Monday, November 9, 2009

I'm Deflationary

Roubini sees heavy deflationary forces through '12

At a conference, Roubini said that although easy monetary policies have fueled another asset bubble, the deflationary forces coming from industrial overcapacity, falling labor costs and a still damaged financial system will prevail over the next two years.

I have listened to the arguments of commodity bull Jim Rogers and the counterarguments of Nouriel Roubini. I find Roubini's arguments much more compelling. That's especially true after looking at long-term cement prices in my last post.

I did not believe in the global decoupling theories heading into the last commodity bust and I do not believe in them now. (As you may recall, I heckled Chinese investors heading into their Olympics.)

As such, I am changing my short-term inflation mood in the upper left hand corner of my blog to show my deflationary bias. That doesn't mean that I think oil can't make it to $100. Who knows? I don't think it will stay there if it does though, any more than it could stay at $140 the last time.

It eventually all comes down to supply and demand. We built a supply side based on never ending debt-based demand. Now we're watching it all fall apart.

As a side note, my girlfriend just bought a gallon of milk for 99 cents. How is that even possible?

Milk Prices Start to Rise

Dairy officials say this slight uptick in prices is not a long-term fix and they're still pushing for a change in the federal milk pricing system.


mab said...


I'm still deflationary!

I had a mini debate with a poster on another blog. They claimed that prices were only down slightly from recent highs and that prices were still much higher than a few years ago. I couldn't agree more. However, those facts only make me less fearful of inflation, not more fearful. People can't spend what they don't have. It's that simple to me.

In the 1970s, inflation was rising rapidly, but so were wages. I know wages trailed inflation but they were still rising rapidly. Wages are a very important cog in the inflation transmission mechanism. And I just don't see wage inflation now or in the foreseeable future in the I.O.U.S.A. Too much debt.

Here's another brick in the foundation of my deflationary thinking. I bought my house 15 years ago using an adjustable mortgage with a 5 year lock. The mortgage interest rate I pay has been dropping consistantly since the lock expired except for the last year of the housing bubble when the rate shot up. But even that increase was after a period where I was paying well under 5% interest for several years. A week ago, I received notification that my new rate was 3%! My monthly mortgage payment is now less than the original payment despite the fact that insurance and property taxes have gone way up.

I'd pay the mortgage off, but at 3%, the Fed has put me in a positive carry trade position. I have safe (I think) fixed income securities that yield more than the 3% even after taxes.

And there is more to my deflationary thinking with regards to real estate. The current value of my house is off ~ 25% based on recent sales and confirmed by Case Shiller (NYC metro area). Yet, even with that decline, if I sold my house the proceeds would be such that I not only would have lived 15 years rent free (counting PITI only), but I would have a small profit. Mind you, I don't live in a trophy house that people would enter a bidding war over. Not by a long shot.

No way can people live rent free.

I think real estate prices have further to fall and, hence, I just don't see the CPI getting out of hand with the biggest component in the crapper.

Stagflationary Mark said...


I too would have lived rent free if I took profits on my home today (bought in 1997).

Maybe we'll be similarly lucky with healthcare reform!

And maybe monkeys will fly out of my... well, you know.

mab said...


I unloaded half of my TIPS investment for a very nice short term return. It was supposed to be a long term holding, but returned far more than I ever anticipated.

Inflation expectations are rising, now ~ 2.25% over the next 10 years. That's not an unreasonable inflation expectation, but it is above my forecast.

Real yields are falling, now ~ 1.25% based on the 10 yr TIPS. That's probably not a bad deal given the alternatives.

In any event, the potential volatility didn't seem worth the potential return.

I've basically decided to bury the proceeds in the back yard. Bernanke is steering people toward risk, but he won't let them get a market based risk premium. I refuse to play in his rigged game.

Stagflationary Mark said...


You've basically made a double-dip recession bet. Haven't you heard?

"Investors Needn’t Fear a Double-Dip Recession"

"After reviewing U.S. economic history all the way back to the 1850s, Deutsche Bank AG (NYSE: DB) economists found that double-dip recessions are exceedingly rare: There have only been three episodes in which the economy has fallen back into recession within a year of a previous recession ending. And that’s out of 33 recessions that have taken place since 1854."

Perhaps we were relying on foreign oil in 1854 to power our horses? Perhaps there was a "cash for horses" program to help stimulate demand? Where do China and India fit in?

