to be able to get a handle on it.

  65. Posted by "Dave"

    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.

  66. Posted by Laughing Millionaire Renter in Marin

    Deflation makes it easier for government to roll its debt. Right now the USG is facing an external accounts deficit. When the deep recession/depression has worked its magic, the external picture will be in balance (import demand and prices will have collapsed, and savings rates will try to rise, and probably will). At that point, the USG and Fed will be free to hyperinflate (but they’ll try to keep it to just just “mass inflation” – say, on the order of 10-15%) because the USG will not face the same need to roll the debt on a current basis with foreign central banks. The balanced external picture, combined with the depression mindset that will have sunk in, will make internal financing of the debt radically easier than today – think of where yields were in the tremendously inflationary period of WWII.
    People worry a lot about social security and medicare. I don’t. They simply will be defaulted. Either through Act of Congress or act of mass inflation. Health care will be rationed and real spending on elderly medical care will collapse. I hope everyone is prepared!

  67. Posted by downright scared

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

  68. Posted by Laughing Millionaire Renter in Marin

    downright scared,
    Don’t get too worried about the future. It’s going to be a mess, but the US will get through it I’m betting. I really haven’t gotten in contact with anyone off-SS (there are probably too many realtors who wish me or my alter-ego harm!).
    My best advice for people is to concentrate on maintaining employment, and adjusting to the idea that the last 30 years were really pretty aberrational. Oh, and when things look worst, start buying Asian stocks with a portion of your income/wealth! (I’ve already started, but very slowly and deliberately – and no, I don’t really want to make specific recommendations). One more thing, if the government starts up any loan programs with no (or basically nothing) down payment requirements, load up on residential real estate in beaten down areas to rent out! Mass inflation in the future (could be 2 years, could be 10, I really don’t know) will drive rents up.

  69. Posted by anon

    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.

  70. Posted by tipster

    Dave,
    Those of us predicting DEflation are not assuming it is going to turn into anything but INflation down the road. But in the next year? I think the deflationary forces just overwhelm anything else.
    In two years, yes, we’ll be back to inflation. Massive? Moderate? Paul Volker (the one man in America who was able to tame inflation, understands that it is an evil that has to be quashed, etc.) on the job and he is watching that needle pretty carefully. He’s a pretty smart guy. I think he’s there to make sure they don’t do anything that will be too difficult to undo.
    As much as I was not a supporter of Obama, at least with the people surrounding him, he’s doing pretty well so far.

  71. Posted by DataDude

    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.

  72. Posted by ex SF-er

    It should be obvious these guys can’t figure out what to do. I wouldn’t trust Bernanke to run a taco stand
    aha! another thing we disagree with. I would for sure trust Bernanke to run a taco stand. even better, he’d be good in the Bluth Family Banana Stand.

  73. Posted by dub dub

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

  74. Posted by Jackal

    I aced economics in college but I think all you guys are the real professors and I am hooked on this thread.
    Don’t know too much on theory but an observation as a looking buyer for a property, I think the market is getting worst by the day. There is almost no bidders on many properties that I went.

  75. Posted by Laughing Millionaire Renter in Marin

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

  76. Posted by EBGuy

    Trying to read the tea leaves with this week’s H.4.1 release from the Fed. After two weeks of declines we saw an increase of $20+billion in the Fed balance sheet. Increases of $15billion in the Commercial paper facility and Maiden Lane III LLC. Also, “other assets” increased by $20 Billion. There were declines in some other accounts (most notable AIG’s credit line). Banks increased deposits (this has been going on for several weeks since the Fed started giving interest) at the Fed by $56Billion, which allowed the Treasury supplemental account to actually DECREASE by almost $40 Billion. The alphabet soup of new Fed programs should kick in soon (TALF, etc) and it will be interesting to see how they get funded (bank deposits or Treasury supplemental).
    As a side note H.3’s negative “non-borrowed” reserves improved to only -$32Billion. At this rate we will be positive soon.

  77. Posted by Trip

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

  78. Posted by NoeValleyJim

    I responded to your article about whether or not banks are still lending on the other thread if you were still interested.
    Sorry, I cannot find it. Can you tell me the name of the thread? I spent twenty minutes looking and I still can’t find it. Editor, can’t we get the site crawled more frequently? Please???
    The chart I posted is not flat, it showed $600B in new lending during September and October. Flat since then, yes.

