Tuesday, August 17, 2010

First Deflation, Then Stagflation?

I once again find the thoughts of Andy Xie compelling. Here's an excerpt.

August 17, 2010
China Swallows Obama Stimulus Meant for U.S. Economy: Andy Xie

How will this all end? Ideally, before inflation takes hold in the U.S. and Europe, the costs in emerging economies will rise high enough for multinationals to invest and hire in the West again. I wouldn’t count on that. The average wage in the developed economies is 10 times that in emerging markets. There are five people in the latter for one in the former.

A more likely scenario is that the West will have to stop stimulus programs when inflation spreads to it from the emerging economies. The most immediate channel is through rising commodity prices. It’s a tax on the West to benefit emerging economies that produce raw materials. That’s the irony: The stimulus in the West can immediately bring harm to itself. It’s also the magic of globalization.


I turned deflationary on November 9, 2009. WTI crude oil was $79.44 on that day. As of today, it is now $75.77. The seasonally adjusted CPI was 216.859 in November 2009 and it was 217.597 in July 2010. That's a 0.34% increase (0.51% annual pace). I had hoped for a bigger bang for the deflationary buck.

I'm willing to stay deflationary through yet another Christmas season but then all bets are off.

I continue to own inflation protected treasuries and I-Bonds. That's my long-term plan to ride out the storm. I expect to experience pain, mostly through the taxation of the inflationary gains if serious stagflation does appear.

August 3, 2010
Andy Xie: Fear empty flats in China's property bubble

China's housing oversupply isn't surprising. Excess supply reflects the under-pricing of capital, and China's system is structured to increase supply quickly. But rising prices alongside rising vacancy rates are surprising. Normally, speculators are spooked by high vacancy rates. But China's phenomenon is unique for at least four reasons:

I will leave that as a teaser. The article deserves to be read in its entirety.

And lastly, if Andy Xie is right then the 1970s will look like a picnic by comparison. We'll be heading into a stagflationary environment with unemployment already high. Ouch.

13 comments:

  1. 1970s Trivia

    Oct 1973 -> Nov 1982

    Unemployment: 4.6% -> 10.8%
    Average Hourly Wages: $4.21 -> $7.98
    CPI: 45.6 -> 98.0
    10 Year Treasury: 6.79% -> 10.55%

    Wages: +90%
    CPI: +115%
    Real Wages: -12%

    ReplyDelete
  2. Stag,

    From the first Andy Xie link:

    Lastly, labor in the West will demand wage increases to compensate for current and future inflation.

    Demand? Wage Blowout???? I just don't see it. Seriously, if American workers had any wage bargaining power they would have been using it already. The average American is screwed - forced to compete with robots and $1/hr global labor.

    One thing to keep in mind about the stagflationary 1970s is that, despite a high unemployment rate, the total labor force was increasing. That's not the case today. As you know, we haven't created a single private sector job for a decade.

    http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=CLF16OV&s[1][transformation]=pc1

    Deflationary depression looms!

    ReplyDelete
  3. mab,

    That's the main reason I offered the 1970s trivia and ended with real wages.

    I was not sure what he was intending to say with his "wage-price surge". I could only assume that he was speaking in nominal terms, not real terms.

    As I showed above, real wages DROPPED 12% from October 1973 to November 1982.

    I think he's saying that if we continue down the path of trying to create inflation to stave off deflation, all we're going to get for it is higher commodity prices and more pain. Seeing as how oil is now in the $70s and copper is once again near its all time high, I do think he's got a point.

    That said, I'm not sure where he stands on our second half slowdown potential.

    Here's a concern. An ongoing 1970s environment would be one mechanism to lower American real wages to match China's. Sigh.

    I agree with him on almost everything he writes, so when I disagree I tend to get very nervous.

    I do think we'll get stagflation eventually, but like you I think we've got some more deflation to burn through first.

    Chanos thinks the commodities China's using to build infrastructure will crash. Xie thinks China is in a bubble too.

    China is already in a stagflationary environment to some degree. See Xie's second link and the four reasons investors are buying real estate.

    1) A sustained negative real interest rate has led to a falling demand for money and rising appetite for speculation. Greed and inflation fears are working together to form unprecedented speculative demand for property.

    That's so 1970s.

    ReplyDelete
  4. mab,

    In other news, you might enjoy this. I do, lol.

    Richard Koo, Chief Economist, Nomura Research Institute explains how this "Balance Sheet Recession" is different

    With the credit available to the private sector falling, how are you going to get inflation? So I think those people who are worried about inflation will be disappointed.

    I am worried about inflation by being in TIPS clearly, but I will most certainly NOT be disappointed if we don't get it!