For what it is worth, when the financial experts tell me not to worry about something I tend to worry about it more. I'm especially "eager" to worry when the reasons date back to 1854. Maybe that's just me not believing that all that prosperity in the rear view mirror will necessarily translate into future prosperity.

How can it be exceedingly rare that double-dips occur? A roughly 10% chance of something happening is NOT exceedingly rare. If I had a car accident 10% of the time I drove my car, my insurance company would certainly not buy into my claim that my accidents are exceedingly rare and that I should continue to deserve low rates, lol.

Further, what are the odds of a recession in any given year? 10%? If true, that would mean a double-dip recession would be just as common as a normal recession.

"Never assume that because a man has no eyes he cannot see."

I may not see exactly what is going on, but I do know that the wool being placed over my eyes is itchy!

P.S. I too have thought of locking in some profits on TIPS by the way. I've decided to just ride it out again if it happens. As a saver, deflation is the last of my worries and my market timing skills aren't all that great. I turned bearish in 2004 and it took over three years for the economic dam to break. It might take a similar amount of time for the dam to break again. I doubt it, but you never know.

Stagflationary Mark said...


One more thought. For what it is worth, it seems William Pesek agrees with my take.

"To me, Roubini’s worries are more persuasive than Rogers’s bet on gold. That also goes for Roubini’s view that bubbles pervade rallies in emerging-market stocks. They do."

That's almost exactly what I said (and you have been saying).

mab said...


"Never assume that because a man has no eyes he cannot see."

Ha! Kung Fu was one of my favorite shows growing up. I also wasted a lot of time watching Black Belt Theater.

For much of my childhood we only had a TV with rabbit ears. The reception was awful and we only got about six or seven channels. We used to take turns standing in a certain spot near the TV. For some reason, standing in that one particular spot improved the reception. No joke.

I'll add a little yin to go with the yang from your Kung Fu quote.

Never assume people know what they are doing just because they are in charge

Bernanke may know how to save banks, but he has no clue how to save the rest of the economy.

mab said...


For what it is worth, when the financial experts tell me not to worry about something I tend to worry about it more.

Fantastic point. As soon as I hear the words "financial expert" I start to worry. Financial "experts" are salesmen in nice suits. They're especially effective at selling lies when they have a "validation" from an Ivy League school and/or work for an imfamous firm like Lehman, Bear, Morgan or Goldman. Here's the idiotic thinking of most investors:

Oooooohhhhh! They make lots of money so they must be really smart. I definitely should let them gamble with my money.

It's not hard to see the circular logic and self reinforcing behavior that ensues.

Here's one. All the "experts", including Pesek, are watching reserves. Based on a corollary to your above theory, we shouldn't be worried about what the "experts" are worried about.

When I was reading about the Basel Accord Bank regulations I also looked up the history of bank reserves. As far as I can tell, reserves have far less bearing than people commonly believe. In fact, banks were never really constrained by reserves:

The bank of Japan flooded the system with reserves to no avail. Bernanke has done the same thing and yet net bank lending is still alarmingly negative.

Banks are constrained by asset/collateral values. Hence the low interest rates, quantitative (dis)easing, off balance sheet bullsh%t, mark to model accounting changes and extend and pretend games.

Even if Bernanke can successfully pump up asset prices, will it be sustainable while incomes are falling and private credit demand is negative? I have my doubts. Greenspan couldn't do it when incomes were rising.

Those that are able to borrow are largely unwilling. Those without incomes and those that are over-indebted can't borrow.

Our future looks like Japan to me with one key difference. Households in Japan were big savers so they didn't need to lower their living standard much if at all. American households have way too much debt and I think many will be forced to reduce their standard of living.

One more thought. Finance is the only profession where the experts are more successful if they only possess partial knowledge.

Stagflationary Mark said...


"It's not hard to see the circular logic and self reinforcing behavior that ensues."

Speaking of expert "circular" logic, Steve Liesman on CNBC recently compared our 10% unemployment to the circumference of a quarter and held up a basketball to represent those with jobs. I was instantly reminded of the experts marginalizing subprime problems as being so small just a few years ago.

Circumference? Is that really a good analogy? That's just proportional to the diameter. How about volume! How many baseballs could we fit inside the basketball. Then we'd have a decent analogy. I'd guess about 10 more or less.

Further, now that we have a baseball representing the unemployed we could let outsourcing and the rise of the banking system represent the bat. I think the ball's been hit way out of the park. For the game to continue, we're going to need to find more balls.

Oops. I think I just offered a bonus analogy! ;)