Nenner: Deflation Now, Inflation Later
A: Charles Nenner is out today with a call that the deflationary episode is not yet over, and still has to run its course. Meanwhile, he discusses how inflation will kick in down the road (18 months) and continue in an 'upcycle' for about 30 years. I have to admit, I am in a very similar camp as Nenner in terms of another wave of deflationary pressures before the true inflation cycle begins.
Charles Nenner, founder of the Charles Nenner Research Center, discusses on Yahoo Ticker:
Renowned for his cycle work, Nenner sees deflation remaining dominant until year-end and inflation not picking up for another 18 months. But that will be the start of a 30-year (yes, year) upcycle for inflation says Nenner, who spent 12 years as a market-timing consultant for Goldman Sachs. Nenner believes the "deflation trade" is about to reassert itself in the short-term, meaning strength in the dollar and Treasuries, and weakness commodities and equities, as we'll discuss in more detail in a forthcoming segment.Nenner did discuss the deflation 'scare' in late 2007. Here is a question for you:
For those who believe the dollar is doomed, Nenner notes "all currencies are bad." In other words, currency trading will be a game of relative bets vs. a one-way trade against the greenback, as so many expect.
Q: If the fed continues with a Zero Interest Rate Policy, stimulus everywhere both monetary and fiscal, tons of credit facilities and programs to recapitalize the banks, bailouts galore, and pure QE money printing to the tune of trillions of greenbacks out of thin air, then WHY oh WHY won't there be hyperinflation, or at least inflation in our immediate future?
This is a question many people ask me, as if I am omnipotent or something. I'm not. But I do have my views on this topic, like most people. Fact is, YES, the fed is printing trillions of dollars and stimulating like mad, and you can see the surge in the adjusted monetary base - but that surge is mainly sitting idle in excess reserves. Thats the thing. Our fractional reserve system of banking, with its money multiplying debt creation effects, is not operating normally and very rightfully so.
If you have trouble grasping this concept, that the newly created money is not entering 'the system' so to speak, think of it this way: the money that Helicopter Ben is printing and dropping from the air is caught in an updraft and circling high above us! Its not hitting ground where we all pick it up and go willy nilly spending it. This is evident in the plunge in the velocity of money, that I discussed back in January. Fact is credit is contracting, HELOCs are being cut, loans are harder to get as underwriting standards have tightened, the shadow banking system saw hundreds of billions of lost wealth, trillions of lost wealth from housing and stock market collapse - does any of this sound inflationary to you? No.
The main reasons why the feds printing and stimulus wont produce hard core inflation right off the bat, include:
1) The deflationary episode we are in will negate any inflationary effects for as long as the system takes to delever, restructure, handle bankruptcies and failures, write down toxic assets, and destruction of bad debts through defaults - this is ongoing and WAVE 2 still lies ahead of us
2) The feds hundreds of billions of money printing is sitting idle in excess reserves and not being lent out - this is what is keeping the multiplier effect of our fractional reserve system muted. Recall that the fed requested and received authority to pay interest on excess reserves last September, and since that approval came in, boooooom, excess reserves started to surge. The reason the fed did this was to sterilize their stimulus and money printing policies so that the banks had an incentive to keep that money sitting idle instead of putting it to work through new loan creation that could have sent the system overboard in terms of credit creation and inflation. Plus, the fed knew the banks needed to recapitalize and still had loan losses and toxic assets improperly marked that needed to be taken care of.
Recall Jeff's statement on excess reserves in January: "My guess is that these excess reserves will be melted away as banks absorb losses on delinquent loans and as marked down securities see their income streams actually collapse."
3) Credit is contracting! Mish is all over this and a believer that money supply contract/expansion and credit contraction and expansion play a major role in the definition of inflation. In short, you cant have hyperinflation if credit is contracting! I tend to agree 100%!
4) Destruction of credit is greater than money creation - think of Printer Ben pouring hundreds of billions of newly created dollars onto the ground, except, there is a huge hole in this ground that represents the destruction of hundreds of billions in credit. This money is not piling up on the ground, ready for people to take, because it is falling into the big hole, not to be seen!
These are the main reasons why I dont see inflation as a threat right now, or even in 2010. Yes, we are seeing a stimulus induced reflation trade that people are building foundations of hope on. Not me. I am still cautious, will continue to ask questions about the stuff sitting on balance sheets (off and on) and the accounting tricks that allowed things to get covered over, and I am less bearish than I was in late 2007 before the process really got going. At least now it is happening and we felt a great deal of pain already, which tells me we are on our way to get through this mess that our system created! But, its hard to solve a debt deflation problem with more debt and accounting tricks. Hence my caution.