  79. Posted by anon

    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…

  80. Posted by Mole Man

    People have been given breaks on their loans? Boo hoo. Next up is RTC-2, and guess who has cash and is ready to buy up some nice packages of goodies put together by their best buddies? That’s right, Mozillo and his ilk. But somehow we should believe that is more just. The only just path was not to blow such a bubble in the first place.
    Then, by naively thinking a speedy correction is best will cause the overcorrection to be even bigger. Because this is a big one and labor markets were shifting in a big way even before the results will be unrest.
    Think of the situation as a door in a damaged frame that has blown open in a storm. It needs to be closed as soon as possible, but if it is slammed then the frame may give way and all is lost. Speeding the correction is like slamming the door against the storm in a way that is likely to ruin it for good.

  81. Posted by ex SF-er

    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!

  82. Posted by NoeValleyJim

    Thanks for the pointer ex SF-er, yes we don’t really disagree here. The banks are lending more, not enough to make up for the collapse of other lending sources, and mostly using government money to clean up their own balance sheets.
    Don’t be so sure that the government won’t nationalize banks, though I personally think it is more likely that the Fed will find a way to lend directly to the consumer. There really isn’t much difference in those two situations though.
    If things get bad enough, we will see one or the other.

  83. Posted by "Dave"

    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.

  84. Posted by TinyTim

    There two problems with the definition of inflation as an increase in the money supply. First, money supply is nearly impossible to measure, since most “money” is credit. If a credit card company increases your credit limit, then “money” has been created, but this doesn’t show up in any conventional measures of money supply. Second, there is not necessarily an increase in actual spending as money supply increases, as the credit line increase should make obvious. Only if we assume velocity constant does an increase in money supply cause a proportionate increases in price level. But velocity is not merely nearly impossible to measure like money supply, velocity is totally impossible to measure, because it corresponds to nothing in reality. Velocity is simply an artificial construct equal to price level divided by the ever nearly-impossible-to-measure money supply. So if an increase in nearly-impossible-to-measure money supply increases price level, you say “see, the increase in money supply caused the inflation and thus IS inflation” whereas if the increase in nearly-impossible-to-measure money supply doesn’t increase price level, then you blame it on changes in velocity. Talk about mumbo-jumbo voodoo economics.
    Inflation is exactly what everyone except a few ideologues thinks it is. Namely, a generalized increase in the overall price and wage level. Similarly for deflation. I am not sure of the psychological reasons for these ideologues wanting to redefine inflation, but you can definitely sense some sort of fanasticism coming from them.
    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. In particular, a rise in asset prices without a rise in wages is NOT true inflation and shouldn’t be named as such. The correct term is asset price bubble. House price bubble is a more specific term for a particular type of asset price bubble.
    True inflation is insidious precisely because it has no real cause, but rather is a self-sustaining phenomenon. Prices go up because everyone else is raising prices, and wages go up because prices are going up, and prices go up some more because wages are going up, and so on. It can be very difficult to break this wage-price spiral, as we saw in the 1970’s.

  85. Posted by DataDude

    @ 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)

  86. Posted by LMRiM

    “True inflation is insidious precisely because it has no real cause, but rather is a self-sustaining phenomenon. Prices go up because everyone else is raising prices, and wages go up because prices are going up, and prices go up some more because wages are going up, and so on.”
    Oh, gracious, we are in a lot more trouble than even I thought….
    @”Dave” – I’ll post a more substantive reply later about deflation and rolling the debt. You raise an important point IMO and I think it highlights a key distinction that is often overlooked: “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 (cancelling by Act of Congress social security benefits for large swaths of the population by either extending the retirement age or means testing; or rationing health care and effectively euthanizing large categories of elderly). Actually, both are practically guaranteed IMO. But that is all down the road.
    More later.

  87. Posted by NoeValleyJim

    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.

  88. Posted by LMRiM

    “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.”
    No need to explain in great detail here, NVJ. You’re simply arguing against a self-evident tautology. 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?
    (The art of using this information practically in order to help generate good invesment decisions is to try to estimate which prices will go up in response to the character of any particular period of money supply inflation, as “a sustained rise in the general price level over time” is pretty useless as specific investment direction, don’t you think?)
    BTW, thanks for the html code page – I hope it worked.

  89. Posted by NoeValleyJim

    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.

