Credit inflation, Deflation: Prechter Interview

[jk]

Re: Credit inflation, Deflation: Prechter Interview

Quote:

Originally Posted by finster One further perspective: You apparently believe the US dollar will rise relative to the stock market - another way of saying that stock prices will fall (you say you have a zero stock position). Yet you worry it will fall relative to the rest of the world's currencies.

finster, forgot to include this: i don't expect all of my investments to perform similarly under all scenarios. as you made clear in your discussion of your model 320k portfolio of etf's, i want the components to perform differently. i could well believe that in a deflationary scenario the us stock market would tank but the dollar soar.

[jk]

Re: Credit inflation, Deflation: Prechter Interview

Another example should help. Many are prone to citing high "demand" from Asia as the driver behind high commodity prices. But exactly what makes up this demand, and how is it exercised? Did it never before occur to the Asians that it might be nice to build roads and schools and drive cars and such? They just woke up one morning a few years ago and thought that would be cool? No. So what’s different now?

They have dollars. The Fed made billions of them, sent them to house owners all over America, and those house owners sent them to China and India. (Obvious oversimplification, but you the get general idea.) The house owners didn’t produce anything to get those marginal dollars, but the Asians did. But as a result, the Asians now had lots of dollars with which to compete for resources with the remaining dollars in America. Lots of dollars sloshing around, but the same amount of oil. Therefore, the dollars fell in value in relation to the oil.

The bottom line vis-a-vis "demand" is that as far as the prices of things is concerned, "demand" is measured by the number of dollars available with which to express a desire. The Chinese could pine for a billion barrels of oil all they want, but only to the extent they can deploy dollars in pursuit of that wish can they make it so that it takes more dollars to buy that oil.

i'm not quite with you here.

first, e.g., because the chinese demand for oil is in part determined by their infrastructure and development. when they all rode bicycles they didn't need nearly as much oil. when they didn't manufacture a lot of goods which included plastics, they didn't need the feedstock. an economy has to grow like an organism.

second, because your model here doesn't address the fact that the chinese can theoretically cut out the middleman. although oil has been priced exclusively in dollars for some time, there is nothing preventing the chinese from approaching e.g. the iranians, offering to exchange some nice silkworm missiles. [in fact, my guess is that this trade is already occurring.] anyway, the chinese only got their dollars by virtue of producing things that others wanted.

if you don't like the sentence: "global demand for oil will shrink during a global recession," how about substituting "global consumption of oil will shrink during a global recession." let's not get hung up on a word-- not because words are unimportant, they are important, but in this instance it's tangential to the central argument. in a u.s. led global recession, u.s. consumption of commodities will decrease. and since the u.s. doesn't produce a lot that the rest of the world has wanted lately, with the exception of financial products, one can imagine the u.s. and the dollar losing its central role in the global economy. furthermore, since the u.s. will no longer be consuming quite so much, the cost of resources will in general decline, making them more affordable for other countries.

[bart]

Re: Credit inflation, Deflation: Prechter Interview

Meanwhile I kept trying and finally got it.

The results are a little hard to discern, because the CPI is so smooth on this scale that the undulations are hard to pick out. Plus it's plotted linear, which compresses detail towards the bottom of the chart. But this is the raw FDI (reciprocal and scaled to 1985=100) along with the four year moving average of the same (FDI4). Then the raw CPI, along with the (Williams) SGSCPI (Shadow Government Stats Consumer Price Index).

Comparing the raw and averaged FDI, notice the lag introduced by taking the four year moving average, along with the smoothing. The tracking of the undulations in the CPI (both versions) with the smoothed and lagged FDI is just visible. The match could be made closer by applying more (longer term) smoothing to the FDI, but in a way that retains the same overall net lag. But that would result in loss of detail for both series. Probably plotting the rate of change would have worked better, but it is getting late and that's a lot more work!

I decided to take a shot at it too, via the rate of change method but as you can see there's likely something I'm missing about the FDI since its volatility is way higher than I expected on an RoC basis - or I blew it somehow. I tried to smooth it with a 1 year MA but no luck.

I also added in my inflation prediction just to see what it may show as we proceed.