Sudden Debt has a great piece out discussing how the boom during the past decade was really a 'debt fueled' unsustainable growth period:
This blog's position has always been that the US economy's performance post-2000 has been due to ever-increasing assumption of debt, particularly by households to finance real estate purchases and personal consumption. I don't think anyone can dispute this any more: just look at the chart below. Debt kept accelerating while GDP remained "stuck" at around 5% annually (these are nominal figures). In the end, the debt boom created its own bust and dragged down the entire economy. Cement shoes come to mind...Interesting stuff. My stance has been deflationary since early 2008, and prior to that I used statements such as 'housing deflation + commodity inflation' to discuss the pressures facing our national economy. I still expect another wave of deflationary forces before this cycle is done that will be triggered by pressures from cmbs, helocs, prime, jumbo prime, credit cards, lbo's, types of holdings. I am not sue when this will hit, or if it will be as severe as the first wave that we went through, but I think it's something that needs to come and go for us to get through this cycle. This is not your ordinary recession and there are no free lunches. Any inflation that does show up at first will be in the form of higher food, energy, metals, commodities, health care, types of costs. Basically the stuff we need to live will see the first wave of inflation and it will be the form of inflation that squeezes consumers wallets and pressures corporate margins, at first. The policy makers will have to shift their policy to combat this form of inflation and that means higher rates. The cycle's endgame in full effect. Of course this has not happened yet and is only my opinion on the topic. Because of the nature of what we experienced, how the world has changed, I do not see inflation sending house prices surging. But it should kick in at some point down the road to help stabilize the downfall. I think Nenner might be on to something here.
We are now deep in a debt-bust crisis and it is the first time since at least 1953 that household debt is decreasing in absolute numbers, year on year.
A touchy topic I know, and one I would love to hear your thoughts on.
Posted by jeff
Mon Jun 22nd, 2009 11:07 AM
Noah,
I agree with all of the above except I would add that there is plenty of available labor....so not only is there no wage pressure, there is actually wage deflation, to a greater degree than we have ever seen. U.S. companies are so lean, they are loath to cut anyone, so instead they are cutting people's salaries and employees are saying "thank you sir may I have another", because at least they still have jobs. There is also lots of slack production capacity, so it will take a big recovery in unit demand before there is pressure on the marginal cost of producing an additional unit of anything. However, despite all this I am still worried that there could be commodity inflation, in fact I hope there is. China is throwing every ill gotten, soon to be devalued dollar they have into making up for the lack of U.S. demand, and in doing so cranking up their use of commodities (and boosting other emerging economies), such that they could put pressure on prices, even with slow U.S. demand. Additionally if you cut oil prices in half instead of by 75% you still get some bounce back in demand in the U.S. If there is a bout of commodity deflation from here, the world is going to have serious problems as seemingly resilient emerging markets will get crushed again and the China bubble (recently described by a Societe Generale economist as "the sickest joke yet played on investor.") may just pop.
Posted by In Debt We Trust
Mon Jun 22nd, 2009 12:19 PM
Good pts. Also a higher consumer savings rate (I don't remember what it is but somewhere north of 4% seems plausible).
As for the labor market we also have
i) benefits deflation (compare that to the 1950s when GM and Ford GAVE bennies as an incentive to new hires)
ii) hours deflation "mandatory" furloughs
iii) retirement deflation - more boomers staying at work and competing w/recent graduates (like yours truly) for work.
Posted by Noah
Mon Jun 22nd, 2009 03:12 PM
Jeff - great points. I dont see any threat of wage inflation spiraling out of control in our near future, OR, any threat of not enough capacity to produce goods. In fact we saw way too much capacity being built out during the parabolic credit boom. I mean how many thousands of factories in China are there?
we saw what happens when commodities tumble, mid 2008 to early 2009. Its scary, and people realize there is a demand problem! Anyway, those seeking hyperinflation are in another world, for now. Maybe in 15 years.
Posted by Noah
Mon Jun 22nd, 2009 03:13 PM
IDWT - great points! Many are not bringing those out and all my mothers friends are putting off retirement indefinitely. Yet the debts remain.
Posted by cfranch
Mon Jun 22nd, 2009 05:05 PM
Well the stock market took Nenner's words to heart today. From a technical stand point the market looks poised to test the March lows. We are rolling over on all time frames. The equity green shoot just got whacked.
Posted by MeekSheep
Mon Jun 22nd, 2009 09:10 PM
I know you folks are all worried of the hyper-inflation trade but I still believe that there is such a large amount of debt deflation it will take 5-6 years to peter out. Just look at Europe's banks. We're in a global economy, still. Protectionism hasn't cut ties between UBS, HSBC, DB and our banking situation. If the world experiences unprecedented but simultaneous deflation will it really lead to that much inflation in America? I truly think not. Maybe 5-6% more not the 10-15% I keep hearing.
Posted by John Davis
Mon Jun 22nd, 2009 09:46 PM
And also remember that when inflation does begin, it will not be uniform. Necessary things will inflate quickly while unnecessary things may not inflate at all. In fact, inflation of basics such as healthcare (which even at this time is inflating at the rate of 9%) may even cause many things which are deflating now to deflate even faster.
