Turkeys fall back to earth: It started with real estate

[EJ]

Re: Turkeys fall back to earth: It started with real estate

As it has been discussed before in iTulip, central banks often act in the name of politics and not self best economic interest.

What makes you so sure that foreign central banks will allow the demand for T-Bills to fall? So far, as investor demand has fallen for T-Bills, foreign central banks have been jumping in to compensate.

Your theory is spot on, if you assume that everyone in the market place acts rationally. But, we have seen many times that central banks often do not act rationally. They act for political reasons, which may not be rational at all.

Point well taken. This is precisely why "Poom" did not happen in the previous cycle. We got the dollar depreciation we predicted as part of reflation policy, and the corresponding rise in PMs and oil priced in dollars, but due to cooperation by foreign central banks, no self-reinforcing cycle of inflation and dollar depreciation, as central banks stepped in where private investors feared to tread. We have been arguing for an equally gradual process in this cycle, except longer and deeper, that depreciates the dollar approximately 40% over about ten years. Gross sees the 10 yr peaking at 6.5%. That sounds plausible, as actual inflation will need to average around 7% to get us the 40% inflation we need to support nominal asset prices, especially real estate.

This assumes the same level of cooperation among global central banks as we saw 2000 to 2005, and that nothing unexpected happens along the way, such as a financial crisis that is not as easily cured as in 1998. Many forget, but more than a couple central bankers we talked to believed, at least for a few weeks at the peak of the crisis, that the global financial system had bought the farm. Mayer believes the risks are significantly higher today for an event that will be an even greater challenge. I feel that it's prudent to hedge the crisis case, even if it is low probability, as well as the benign case.

[rzero]

Re: Turkeys fall back to earth: It started with real estate

Thanks for the replies.

So if I understand correctly, if the Fed were to raise rates, this would weaken the US economy, thus weakening the dollar, thus raising the price of imports, thus creating price inflation.

jk - The deflation comment comes from this article:

"There will be no deflation. I repeat: there will be no self reinforcing spiral of debt defaults, an irreversible collapse in the money supply and a decline in the general price level. Central banks will never again allow short term interest rates to fall below the rate of inflation, nor fail to supply sufficient liquidity to meet the demands of financial markets. There will be no repeat of a 1930s US depression or the grinding 1990s Japanese deflationary recession."

But now as I read the article, this appears to be a typo, as it is also stated:

"The trick to avoiding deflation is to not be too slow on the draw. Once the rate of inflation falls below short term rates, as happened to the BoJ in Japan in 1992, the economy is an airplane flying with no forward air speed."

So what I gather from this is the Fed may now have the ability to avoid deflation by actually increasing rates, thus appearing to be fighting the inflation they are actually causing.

[EJ]

Re: Turkeys fall back to earth: It started with real estate

Thanks for the replies.

So if I understand correctly, if the Fed were to raise rates, this would weaken the US economy, thus weakening the dollar, thus raising the price of imports, thus creating price inflation.

jk - The deflation comment comes from this article:

"There will be no deflation. I repeat: there will be no self reinforcing spiral of debt defaults, an irreversible collapse in the money supply and a decline in the general price level. Central banks will never again allow short term interest rates to fall below the rate of inflation, nor fail to supply sufficient liquidity to meet the demands of financial markets. There will be no repeat of a 1930s US depression or the grinding 1990s Japanese deflationary recession."

But now as I read the article, this appears to be a typo, as it is also stated:

"The trick to avoiding deflation is to not be too slow on the draw. Once the rate of inflation falls below short term rates, as happened to the BoJ in Japan in 1992, the economy is an airplane flying with no forward air speed."

So what I gather from this is the Fed may now have the ability to avoid deflation by actually increasing rates, thus appearing to be fighting the inflation they are actually causing.

Apples and oranges.

The "No Deflation" piece you quote refers to the event of a 1929 or 2000 US stock market crash or 1990 Japan stock market crash event. Negative wealth effects are countered by monetary policy to prevent debt deflation.

At the moment, deflation is the last thing on the Fed's list of worries. What we are talking about here is the buildup of inflation in the global economy due to an extended period of excess liquidity, and how to deal with it when asset prices (represented by the flying turkeys) are dependent on continued liquidity. Should the Fed act precipitously and unilaterally to deal with inflation, it is likely to crash the bond markets that are supporting the turkeys. (Greenspan tried this in 1994, with less than delux results.) So that isn't going to happen.