This post first appeared on Minyanville and Cirios Real Estate.
Deflation, the economic beast many feared would devour the next decade, appears to have been vanquished.
Or has it?
Superficial signs of renewed inflation are everywhere: Oil prices appear to be stabilizing, and concern is growing about future supply shortages (which, by extension, could lead to higher prices at the pump). The stock market has staged an impressive rally, with expectant bulls and former bears finding for "green shoots" of economic growth everywhere. Home prices, if you look purely at the data and ignore fundamentals, are starting to slow their fantastic decline.
Even the consumer price index, or CPI, is looking tame. Well, except for last month's drop, the largest in more than 50 years.
And herein lies the problem.
The CPI, the market's favorite inflation gauge, has been masking the structural deflation in our midst since the housing market fell of its wheels almost 4 years ago. Given the precipitous drop in property values, one would naturally expect the housing component of the CPI to fall in kind. Not so.
The statistical alchemists, err, experts, at the Bureau of Labor Statistics use something called "owners equivalent rent," OER, to measure consumer housing expenses. OER tries to approximate the cost to rent the country's typical home, and according to the Wall Street Journal makes up 24% of the CPI and 31% of the core CPI, which backs out food and energy costs.
And since even as property values have slid in record-breaking fashion rents remained buoyant, OER has vastly understated the drop in home prices. This means the CPI -- were it to reflect some sort of economic reality -- would have fallen more than it actually has.
As the housing slump rolls on, the pain is increasingly being felt by landlords, not just owner occupiers. Rents in big cities like New York and San Francisco are already dropping, as would-be tenants demand concessions from property owners. Vacancies are increasing, as even those driven from the housing market by foreclosures and the tight mortgage market can't fill up empty apartments, condos and track homes.
Drive around suburbia and "For Rent" signs are nearly as common as "For Sale" signs.
Rents are likely to keep falling and as a result, OER could begin to drag down the CPI. Of course, statisticians can and likely will play games with adjustments for volatile energy prices (renters often don't pay for utilities, so energy costs are backed out of OER). Further, government bean counters are even considering adapting OER to reflect new, high levels of home ownership (just in time for a reversion to the historic mean, thanks for being ahead of the curve guys).
As long as construing economic data in a way that makes it seem more likely for effectively insolvent financial institutions like Bank of America (BAC) and Citigroup (C) to raise capital and remain in business, that will remain the status quo.
Meanwhile, back in reality, saving is now en vogue, deleveraging is ongoing and the repayment (and destruction) of dollar-denominated debt will keep inflation in check for the foreseeable future. More importantly, the recognition that smaller can be better and less can be more are becoming entrenched in the lives of ordinary Americans.
Don't believe the hype: Deflation isn't going away any time soon.
Showing posts with label deflation. Show all posts
Showing posts with label deflation. Show all posts
Monday, May 18, 2009
Tuesday, April 14, 2009
Inflation vs. Deflation: Endgame Approaches
This post first appeared on Minyanville and Cirios Real Estate.
Of the myriad highbrow economic debates currently raging throughout the world of punditry, academia and government policy, few are as contentious as the one over the future of prices: Inflation vs. Deflation.
Indeed, the endgame for this issue is not insignificant, as many believe our economic future hinges on the Federal Reserve’s ability to deftly engineer a return to steady, manageable inflation. To say the least, this is no easy task.
With the unemployment marching upwards, credit markets still largely frozen and global trade grinding to a halt, the American economy is in desperate need of a monetary jolt. The trouble for Fed Chairman Ben Bernanke is that with interest rates already at zero, he’s being forced to rely on so-called “quantitative easing” to pump money into our badly bruised financial system.
These efforts are being managed through the alphabet soup of new lending programs like TALF, TAF, CPFF and others.
Meanwhile, a glut of savings from the developing world coupled with reckless financial alchemy caused debt loads to skyrocket to unsustainable levels. The ongoing destruction of that debt, discussed often by Minyanville's Kevin Depew and Mr. Practical, is now raging at full speed, as assets of all types have come screaming back to earth.
Bloomberg highlights the debate by focusing on 2 highly regarded economists with divergent views on inflation and its causes.
John Maynard Keynes, a 20th century British economist gained notoriety for his thesis that inflation was controlled by supply-demand fundamentals within an economy. He advanced the view that well-directed government spending could help a country balance economic growth with a moderate, healthy rise in prices.
Western politicians jumped on the Keynesian bandwagon during much of the last century to support a vast expansion in government spending and intrusion into the private sector.
Opposing Keynes was Milton Friedman, who instead believed that “inflation is always and everywhere a monetary phenomenon.” Friedman’s focus on monetary policy, that is, interest rates and controlling the flow of money through a country’s economy, clashed with the Keynesian view that inflation could be controlled with fiscal measures and legislation.
Bernanke is doubling down on Keynes, evidenced by recent lending initiatives, bailouts of financial institutions like American International Group (AIG) and his support of President Barack Obama's massive fiscal spending program. The Fed’s involvement in cleaning up the balance sheets of Citigroup (C) and Bank of America (BAC), along with efforts to jumpstart the mortgage market have also diminished its ability to remain apolitical and tend solely to the needs of the economy.
The Fed's gamble is a bold one, as inflating our way out of a deflationary debt unwind could lead to a rapid, uncontrollable rise in prices should the economy rebound sooner than expected.
For example, big oil companies like Exxon Mobil (XOM) and Chevron (CVX) will be reticent to invest in new technologies or drill new wells should crude prices remain low. Limited production capacity could squeeze supply when demand picks back up, leading to a rise in prices.
This trend of firms retrenching in response to rapidly waning demand for goods is being mirrored throughout the economy. And although the Fed promises to take back the monetary stimulus when the economic growth returns, the timing and political implications of such a move are anything but a slam dunk.
And unlike other more esoteric debates over economic ideology, the result of the inflation vs. deflation slugfest has real implications for all Americans.
Inflation, while generally viewed as a necessary evil for economic growth, lines the pockets of those invested in financial and other economic assets at the expense of those on the lower rungs of the economic ladder. If real incomes rose at the same rate prices did since the Fed was created in 1913, they would currently stand at $300,000 per year, six times the current median household income of around $50,000.
In other words, Americans earn about 80% less, in real terms, than they did 100 years ago.
Deflation, while causing a drag on the economy at large, benefits those making less money as each additional dollar they earn stretches further. Meanwhile, at the top of the economic spectrum, the wealthy dislike deflation since their stocks, bonds, commodities, homes and Rolexes all fall in value.
As calls for a stock market bottom and impending economic recovery gain momentum, so too will predictions of rampant inflation. Ironically, Bernanke and fellow central bankers around the world are counting on the hangover from the financial crisis to be bad enough to forestall a resurgence in demand and enable them to slowly, carefully withdraw their monetary steroids.
Whether that will be possible, or even politically acceptable is anybody's guess.
Of the myriad highbrow economic debates currently raging throughout the world of punditry, academia and government policy, few are as contentious as the one over the future of prices: Inflation vs. Deflation.
Indeed, the endgame for this issue is not insignificant, as many believe our economic future hinges on the Federal Reserve’s ability to deftly engineer a return to steady, manageable inflation. To say the least, this is no easy task.
With the unemployment marching upwards, credit markets still largely frozen and global trade grinding to a halt, the American economy is in desperate need of a monetary jolt. The trouble for Fed Chairman Ben Bernanke is that with interest rates already at zero, he’s being forced to rely on so-called “quantitative easing” to pump money into our badly bruised financial system.
These efforts are being managed through the alphabet soup of new lending programs like TALF, TAF, CPFF and others.
Meanwhile, a glut of savings from the developing world coupled with reckless financial alchemy caused debt loads to skyrocket to unsustainable levels. The ongoing destruction of that debt, discussed often by Minyanville's Kevin Depew and Mr. Practical, is now raging at full speed, as assets of all types have come screaming back to earth.
Bloomberg highlights the debate by focusing on 2 highly regarded economists with divergent views on inflation and its causes.
John Maynard Keynes, a 20th century British economist gained notoriety for his thesis that inflation was controlled by supply-demand fundamentals within an economy. He advanced the view that well-directed government spending could help a country balance economic growth with a moderate, healthy rise in prices.
Western politicians jumped on the Keynesian bandwagon during much of the last century to support a vast expansion in government spending and intrusion into the private sector.