Let us not forget that inflation at one end of this vast economy can cause deflation at the other end.
Indeed, I am convinced that it was continuously compounded healthcare inflation which caused the housing bubble to burst.
Posted by sue
Mon Jun 22nd, 2009 10:14 PM
We have the Japanese disease. Asset deflation for 20 years. Name me an one example in history where an economy went thru deflation then jumped to hyper inflation. I can't think of one. It's one or the other, never both.
Posted by Thisson
Tue Jun 23rd, 2009 01:33 PM
I am in agreement with Sue.
The best quote I've seen on this recently: "Deflation is a fact. Inflation is an opinion."
This could change: be on the lookout for increasing transfer payments (welfare, unemployment insurance, etc.) or state bailouts (if treasury bails out California, for example).
Anecdotally, I am watching NYC wages (they are still being cut) and prices of things I buy everyday. So far no signs of increases. If this changes, it will be time to make inflation trades, but it's too early now.
Here's a great article on the Weimar Republic for those who want to be able to recognize the symptoms of oncoming hyperinflation:
http://mises.org/resources/4016
Posted by RegularAnon
Tue Jun 23rd, 2009 02:49 PM
I am not saying I agree with this statement...
It's just food for thought...
"This is truly a contrarian view. If you are anything like me you demand an explanation, and rightfully so. The newsletter continues as follows: 'The sheer amount of outstanding US debt should prove bullish for the longer term. Here's why: The US dollar is by far the most inflated currency. It is also the most commonly used currency in the world. As such, most of the debt - and toxic assets - in the world is US dollar denominated. As those toxic assets continue to deflate, US denominated wealth will continue to shrink. The law of supply and demand teaches us that scarcity of any product results in higher prices. In other words, the fewer dollars in circulation the more valuable the remaining dollars will become."
Posted by Fred
Tue Jun 23rd, 2009 03:41 PM
calling the USD inflated is a misnomer on several fronts. first, everyone is floating their banking system and the US float as a % of GDP, while unseemly, is well within the range for the EU and Japan; second, the reserves pumped into the banking system here have not been lent out there, or anywhere for that matter; they sit, like a little accounting entry, on the banks' balance sheets; third, drawing comparisons to Japan or Weimar Republic, while entertaining, neglects the significance of the times. truth is no one really can say what will happen when the US consumer slows down for an extended period of time, which is one of the potential outcomes here. can China really grow at 12% without its pre-crisis export revenues? can Germany compete in an environment where its population is simultaneously contracting and its manufacturing base can't compete globally? is India's middle class almost too important for the country to actually grow its external economy? its all connected and to simply say the US is going to be another Japan for 20 years is kind of cliche at this point. you just don't know. what we do know, is that there is no consumer like the US consumer. we don't follow the trend; we make it.
Posted by Noah
Tue Jun 23rd, 2009 04:11 PM
RegularAnon - part of Fishers debt deflation theory, the dollar should swell
Posted by Keith Burkhardt
Tue Jun 23rd, 2009 04:14 PM
Great discourse, but boy is all this very,very confusing(to a layman)! I have been investing my own money for 20 years and never have felt so uncertain about which way the wind was blowing. I was smart(read lucky?) enough to get into cash over a year and a half ago. And except for a few day trades(flat with some scary moments)I just don't know where to put long or short term money. I have this feeling in my stomach that all this smoke and mirrors the treasury/fed are doing is not going to end nicely! Ok, I do read quite a bit of the anti-fed/conspiracy stuff! I do feel certain we will see another big leg down, is looking to buy the S & P at 600-700 just being plain ridiculous?
Posted by G J Thomas
Mon Sep 21st, 2009 10:29 PM
Why is debt described as a hole? Debt is not about the annihilation of money, it is about who owns the money. The people who borrowed money did not annihilate it, but spent that same money back into the system. Spent money isn't an empty hole like someone's empty pocket. The pocket is empty because the money is spent, that is, has gone back into circulation. That money is still out there being spent again and again by other people. The idea that much money has been recently lost regards only the proprietorship of the money, not its existence. The money that was borrowed and spent is circulating and the money that has been printed by the Government to bail out the debts of the people who spent too much money is circulating. Where is the cancelation of bailout money by debt deflation here? If the record shows that Americans owe 45 trillion dollars, that is not a hole. That is a description of how much money was created and spent through borrowing and that money is still circulating. If it isn't paid back, the money is still out there somewhere being spent by someone. If new money is created to pay off the loan, then both the spent money and the new money circulate together. The debt is canceled but the money is doubled.
Posted by jayinoz
Sat Nov 7th, 2009 10:41 PM
GJ lets not forget about the concept of the velocity of the money circulating