  90. Posted by TinyTim

    We could also half the money supply while doubling the price of Tulip Bulbs. Money supply is no longer a meaningful concept in this day of computers, since velocity is infinitely flexible. Money supply increases and shrinks depending on how much money people want to hold, and velocity simply reflects price level divided by money supply. Price level is completely independent of money supply, in other words. I know this is complicated, but that’s the way it is. Economics in an age of computerized financial transcation is not as easy as back when people paid for everything with gold coins.

  91. Posted by Robert

    @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.

  92. Posted by LMRiM

    That’s an interesting post, Robert, with a lot in there. I don’t think we disagree on much, especially the idea that the US can sustain a Japan-style future period in which asset prices can be smashed while the economy avoids some of the “pain” associated with dramatic collapses like 1929-33 or Indonesia 1997-98, for instance.
    A few things that strike me immediately, though, especially within the discussion of the period after the Great Contraction (1929-32) is your omission of a few important factors such as (1) the rapid increase in base money as a result of partially removing the dollar from the gold standard in 1933 and devaluing it (in terms of gold) for purposes of foreign account settlement; (2) asset returns from 1933 were not that low at all, at least looking at equity returns in the broad US stock indexes; additionally, I’ve seen evidence that the bulk of home price declines were stemmed from 1933 as well (e.g., the Shiller data)(3) there is no conceptual reason why deflationary conditions should yield low real GDP growth – at least in conditions of moderate inflation or deflation real GDP can grow just fine; for instance, the substantially deflationary period from after the Civil War until 1894 saw the fastest real GDP growth in US history on a sustained basis (averaging +4% annually) even though the entire period from 1873 onwards is often referred to as a “Depression”; and (4) isn’t the real question not government debt only but total debt of the economy? Following 1933, we saw sustained credit deflation in the private and household sectors, while government debt increased dramatically under conditions of near 0% treasury yields.
    I would also be careful of the characterization of the entire period 1933-1940 as one of robust growth (I see that you noted the “break” point of 1936). As you know, the “Recession of ’37” was severe, and in any event I’m sure you’ll agree that “base effects” were huge as a result of the contractionary 1929-33 period.
    I don’t disagree at all with your characterization of consumer markets being better price “discoverers” than predictive investor markets. BUT, again isn’t the real question for sustainable and productive allocation of capital whether the pool of investors and lenders is a better arbiter of the interest rate that balances real savings (deferred consumption) and real capital needs (investment for future productive uses) or rather the wise Solon who sits at the Federal Reserve?
    We agree totally that the inflation has already occurred, and that printing will likely do nothing more than prevent deflation. My contention is that the amount of money that needs to be printed in order to offset the contractionary effect of the fall of debt value (marked to market) is so large as to be impossible to prevent a deflationary fall in asset values, at least not without risking a hyperinflation (which I don’t think modern central banks would try). It seems like we agree on that as well. I’v enever expected significant CPI-type deflation as in the 1930s. I don’t think that can happen in a wholly fiat regime as Japan has showed and you have hinted at.
    I think we only disagree substantively on the more distant future, namely, that ultimately the USG will default on its sovereign debt through mass inflation (perhaps you agree as well?). I strongly suspect this because of the character of the modern welfare state (probably unseen ever before in history I’d bet) and the fact that every “fiat” currency in history has ultimately ended in some blowout in which it became valueless (I think the Ottomans had the longest surviving gold-backed currency, but don’t hold me to this!). Time will tell, but I think the structural misallocations of capital combined with the trappings of a modern welfare state with our sort of politics (one person = one vote even if the person pays no taxes) is going to make this inevitable.
    Anyway, there are a lot of interesting ideas in your post. I’ll mull it over some more. I think we also probably disagree about whether swapping treasuries for worthless CDO paper (for example) at face value would ultimately lead to a debt that is serviceable by GDP growth. We are at 360% debt-GDP (that’s all sectors) and adding more. It would seem that there is no way to grow out of that in a smooth fashion (ie, lenders continuously rolling the debt at low interest rates while nominal GDP rises through moild-moderate inflation and real GDP growth). But like I said, let me mull it over some more and thanks for a very interesting and lucid response to my post (more lucid than my posts usually are!).

  93. Posted by NoeValleyJim

    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.

