The truth about deflation - Eric Janszen

[sadsack]

Re: The truth about deflation

A quick and simple question for smart itulipers.
If printing $ is so easy as often hinted on itulip, why this deflation (I'm sorry, disinflation) was allowed to happen just before the elections, cratering all possible assets and creating a huge misery for US citizens?

If helicopter Ben had it all figured out and planned, why this financial fiasco reached these proportions?

Another related question. If some of the recent action on the stock markets was caused by margin calls and forced liquidations and redemption that became worse as the nominal priced went lower and lower, why this is not a deflationary spiral?

If the WMD derivatives started to implode, doesn't it create a chain reaction with more deflationary implosions?

Finally, if the future earnings go down in 2008/2009 due to credit squeeze/bursting or higher dollar or record low sentiment ratings and generate more stock selling and more margin calls, why it would not be a spiral action?

In simple words please!

I've heard so much about "printing dollars" story that I don't believe it's true anymore. Most money in modern societies is credit (isn't it 90%?). Didn't EJ declare start of credit destruction in 2007 (one of the best calls in itulip IMHO)?

While EJ has not IIRC explicitly named the bolded item as the trigger, at least one of the "smart itulipers" has mentioned that CDS settlements/defaults over the next few months are a possible milepost.

I.e., if derivatives tank -> chain reaction of deflationary implosions -> the fed would presumably be forced to inflate by any means (AKA monetization) necessary

[metalman]

Re: The truth about deflation

While EJ has not IIRC explicitly named the bolded item as the trigger, at least one of the "smart itulipers" has mentioned that CDS settlements/defaults over the next few months are a possible milepost.

I.e., if derivatives tank -> chain reaction of deflationary implosions -> the fed would presumably be forced to inflate by any means (AKA monetization) necessary

the question is like asking, if the fed can't put out the fire in the whorehouse with water (discount window tricks), why don't they just use dynamite (monetization and/or devaluation)?

answer: because they don't want to use dynamite and will keep using water as long as they think they have a frigging prayer. oh, and they still think it's an orphanage... similar kind of screaming.

[ASH]

Re: The truth about deflation

I read a long time ago that the reason for the Japanese creaming the Americans in terms of technology was because their government invested their revenue in their own companies in research and development and with subsidies etc. The Americans invested their money in their military which while having a few trickle down breakthoughs in technology could not compete with the Japanese.

Moral of the story: the military/industrial complex must die. The military must be massively reduced.

I wouldn't say that Japan "creams" America in terms of technology, although they are indeed very good. The emphasis of Japanese R&D has tended to be on product development rather than pure science. My understanding is that the Japanese business climate is not supportive of startup companies, and tends to favor a handful of giant corporations. Within a company, there's not much scope for creative underlings to pursue ideas other than those of their superiors. This in not a climate that leads to many breakthroughs, but rather a whole bunch of regimented crank-turning. That's why new technology is less likely to be invented in Japan than it is to be perfected there.

I think the Japanese have a national genius for quality, design (in the aesthetic, non-technical sense), and attention to detail. On top of this, the government support you cite does help a lot. However, the rewards for original thinking and high-performing individuals are worse in Japan than in the States. Consider the case of Shuji Nakamura, who invented the blue laser diode (of blu-ray fame) for Nichia Corp. Although he was eventually awarded $8 million as the result of a lawsuit, the original bonus awarded by Nichia for this invention was about $200 (link). Nakamura left Japan to become a professor at UC Santa Barbara in the United States (at the time, I was a graduate student in the first academic research group to produce a blue diode laser, although I was working on a different type of diode laser at the time).

