Deflation, impotent injections by the FED, & the forgotten value of perceived scarcity.
So, I was having this particularly vivid dream last night.
>>>>In my dream, I am a reporter. I am entering (ostensibly for a story) a seedy brothel evidently named 'US Economy' from the flashing neon sign. After working my way inside, I find a long line of pleasure industry workers. I note plenty of makeup and perfume have been applied, but far too few baths.. Branded on the buttocks of each of these beauties is their working name; Citi; AIG, Chrys(ler), GM. and numerous others. The line leads to a door that opens upon a most repulsive scene. There is Bernanke, riding on GM's twin sister GMAC, yelling 'You brought this on yourself!' 'Take it Take it, you know you like it!'. Bernanke glances over to the corner where Snoop Dog nods approvingly and adds, 'Take it, BAiaaanchNK'.
I can tell Bernenke thinks he's giving it to GMAC, like GMAC has never had it. Maybe he is, but from the look on GMAC's face, he's not even touching both sides of that loose coffer. Like a hot dog down a hallway, his multi-billion buck 'contribution' doesn't get a rise out of GMAC, or anyone else for that matter. A little flush and far too naked, Bernanke dismounts and bellows 'NEXT'!!<<<<
Were it not for a previous dream in which I was witness to a very graphic and most unsettling menage-a-trois between Alan Greenspan, Margaret Thatcher and Yassar Arafat, this would easily have qualified as a nightmare. That, and the fact, it pales in comparison to many probable outcomes of our present economic trajectory. So, while you have been spared the ludir details of said menage-a-trois,you should realize the potential catastrophe looming, and with that point of reference, agree I merely experienced a bad dream but no nightmare.
Nightmare or not,, why proceed this way? Why present these scenes, which by all accounts should have remained private? Consider it a vaccination, temporarily inoculating against prurient distractions, and allowing concentration upon a completely non-sexy topic: economics.
A few themes concerning economics, which I consider very off base, come up again, and again, in traditional media, blogs, commentary, and everyday conversation.
Here is a partial list of the themes and why these are misguided:
1. Deflation is a 'good', since it makes things more affordable.
This myth probably stems from a confusion between 'a decrease in prices' and 'deflation', as well as a lack of understanding about the effects of actual deflation. A good analogy is weight loss. For most Americans, losing 10 lbs in a month would be a good thing, but losing 10 lbs a month continuously quickly becomes disastrous if it cannot be stopped. The former is analogous to a decrease in prices, the latter to deflation.
Specifically, three aspects of deflation make it particularly troublesome: Delaying/Hoarding Feedback Loop, Prices Falling Below Production Costs, Production Destruction.
Delaying/Hoarding Feedback Loop: This is a self exacerbating characteristic of deflation. When presented with continually declining prices, consumers delay or cancel most planned purchases (when money is tight, why would you buy today for $10 what you can buy next month for $9) , and investors are heavily biased to short term, high liquidity investments or cash. As economic activity decreases as a result of decreased investment and decreased purchases (i.e. Demand Destruction), more people are laid off and investments decline even more, causing further Delaying/Hoarding, and creating a self amplifying feedback loop, or deflationary spiral.
Prices falling below production costs: typically material costs are only a fraction of the total cost of producing goods. As prices fall, producers are hard pressed to reduce other costs so they can remain profitable (and in business). The largest component is typically labor costs, so reduction in wages is inevitable. Wage concessions that were previously unthinkable will be accepted in a time of high and increasing unemployment, after all, any wage is better than no wage. Prices do not decline evenly and some costs are more fixed than others. When price declines reach the point that the cost to produce exceeds the price at which goods can be sold, massive layoffs result. When this effects numerous businesses, deflation accelerates. This phenomenon is now evident in US housing and some other industries.
Production Destruction: If Demand Destruction causes and fuels deflation, Production Destruction is one of the results. As demand continues to fall, and businesses shut down, the capability to produce goods may actually be destroyed at a more rapid pace and to a greater degree than the decline in ultimate demand. The ubiquitous delays in purchasing even vital goods (as consumers eliminate personal inventory, or go without for a limited time) and the stocks of unsold goods remaining in inventory and supply chains, create conditions where substantial production capability may be lost, before any scarcity develops. Since production cannot be turned on, as quickly as it was turned off (companies that went out of business, sold assets, and dispersed remaining capital. workers who were laid off, may not be easy to contact and rehire), when consumers can no longer delay vital purchases and return to purchase, they may find an alarming under supply of vital goods. Hyperinflation, even to the point of complete destruction of the currency (how much would a mother pay for food for her children...) and civil unrest could result.
Food is an easy example to consider.. As prices drop, and families become more worried about layoffs, they begin to use the food inventory in freezer and pantry. Because times are tough, everything gets used, even the old cans of cranberries and the frozen who-knows-what in the back of the freezer. The steep reduction in sales causes the grocery store to cancel or severely reduce orders to restock. The elimination in orders cause the food processing companies to layoff workers and idle plants. With no demand from those processing plants, farmers and ranchers curtail future production: for example if corn is not selling, then fewer acres will be planted and less fertilize used (leading to a destruction of the ability to produce fertilizer); if chicken are not selling, or the price keeps dropping, fewer will be kept to produce, instead most will be sold or eaten. This effect is compounded by livestock sold and acres unplanted due to bankruptcies. Commodity futures are likely to exacerbate this effect. By the time inventory at the consumer, retailer, and wholesaler levels have been depleted and demand returns to the vital minimum, the supply deficit may take more than a year to correct, since the fields are not planted and the brood stock has been sold off. At this point, people become acutely aware that no amount of money can correct the gap between what is required to feed people and what is available.