  94. Posted by LMRiM

    NVJ,
    The great thing about the Austrian approach – which is fairly intuitive and conceptual and disdains “scientism” in the specification of which aggregates to follow – is that the individual observer need not get the precise definition correct. You’ll find very few formulas in Hayek’s work 🙂 (While Krugman, e.g., is mostly gobbledy-gook even if you’re fluent in the concepts, perhaps especially if you are fluent :))
    In constructivist approaches such as monetarism or the current “core” CPI-type inflation targeting approach of the Fed (not fully explicit, and of course balanced with the other supposed objectives of the Fed), it is necessary to identify the aggregate or statistic specifically. This is because one wise Solon at the Fed (or at the monetarist Bundesbank in the 1990s with its obsession over M3, eg) has to set the interest rate. The Austrians want the market to do that, as you know, and trust that the market in its collective wisdon will perceive the “correct” aggregate 🙂 After the latest bubble-blowing fiasco, I had hoped (against hope) that people would start to question the wisdom of letting one man substitute his judgment for the market’s in so complex an undertaking, but it looks like that’s not to be….
    All that being said, as I am sure you know, there has been a lot of work done on what aggregates are best to look at from the Austrian school, including the AMS (Mises, Rothbard), TMS (Rothbard, Salerno, et al.), etc. There has also been some work done trying to correlate median-CPI (which is the preferred price inflation measure of most Austrians these days I think) with the aggregates and M1 seems the most promising fit (North).
    In any event, it seems light years more cogent and consistent than the approach of Bernanke and Greenspan: which is to mouth platitudes about “core” CPI, which as you know is a measure that excludes food and energy and weights 30% a government bureacrat’s estimate of “owner’s equivalent rent”.
    Like I said many times, I like this approach because it leads to better investment decisions in my personal trading. Good thing I – or any individual – do not have to set the world’s interest rate (because that’s what the monopoly controller of the world’s reserve currency effectively does!) on the basis of some hocus pocus relationship to a bureacratically-derived incomplete statistic like “core CPI” and a studious avoidance of the role of credit and asset values! Massive distortions and economic wipeouts could follow from getting it wrong 🙂

  95. Posted by ex SF-er

    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.

  96. Posted by ex SF-er

    Price level is completely independent of money supply, in other words
    I’m sorry but I just have to say this is the most incorrect thing I’ve ever seen.
    there are 2 very easy examples to counteract this
    1) Weimar Germany
    2) Zimbabwe.
    both of these examples are from a time of hyperinflation CAUSED BY THE CENTRAL BANK “PRINTING” MONEY. Nobody argues that the central banks in those examples flooded the system with extra money supply. And prices rose by the hour. There is archived references of shopkeepers changing prices HOURLY.
    I’m sorry, but your quote is 100% wrong, and easily disproven.
    The rest of your post, while written with good syntax, is also wrong.
    I personally use the word “inflation” to mean a general rise in the supply of money and credit (must add this last part given our economy), and “price appreciation” to denote the general rise in asset prices. This makes a differentiation in prices and money supply.
    both are esoteric ideas that are difficult if not impossible to quantify scientifically.
    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.

  97. Posted by Robert

    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.