[Finster]

Re: Credit inflation, Deflation: Prechter Interview

I decided to take a shot at it too, via the rate of change method but as you can see there's likely something I'm missing about the FDI since its volatility is way higher than I expected on an RoC basis - or I blew it somehow. I tried to smooth it with a 1 year MA but no luck.

I also added in my inflation prediction just to see what it may show as we proceed.

A sore shoulder was keeping me awake anyway so I figured I'd come back and do the ROC chart. It shows the relationship much better.

Since it's ROC anyway, I just plotted it log. This is the negative of the FDI, along with the CPI, each filtered with a two year triangle differentiator. That's the same function I use for the FDR on my site. Indeed, the FDI is much more volatile - it's part and parcel of being more sensitive to changes - so to make the comparison closer I could have used more smoothing on the FDI than the CPI, but decided to just give them the exact same treatment (just for the purist in you ;-).

In addition, I applied no time-shifting. So what you see is each series plotted straight, showing the rate of inflation per each at the time marked on the X axis.

The lag of the CPI is clearly visible. This is especially the case prior to its Boskinization around the middle of the chart. After that bit of tomfoolery, both the level and the volatility of the CPI decline markedly, and the clear lead-lag relationship becomes more irregular.

In addition, only the "regular" CPI is plotted here. The SGSCPI, while maintaining about the same level, loses its volatility just like the BLS version. This is due to the fact that Williams essentially just applies a fixed offset.

In a nutshell, if you smooth and lag the FDI, you get something very close to the what the pre-Boskin CPI reported, and to what it would show now if the same methodology had been maintained.

[Finster]

Re: Credit inflation, Deflation: Prechter Interview

i'm not quite with you here.

first, e.g., because the chinese demand for oil is in part determined by their infrastructure and development. when they all rode bicycles they didn't need nearly as much oil. when they didn't manufacture a lot of goods which included plastics, they didn't need the feedstock. an economy has to grow like an organism.

You're forgetting about the part played by the role of US economic mismanagement in that transition - a key point of my prior post.

second, because your model here doesn't address the fact that the chinese can theoretically cut out the middleman. although oil has been priced exclusively in dollars for some time, there is nothing preventing the chinese from approaching e.g. the iranians, offering to exchange some nice silkworm missiles. [in fact, my guess is that this trade is already occurring.] anyway, the chinese only got their dollars by virtue of producing things that others wanted.

My point was not about the Chinese enonomy. It was merely used to help illustrate a point about the term "demand".

if you don't like the sentence: "global demand for oil will shrink during a global recession," how about substituting "global consumption of oil will shrink during a global recession." let's not get hung up on a word-- not because words are unimportant, they are important, but in this instance it's tangential to the central argument. in a u.s. led global recession, u.s. consumption of commodities will decrease. and since the u.s. doesn't produce a lot that the rest of the world has wanted lately, with the exception of financial products, one can imagine the u.s. and the dollar losing its central role in the global economy. furthermore, since the u.s. will no longer be consuming quite so much, the cost of resources will in general decline, making them more affordable for other countries.

It doesn't help. It merely transfers the indefiniteness of "demand" to another vague term - "recession". This in turn facilitates the rhetorical invention of a hypothetical recession in which consumption shrinks, but production does not. If both shrink, however, the ostensible price effect disappears.

Moreover, neither production nor consumption alone are sufficient to determine prices. Neither supply nor demand. Not even both. A "price" is something conventionally spoken of in relation to a single commodity, but leads to much mischief if we allows ourselves to actually think of it that way. A sales transaction inevitably involves the exchange of at least two commodities - in the case of oil, one being the oil and the other being the dollars. Or whatever currency the exchange is being conducted in. So to fully analyze the price of oil, we need consider not only the supply and demand (or if you prefer, production and consumption) for the oil, but the supply and demand for the dollars as well. The price then, is not merely the value of the oil, but a ratio of the value of the oil to the value of the dollar.

[bart]

Re: Credit inflation, Deflation: Prechter Interview

A sore shoulder was keeping me awake anyway so I figured I'd come back and do the ROC chart. It shows the relationship much better.