Opposing Keynes was Milton Friedman, who instead believed that “inflation is always and everywhere a monetary phenomenon.” Friedman’s focus on monetary policy, that is, interest rates and controlling the flow of money through a country’s economy, clashed with the Keynesian view that inflation could be controlled with fiscal measures and legislation.
Bernanke is doubling down on Keynes, evidenced by recent lending initiatives, bailouts of financial institutions like American International Group (AIG) and his support of President Barack Obama's massive fiscal spending program. The Fed’s involvement in cleaning up the balance sheets of Citigroup (C) and Bank of America (BAC), along with efforts to jumpstart the mortgage market have also diminished its ability to remain apolitical and tend solely to the needs of the economy.
The Fed's gamble is a bold one, as inflating our way out of a deflationary debt unwind could lead to a rapid, uncontrollable rise in prices should the economy rebound sooner than expected.
For example, big oil companies like Exxon Mobil (XOM) and Chevron (CVX) will be reticent to invest in new technologies or drill new wells should crude prices remain low. Limited production capacity could squeeze supply when demand picks back up, leading to a rise in prices.
This trend of firms retrenching in response to rapidly waning demand for goods is being mirrored throughout the economy. And although the Fed promises to take back the monetary stimulus when the economic growth returns, the timing and political implications of such a move are anything but a slam dunk.
And unlike other more esoteric debates over economic ideology, the result of the inflation vs. deflation slugfest has real implications for all Americans.
Inflation, while generally viewed as a necessary evil for economic growth, lines the pockets of those invested in financial and other economic assets at the expense of those on the lower rungs of the economic ladder. If real incomes rose at the same rate prices did since the Fed was created in 1913, they would currently stand at $300,000 per year, six times the current median household income of around $50,000.
In other words, Americans earn about 80% less, in real terms, than they did 100 years ago.
Deflation, while causing a drag on the economy at large, benefits those making less money as each additional dollar they earn stretches further. Meanwhile, at the top of the economic spectrum, the wealthy dislike deflation since their stocks, bonds, commodities, homes and Rolexes all fall in value.
As calls for a stock market bottom and impending economic recovery gain momentum, so too will predictions of rampant inflation. Ironically, Bernanke and fellow central bankers around the world are counting on the hangover from the financial crisis to be bad enough to forestall a resurgence in demand and enable them to slowly, carefully withdraw their monetary steroids.
Whether that will be possible, or even politically acceptable is anybody's guess.
Tuesday, March 24, 2009
Fed Fumble: Lots of Cash, No One to Spend It
This post first appeared on Minyanville.
But not so fast: While the Fed’s announcement might seem alarming, Chairman Ben Bernanke is fighting a forest fire with a water weenie.
Back in reality, the ongoing debt destruction and shift back toward savings is having a far greater effect on the American economy than a paltry few hundred billion dollars of “liquidity.” The Wall Street Journal reports that, although M2 money supply has increased 10% in the past year, the cash isn’t really going anywhere.
The more significant number -- what’s known as the “velocity of money” -- fell to its lowest level since 1991. The velocity of money simply means how quickly money is spent: It measures the amount of gross domestic product, or GDP, generated for each dollar of cash sloshing around the system.
When confidence is high, credit is loose, and spenders are running rampant, money flows quickly through the system, boosting GDP. When social mood turns, however, and savers hoard their cash, the velocity of money slows down - and GDP grinds to a halt.
So even though the Fed is injecting more money into the system, consumers are socking it all away in savings accounts or paying down debt. Banks, for their part, aren't doing anything with the money, either. Big banks like Citigroup (C), Bank of America (BAC) and JPMorgan Chase (JPM), still reeling from mounting losses on bad debt, are hording what little cash they have.
Until the bad debt can be destroyed -- and until savers can receive attractive returns -- higher prices will remain merely hypothetical.
Inflation, like other economic entities, is controlled by supply and demand. The velocity of money is one way to represent the demand for “stuff” - when it goes up, prices tend to follow.
Fears about inflation are based partly on the assumption that, as consumer demand picks back up, empty store shelves and warehouses will create shortages that could lead to rampaging inflation.
Maybe - all in due time.
As the Journal points out, consumers jumping back into the spending game en masse depends on people not only having actual money to spend, but on having the desire to spend it. And while consumption certainly won't stop altogether, this slowdown may be something more than a run-of-the-mill recession: It may be a structural shift away from the consumerist leanings of the past 30 years.
Maybe, instead of stockpiling oil and gold, we should focus on stockpiling cash.
But not so fast: While the Fed’s announcement might seem alarming, Chairman Ben Bernanke is fighting a forest fire with a water weenie.
Back in reality, the ongoing debt destruction and shift back toward savings is having a far greater effect on the American economy than a paltry few hundred billion dollars of “liquidity.” The Wall Street Journal reports that, although M2 money supply has increased 10% in the past year, the cash isn’t really going anywhere.
The more significant number -- what’s known as the “velocity of money” -- fell to its lowest level since 1991. The velocity of money simply means how quickly money is spent: It measures the amount of gross domestic product, or GDP, generated for each dollar of cash sloshing around the system.
When confidence is high, credit is loose, and spenders are running rampant, money flows quickly through the system, boosting GDP. When social mood turns, however, and savers hoard their cash, the velocity of money slows down - and GDP grinds to a halt.
So even though the Fed is injecting more money into the system, consumers are socking it all away in savings accounts or paying down debt. Banks, for their part, aren't doing anything with the money, either. Big banks like Citigroup (C), Bank of America (BAC) and JPMorgan Chase (JPM), still reeling from mounting losses on bad debt, are hording what little cash they have.
Until the bad debt can be destroyed -- and until savers can receive attractive returns -- higher prices will remain merely hypothetical.
Inflation, like other economic entities, is controlled by supply and demand. The velocity of money is one way to represent the demand for “stuff” - when it goes up, prices tend to follow.
Fears about inflation are based partly on the assumption that, as consumer demand picks back up, empty store shelves and warehouses will create shortages that could lead to rampaging inflation.
Maybe - all in due time.
As the Journal points out, consumers jumping back into the spending game en masse depends on people not only having actual money to spend, but on having the desire to spend it. And while consumption certainly won't stop altogether, this slowdown may be something more than a run-of-the-mill recession: It may be a structural shift away from the consumerist leanings of the past 30 years.
Maybe, instead of stockpiling oil and gold, we should focus on stockpiling cash.
Saturday, March 7, 2009
Desperately Seeking Dollars: Greenback Catches a Bid
This post first appeared on Minyanville.
And while the answer to this conundrum is indeed complicated, its roots lie in how economic participants react to economic crisis and, ultimately, to deflation.
According to Bloomberg, in banking panics past, lenders tended to focus on doing business at home, rather than abroad. This makes logical sense: Bankers want to begin by helping those in their own backyards. The ongoing spat between Western and Eastern Europe, with the latter begging the former for help, is evidence that saving one’s own skin tends to take precedent when times get tough.
As a result, countries heavily reliant on foreign lending tend to fare poorly when such currency “protectionism” takes hold. Despite profound troubles at Citigroup (C), AIG (AIG) and Bank of America (BAC) -- to name but a few US financial institutions swimming in shark-infested waters -- many believe our banks, and indeed our economy, will fare better than those around the world.
Furthermore, as an economy spins out of control, politicians respond by firing up nationalistic rhetoric, urging a country’s citizens to band together. The widely-discussed “Buy American” provision in President Obama’s economic stimulus plan is but one example of lawmakers asking the electorate to “turn inward” in the face of danger.
Returning to the dollar, in addition to investors betting on the American economy to outperform its international counterparties, ongoing deleveraging favors the American currency. Dollar-denominated debt must be repaid with dollars, and as debtors scrounge up greenbacks to pay back their creditors, dollars become more scarce, driving their value upwards.
Deflation, which goes hand-in-hand with deleveraging, encourages consumers to hold on to cash, since as prices fall their dollars stretch further tomorrow, than they did today. Housing is a perfect example -- why buy a home today that will be worth less tomorrow?
The dollar is now approaching a near-term high not seen since the last time equity markets plunged to new lows (last November). This echoes Toddo's persistent theme of "asset class inflation vs. dollar devaluation." It's no doubt policymakers and the Plunge Protection Team are acutely aware of this relationship -- it's now a question of when, and how, they'll act.
Stay tuned, as Mr. Practical is apt to say: Risk is high.
And while the answer to this conundrum is indeed complicated, its roots lie in how economic participants react to economic crisis and, ultimately, to deflation.