So, no, deflation does not make things more affordable. Deflation is definitely not good.
2. The credit crisis was caused by the Greedy _________ (fill in the blank with: Bankers, Consumers, Wall Street Executives, CEOs, or choose your own favorite group to hate on).
Sure, there is plenty of blame to go around. What strikes me as absurd is that invariably, the adjective used to describe those to blame is Greedy. What the blame casters are suggesting is that the Greedy are responsible, or that Greed itself is responsible.
Perhaps you even agree the Greedy are to blame. 'Pot calling Kettle... Come in Kettle'
Just so we are on the same page, here is Merriam Webster's definition: Greed: a selfish and excessive desire for more of something than is needed.
I'm going to go out on a limb here and say that no one reading this is a subsistence farmer, producing only what is needed for you and your family. Even if you are, and you just happened to wander into a friends house, or a library to use the Internet, why would you be in CAPS, if you do not desire for more than you need? Even if you have rationalized yourself past those two ideas... which of you would not accept a $10,000,000.00 Publisher's Clearing House prize, if it showed up on your doorstep tomorrow morning?To accept it is to desire to more than you need, even if your desire is ostensibly for the purpose of deciding to which charity it is to be given.
If it is just now you realize greed is part of your person, do not despair. Greed is a healthy part of the human condition. Greed is not evil as some would suggest. Closer to evil, is making suggestions to others that cause feelings of guilt for possessing very human qualities (such as greed).
You may not swallow that last bit, but hopefully you will think twice about blindly blaming Greed. Greed is a necessary part of a market driven capitalist economy, and although a representative capitalist republic is a terrible form of government, it is still better than all the rest.
3. Allowing __________ (fill in the blank: Auto producers, home builders, horse and buggy whip manufacturers, etc) to go bankrupt will be a huge blow to the economy, so we need to provide loans, and loans are not a bailout.
First of all: Yes it is a bailout. These loans have a high likelihood of default, and just because you might get paid back, does not mean you didn't bail them out (if you help a guy push his stalled car out of traffic, when he says "thanks, I owe you one', that doesn't mean you didn't help him out.)
More importantly, in industries where financial difficulties exits throughout the industry because the assets and labor allocated to production far outweighs what is required by demand, propping up failing companies only delays that companies downfall, or worse, shifts the downfall to a more health competitor in the market. A supply demand imbalance cannot be fixed by artificially sustaining the ability to produce at levels greater than that required by demand.
Supporting builders or auto makers or whomever, on the grounds that any downfall will be devastating, is idiocy. The tragedy is that any devastation is unavoidable, has already begun, and is only exacerbated by dim-witted meddling. Bankruptcy must occur so that assets can be liquidated and put to better use, and so that production can be curtailed to those who are more efficient.
4. All the stimulous is INFLATIONARY, the powers that be will continue injecting liquidity, and soon we will see growth again.
The fallacy here is a misunderstanding about what constitutes money. For the purposes of money supply and inflation/deflation, money is only money if it is transacted. Every citizen in the United States could be given an extra $100,000.00 in their bank accounts, and if they only spent $10.00 of it, it would have the same stimulative effect as if every citizen has only been given $10.00 and spent all $10.00.
Increasing the money supply is reaching a level of diminishing returns of effect. Thankfully there is another side available for managing this money supply/demand imbalance causing our current pricing crisis. This other side goes woefully unmentioned; the demand side.
What is desperately needed is an increase in the demand for money. A increase in the demand for money can be brought about using incentives to invest and to loan to those who would invest.
Most investors are searching for investments with a favorable probability of sufficient returns as related to the risk incurred. If a large asset class can be expected to experience significant market based price increases over a long period, then investment will eagerly follow.
And this (finally) brings me to the point. Increases in perceived future scarcity is a strong motivator for price increases. Reasonable expectations of continued price increases in a major asset class would certainly stimulate significant investment. Significant investment is a demand for money and would be an increase in the velocity of money and therefore and increase in the real supply of money. If sufficient in scope, this inflationary effect would end the deflationary spiral, and begin reflation. Growth in the economy would soon follow.
Investors can reasonably expect sustainable price increases in residential housing, if the future production of newly constructed residences will be significantly constrained. Pricing disincentives are likely to be the most effective method for constraining production and maintaining a perceived future scarcity.
An example of such a pricing disincentive is a tax targeting both housing starts and sales of newly constructed homes. Ideally the portion on housing starts would go into effect immediately while the sale portion would be initially delayed to go into effect no sooner than 6 months after passage, but no later than one year. The tax should also be significant but should lessen in later years.
An example would be a tax with two components. The first component being a tax due when permits are approved in the amount of 10% of the estimated final sales price (with a penalty due at closing for portions unpaid due to underestimating or a refund for any excess), this tax would go into effect when signed into law. The second component would be a tax of 10% of the actual sales price or 10% of twice the assessed value due prior to occupancy or at closing. One year later the tax at closing or occupancy would decrease to 9%, and 1% each year thereafter until eliminated, after which the tax upon permit approval would decrease by 1% each year until eliminated.
The growing need for housing and the predictable constraint on new supply would cause an increase in existing housing prices and an increase in investment in housing.
I encourage critical comments and suggestions.