Since it's ROC anyway, I just plotted it log. This is the negative of the FDI, along with the CPI, each filtered with a two year triangle differentiator. That's the same function I use for the FDR on my site. Indeed, the FDI is much more volatile - it's part and parcel of being more sensitive to changes - so to make the comparison closer I could have used more smoothing on the FDI than the CPI, but decided to just give them the exact same treatment (just for the purist in you ;-).

In addition, I applied no time-shifting. So what you see is each series plotted straight, showing the rate of inflation per each at the time marked on the X axis.

The lag of the CPI is clearly visible. This is especially the case prior to its Boskinization around the middle of the chart. After that bit of tomfoolery, both the level and the volatility of the CPI decline markedly, and the clear lead-lag relationship becomes more irregular.

In addition, only the "regular" CPI is plotted here. The SGSCPI, while maintaining about the same level, loses its volatility just like the BLS version. This is due to the fact that Williams essentially just applies a fixed offset.

In a nutshell, if you smooth and lag the FDI, you get something very close to the what the pre-Boskin CPI reported, and to what it would show now if the same methodology had been maintained.

Bummer on your shoulder - hope its much better tomorrow.

Gesundheit on that "triangle differentiator" item - can you explain what that is... or is it too kinky? ;)
Maybe it'll help smooth mine so it looks more like yours, and I can then also drop the MA (and yes, to satisfy my purism... but not purity ;)).

Having never charted the RoC of the FDI before, it sure looked like I blew it somehow. I can see the lag to the CPI on both charts too, although it has seemed to shorten since the '80s (and was very close in the '70s - yet another "proof" for the existence of CPI manipulation). I think my 1 year MA removes a bunch of it too.

I'm also not as sure as you on the SGSCPI and volatility, since it has jumped up quite a bit recently, as in the last 3 years or so.

[Finster]

Re: Credit inflation, Deflation: Prechter Interview

Quote:

Originally Posted by finster One further perspective: You apparently believe the US dollar will rise relative to the stock market - another way of saying that stock prices will fall (you say you have a zero stock position). Yet you worry it will fall relative to the rest of the world's currencies.

finster, forgot to include this: i don't expect all of my investments to perform similarly under all scenarios. as you made clear in your discussion of your model 320k portfolio of etf's, i want the components to perform differently. i could well believe that in a deflationary scenario the us stock market would tank but the dollar soar.

It's not a good idea to completely eliminate an entire major asset class from your portfolio. It's almost as risky as holding only one. Stocks, moreover, over the long run, are hands down the best hedge against inflation of all. The benefit of including other inflation hedges such as gold and other commodities comes primarily from their tendency to outperform at a different portion of the inflation cycle. To oversimply somewhat, stocks are the best overall inflation hedge, but perform better during times of stable or falling inflation while commodities perform better during times of rising inflation.

That's one part of having your "components to perform differently" that you apparently do not consider. Instead you appear to view the financial landscape as a binary one-dimensional world of either inflation or deflation. Not that there is no merit in considering such a dimension, but it is only one of the important factors to consider in a multidimensional real financial world.

[Finster]

Re: Credit inflation, Deflation: Prechter Interview

Bummer on your shoulder - hope its much better tomorrow.

Gesundheit on that "triangle differentiator" item - can you explain what that is... or is it too kinky? ;)
Maybe it'll help smooth mine so it looks more like yours, and I can then also drop the MA (and yes, to satisfy my purism... but not purity ;)).

Having never charted the RoC of the FDI before, it sure looked like I blew it somehow. I can see the lag to the CPI on both charts too, although it has seemed to shorten since the '80s (and was very close in the '70s - yet another "proof" for the existence of CPI manipulation). I think my 1 year MA removes a bunch of it too.

I'm also not as sure as you on the SGSCPI and volatility, since it has jumped up quite a bit recently, as in the last 3 years or so.

Don't take my comment on the SGSCPI and volatility as the last word! (Not that you would ;) ). I didn't actually try the SGSCPIROC (another gesundheit), but merely surmised the volatility would be the same as the BLSCPIROC based on your earlier table showing a fixed offset (albeit which increased from one period of years to another).