According to Bloomberg, in banking panics past, lenders tended to focus on doing business at home, rather than abroad. This makes logical sense: Bankers want to begin by helping those in their own backyards. The ongoing spat between Western and Eastern Europe, with the latter begging the former for help, is evidence that saving one’s own skin tends to take precedent when times get tough.
As a result, countries heavily reliant on foreign lending tend to fare poorly when such currency “protectionism” takes hold. Despite profound troubles at Citigroup (C), AIG (AIG) and Bank of America (BAC) -- to name but a few US financial institutions swimming in shark-infested waters -- many believe our banks, and indeed our economy, will fare better than those around the world.
Furthermore, as an economy spins out of control, politicians respond by firing up nationalistic rhetoric, urging a country’s citizens to band together. The widely-discussed “Buy American” provision in President Obama’s economic stimulus plan is but one example of lawmakers asking the electorate to “turn inward” in the face of danger.
Returning to the dollar, in addition to investors betting on the American economy to outperform its international counterparties, ongoing deleveraging favors the American currency. Dollar-denominated debt must be repaid with dollars, and as debtors scrounge up greenbacks to pay back their creditors, dollars become more scarce, driving their value upwards.
Deflation, which goes hand-in-hand with deleveraging, encourages consumers to hold on to cash, since as prices fall their dollars stretch further tomorrow, than they did today. Housing is a perfect example -- why buy a home today that will be worth less tomorrow?
The dollar is now approaching a near-term high not seen since the last time equity markets plunged to new lows (last November). This echoes Toddo's persistent theme of "asset class inflation vs. dollar devaluation." It's no doubt policymakers and the Plunge Protection Team are acutely aware of this relationship -- it's now a question of when, and how, they'll act.
Stay tuned, as Mr. Practical is apt to say: Risk is high.
Tuesday, February 24, 2009
AmEx to Customers: Take the Money and Run
This post first appeared on Minyanville.
This phenomenon, formerly reserved for big-city landlords in New York or San Francisco, appears to be migrating to the financial industry.
According to Reuters, American Express (AXP) is offering select clients $300 to close their credit-card accounts. The company didn’t disclose how many such offers it planned to send out - but did say customers will have until the end of the month to accept, and until the end of March or April to pay off their balances. In exchange, they’ll receive a $300 pre-paid American Express gift card.
Rivals Capital One (COF), Discover (DFS) and JPMorgan (JPM) haven’t announced similar programs, but efforts to rein in consumer credit lines are ongoing throughout the industry. The once-steady stream of new card offers that used to fill our mailboxes has finally dried up.
Besieged by higher defaults and rising delinquencies, American Express is regretting its decision a few years ago to start offering cards to customers with sketchier credit records. Once known as card company of the well-to-do, the firm expanded its offerings down the credit spectrum at just the wrong time.
Surprised by a sharp downturn in economic conditions and the new allergy to structured credit card debt, American Express has seen its stock decimated in recent months: Shares are down more than 75% from their high last year. Capital One is off a more dramatic 86% since peaking at over $63 per share last year; Discover is off a mere 72% from its high.
The relative success of the new program could have 2 noteworthy effects. First, if successful, other card companies may rush to mimic AmEx's bold initiative.
Second, consumers' willingness to voluntarily close credit lines, precisely at a time when logic would dictate a desire to keep available as much rainy-day credit as possible, provides stark evidence of the ongoing rejection of debt, credit and excess.
As consumers return to more sustainable, responsible buying patterns -- first by necessity then by choice -- purveyors of the just-not-really-necessary aren't likely to fare well.
But as is the case in a broadly deflationary environment, even purveyors of the kind of things that you stockpile in case of apocalypse are facing hard times. Campbell's Soup (CPB), for example, reported weaker-than-expected earnings and offered less-than-inspiring guidance for 2009.
Consumers, it seems, are just buying less. Of everything. Maybe closing that credit card isn't such a bad idea after all.
This phenomenon, formerly reserved for big-city landlords in New York or San Francisco, appears to be migrating to the financial industry.
According to Reuters, American Express (AXP) is offering select clients $300 to close their credit-card accounts. The company didn’t disclose how many such offers it planned to send out - but did say customers will have until the end of the month to accept, and until the end of March or April to pay off their balances. In exchange, they’ll receive a $300 pre-paid American Express gift card.
Rivals Capital One (COF), Discover (DFS) and JPMorgan (JPM) haven’t announced similar programs, but efforts to rein in consumer credit lines are ongoing throughout the industry. The once-steady stream of new card offers that used to fill our mailboxes has finally dried up.
Besieged by higher defaults and rising delinquencies, American Express is regretting its decision a few years ago to start offering cards to customers with sketchier credit records. Once known as card company of the well-to-do, the firm expanded its offerings down the credit spectrum at just the wrong time.
Surprised by a sharp downturn in economic conditions and the new allergy to structured credit card debt, American Express has seen its stock decimated in recent months: Shares are down more than 75% from their high last year. Capital One is off a more dramatic 86% since peaking at over $63 per share last year; Discover is off a mere 72% from its high.
The relative success of the new program could have 2 noteworthy effects. First, if successful, other card companies may rush to mimic AmEx's bold initiative.
Second, consumers' willingness to voluntarily close credit lines, precisely at a time when logic would dictate a desire to keep available as much rainy-day credit as possible, provides stark evidence of the ongoing rejection of debt, credit and excess.
As consumers return to more sustainable, responsible buying patterns -- first by necessity then by choice -- purveyors of the just-not-really-necessary aren't likely to fare well.
But as is the case in a broadly deflationary environment, even purveyors of the kind of things that you stockpile in case of apocalypse are facing hard times. Campbell's Soup (CPB), for example, reported weaker-than-expected earnings and offered less-than-inspiring guidance for 2009.
Consumers, it seems, are just buying less. Of everything. Maybe closing that credit card isn't such a bad idea after all.
Friday, February 13, 2009
Americans to More Debt: Talk to the Hand
This post first appeared on Minyanville.
While congressmen berating bank CEOs for their unwillingness to lend out their bailout money makes for a nice media clip, it reflects the growing disconnect between our elected officials and any semblance of reality. Not that the relationship was ever particularly close - but lawmakers are floundering for good press while the nation’s economic future slips further and further from their tenuous grasp.
Bloomberg reports American consumers are wary of taking on more debt, as expectations about eroding economic conditions are forcing people, to *gasp* make responsible decisions about their personal finances.
Bloomberg cites Midsouth Bancorp (MSL) president C.R “Rusty” Cloutier, who says that, despite aggressive marketing, town hall meetings, and $20 million in TARP money, Midsouth's customers just aren’t taking out new loans.
This is the rejection of debt Professor Depew speaks of when discussing the structural deflation we’re currently experiencing.
Credit is based on trust. And while conventionally we view this relationship as one in which the lender must trust the borrower to repay his debt -- at least to an extent that’s commensurate with the interest rate -- it does go both ways.
As lenders like Citigroup (C), Bank of America (BAC) and Wells Fargo (WFC) are increasingly being painted as corporate marauders out to rape and pillage the American public, would-be borrowers are wary of putting their financial future in the hands of these men of questionable repute. And with credit-card companies rushing to alter terms, it’s no surprise consumers are reluctant to extend themselves further.
Still, lawmakers are pushing through an economic stimulus package that depends, in part, on a willingness on the part of consumers to keep spending. Their delusion is only outmatched by their hubris - the belief that a bunch of self-interested politicos can coerce the average American into making ruinous financial decisions for the betterment of the country.
Floundering industries -- notably automakers and homebuilders -- are counting on government subsidies to encourage Americans to keep borrowing to buy their products. But what General Motors (GM), Ford (F), Centex (CTX) and KB Homes (KBH) don't understand is this: We just don't want what they're peddling. And we certainly don't want to borrow against it.
The transition from a debt-dependent, credit-drunk consumerist society won't be immediate: It's taken 18 months of financial panic for evidence of the shifting social mood to make its way into the mainstream.
But as the economic outlook continues to darken, the country becomes more disenfranchised, and the government grows ever-more addicted to sound bites and empty promises, reality will set in.
For the past 20 years, we've been blithely driving along an economic road that ends in a cliff. And that cliff is now in our rear-view mirror. We're tumbling, groping for any branch that can save us from the fall. But each one of these new government programs, bailouts and rescues simply tries to set us gently back on the road from which we only just plummeted.
We already know where that path ends, and it ain't pretty. What say we try another road?