[BEGIN RANT]

In my opinion, you guys who talk about a military industrial complex are stuck in the 50's, when military spending dominated the federal budget. See Table 3.1 from the Historical Tables published by OMB:

1950 32.2%
1951 51.8%
1952 68.1%
1953 69.4%
1954 69.5%
1955 62.4%
1956 60.2%
1957 59.3%
1958 56.8%
1959 53.2%
1960 52.2%

1997 16.9%
1998 16.2%
1999 16.1%
2000 16.5%
2001 16.4%
2002 17.3%
2003 18.7%
2004 19.9%
2005 20.0%
2006 19.7%
2007 20.2%

Yes, we spend an awful damn lot of public money on the military, and yes -- the defense industry does have effective lobbyists. Neither do I dispute that defense R&D dollars would be more productive of civilian technology if spent directly on basic R&D. However, the phrase "military industrial complex" was coined in an era where public spending on the military was MUCH larger (both as a percentage of total spending, and as a percentage of GDP) than it is today. Influence of the defense industry over public spending was probably also a lot greater. Personally, I scope that political influence as a lot more like the farm lobby than like the freakin' Illuminati. If the defense industry lobby was really effective enough to warrant its own sinister moniker, ask yourself how the peace dividend at the end of the Cold War was realized so easily -- with the attendant contraction and consolidation of the defense industry. In 1988, defense spending hit a local maximum of 27.3% of total spending (5.8% of GDP); ten years later, in 1998, defense spending had fallen to a low of 16.2% of total spending (3.1% of GDP -- almost half!). My point is that if you really look at the history, Ike had a legitimate point about the military industrial complex being something of ominous size and influence, but defense spending has shrunk INCREDIBLY since then, and it is a matter of historical record that the defense industry lacks the political power to keep defense spending high during tranquil times.

Before you demand an end to the defense industry and defense R&D spending, you need to ask yourself this: If public money isn't spent on defense R&D, do you think it will necessarily be spent on civilian R&D, or will it instead go to yet more payments to individuals (22.2% of outlays in 1957; 61.9% of outlays in 2007 -- from Table 6.1 of the Historical Tables referenced earlier). The way I see it, you can get a lot more votes for "defense" anything than you can "pure science" -- just look at how little we spend on NASA or high energy physics, etc. If we cut defense R&D spending, the money isn't going to end up in civilian R&D spending -- it will end up in civilians! There are some other things to consider, too: The defense industry actually builds stuff -- better stuff than anyone else in the world, and stuff that we can (selectively) export. If we're all fired up to "re-industrialize", how much sense does it make to demonize a manufacturing industry that can't be out-sourced, that promotes scientific advancement, and that is one of a very few things that America is still good at?

[/END RANT]

P.S. Feel free to flame. I realize the topic of defense versus social spending -- and the defense industry in general -- is rather incendiary; I won't take it personally.

P.P.S. I'm ethnically half-Japanese, and almost all of my company's business originates from defense R&D spending, so obviously I have a horse in this race.

[metalman]

Re: The truth about deflation

no industry on the gov't tit for 50 yrs still needs a lobby. the mil industry is part of the gov't at this point with a guaranteed 20% entitlement.

[donalds]

Re: The truth about deflation

We have an inflated number of retail stores today. That number will deflate.

Unemployment will increase, access to credit will decrease, purchasing power will decrease.

With increasing store closures, fewer stores are available to service the same number of people who have fewer dollars to spend.

Yet, following your reasoning here, it would seem fewer stores mean fewer goods available to sell to buyers who are able to buy less and less. So prices will inflate?

Prices for what? Certainly not for those goods that are not needed. Supply shortages may come about, resulting in higher prices for goods needed (as opposed to goods wanted), but that will be due to international trade breakdowns. It won't be the result of fewer stores that are more crowded.

Guess I'm missing something here, or my suspicion that the argument for inflation has now gotten to the point of reaching . . . for an explanation in the face of overwhelming evidence to the contrary.

The inflationary argument ultimately rests on the 'belief' that dollar printing will exceed credit deflation, deflation of purchasing power, deflation of jobs, deflation in the means of production, deflation in the velocity and amount of dollars circulating, on and on.

Such a 'belief' rests firmly in the assumption that government power exceeds that of all else, including what is happening in the 'real' global economy.

[metalman]

Re: The truth about deflation

We have an inflated number of retail stores today. That number will deflate.