  98. Posted by LMRiM

    “Now, you add leverage to the mix. Don’t you believe that leverage distorts people’s time preference? ”
    That’s it in a nutshell. Absolutely right and I couldn’t have said it better myself. In fact, this is the central insight into the Austrian view of credit’s effects on the business cycle. Unlimited monopoly ability to inflate the credit supply (subject of course to market participants’ and banks’ risk profile at any given time) leads to systematic distortions of this time preference, which should of course vary over time as new productive investment opportunities present themselves and the mix of consumption goods changes (among other reasons). These distortions lead to false price signals and ultimately misallocate the structure of the real economy.
    This is also one of the central criticisms of the Austrians as regards Keynesianism. Governmental borrowing forcibly substitutes a constructivist elite’s time preference (in theory to prop up aggregate demand – what happens when voluntary decisionmaking by the population as a whole decides to save rather than invest? Too bad, government knows best 🙁 )
    Keynesianism equates political allocation of capital (through deficit spending) with the pool of real savings (that which represents voluntarily deferred consumption), and makes no note of the distortive effect of that substitution on the evolution of the structure of the real economy.
    As the most relevant example to our forays in SS, do you think it was a wise capital allocation decision to (over)invest so much in residential real estate? Would this have been possible without the distortive price signals that resulted from repeated and wilful attempts to avoid short, recessions (necessary in the Austrian view – how else would the market signal what hasn’t worked and how else could malinvestments be “cleansed”?) by forcing down the rate of interest that would be required to intermediate the pool of real savings with the possible consumption/investment mixes available? The Austrians say no, and I can’t see how someone could disagree. (The rate is forced down through expansive monetary policies and in practice “steered” into politically favored areas like housing through regulatory “gifts” like the lifting of Glass Steagall in 1999, the favoring of mortgage interest over other debt from 1986, capital gains exclusions from 1996, lifting of leverage limits by the SEC in 2004, etc.)
    Clearly, the Austrians thus require a stable monetary system, and for that reason most favor a gold backed, 100% reserve ratio system as you note.
    I haven’t read that von Peter BIS paper
    I have to confess. It looks interesting and I have a lot of reading to catch up with. I want to go back and read the 2004 Kotlikoff Fed paper “Is the US Bankrupt” in conjunction with what we have been talking about and (perhaps) with some light shed by that BIS paper as regards an alternate conceptual framework. It’s worth reading if you haven’t seen it:
    http://research.stlouisfed.org/publications/review/06/07/Kotlikoff.pdf
    Wow, this is all about as far afield as SS has ever gotten (even though these issues are about as central as any when thinking about what is going to happen to SF real estate values. 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? That’s my base case forecast for the immediate future, and it will require substantial printing and taking of bad debt onto the sovereign balance sheet, with the certainty of an even more misallocated and inefficient economy going forward (although thankfully at least some of the real overvaluation of equities and real estate will have been washed out).
    Lastly, I disagree strongly about the idea of trying to enforce overall leverage limits in relation to GDP. That is just as bad as trying to attack the issue from the other side: manipulation of the gross interest rate by fiat (which is what we have now). I do understand why you propose it, though. Absent a gold standard or some other means of enforcing monetary discipline, we are going to flail around trying to find a substitute 🙂

  99. Posted by joe shome

    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.

  100. Posted by Robert

    …do you think it was a wise capital allocation decision to (over)invest so much in residential real estate?
    Of course it was terrible. I find the Austrian school very appealing. However, I don’t think your thesis in this case is robust. The same bubble happened worldwide, in countries with different interest rate and tax regimes. A similar run up occurred in England — with a high rate. Spain, Eastern Europe, Australia. Not to mention real estate bubbles in China and Latin America. Bank leverage exploded to 60x at Barclays, 50x at Deutsche Bank. Consumer debt exploded in Brazil with the introduction of installment plans. Not to mention the balance sheets of the swiss banks, and for the sake of politeness, we wont mention Iceland.
    It doesn’t seem plausible that the tiny fed, by changing the overnight lending rate, was able to force a global 80 trillion investment community to take undue risks and lever up with worthless paper.
    While we are at it, I would like to see how the private sector is able to reliably set interest rates in the first place. Where are the high interest rates preceding a wave of defaults, and the low interest rates preceding times of stability? It’s a central tenant, so it should be easy to defend with historical data. Let’s see the data on the accuracy of prediction markets before we complain that the fed funds rate is distorting their good work.
    Does your analysis leave room for private sector mal-investment independent of government? If so, how do you decide who to blame?
    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.

  101. Posted by chuckie

    “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.

  102. Posted by mahalo bruddah

    this is hilarious. people need to look at reality, and that is employment. it is falling. hotel revenues. that is falling. air traffic, that is falling.
    those are the key indicators for economic activity. we are going to go into a period of deflation, and home prices are not excluded.
    things will ultimately get better, but it will take some time, perhaps 2 years. until things turn around, prices will continue to deteriorate.

  103. Posted by NoeValleyJim

    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.

  104. Posted by San FronziScheme

    On the other end of the money supply, a Ponzi Scheme of biblical proportions siphoned 50B of funny money into a giant sewer.
    http://bloomberg.com/apps/news?pid=20601087&sid=a8S7tFK0wZYg&refer=home
    That’s 50B of paper wealth gone from very wealthy clients. Incredible. This system is built on debt and thin air. Very much like fumes in an engine. One spark and it all blows up.

  105. Posted by dub dub

    @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!

  106. Posted by diemos

    when the only metric for giving people respect is how much money they make you will find thieves, grifters and con men well respected indeed.

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