While congressmen berating bank CEOs for their unwillingness to lend out their bailout money makes for a nice media clip, it reflects the growing disconnect between our elected officials and any semblance of reality. Not that the relationship was ever particularly close - but lawmakers are floundering for good press while the nation’s economic future slips further and further from their tenuous grasp.
Bloomberg reports American consumers are wary of taking on more debt, as expectations about eroding economic conditions are forcing people, to *gasp* make responsible decisions about their personal finances.
Bloomberg cites Midsouth Bancorp (MSL) president C.R “Rusty” Cloutier, who says that, despite aggressive marketing, town hall meetings, and $20 million in TARP money, Midsouth's customers just aren’t taking out new loans.
This is the rejection of debt Professor Depew speaks of when discussing the structural deflation we’re currently experiencing.
Credit is based on trust. And while conventionally we view this relationship as one in which the lender must trust the borrower to repay his debt -- at least to an extent that’s commensurate with the interest rate -- it does go both ways.
As lenders like Citigroup (C), Bank of America (BAC) and Wells Fargo (WFC) are increasingly being painted as corporate marauders out to rape and pillage the American public, would-be borrowers are wary of putting their financial future in the hands of these men of questionable repute. And with credit-card companies rushing to alter terms, it’s no surprise consumers are reluctant to extend themselves further.
Still, lawmakers are pushing through an economic stimulus package that depends, in part, on a willingness on the part of consumers to keep spending. Their delusion is only outmatched by their hubris - the belief that a bunch of self-interested politicos can coerce the average American into making ruinous financial decisions for the betterment of the country.
Floundering industries -- notably automakers and homebuilders -- are counting on government subsidies to encourage Americans to keep borrowing to buy their products. But what General Motors (GM), Ford (F), Centex (CTX) and KB Homes (KBH) don't understand is this: We just don't want what they're peddling. And we certainly don't want to borrow against it.
The transition from a debt-dependent, credit-drunk consumerist society won't be immediate: It's taken 18 months of financial panic for evidence of the shifting social mood to make its way into the mainstream.
But as the economic outlook continues to darken, the country becomes more disenfranchised, and the government grows ever-more addicted to sound bites and empty promises, reality will set in.
For the past 20 years, we've been blithely driving along an economic road that ends in a cliff. And that cliff is now in our rear-view mirror. We're tumbling, groping for any branch that can save us from the fall. But each one of these new government programs, bailouts and rescues simply tries to set us gently back on the road from which we only just plummeted.
We already know where that path ends, and it ain't pretty. What say we try another road?
Wednesday, January 21, 2009
Falling Rents Signal Deflation
This post first appeared on Minyanville and Cirios Real Estate.
Since the housing market began to crumble, would-be homeowners were forced to become renters, keeping demand for rental units relatively strong even as home prices fell. Now, however, as landlords convert condos into rentals, supply is beginning to move in tenants' favor.
And while this is welcome news for millions of renters around the country, its impact on consumer price measurements could materially impact mounting deflation expectations.
The reason can be found in the nuances of how the US Bureau of Labor Statistics measures the Consumer Price Index, or CPI. The CPI is the most widely quoted gauge of inflation, it being the easiest to explain to the consuming public. Tally up a basket of commonly purchased items, see how their prices compared to last month, then last year and voila! consumer prices at your fingertips.
In realty, of course, it’s a bit more complicated: Just take a gander at this sophomoric equation from a recent CPI release:
Riiiiiiiiiight.
The most heavily weighted item in the CPI is something known as Owners’ Equivalent Rent, or OER, which accounts for almost 24% of the total index. OER is the government bean counters’ preferred method for measuring the cost of owner occupied housing, calculated by figuring out how much the median homeowner in the country would have to pay to rent his or her family’s dwelling.
Many observers, Minyanville’s Professor Mish Shedlock included, believe the CPI has been understating inflation for years by ignoring housing prices. Now, that rents are beginning to fall, however, inflation readings could become dire.
As Professor Kevin Depew noted last week, the December CPI registered the lowest inflation reading since 1980. And while most media outlets touted the effect of dramatically lower energy prices, OER is quietly reversing a long-standing trend and contributing to the decline.
Examining the data, available on the BLS’ website, OER has been steadily trending upwards for years. Even though the housing market peaked in late 2005, OER rose in 2006, 2007 and even 2008. The rate of change, however, is slowing. Notably, in December 2008, OER rose just 0.08% from November, breaking from the rest of the year’s trend.
And while 1 month does not a trend make, the data support stories from Manhattan to Los Angeles of landlords giving into thrifty tenants shopping for the best deal. With mounting job losses and weak economic conditions persisting, this will be an important trend to watch in coming months. Property liquidations by big banks like Wells Fargo (WFC), Bank of America (BAC) and Citigroup (C) will add to housing supply, further pressuring rents.
CPI data matter, despite their myriad of potential problems, because of their effect on inflation expectations - or in this case, deflation expectations.
Federal Reserve officials, including Chairman Ben Bernanke, are wary of these expectations because they represent future consumer behavior. In a speech last summer, as energy prices rose to all-time highs, Bernanke said “Some indicators of longer-term inflation expectations have risen in recent months, which is a significant concern for the Federal Reserve.”
Fearful of higher prices in the future, consumers increase buying now, spurring demand and pushing prices up even further. The same is true the other way. If the public thinks prices will keep falling, they will delay purchases, waiting for a better deal down the road. This weakens aggregate demand, accelerating price declines.
So as rents, the largest component of the CPI, continue to fall, pricing measurements are likely to signal deflation, even as conventional wisdom calls for hyperinflation. And as a deflationist attitude gains currency, social mood continues to darken, and consumerism is shunned, lower prices will ultimately become a self-fulfilling prophecy.
Since the housing market began to crumble, would-be homeowners were forced to become renters, keeping demand for rental units relatively strong even as home prices fell. Now, however, as landlords convert condos into rentals, supply is beginning to move in tenants' favor.
And while this is welcome news for millions of renters around the country, its impact on consumer price measurements could materially impact mounting deflation expectations.
The reason can be found in the nuances of how the US Bureau of Labor Statistics measures the Consumer Price Index, or CPI. The CPI is the most widely quoted gauge of inflation, it being the easiest to explain to the consuming public. Tally up a basket of commonly purchased items, see how their prices compared to last month, then last year and voila! consumer prices at your fingertips.
In realty, of course, it’s a bit more complicated: Just take a gander at this sophomoric equation from a recent CPI release:
Riiiiiiiiiight.
The most heavily weighted item in the CPI is something known as Owners’ Equivalent Rent, or OER, which accounts for almost 24% of the total index. OER is the government bean counters’ preferred method for measuring the cost of owner occupied housing, calculated by figuring out how much the median homeowner in the country would have to pay to rent his or her family’s dwelling.
Many observers, Minyanville’s Professor Mish Shedlock included, believe the CPI has been understating inflation for years by ignoring housing prices. Now, that rents are beginning to fall, however, inflation readings could become dire.
As Professor Kevin Depew noted last week, the December CPI registered the lowest inflation reading since 1980. And while most media outlets touted the effect of dramatically lower energy prices, OER is quietly reversing a long-standing trend and contributing to the decline.
Examining the data, available on the BLS’ website, OER has been steadily trending upwards for years. Even though the housing market peaked in late 2005, OER rose in 2006, 2007 and even 2008. The rate of change, however, is slowing. Notably, in December 2008, OER rose just 0.08% from November, breaking from the rest of the year’s trend.
And while 1 month does not a trend make, the data support stories from Manhattan to Los Angeles of landlords giving into thrifty tenants shopping for the best deal. With mounting job losses and weak economic conditions persisting, this will be an important trend to watch in coming months. Property liquidations by big banks like Wells Fargo (WFC), Bank of America (BAC) and Citigroup (C) will add to housing supply, further pressuring rents.
CPI data matter, despite their myriad of potential problems, because of their effect on inflation expectations - or in this case, deflation expectations.
Federal Reserve officials, including Chairman Ben Bernanke, are wary of these expectations because they represent future consumer behavior. In a speech last summer, as energy prices rose to all-time highs, Bernanke said “Some indicators of longer-term inflation expectations have risen in recent months, which is a significant concern for the Federal Reserve.”
Fearful of higher prices in the future, consumers increase buying now, spurring demand and pushing prices up even further. The same is true the other way. If the public thinks prices will keep falling, they will delay purchases, waiting for a better deal down the road. This weakens aggregate demand, accelerating price declines.