Unemployment will increase, access to credit will decrease, purchasing power will decrease.

With increasing store closures, fewer stores are available to service the same number of people who have fewer dollars to spend.

Yet, following your reasoning here, it would seem fewer stores mean fewer goods available to sell to buyers who are able to buy less and less. So prices will inflate?

Prices for what? Certainly not for those goods that are not needed. Supply shortages may come about, resulting in higher prices for goods needed (as opposed to goods wanted), but that will be due to international trade breakdowns. It won't be the result of fewer stores that are more crowded.

Guess I'm missing something here, or my suspicion that the argument for inflation has now gotten to the point of reaching . . . for an explanation in the face of overwhelming evidence to the contrary.

The inflationary argument ultimately rests on the 'belief' that dollar printing will exceed credit deflation, deflation of purchasing power, deflation of jobs, deflation in the means of production, deflation in the velocity and amount of dollars circulating, on and on.

Such a 'belief' rests firmly in the assumption that government power exceeds that of all else, including what is happening in the 'real' global economy.

travel much? visit a few countries where wages are not keeping up with prices that are set by not your currency.

[defomcduff]

Re: The truth about deflation

EJ,

I agree that we ought to be skeptical of governments that hold the power of the printing press. They will always choose inflation in the end.

In some ways, isn't inflation via fiscal stimulus (with borrowed money) what you argued for in "No Time for Utopian Anti-Interventionism", so that the U.S. might avoid another truly deflationary Great Depression?

Investing aside, do you have an opinion on whether the U.S. *should* be on a gold standard? Can an inflationary policy be socially beneficial? It seems so if a deflationary depression is an unacceptable outcome.

- DeForest

[labasta]

Re: The truth about deflation

Ash, you won't get flamed by me. You make some valid points and yes I had thought you must have connections to the "defence" (I love that definition) industry.

I actually think I saw a documentary on the Japan/American thing. I had myself figured that it is strange that the Japs have this dominant tech industry and yet I also know them to be lacking "creative" skills where inventions are concerned. The borg mentality and all that. I was always told as a kid that a Westerner invents the product and the Japanese take it, develop it and then flood the market in as anti-competitive way as possible. Similar to the Chinese. I remember reading about an Israeli weapons producer who told his sales manager when going to a trade fair in Taipai to never leave the sample gun with them for too long as they could copy anything in 48 hours. lol.

Sure, there's money in Intellectual Property, but it's not where employment lies is it? People still need to make the stuff, or do machines? Is this Zeitgeist Addendum all over again.

20% of a non-outsourced industry would be good on the face of it, but as I have understood it, this industry is supporting the FIRE economy which is now ending. The brains of this industry needs to turn to something else to get the US beyond the FIRE. Don't ask me what though. The change is too great for the politicos to do this willingly. Politicians won't change a thing unless forced in my opinion. Kind of sad really, when you think of it.

It's good to have a rant now and again, hell, I do. Unsubstantiated or not lol.

[EJ]

Re: The truth about deflation

EJ,

I agree that we ought to be skeptical of governments that hold the power of the printing press. They will always choose inflation in the end.

In some ways, isn't inflation via fiscal stimulus (with borrowed money) what you argued for in "No Time for Utopian Anti-Interventionism", so that the U.S. might avoid another truly deflationary Great Depression?

Investing aside, do you have an opinion on whether the U.S. *should* be on a gold standard? Can an inflationary policy be socially beneficial? It seems so if a deflationary depression is an unacceptable outcome.

- DeForest

Politicians learned from the 1930s that "depressions are bad," and from the 1934 experiment that they can be "prevented." All you need is a guaranteed source of demand. Keynes is no doubt rolling in his grave at the abuses that his brilliant ideas have been subjected to by politicians. He was an intellectual, and like many–such as Greenspan–naive. He expected politicians to remove stimulus after crisis passed.

In the end it's all jocks and geeks I suppose–authoritarian, or otherwise.