The triangle differentiator helps a lot. It simpler than it sounds. When you take a simple moving average and then take a rate of change, that's something you could call a square differentiator. Square because all values being averaged get the same weight, and differentiator because you're convolving in a rate of change. The "square" part refers to the moving average. But there are variations on and alternatives to taking a simple moving average. An exponential moving average is one you are probably already familiar with. A triangle filter is just the same thing, except the values in the middle of the range get the most weight, tapering off towards zero at both ends of the range. The idea is that abrupt changes in only one or two values don't cause abrupt changes in your moving average. The overall smoothing applied by a two year triangle moving average is the same as a one year square moving average, but when you take the rate of change, the triangle one comes out smoother because of the lack of those abrupt cutoffs at each end of the range.

Also, rather than perform separate steps of averaging and taking a rate of change, you can do them both at once. You just take your triangle series, take the rate of change of it, and then use SUMPRODUCT to sequentially multiply through the data you want to take a smoothed rate of change of.

Just like you say, this way you drop the separate MA step.

I'll email you the actual spreadsheet that generates the above chart. The triangle differentiator is the outlined box in Column Q. In Columns N & O you see the triangle series - two instances offset by one. Then you just take the differences of them and divide by the total and by the data frequency and you get the multiplier in Q.

This is all on the FDICPIROC tab. It contains the FDI (negative) and CPI in Columns F & G. In J & K, you just have the SUMPRODUCT mentioned above. Chart it on FDICPIROCChart, and presto, you're done.

Figure this way if you want to play with these data or try it with the William's series, you've got the exact same starting stuff as above. Not only that, but it might be interesting to do something like this with your inflation predict. If past is prologue, their should be some correlation. Regardless, you may find it provides a little charting revelry for da Man O Chart!

[jk]

Re: Credit inflation, Deflation: Prechter Interview

finster, re "demand," "consumption." the standard economics 101 supply v demand graph, with each plotted against something called "price" does indeed assume that price is in fixed, even eternal, units. and of course that's not true. but i don't think it adds to our understanding to say that the words normally used in economics have no meaning. to say "demand" doesn't mean anything, "recession" doesn't mean anything is an extreme overstatement of the degree of ambiguity in those terms. no offense, but it feels like quibbling.

i think, in general, that your point about the slipperiness of our units of measure, the changing size of our measuring stick as we seek to describe economic transactions, is an important one. but we understand, or at least i understand, through a series of successive approximations. in the first approximation i assume a fixed unit. in the second i may allow that unit to vary. my original post, lo those many posts ago, was in the first approximation, and i thought of some analytical use. if you don't think so, that's ok too.

re inflation, deflation, and asset classes. recall the 1970's. people entered that decade thinking that equity was a good inflation hedge. [of course using "inflation" in the cpi sense.] it turned out not to be the case. inflation adjusted, the dow lost 75% of its value as it traveled from 1000 in 1966 to 1000 in 1982. in a period of what we would now consider mild inflation, equities might do well, but most folks i respect, e.g. jeremy grantham, hussman, russell, shiller et al, don't see much value in the equity markets currently. on the other hand, they all seem to perceive a great deal of risk. thus i prefer my exposure to be hedged.

[Finster]

Re: Credit inflation, Deflation: Prechter Interview

finster, re "demand," "consumption." the standard economics 101 supply v demand graph, with each plotted against something called "price" does indeed assume that price is in fixed, even eternal, units. and of course that's not true.

Now we’re getting somewhere. You have put your finger on one of the reasons the average conventional university-indoctrinated phd in economics can’t economize his way out of a paper bag. Why he is perpetually confused about things like inflation and growth, why he hasn’t the foggiest notion how to measure either, and why his recommended public policies always seem to end up nudging living standards lower.

but i don't think it adds to our understanding to say that the words normally used in economics have no meaning. to say "demand" doesn't mean anything, "recession" doesn't mean anything is an extreme overstatement of the degree of ambiguity in those terms. no offense, but it feels like quibbling.

Alas, that didn’t last long. Not the least bit of offense taken, but I take it be not only not quibbling, but a principled avoidance of so much sloppy thinking that has led conventional economics astray. Think about it, jk, if conventional economics was so great, why did its polices mess things up so badly in the 1970s? How did somebody as smart as Alan Greenspan let himself be lulled into thinking that his massive monetary expansion and bubble-blowing was not ultimately leading us into a debt-ridden, inflationary mess? How can so many of those ostensibly educated people be arguing all these years about the wonders of our "free trade" policies, monetary and tax policies, while the US goes from creditor nation to the biggest debtor in the history of the planet?