So as rents, the largest component of the CPI, continue to fall, pricing measurements are likely to signal deflation, even as conventional wisdom calls for hyperinflation. And as a deflationist attitude gains currency, social mood continues to darken, and consumerism is shunned, lower prices will ultimately become a self-fulfilling prophecy.
Tuesday, January 20, 2009
Libraries Boom as Banks Swoon
This post first appeared on Minyanville.
Even as Bank of America (BAC) and Citigroup (C), 2 of the biggest banks in the world and the erstwhile pillars of our economy fight for survival, the business of handing out information for free is booming.
The Wall Street Journal reports public libraries around the country are experiencing a spike in attendance, confounding skeptics who thought the Internet would render these time-honored community centers obsolete.
The recent increase in library use isn't necessarily surprising: Free Internet and other resource materials attract the unemployed and others long on time, short on income-producing work. Libraries often see attendance spikes during recessions. Library administrators, eager to retain their position as a public media source, have also begun carrying videogames and DVDs to attract younger patrons.
Libraries offer a quiet place to work, away from the clutter and distractions of home. My younger brother, for example, recently completed the challenging task of finding a job in an abysmal market. After a morning gym session, he schlepped his computer to the local library for a few hours of diligent job hunting. The change of scenery (let's face it, even hanging out at the library is better than living at home at 26) allowed him to focus on the task at hand, leaving the rest of the day to enjoy the freedom unemployment affords those deft enough to seize it.
The flood of new patrons is straining library staff, as already tight budgets are hacked away by municipalities' financial troubles. This is a trend we are only beginning to witness, as our economic woes chew into public funds at a time when coffers are running dry.
Our federal government is aggressively ramping up its support of our economy, asking public employees to implement a mountain of new programs and initiatives, despite the need to slim down payrolls in the face of weak tax revenues. Government is already notoriously lousy at implementing, well, anything, so to say the execution of President-Elect Obama's ambitious economic stimulus package will be challenging in the current environment is an understatement.
A return to the library is also evidence of the broader deflationary forces at work in this country, and indeed around the world. Libraries are the ultimate deflation trade: They're free. Consumers are trading down in their purchasing options - the only difference between choosing McDonald's over the Cheesecake Factory and playing Wii at the library instead of at home is the increased calorie count.
Even as Bank of America (BAC) and Citigroup (C), 2 of the biggest banks in the world and the erstwhile pillars of our economy fight for survival, the business of handing out information for free is booming.
The Wall Street Journal reports public libraries around the country are experiencing a spike in attendance, confounding skeptics who thought the Internet would render these time-honored community centers obsolete.
The recent increase in library use isn't necessarily surprising: Free Internet and other resource materials attract the unemployed and others long on time, short on income-producing work. Libraries often see attendance spikes during recessions. Library administrators, eager to retain their position as a public media source, have also begun carrying videogames and DVDs to attract younger patrons.
Libraries offer a quiet place to work, away from the clutter and distractions of home. My younger brother, for example, recently completed the challenging task of finding a job in an abysmal market. After a morning gym session, he schlepped his computer to the local library for a few hours of diligent job hunting. The change of scenery (let's face it, even hanging out at the library is better than living at home at 26) allowed him to focus on the task at hand, leaving the rest of the day to enjoy the freedom unemployment affords those deft enough to seize it.
The flood of new patrons is straining library staff, as already tight budgets are hacked away by municipalities' financial troubles. This is a trend we are only beginning to witness, as our economic woes chew into public funds at a time when coffers are running dry.
Our federal government is aggressively ramping up its support of our economy, asking public employees to implement a mountain of new programs and initiatives, despite the need to slim down payrolls in the face of weak tax revenues. Government is already notoriously lousy at implementing, well, anything, so to say the execution of President-Elect Obama's ambitious economic stimulus package will be challenging in the current environment is an understatement.
A return to the library is also evidence of the broader deflationary forces at work in this country, and indeed around the world. Libraries are the ultimate deflation trade: They're free. Consumers are trading down in their purchasing options - the only difference between choosing McDonald's over the Cheesecake Factory and playing Wii at the library instead of at home is the increased calorie count.
Tuesday, November 25, 2008
Treasuries: Not So Safe?
This post first appeared on Minyanville.
And when the financial panic abates, the safety of Treasuries will cease to be the trade du jour. Slowly, risk appetite will return - and those late pulling their money from the Treasury market could face steep losses.
The Wall Street Journal reported yesterday that, since professional money mangers can’t park their millions in wobbly US banks, they’ve flocked to the security and liquidity of the Treasury market.
Government-backed bonds, despite offering essentially no yield, have attracted billions in “smart” money in recent months. As banks failed and credit markets all but stopped functioning, the Treasury market was the only game in town. Seeking the perceived safety of the US dollar, investors drove up Treasury prices and sent their yields towards nil.
But at some point, when the willingness to take on risk returns, investors could leave the Treasury market in droves. If this were to happen, whether it be today, next week or next year, that safe trade may no longer be so safe.
In the past 2 trading days, the dollar -- for which Treasuries offer a proxy investment -- has fallen sharply, giving up recent gains. Shorts rushed to cover profitable bets on falling asset prices - and commodities responded by spiking upwards.
Respectively, gold and crude oil jumped more than 2% and 7% yesterday, while companies for which the price of “stuff” is hugely important, like US Steel (X) and Freeport McMoRan (FCX), soared.
To be sure, one day does not a trend make, and despite the longer term deflationary pressures affecting the economy, the road to lower prices won't be without its share of speed bumps. The massive amounts of liquidity injected into the financial system by the Federal Reserve and multi-billion bailouts of financial giants like Citigroup (C) and AIG (AIG) are, in the short run, inflationary.
Since the greenback is being used around the world as the equivalent of financial toilet paper, a dollar just isn’t worth what it used to be. This in turn makes imports more dear and pushes up the price of commodities, many of which are denominated in dollars.
Longer term, however, deleveraging will require the accumulation of dollars to repay debts, driving up its value. The cost of stuff, in dollar terms, will fall. And while this may sound good for a shopping trip, economists fear deflation almost as much as socializing with the opposite sex at the company Christmas party.
To find out why, just put yourself in the position of a store owner, faced with the prospect of selling everything for less. Expansion plans: Postponed. New hiring: Next year. Computer upgrades: Not a chance.
Deflation is an economy's kryptonite.
And when the financial panic abates, the safety of Treasuries will cease to be the trade du jour. Slowly, risk appetite will return - and those late pulling their money from the Treasury market could face steep losses.
The Wall Street Journal reported yesterday that, since professional money mangers can’t park their millions in wobbly US banks, they’ve flocked to the security and liquidity of the Treasury market.
Government-backed bonds, despite offering essentially no yield, have attracted billions in “smart” money in recent months. As banks failed and credit markets all but stopped functioning, the Treasury market was the only game in town. Seeking the perceived safety of the US dollar, investors drove up Treasury prices and sent their yields towards nil.
But at some point, when the willingness to take on risk returns, investors could leave the Treasury market in droves. If this were to happen, whether it be today, next week or next year, that safe trade may no longer be so safe.
In the past 2 trading days, the dollar -- for which Treasuries offer a proxy investment -- has fallen sharply, giving up recent gains. Shorts rushed to cover profitable bets on falling asset prices - and commodities responded by spiking upwards.
Respectively, gold and crude oil jumped more than 2% and 7% yesterday, while companies for which the price of “stuff” is hugely important, like US Steel (X) and Freeport McMoRan (FCX), soared.
To be sure, one day does not a trend make, and despite the longer term deflationary pressures affecting the economy, the road to lower prices won't be without its share of speed bumps. The massive amounts of liquidity injected into the financial system by the Federal Reserve and multi-billion bailouts of financial giants like Citigroup (C) and AIG (AIG) are, in the short run, inflationary.
Since the greenback is being used around the world as the equivalent of financial toilet paper, a dollar just isn’t worth what it used to be. This in turn makes imports more dear and pushes up the price of commodities, many of which are denominated in dollars.
Longer term, however, deleveraging will require the accumulation of dollars to repay debts, driving up its value. The cost of stuff, in dollar terms, will fall. And while this may sound good for a shopping trip, economists fear deflation almost as much as socializing with the opposite sex at the company Christmas party.
To find out why, just put yourself in the position of a store owner, faced with the prospect of selling everything for less. Expansion plans: Postponed. New hiring: Next year. Computer upgrades: Not a chance.
Deflation is an economy's kryptonite.
Monday, November 24, 2008
Powering Down
This post first appeared on Minyanville.
With each passing day, it becomes clearer this is no ordinary economic downturn.