Did you know there has not been one recession in China in 30 years? Wonder what they'd do if one threatened?

[Guest]

Re: The truth about deflation

Did you know there has not been one recession in China in 30 years? Wonder what they'd do if one threatened?

Came across this intriguing remark about China growth going forward, from one Felix Zulauf, one of the foremost fund managers in Europe. He's been prospering this year apparently.

Swiss Guru Braces for Soft Economic Depression

In 1990, Felix Zulauf founded Zulauf Asset Management AG in Zug, Switzerland. He currently manages money for global investors in the Zulauf Europe Fund, which is actually profiting during this disastrous year. Zulauf was bearish starting in 2006 and positioned his funds accordingly. He's been compared to Marc Faber in the consistency of his astute calls.

He implies precisely the same thing regarding China's growth trajectory, as EJ mentions - that people underestimate the extent to which China's internal growth is simply "administered". Read Zulauf here, casually mentioning that China's growth simply "resumes" somewhere out in mid 2009.

While many iTulipers take it for granted we are staring an utter global collapse and a US (and EU) led "global depression" in the face, that aparently does not encompass the full extent of Zulauf's assessment, and indeed it seems he would cast a skeptical eye on the notion of unmitigated gloom for global growth in all quarters.

We may see it otherwise, but look what he's writing:

<China will do everything it can to boost domestic consumption and might experience a mild recession, claims Zulauf. Until China's economic growth accelerates in mid-2009, commodities will remain under pressure. >>

How are you supposed to stage a respectable "global depression" if China ignores the idea that all economies are supposed to lie down here and simply languish and expire like starved mutts? If Zulauf is correct, there is a gap or mis-estmation in our understanding of the next decade's trajectory for China's growth. According to this reputedly very astute fund manager, they simply have "other plans".

This does not mean we can't see some horrific currency blowups elsewhere, but summarily counting the motor of East Asia's growth out on the strength of the implosion of the US is a thesis still in search of it's full validation. If a serious recession threatened China it would appear Mr. Zulauf figures they have substantive internal growth cards yet to play.

And BHP Billiton is going for a song these days. Down in the sub-sub-basement, and thoroughly shunned. But for how long?

[ASH]

Re: The truth about deflation

Ash, you won't get flamed by me.

...

It's good to have a rant now and again, hell, I do. Unsubstantiated or not lol.

Thanks for being understanding, friend.

I think you're right about the limited employment potential of defense spending. Skilled workers do build the weapons, and those are generally good jobs, but as we develop more and more capable weapons (higher tech) we also build fewer of them. I think that reduces the size of the manufacturing workforce that is required. It seems like someone must have done the analysis already, but I have not yet found a good reference that tracks jobs per defense dollar over history; I'd be very interested in those numbers. Other areas of high tech outside the defense industry have a similar problem -- even when there's fairly high-volume manufacturing, it can be done overseas (because not secret), so the potential for lots of good domestic manufacturing jobs is limited.

I'm not sure about the ties between the defense and FIRE industries. My immediate impression is that General Electric and General Motors are tied more directly into the FIRE economy than General Dynamics -- perhaps because the defense industry has a captive source of income in the form of public defense spending, and so didn't need to dabble as much in the FIRE economy to turn a profit (the way our non-defense industrial companies did). Of course, there is the obvious relationship through government borrowing, and I think the idea of a substantial indirect tie to the FIRE economy, with American military power underpinning dollar hegemony, is useful to a point. That latter dynamic is kind of a chicken-and-egg problem: our military spending is mainly enabled by the dollar hegemony it supports, because it allows us to borrow cheaply. Looking at the recent policies of our government, I get the distinct impression that there is no coherent defense of dollar hegemony, but rather a defense of the status quo which happens to support dollar hegemony. Yes -- minor and gradual threats to dollar hegemony are met with military force (e.g. Gulf War I) or military spending (e.g. limited missile defense) when the status quo is threatened, yet we follow economic policies which seem destined to undermine the dollar's reserve currency status in the long run. (If the dollar emerges stronger from this crisis after a matter of years, then I will doff my cap to Symbols and phirang, adjust my world view to match theirs, and consider myself "schooled".) Likewise, if World War III actually results from an American attempt to defend dollar hegemony or directly seize physical assets like oil wells (confiscating the resource as opposed to safeguarding access to it at market prices), I will salute those of you who are predicting this. My own position is that if there is a sudden collapse of the dollar, or if it ceases to be the medium of international trade, then we will not be in a position to re-impose dollar hegemony at the tip of a sword, because we won't be able to pay for sustained military operations. I also think that public sentiment would prevent a war of conquest from occurring at first, and by the time hard living brings public sentiment around to the idea of just taking what we want, we will no longer have the strength to do so.

