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The Task of Depression is Margin Compression



October 19, 2010 – Comments (2)

I originally found this on the Pragmatic Capitalist. Great post.


gaius marius
Thursday, October 14, 2010


Serious economic downturns can be characterized any of inflation, deflation or price stability. What they all have in common is margin compression -- where the change in the price level of raw inputs and unleveraged assets rises relative to the price level of finished goods and leveraged assets. While many consider the great depression of the 1930s to have been a deflationary event (and it surely was) it is instructive to note that commodities deflated by far less than finished goods, and those by far less than the value and income generated by financial assets. What made the economy of the 1930s so destructive was the inability of businesses, beginning in late 1930, to sell products in any meaningful quantity at prices that covered their cost of manufacture. This has been true in every serious depression to my knowledge.

Today, the Federal Reserve is attempting -- brazenly -- to raise the general price level of the economy as a whole by exchanging financial assets with the private sector, substituting income-generating instruments for newly-created cash reserves. This is an effort to undo some of the tremendous balance sheet damage in the private sector, as well as improve terms of trade for American exporters (as the trade value of the dollar is expected to fall under such circumstances). An examination of the fed's h.4.1 will show that the size of the fed's balance sheet continues near an all-time high of $2.3tn. More asset purchases are likely underway -- the fed's POMO schedule of acquisitions continues relentlessly, and an explicit program of quantitative easing is expected in response to ongoing economic weakness.

Here's why i think the FED may be forced to relent.

The leveraged asset market that the fed would like to raise from the dead it cannot touch. Housing is titanically oversupplied, and the FED's efforts to cheapen rates have served mostly to increase the percentage take of the banks in refinancing rather than increase purchasing power of new buyers.

2 Comments – Post Your Own

#1) On October 19, 2010 at 7:22 PM, MegaEurope (< 20) wrote:

If you recall, there was quite a bit of margin compression in 2008-early 2009.

Of course, bears think a recession is not enough.  We deserve a full-blown depression.

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#2) On October 21, 2010 at 8:05 PM, ChrisGraley (28.71) wrote:

Good post binve!

Also, good reply MegaEurope.

But I think the Bears are more concerned about what we fixed than if we suffered enough damage.

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