Data show Americans aren’t just cutting back in traditional ways: Paring non-essential purchases and getting by with fewer luxuries. Rather, there are fundamental shifts going on in the way we live.
These emerging trends evidence a shift not just in purchasing habits, but in lifestyle.
According to the Wall Street Journal, businesses and households alike are using less energy. Specifically, large utility companies like Minneapolis-based Xcel Energy (XEL), Charlotte’s Duke Energy (DUK) and American Electric Power (AEP) in Ohio are seeing steeper drops in electricity consumption than in previous downturns.
To be sure, energy demand weakens as the economy slows. Consumers buy fewer electronic gadgets, drive less and generally use less stuff that needs to be turned on.
This time, however, executives are worried fundamental behaviors are changing. Jim Rogers, CEO of Duke Energy, told the Journal consumption is falling even in places where prices are stagnant. “Something fundamental is going on.”
Xcel CEO Dick Kelly said for “the first time in 40 years [he’s] seen a decline in sales” to homes.
If the pattern persists, it could cause utilities to drastically change their business model. Typically, purveyors of power count on small, but consistent growth in energy demand. They build this assumption into their business models, which plays an integral role in expansion plans and breaking ground on new plants. Coupled with the rising cost of capital resulting from the credit crisis, this means Americans are likely to see higher energy prices in the future.
And while the data is far from conclusive, it could be an early sign that we are (begrudgingly) embracing the concept that less is, actually, more.
Minyanville’s Kevin Depew and others have been cataloguing this shift in consumer behavior, as broad deflation grips society. More than just lower prices, deflation is taking hold in all aspects of our lives. It’s a slow process, to be sure, but one that is undeniably gaining momentum as social mood darkens and the public rejects consumerism.
Despite lower gas prices, Americans are still driving less. Ever hungry for bigger offerings from McDonald's (MCD) and Burger King (BKC), restaurants are increasingly being forced to inform their customers just how bad an idea it is to eat a Triple Whopper with cheese. Someday, the lesson may actually stick.
Confucius once said a journal of a 1000 miles begins with a single step. Turning off the lights when you leave a room may be that first step. Watching less television may be the second. Maybe, just maybe, spending less time on Facebook could be that third step that sets the whole thing running down hill.
Hey, a guy can dream right?
With each passing day, it becomes clearer this is no ordinary economic downturn.
Data show Americans aren’t just cutting back in traditional ways: Paring non-essential purchases and getting by with fewer luxuries. Rather, there are fundamental shifts going on in the way we live.
These emerging trends evidence a shift not just in purchasing habits, but in lifestyle.
According to the Wall Street Journal, businesses and households alike are using less energy. Specifically, large utility companies like Minneapolis-based Xcel Energy (XEL), Charlotte’s Duke Energy (DUK) and American Electric Power (AEP) in Ohio are seeing steeper drops in electricity consumption than in previous downturns.
To be sure, energy demand weakens as the economy slows. Consumers buy fewer electronic gadgets, drive less and generally use less stuff that needs to be turned on.
This time, however, executives are worried fundamental behaviors are changing. Jim Rogers, CEO of Duke Energy, told the Journal consumption is falling even in places where prices are stagnant. “Something fundamental is going on.”
Xcel CEO Dick Kelly said for “the first time in 40 years [he’s] seen a decline in sales” to homes.
If the pattern persists, it could cause utilities to drastically change their business model. Typically, purveyors of power count on small, but consistent growth in energy demand. They build this assumption into their business models, which plays an integral role in expansion plans and breaking ground on new plants. Coupled with the rising cost of capital resulting from the credit crisis, this means Americans are likely to see higher energy prices in the future.
And while the data is far from conclusive, it could be an early sign that we are (begrudgingly) embracing the concept that less is, actually, more.
Minyanville’s Kevin Depew and others have been cataloguing this shift in consumer behavior, as broad deflation grips society. More than just lower prices, deflation is taking hold in all aspects of our lives. It’s a slow process, to be sure, but one that is undeniably gaining momentum as social mood darkens and the public rejects consumerism.
Despite lower gas prices, Americans are still driving less. Ever hungry for bigger offerings from McDonald's (MCD) and Burger King (BKC), restaurants are increasingly being forced to inform their customers just how bad an idea it is to eat a Triple Whopper with cheese. Someday, the lesson may actually stick.
Confucius once said a journal of a 1000 miles begins with a single step. Turning off the lights when you leave a room may be that first step. Watching less television may be the second. Maybe, just maybe, spending less time on Facebook could be that third step that sets the whole thing running down hill.
Hey, a guy can dream right?
Monday, November 17, 2008
Copper Prices Fall, Deflation Takes Hold
Looting abandoned homes just ain’t the fun it used to be.
Stripping foreclosed homes of their copper pipes became big business when commodity prices soared, driven by easy credit, a weak dollar and a robust global economy. Since the summer, however, the prices of base metals have fallen precipitously, with copper's decline being the most dramatic.
Analysts don’t expect the trend to reverse any time soon. Despite a massive economic stimulus package from China, the world’s largest copper purchaser, some experts believe the metal could slide as much as 40% further.
Bloomberg reports global inventories have risen twofold in the past 4 months, as auto sales have slumped, new home construction has all but ground to a halt, and fears about a worldwide economic slowdown are becoming reality. Bigger stockpiles, coupled with faltering demand has led to a collapse in commpodity prices: The S&P GSCI Index, which tracks 24 raw materials, has fallen by more than half since July.
Minyanville’s Ryan Krueger regards copper as a proxy for global productivity. Unlike gold or silver, copper is unaffected by speculation, since demand for it is purely pragmatic: It serves as the essential material for construction of all types.
Miners like Freeport MacMoran (FCX) and BHP Billiton (BHP) have been hauling the stuff out of the ground at record rates in the past few years in order to keep up with skyrocketing demand. Shares soared, reaping big profits for investors.
Since its low in 2000, Freeport rose almost 1800% to its high just a few months ago. Shares have since come back to earth: Freeport and BHP are down 81% and 66%, respectively.
According to the Wall Street Journal, miners are now racing to cut production in reaction to slumping demand. US Steel (X) will lay off 2% of its workforce, as mining companies around the world are forced to cut overhead to stay alive.
Meanwhile, construction costs are tumbling, fueling fears about central bankers’ worst nightmare: Deflation. It seems like yesterday that Federal Reserve Chairman Ben Bernanke and his ilk were scared stiff about inflation; rising prices have already sparked riots in developing countries around the world.
As Professor Kevin Depew put it last week,
"The argument against deflation and inflation is both academic and political. Present economic elites benefit from inflation and suffer terribly in deflation. Therefore, there is great incentive for the small minority -- the 2-3% of wealthy who control the vast majority of assets in this country -- to continue to press government and the Fed to maintain the present course of inflation over deflation."
Deleveraging is lowering the value of all assets, from stocks to bonds to houses to steel. Those whose wealth is tied up in these commodities are scrambling to halt the accelerating evaporation of their value.
After years of watching the rising tide lift their boats, they now find themselves foundering on the shore - which is already littered with those who never set sail in the first place.
Stripping foreclosed homes of their copper pipes became big business when commodity prices soared, driven by easy credit, a weak dollar and a robust global economy. Since the summer, however, the prices of base metals have fallen precipitously, with copper's decline being the most dramatic.
Analysts don’t expect the trend to reverse any time soon. Despite a massive economic stimulus package from China, the world’s largest copper purchaser, some experts believe the metal could slide as much as 40% further.
Bloomberg reports global inventories have risen twofold in the past 4 months, as auto sales have slumped, new home construction has all but ground to a halt, and fears about a worldwide economic slowdown are becoming reality. Bigger stockpiles, coupled with faltering demand has led to a collapse in commpodity prices: The S&P GSCI Index, which tracks 24 raw materials, has fallen by more than half since July.
Minyanville’s Ryan Krueger regards copper as a proxy for global productivity. Unlike gold or silver, copper is unaffected by speculation, since demand for it is purely pragmatic: It serves as the essential material for construction of all types.
Miners like Freeport MacMoran (FCX) and BHP Billiton (BHP) have been hauling the stuff out of the ground at record rates in the past few years in order to keep up with skyrocketing demand. Shares soared, reaping big profits for investors.
Since its low in 2000, Freeport rose almost 1800% to its high just a few months ago. Shares have since come back to earth: Freeport and BHP are down 81% and 66%, respectively.