Perhaps you can understand my profound skepticism of what passes for conventional economic thinking? My unwillingness to just uncritically let pass some of the fuzzy and vague but core terms and concepts that it does uncritically accept?

i think, in general, that your point about the slipperiness of our units of measure, the changing size of our measuring stick as we seek to describe economic transactions, is an important one. but we understand, or at least i understand, through a series of successive approximations. in the first approximation i assume a fixed unit. in the second i may allow that unit to vary. my original post, lo those many posts ago, was in the first approximation, and i thought of some analytical use. if you don't think so, that's ok too.

My memory may be failing me, but I don’t recall criticizing your use of an analytically useful first approximation for units of value measurement. I thought that was about "demand". The issue here is another platitude we continually hear from the Wall Street and Washington economics crowd, and that is that oil prices are going up largely due to "increased demand" from Asia. As if badly broken American tax policy and profligate monetary policy had nothing to do with it. Until we recognize that those high oil prices are made right here in the U S A, we haven’t a prayer of fixing what caused them.

re inflation, deflation, and asset classes. recall the 1970's. people entered that decade thinking that equity was a good inflation hedge. [of course using "inflation" in the cpi sense.] it turned out not to be the case. inflation adjusted, the dow lost 75% of its value as it traveled from 1000 in 1966 to 1000 in 1982. in a period of what we would now consider mild inflation, equities might do well, but most folks i respect, e.g. jeremy grantham, hussman, russell, shiller et al, don't see much value in the equity markets currently. on the other hand, they all seem to perceive a great deal of risk. thus i prefer my exposure to be hedged.

You should re-read my last comments on this. As I pointed out, the problem here is an oversimplified, one-dimensional view of inflation versus deflation. The behavior of the various asset classes under inflation or deflation is profoundly different depending on things other than the mere static presence of one or the other. Taking an entire multi-decade cycle of inflation to disinflation (and perhaps deflation) and back to the same point of inflation again, stocks are hands down the best hedge against the cumulative inflation over the cycle. That advantage is particularly great in the part of the cycle where inflation is high but falling. The period in which inflation is rising is much kinder to commodities. You can even see a mini (subcycle) example of that in the recent action of the markets as people perceive the threat of inflation to be receding. Commodities soared while inflation was thought to be rising, and stocks while it was thought to be falling. But - and this is critical - the whole time there was just one ‘flation - inflation.

[bart]

Re: Credit inflation, Deflation: Prechter Interview

... i don't think it adds to our understanding to say that the words normally used in economics have no meaning. to say "demand" doesn't mean anything, "recession" doesn't mean anything is an extreme overstatement of the degree of ambiguity in those terms. no offense, but it feels like quibbling.
...

I fail to see where Finster tried to assert that those terms have no meaning. On the contrary, and no offense intended, but I don't believe you understand his basic points and/or have taken his statements way out of context.

Part of it actually *is* pointing out the woefully and badly misunderstood ambiguity in those terms as well as many other terms, and the concomitant effects on the way "economics" is practiced.

But much more of it is that his main point about the extremes of dollar creation (or "excess liquidity" if you prefer) has seemingly been ignored. When money measures like M3 have quintupled since the early '80s when oil (for example, but there are many others) prices have not, the issues of supply and demand are not the primary factors.
Also note that the Fed is not the only central bank in the "game".

[Finster]

Re: Credit inflation, Deflation: Prechter Interview

I fail to see where Finster tried to assert that those terms have no meaning. On the contrary, and no offense intended, but I don't believe you understand his basic points and/or have taken his statements way out of context.

Part of it actually *is* pointing out the woefully and badly misunderstood ambiguity in those terms as well as many other terms, and the concomitant effects on the way "economics" is practiced.

But much more of it is that his main point about the extremes of dollar creation (or "excess liquidity" if you prefer) has seemingly been ignored. When money measures like M3 have quintupled since the early '80s when oil (for example, but there are many others) prices have not, the issues of supply and demand are not the primary factors.
Also note that the Fed is not the only central bank in the "game".

