Those that read my stuff know I am a deflationist. This outlook is based on a couple of ideas, one that fractional reserve banking has no mathematical solution and thus through mathematics, there is a limit to credit and that without US demand, the output of the worlds factories and mines is well in excess of what would be demanded. I am of the opinion that to keep the mathematical equation from collapsing, so much credit has to be manufactured to just support the debt structure without adding to the amount that can be purchased. It is clear that society is divided into two groups, spenders and savers and that the banking system is divided into debits and credits. The problem is eventually the people that hold the deposits are an entirely different group than those that owe the debits on the bank balance sheet. Thus the bank has acted as surety for a group that cannot pay the other group. This results in a credit crunch and if not resolved, results in a depression. In Keynesian economics, a wild card has been introduced, which we are going to see played out in the next couple of years, that government can put enough credit in to prop up the debit side to the point that the credit side can be serviced. This solution worked in the early 1990's period in reflating the economy and the banks balance sheets after the banking collapses of the late 1980's. The difference between then and today is that any effort today is to prop up a bubble that has arisen through 2 decades of financial mismanagement, starting with the Rubin/Greenspan/Clinton regime and all the efforts since to keep the system from collapsing from the 2000 bursted tech bubble.
Where I am raising questions is that it appears the bank credit is continuing to expand at a double digit rate, despite much crying that bank credit and lending is too tight. One would expect that consumer spending would be falling rapidly, that home sales would be at recessionary levels rather than at historic boom levels and that imports would be declining rapidly. I sense that the balance of manufactured goods payments is in fact declining rapidly and that the trade deficit is now floating on a massive oil bill. If this is the case, then we should soon see a massive decline in growth in China and a resulting deflation of stock markets around the world.
Here is the other side of the equation. If the US persists on pushing on a string, we are going to have problems. Despite the news, economic activity is at historic levels. It might not be quite at the mania levels we have seen in the past few years, but all the same, retail sales are still increasing and home sales are coming in at a 5 million level for pre-owned homes. The prior to bubble record was 4 million and normal is around 3 million, so we are far from bread lines or a busted system. This means something is still financing this. I do believe that gasoline sales are included in retail sales, so in truth we are declining in the sale of goods.
A friend and I walked right into a Outback Steakhouse last night at 8 PM and ate. This is almost an unheard of situation on a Friday night in Addison, Texas. The Texas economy seems to be doing better than the nation and the housing bust isn't here what it is in a lot of other places. There have been 1 million people move into the DFW metroplex since 2000 according to a story on the front page of the paper yesterday and despite this, home prices have been pretty stable since 2000. There is not a sub-prime bubble here, but at the same time, there has to be some kind of supply problem here. On the contrary, if there is a Bernanke/Paulson/allow no pain Democratic congress put under housing, I fully expect a huge bubble to develop here soon if we in fact don't have a real recession. Why not if you can buy a house and stop making payments and get debt relief? I would like my free $30,000, $50,000 or $100,000 for the mistake I made. Why not go ahead and restore the stock market losses of the 2000 tech bubble collapse while they are at it? Don't people need retirement funds more than a 3000 square foot house they can't afford to heat, cool, maintain and make payments on?
The US has walked into the twilight zone and I suspect there is going to be a back lash. The chant is dollar devaluation and at some point, they are going to have to support the dollar. Housing is going to collapse, regardless of what Congress does, because there is too much excess in the system and maintaining the excess isn't going to solve the problem of too much excess. We are looking at below 6% rates on mortgages right now and if the inflationists win out short term, mortgage rates will go to 10%, which will add 50% to the payment of buying a home and housing will then deflate on those terms. If the dollar declines, demand from the US will have to decline. The banks won't continue to make sub-prime financing and I highly doubt they are going to be in the mood to take a lot of risks. The government is part of the system and not the Santa Claus they seem to be viewed as. Neither is the Fed, which requires day to day delivery of what they give out meaning they might not give the treasuries back tomorrow without sound collateral. The Fed can't allow itself to go broke.
Thus, regardless of what transpires short term, longer term we still deflate. The system won't allow for inflation beyond maximum potential. The debt service either isn't enough to carry the debt if rates are too low or it is too high for the economy to live if the rates are too high. We are well over 300% of GDP in debt. This means that the absolute limit of inflation is around 27%. Beyond that, inflation is impossible with corresponding interest rates. I would suspect that any effort to push it beyond this would result in the currency being ignored and thus demand to acquire credit or print money would collapse. This is a deep subject.
If the US was Mexico, I could buy anything going down, but the US is the US. It is kind of like having a strictly heterosexual dance without the girls showing up. Better have some good guitar and booze and forget dancing. The world economy without US demand deflates. It cannot inflate. Maybe in the next universe the world dances without America, not today.