    There is always a possibility that the central bank will do something crazy and stupid like dropping money from a helicopter. I think people are worried because Mr. Bernanke has this nickname “Helicopter Ben”. And at least until 2 years ago, he has said a few things suggesting that one day he might do that. That really got me worried. Even I wanted to buy gold when I heard Mr. Bernanke talk like that. In these days, I don’t see that type of talk coming from Mr. Bernanke. So the possibility of hyperinflation, the central bank losing its credibility and control, is not as high as it seemed 2 years ago.

    ReplyDelete
  5. I read Koo's research and book on "balance sheet recessions" several years ago. It made a lot of sense to me.

    Bernanke's helicopter only drops money on Wall Street. Bernanke knows who his masters are.

    Fed independence is a ruse. The Fed is independent of accountability. And CONgress does NOT serve the majority. I think the odds of a helicopter drop on Main Street are nil.

    ReplyDelete
  6. mab,

    I read Koo's research and book on "balance sheet recessions" several years ago. It made a lot of sense to me.

    Now you tell me! ;)

    Well, what I read right there made sense to me. I especially enjoyed the "even I wanted to buy gold when I heard Mr. Bernanke talk like that."

    No joke! If I had not read that 2002 deflation speech then I probably would not have bought gold and silver in 2004. Oil had NOTHING to do with my bearishness back then. It was pure debt and that SHOULD have made me very deflationary.

    So do I thank Bernanke for writing that speech? Gold and silver treated me very well. Or should I chastise him for writing that speech? It actually got me to hoard hard assets during a hard asset bubble. And I'll tell you this, I was a basket case. The thought of buying MORE stuff to protect me against those who bought TOO MUCH stuff on credit just seemed wrong.

    These days I see few basket cases though. Most seem SO sure where gold will go next now that it is much more expensive compared to toilet paper. Go figure. If all we were doing was looking at toilet paper prices over the last 10 years though, we'd see virtually nothing out of the ordinary, not that I could convince shadowstats fans of that.

    ReplyDelete
  7. 1) Productivity counts too. US workers are more productive than Chinese ones. That might help.

    2) Some jobs may not come back to the USA - they will move to even poorer countries. Wage arbitrage could be with us for decades if not longer. I know a large furniture factory in China just opened their first plant in Bangladesh as they can make low-end items cheaper there.

    3) China (and Taiwan and Japan and Korea) should have not been so mercantilist. A simple open trade system would have let them get rich and keep their customers around for a while. A slower globalization would have arisen then.

    4) I saw inflation coming from China in 2007-2008 as prices kept going up in Asia. For a while, the importers could squeeze suppliers, or switch suppliers, but eventually the inflation may come through. Labor rates have gone up in China and I imagine the population there now has an expectation of rising wages built-in. One thing people say about keeping the RMB artificially low is that it just ends up like this: raw materials and labor ends up inflating in cost, with the same end result.

    5)2007-2008 were shitty years for me. Customers refused price increases and went to the scumbag suppliers instead to save a nickel. It was a constant battle to just keep your current cost in order - product development was cancelled and instead we squeezed out as much steel as we could from products, cheapening them. Whole items died as they no longer met 99.99 price points. If this happens again, it will suck.

    Coba

    ReplyDelete
  8. "I know a large furniture factory in China just opened their first plant in Bangladesh as they can make low-end items cheaper there."

    I felt a lot of schadenfreude on this, as the company is sending their Chinese managers and experts to teach the Bangladeshis that may take their rice bowl. Hope the Chinese enjoy this as much as the Taiwanese/Americans did when we did that.

    ReplyDelete
  9. OK, so as an investor, buy Chinese and Indian company stocks as they will be competitive and gobble up everything until the wage arbitrage is over. That could take 20-30 years.

    ReplyDelete
  10. Coba,

    Thanks for sharing that. Right or wrong, I'm a believer in hoarding goods that we buy from China and India.

    I have nearly a lifetime's supply of t-shirts for example. They were bought at Eddie Bauer's outlet store at a time when the economy was hurting. I don't think it is a given that the downward trend in apparel prices is a permanent trend.

    If nothing else, I'm especially pleased with my sock hoard. Heading into the housing bust, my local Wal-Mart sold fairly high end Gold Toe socks much cheaper than department stores. They don't sell them now though. It's all cheap crap now. That alone made it all worthwhile.

    Another thing that fascinates me is the rise in price of pyrex storage pans in recent years. We bought a LOT at much lower prices. We make our own "TV Dinners" now. That's a permanent change in behavior and the kind of thing that really should keep Bernanke up at night. There is nothing he can do now to change me back. As a saver, his lower real interest rate solution just makes me "save" elsewhere. I therefore eat out less, much to the dismay of our restaurant industry.

    ReplyDelete
  11. "I felt a lot of schadenfreude on this, as the company..."

    An ongoing gallows humor joke of mine...

    You know what they say, misery loves companies!

    ReplyDelete
  12. "I have nearly a lifetime's supply of t-shirts for example."

    Just watch the beer and ice cream consumption, or these assets will be ruined by inflation.

    ReplyDelete