According to the Wall Street Journal, miners are now racing to cut production in reaction to slumping demand. US Steel (X) will lay off 2% of its workforce, as mining companies around the world are forced to cut overhead to stay alive.
Meanwhile, construction costs are tumbling, fueling fears about central bankers’ worst nightmare: Deflation. It seems like yesterday that Federal Reserve Chairman Ben Bernanke and his ilk were scared stiff about inflation; rising prices have already sparked riots in developing countries around the world.
As Professor Kevin Depew put it last week,
"The argument against deflation and inflation is both academic and political. Present economic elites benefit from inflation and suffer terribly in deflation. Therefore, there is great incentive for the small minority -- the 2-3% of wealthy who control the vast majority of assets in this country -- to continue to press government and the Fed to maintain the present course of inflation over deflation."
Deleveraging is lowering the value of all assets, from stocks to bonds to houses to steel. Those whose wealth is tied up in these commodities are scrambling to halt the accelerating evaporation of their value.
After years of watching the rising tide lift their boats, they now find themselves foundering on the shore - which is already littered with those who never set sail in the first place.
Friday, October 31, 2008
Consumers Squeezed from Both Sides
This post first appeared on Minyanville.
One thing’s for sure. We’re all gonna be a lot thinner!
- Han Solo, Star Wars
American consumers are getting squeezed like aspiring Jedis in a Death Star garbage masher.
Hundreds of billions of dollars in losses have forced financial institutions around the world to rein in credit just when their clients need it most. Amid mounting job losses, falling home prices and high energy costs, consumers are finding it harder and harder to make ends meet.
For years, keeping the lights on was a cinch. If times got tough, getting more credit was as easy as sifting through stacks of junk mail and picking the best offer. Now, issuers are reducing limits, jacking up interest rates and discontinuing promotional offers.
The New York Times reports things could get worse. In the first 6 months of 2008, lenders wrote off around $21 billion in loan losses. Analysts say layoffs and a dim economic outlook could result in another $55 billion by the end of next year.
In an attempt to stem the bleeding, issuers like American Express (AXP) and Bank of America (BAC) are reluctant to give new cards out to anyone, let alone borrowers that seem even the least bit risky. Capital One (COF) is closing inactive accounts; it cut credit lines by almost 5% last quarter alone.
Spending money certainly isn’t getting any easier. And to make matters worse, saving it is getting tougher too.
Hitherto generous 401k matching programs are going by the wayside as companies hoard cash in preparation for lean economic times.
According to USA Today, General Motors (GM), which is hoping for a government bailout, announced last week it won’t match employee contributions to their 401k retirement accounts.
GM isn’t the first, and likely won’t be the last, company to cut costs in this way. Goodyear (GT), Dollar Thrifty (DTG) and real estate broker Cushman & Wakefield have all shut down their matching plans. Goodyear, for its part, actually shut the program down in 2003 and plans to start it back up again next year.
For consumers, this all adds up to one easy decision: Buy less stuff. This doesn't bode well for retailers, or any other company dependent on free-and-easy American wallets.
With credit nearly impossible to get, interest rates on savings accounts plummeting and wobbly banks suckling at the government teat just to stay afloat, Americans may soon resort to the age-old practice of stuffing cash under the mattress.
Who knows, as deflation takes hold and the dollar rallies, it may not be such a bad idea.
One thing’s for sure. We’re all gonna be a lot thinner!
- Han Solo, Star Wars
American consumers are getting squeezed like aspiring Jedis in a Death Star garbage masher.
Hundreds of billions of dollars in losses have forced financial institutions around the world to rein in credit just when their clients need it most. Amid mounting job losses, falling home prices and high energy costs, consumers are finding it harder and harder to make ends meet.
For years, keeping the lights on was a cinch. If times got tough, getting more credit was as easy as sifting through stacks of junk mail and picking the best offer. Now, issuers are reducing limits, jacking up interest rates and discontinuing promotional offers.
The New York Times reports things could get worse. In the first 6 months of 2008, lenders wrote off around $21 billion in loan losses. Analysts say layoffs and a dim economic outlook could result in another $55 billion by the end of next year.
In an attempt to stem the bleeding, issuers like American Express (AXP) and Bank of America (BAC) are reluctant to give new cards out to anyone, let alone borrowers that seem even the least bit risky. Capital One (COF) is closing inactive accounts; it cut credit lines by almost 5% last quarter alone.
Spending money certainly isn’t getting any easier. And to make matters worse, saving it is getting tougher too.
Hitherto generous 401k matching programs are going by the wayside as companies hoard cash in preparation for lean economic times.
According to USA Today, General Motors (GM), which is hoping for a government bailout, announced last week it won’t match employee contributions to their 401k retirement accounts.
GM isn’t the first, and likely won’t be the last, company to cut costs in this way. Goodyear (GT), Dollar Thrifty (DTG) and real estate broker Cushman & Wakefield have all shut down their matching plans. Goodyear, for its part, actually shut the program down in 2003 and plans to start it back up again next year.
For consumers, this all adds up to one easy decision: Buy less stuff. This doesn't bode well for retailers, or any other company dependent on free-and-easy American wallets.
With credit nearly impossible to get, interest rates on savings accounts plummeting and wobbly banks suckling at the government teat just to stay afloat, Americans may soon resort to the age-old practice of stuffing cash under the mattress.
Who knows, as deflation takes hold and the dollar rallies, it may not be such a bad idea.
Monday, July 7, 2008
Trading Tip: Ditch TIPS
This post first appeared on Minyanville.
Given the opportunity to bet on inflation 12 months ago, most investors would have fired up the Delorean without so much as a second thought.
Treasury Inflation Protected Securities, or TIPS, are designed to keep pace with inflation as measured by the Consumer Price Index, or CPI. The $500 billion market had once been considered a safe place to sock away funds as a hedge against higher prices. Amidst a barrage of screaming headlines about record oil and food prices, it may therefore seem strange that money managers are advising clients to bail on TIPS.
Bloomberg reports that Morgan Stanley (MS) and FTN Financial, a division of First Tennessee Bank, are suggesting clients move money invested in TIPS to securities that offer a better hedge against higher prices. Investors should bet on derivatives whose value is based on inflation expectations, rather than on the government’s shoddy data. They contend the methodology used to calculate the CPI doesn’t accurately reflect the true rate of inflation.
To Minyanville readers, this shouldn’t come as much of a surprise; Professors Mauldin and Depew have discussed the shortcomings of the CPI at length.
A primary criticism of the CPI is that it doesn’t properly account for fluctuations in food and energy prices. Historically, fuel and food have been more volatile than other consumer goods, so the Bureau of Labor Statistics (BLS) -- the government body tasked with tabulating the CPI each month -- strips out those costs to arrive at its “core” or headline CPI number.
The BLS also juggles the basket of goods used to calculate the CPI, which many contend allows it to distort the inflation rate. By swapping out expensive goods for cheap ones, it’s pretty easy to keep the most widely watched measure of inflation low - even while prices are obviously soaring.
A second factor that’s led investment advisers to steer clients away from TIPS is a divergence between the inflation expected by consumers and that reported by the government. Consumer sentiment readings indicate fear of higher prices, while traders betting on TIPS expect inflation to moderate over the next few years.
Some say this is just another sign of traders’ lack of faith in government data. Others, however, argue that inflationary pressures are actually decreasing as the credit crunch forces firms like Citibank (C), Merrill Lynch (MER) and General Motors (GM) to de-leverage.
Traders may be getting ahead of the curve: The debate highlights the importance of inflation expectations and their impact on consumer behavior.
If a rational consumer believes gas will be more expensive tomorrow than it is today, he'll make sure to swing by the Exxon-Mobil (XOM) station on his way home from work. If his view is the same tomorrow, he should fill up again - since prices will just be higher the following day.
This type of behavior leads to unnaturally high demand, as consumers shift purchases forward, pressuring supply. Increased demand coupled with dwindling supply means higher prices, which fuel more inflation expectations, pushing prices up even further.
Wash, rinse, repeat.
At some point, however, consumers are forced to give up; they simply run out of money.
The best cure for high prices may be high prices. As shoppers trade down, cut back and stash away their pennies for that inevitable rainy day, demand will diminish - and consumers will have no choice but to figure out how to get by on less.
Given the opportunity to bet on inflation 12 months ago, most investors would have fired up the Delorean without so much as a second thought.
Treasury Inflation Protected Securities, or TIPS, are designed to keep pace with inflation as measured by the Consumer Price Index, or CPI. The $500 billion market had once been considered a safe place to sock away funds as a hedge against higher prices. Amidst a barrage of screaming headlines about record oil and food prices, it may therefore seem strange that money managers are advising clients to bail on TIPS.