Here's a hopeful closing thought. The technical skills and capital resources required for defense research and production aren't so specialized that they cannot be used for other ends. "Defense" contractors are really just big high-tech engineering firms. If a lot of public money gets channeled into energy security or climate engineering or certain technology-intensive categories of infrastructure, then I think we'll find "defense" contractors bidding on those new contracts, and positioned fairly well to win some of them. Even though the defense industry has considerable political clout, the ultimate purpose of that clout is to suckle at the teat of government spending -- not specifically to foment wars and sell crib-seeking missiles. Thus, I don't think the defense industry's lobby would prove a significant barrier to shifting public resources from defense procurement to civilian projects, provided the government pork continued to flow.

[And I apologize for shamelessly drifting off the topic of deflation.]

[VIT]

Re: The truth about deflation

My own position is that if there is a sudden collapse of the dollar, or if it ceases to be the medium of international trade, then we will not be in a position to re-impose dollar hegemony at the tip of a sword, because we won't be able to pay for sustained military operations. I also think that public sentiment would prevent a war of conquest from occurring at first, and by the time hard living brings public sentiment around to the idea of just taking what we want, we will no longer have the strength to do so.

I agree in the idea, but would not rely too much on "public sentiment would prevent a war of conquest" This happened all the times in the past and going on today. States start the war when they are strong, not wait for the weakness. And I could not remember any war which have been announced as conquest (maybe in ancient times there were some). It is always "fair" war for faith, defense, freedom, communism, democracy etc. You just need to shape the landscape (it is especially easy to do in these "crisis" days). I believe in, as you say, cost and nuclear weapon most likely will prevent the big war, but not many local wars like in Iraq. If US would like to "secure control" let say on oil supply in mid Asia and/or Africa nobody can prevent this. US would even share some of the benefits with allies to avoid excessive noise.

I am still optimistic, but my idea we need to keep in mind some other outcomes. This might prevent them from coming in reality when it will be too late.

[labasta]

Re: The truth about deflation

<China will do everything it can to boost domestic consumption and might experience a mild recession, claims Zulauf. Until China's economic growth accelerates in mid-2009, commodities will remain under pressure. >>

That's what I would expect China to do. What else can it do? Incease exports to areas outside EU and US. I would have thought this would be difficult. Where else is there? India. China must go domestic. Then again, that's what every country will try to do I imagine, the question is in what way.

[FRED]

Re: The truth about deflation

That's what I would expect China to do. What else can it do? Incease exports to areas outside EU and US. I would have thought this would be difficult. Where else is there? India. China must go domestic. Then again, that's what every country will try to do I imagine, the question is in what way.

We have made the point for the past few years that when US recession came, the next impact on China's exports will be much less significant than is commonly assumed. China trades far more within Asia than it does with the US and Europe combined. In 2006 US exports to the US was 31% of total, now it is even less, closer to 25%. If we cut our imports from China by 20%, that will only cause China's total exports to fall by only 5%. They may be able to make up the difference via increased exports within Asia and by boosting domestic consumption.

[Atlas]

Re: The truth about deflation

"answer: because they don't want to use dynamite and will keep using water as long as they think they have a frigging prayer. oh, and they still think it's an orphanage... similar kind of screaming."

Made me laugh Metalman.