Deflation fare thee well – Part I: In search of real returns

[Green_Bear]

**Deflation fare thee well – Part I: In search of real returns in an unreal world **
Eric Janszen
itulip.com/forums/showthread.php … #post97954

With the S&P up 23% from March 2009 lows, gold up 23% from October 2008 lows, and oil up 42% from December 2008 lows, we bid farewell to the “deflation” that barely was. We’d make the farewell fond but it wasn’t around long enough for us to get intimate. You missed it entirely if you dozed off as the snow fell at the end of 2007 positioned as we were in Treasury bonds and gold to awake in the spring of 2009, yawning and sniffing the daffodils, crocuses, and Krugerrands.

In 1999 we adopted the term “disinflation” to describe these blink-you-missed-it inflation dips that trail behind the collapse of the latest bigger than the last macro-economy scale asset bubble. In the cycle of asset price inflations that has gone on for more than 20 years, post-bubble disinflation ends when the monetary and fiscal stimulus reaction of government kicks in, even if real economic growth does not. With each systemic bailout of a finance-based FIRE Economy more desperately enormous than the last, the concept of “real” goes beyond the usual meaning of growth adjusted for consumer price inflation to include adjustments for asset price inflation, as well.

For the current bubble cycle that started in 2001 when we piled into gold, we took then aspiring Federal Reserve Chairman Ben Bernanke at his word when he promised in his now famous speech Deflation: Making Sure “It” Doesn’t Happen Here to let slip the dogs of inflation should a deflation spiral threaten our economic shores. He assured us the Fed will apply every tried and true monetary tool, and a dozen untested and experimental—nay, lunatic—methods as well, should a self-reinforcing process of debt deflation, falling asset and commodity prices menace the brazenly over-indebted U.S. economy.

The problem with the housing market is not that housing prices are falling. That’s what markets do to over-priced assets. The problem is not that interest rates are too high. If anything they are too low, and anyway we cannot get them lower without pouring even more good money after bad. The problem is that total mortgage debt payments are too high relative to corporate cash flows of the businesses that pay the salaries of mortgage borrowers. High debt levels are an artifact of mortgages taken out and refinancing done during the 2002 to 2006 housing bubble period. Debt levels must be brought down to post housing bubble housing price levels. All attempts to lower mortgage debt payments will cause side effects that are worse than the illness they are meant to cure. Adding liquidity to lower interest rates will create new bubbles. Instead, mortgage debt must be written off.

But will the debt be written off? Not likely. Instead, the insanity of trying to manipulate housing prices back up to bubble price levels by fixing interest rates will continue.

[yoganmahew]

I see a slightly different dynamic in progress in bubble parts of Europe - keeping interest rates low to sustain affordable interest payments on existing debt, while tightening lending rules to reduce the ability to take on new debt. Those on the train-crash get to keep running towards the back of the train as the train is moving very slowly. Eventually they will run off the back as they write-down their debts. Everyone else boards a new train (perhaps the long-term fixed interest train?).

Well. It might happen. In theory, anyway!

There seems to be a recognition rising in Central Banks that they are responsible not only for price inflation, but for asset inflation. They can’t do anything about asset inflation using interest rates (not without causing damage to the economy), so that leaves - quantative easing and quantative tightening - varying money supply, capital adequacy thresholds etc. It also means regulating all forms of liquidity provision. This is the ‘financial services as utilities’ model that is being talked about. I expect it to be fiercely resisted by the current FIRE participants.