Bloomberg reports that Morgan Stanley (MS) and FTN Financial, a division of First Tennessee Bank, are suggesting clients move money invested in TIPS to securities that offer a better hedge against higher prices. Investors should bet on derivatives whose value is based on inflation expectations, rather than on the government’s shoddy data. They contend the methodology used to calculate the CPI doesn’t accurately reflect the true rate of inflation.
To Minyanville readers, this shouldn’t come as much of a surprise; Professors Mauldin and Depew have discussed the shortcomings of the CPI at length.
A primary criticism of the CPI is that it doesn’t properly account for fluctuations in food and energy prices. Historically, fuel and food have been more volatile than other consumer goods, so the Bureau of Labor Statistics (BLS) -- the government body tasked with tabulating the CPI each month -- strips out those costs to arrive at its “core” or headline CPI number.
The BLS also juggles the basket of goods used to calculate the CPI, which many contend allows it to distort the inflation rate. By swapping out expensive goods for cheap ones, it’s pretty easy to keep the most widely watched measure of inflation low - even while prices are obviously soaring.
A second factor that’s led investment advisers to steer clients away from TIPS is a divergence between the inflation expected by consumers and that reported by the government. Consumer sentiment readings indicate fear of higher prices, while traders betting on TIPS expect inflation to moderate over the next few years.
Some say this is just another sign of traders’ lack of faith in government data. Others, however, argue that inflationary pressures are actually decreasing as the credit crunch forces firms like Citibank (C), Merrill Lynch (MER) and General Motors (GM) to de-leverage.
Traders may be getting ahead of the curve: The debate highlights the importance of inflation expectations and their impact on consumer behavior.
If a rational consumer believes gas will be more expensive tomorrow than it is today, he'll make sure to swing by the Exxon-Mobil (XOM) station on his way home from work. If his view is the same tomorrow, he should fill up again - since prices will just be higher the following day.
This type of behavior leads to unnaturally high demand, as consumers shift purchases forward, pressuring supply. Increased demand coupled with dwindling supply means higher prices, which fuel more inflation expectations, pushing prices up even further.
Wash, rinse, repeat.
At some point, however, consumers are forced to give up; they simply run out of money.
The best cure for high prices may be high prices. As shoppers trade down, cut back and stash away their pennies for that inevitable rainy day, demand will diminish - and consumers will have no choice but to figure out how to get by on less.
Monday, May 12, 2008
Housing misconceptions
Mike "Mish" Shedlock points out this morning that the housing bust is not unique to the United States. Spain and Australia, in addition to the U.K. are seeing home prices fall, and pounds and euros are evaporating in the process. Mish is an ardent deflationist, irrespective of the headline-popping rise in the cost of fuel and food.
One comment stood out today in Mish's post -
The misguided hope that housing prices are at or near the bottom ignores the reason for the boom in prices during the earlier part of the decade. As Mish points out, prices were not driven by an increased ability to pay. Instead, unnaturally low interest rates fueled creative lending which fueled speculation which fueled creative lending which fueled speculation.
The chart below courtesy of James Ballenger, shows home prices vs. incomes during the housing bust. Banking on appreciation is wishful thinking as long as banks are wary to lend.
Creative lending is not coming back any time soon, income growth is stagnant, and the economy - by most intelligent measures - is already in recession. Anyone in the market for a home should be patient. Don't try and catch a falling knife. Even if prices don't fall too much further from here, they won't rebound any time soon. There's plenty of time to find the right deal.
Check out our sister site, Cirios Real Estate.
One comment stood out today in Mish's post -
Because the rise in inflation (money supply and credit) fueled asset prices in the 1990's, the housing bubble from 2001 to 2006, and stocks from 2003 until recently. None of this was properly measured for the simple reason it is impossible to measure the effect of credit inflation on the stock market or housing market.
The misguided hope that housing prices are at or near the bottom ignores the reason for the boom in prices during the earlier part of the decade. As Mish points out, prices were not driven by an increased ability to pay. Instead, unnaturally low interest rates fueled creative lending which fueled speculation which fueled creative lending which fueled speculation.
The chart below courtesy of James Ballenger, shows home prices vs. incomes during the housing bust. Banking on appreciation is wishful thinking as long as banks are wary to lend.
Creative lending is not coming back any time soon, income growth is stagnant, and the economy - by most intelligent measures - is already in recession. Anyone in the market for a home should be patient. Don't try and catch a falling knife. Even if prices don't fall too much further from here, they won't rebound any time soon. There's plenty of time to find the right deal.
Check out our sister site, Cirios Real Estate.
Wednesday, May 7, 2008
Deflation and the Food vs. Fuel Debate
This post first appeared on Minyanville.
Record fuel prices and soaring food costs have intensified the debate over the role of biofuels in U.S. energy policy.
One camp claims dedicating farmland to fuel snatches food from the mouths of the world's hungry in favor of American gas tanks. Ethanol, they argue, is little more than a political mechanism for lining the pockets of farmers and special interest groups with taxpayer money. Its production uses more energy than it saves and only marginally reduces our dependence on foreign oil.
In opposition are those that believe biofuels are just one of many factors contributing to the inflation of food prices. High energy costs and booming demand from China and India are the chief culprits, they argue, because oil touches every aspect of food production and plays a much greater role in determining retail food prices.
Absent from the debate, however, is discussion of why we're in this predicament to begin with.
Let's start with the premise that the so-called mortgage meltdown is a symptom, not the cause of, our current financial crisis. Bad mortgages are indicative of an economy too dependent on credit and lacking enough real cash flow to support the debt service.
Extrapolating this idea to the fuel vs. food debate, reliance on foreign oil is a symptom of an economy whose wants and needs outstrip its ability to produce. We are thus forced to import oil from unstable parts of the globe. True energy independence is only possible if our economy demands less oil.
Taking the analogy a step further, the solution to the credit crisis isn't more regulation or government intervention. Market-driven deleveraging has begun and must continue. It will be a painful -- but necessary -- process for those accustomed to living beyond their means.
Likewise, more subsidies and government programs are not the answer to our energy woes. The widespread deflation of asset prices and a reduction of dependence on material goods is the only long-term solution to our dependence on foreign oil. This is the path to sustainable consumption, one that will eventually bring our propensity to consume back in line with our means to produce.
This readjustment is inevitable. Behind the scenes, beneath the headlines, a much broader and slow-moving migration toward the belief that less is, in fact, more has begun. This concept should be paramount in our pursuit of energy independence. Ironically, the credit crunch has put us well on our way.
Record fuel prices and soaring food costs have intensified the debate over the role of biofuels in U.S. energy policy.
One camp claims dedicating farmland to fuel snatches food from the mouths of the world's hungry in favor of American gas tanks. Ethanol, they argue, is little more than a political mechanism for lining the pockets of farmers and special interest groups with taxpayer money. Its production uses more energy than it saves and only marginally reduces our dependence on foreign oil.
In opposition are those that believe biofuels are just one of many factors contributing to the inflation of food prices. High energy costs and booming demand from China and India are the chief culprits, they argue, because oil touches every aspect of food production and plays a much greater role in determining retail food prices.
Absent from the debate, however, is discussion of why we're in this predicament to begin with.
Let's start with the premise that the so-called mortgage meltdown is a symptom, not the cause of, our current financial crisis. Bad mortgages are indicative of an economy too dependent on credit and lacking enough real cash flow to support the debt service.
Extrapolating this idea to the fuel vs. food debate, reliance on foreign oil is a symptom of an economy whose wants and needs outstrip its ability to produce. We are thus forced to import oil from unstable parts of the globe. True energy independence is only possible if our economy demands less oil.
Taking the analogy a step further, the solution to the credit crisis isn't more regulation or government intervention. Market-driven deleveraging has begun and must continue. It will be a painful -- but necessary -- process for those accustomed to living beyond their means.
Likewise, more subsidies and government programs are not the answer to our energy woes. The widespread deflation of asset prices and a reduction of dependence on material goods is the only long-term solution to our dependence on foreign oil. This is the path to sustainable consumption, one that will eventually bring our propensity to consume back in line with our means to produce.
This readjustment is inevitable. Behind the scenes, beneath the headlines, a much broader and slow-moving migration toward the belief that less is, in fact, more has begun. This concept should be paramount in our pursuit of energy independence. Ironically, the credit crunch has put us well on our way.
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