...pssst...

...I think this was where you're supposed to bag 'm with a chart ...

;)

[bart]

Re: Credit inflation, Deflation: Prechter Interview

...pssst...

...I think this was where you're supposed to bag 'm with a chart ...

;)

ssshhhhh.... he hasn't answered yet... its more satisfying when its like a double barreled 12 guage going off with a pause in between... ;)

[jk]

Re: Credit inflation, Deflation: Prechter Interview

ssshhhhh.... he hasn't answered yet... its more satisfying when its like a double barreled 12 guage going off with a pause in between... ;)

finster, i think i understand why you think equities are good inflation hedges. since, i gather, equities are one of the asset classes used to calculate your fdi, and thus your personal indicator of inflation, fdr, they must by definition be inflation hedges. all else being equal, if equities go up, the dollar's value, in terms of how much equity it can purchase, has gone down by precisely the same amount! thus, all else being equal, equities are the perfect hedge for equity-based inflation!

more generally, if we assume for a moment, and for the sake of simplicity, that your fdi is calculated based on a fixed basket of goods and assets, then of course that very basket will be a perfect inflation hedge! [figuring this out is almost as exciting as when i learned i was speaking prose! and i had been speaking prose all along!] and every item in the basket, viewed in isolation, will be a less than perfect inflation hedge, but an inflation hedge nonetheless!

have i got it now?

bart, finster - you two should get a room.
finster- you should clean out your mailbox.

[bart]

Re: Credit inflation, Deflation: Prechter Interview

bart, finster - you two should get a room.

If we do, will you then listen to what either of us are actually saying?

It literally and seriously seems from here that almost no matter what Finster or I post, you question or critique it... which is of course your right. My point here is that disagreeing is fine, but I'm not at all certain you truly understand the basic views.

This chart, for example, should show you a great deal of what both he and I refer to when talking about cycles and stocks and gold too, for that matter.

if we assume for a moment, and for the sake of simplicity, that your fdi is calculated based on a fixed basket of goods and assets, then of course that very basket will be a perfect inflation hedge! [figuring this out is almost as exciting as when i learned i was speaking prose! and i had been speaking prose all along!]

And just precisely what is that supposed to mean???
You make an assumption, based on very few if any facts, and then hold it up to ridicule?



(sarcasm on)
Here are a few more ways to make "logical" comments:

If you agree with me that Appeal to Flattery is the greatest fallacy, it shows that you are intelligent and good looking and really good in bed. And a snappy dresser.

If you don't agree that Appeal to Pity is the greatest fallacy, think how it will hurt the feelings of me and the others who like it!

It's obvious that Bandwagon is going to win as the greatest fallacy. You wouldn't want to be one of the losers who choose something else, would you?

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This is the best logical fallacy, and if you disagree with me, well, you suck.

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Your logical fallacies aren't logical fallacies at all because Einstein said so. Einstein also said that this one is better.

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See, my mom, she had to work three jobs on account of my dad leaving and refusing to support us, and me with my elephantitis and all, all our money went to doctor's bills so I never was able to get proper schooling. So really, if you look deep down inside yourself, you'll see that my fallacy here is the best.

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If you don't agree that Appeal to Force is the greatest logical fallacy, I will kick your ass.

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Begging The Question:
Circular reasoning is the best fallacy and is capable of proving anything.
Since it can prove anything, it can obviously prove the above statement.
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Therefore, circular reasoning is the best fallacy and is capable of proving anything.

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Can you prove that Burden of Proof isn't the best logical fallacy?

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Have you stopped beating your wife and saying Complex Question isn't the best fallacy?

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I've found that either you think False Dilemma is the best fallacy, or you're a terrorist.

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All of the other fallacies are decent, but clearly not the best as they didn't come from my incredibly large and sexy brain.

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*(insert pictures of Hitler, Stalin, and Pol Pot here)*

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Non Sequitur is the best fallacy because none of my meals so far today have involved asparagus.

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Since I've started presuming that correlation equals causation, violent crime has gone down 54%.

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(sarcasm off)