I wrote this August 20, 2008. It never made post status, but what has transpired since, it becomes an interesting read October 26, 2008
Meanwhile, back at bear chat, the debate rages about inflation and deflation, gold and silver shortages and all kinds of wacko stuff. But, what is really happening? I think it is everything contrary to what the news says, that we are actually deflating, that the dollar is getting stronger because there is not only a shortage of them to continue the rest of the world on its merry way, but that they are going to get even shorter in supply. The US political scene is really getting messy and whomever wins the next election is going to prolong this agony any way they can, because government draws its power out of agony and not out of prosperity. Here in the US, they just get us to rubber stamp that what they are doing is agreed to because we voted for it. None of us would vote and I don't because I never agree to what they are doing.
The biggest shoes are about to drop, FNM and FRE. They will either languish for awhile or they will agree to something with the US in return for dropping all suits and prosecutions. Thirdly, the US will at least figure out that FNM and FRE weren't all at fault and were only doing what HUD and Congress told them to do and throw them a bone. The third case would allow them to begin to transact business like they should have all along and shut down the loose lending standards that have been increasingly applied since 1995.
For those on the inflation side, no one has shown me how the big spending consumers are going to get the money to keep the party going. Inflation going forward depends on money or credit to keep the bust going big time. In the 1970's, people went out and hoarded stuff to get a jump on the next price increase. This time they just aren't buying what is going up any more than they have to. Why is clear, they don't have the money or the capacity to ask the boss for more money this time.
The wacko gold bug bears think the dollar is going to nothing. I give them some credit in foresight, but I don't believe we are at that point nor do I believe they are going to be young men when it occurs, as in under 70. The US is still the economic powerhouse of the world and most of the rest of the world merely acts as suppliers to the US economic machine. Today I saw a comparison with Japan, the 1930's and with Argentina, and the comparison was the US was mostly like Argentina. There is a lot to the world besides adding up money flows, as they happen for more reasons than one side getting rich and the other going broke. In the case of the US, its debt is dollars and the financial assets of the world are dollars, mostly by choice. As I have written before, the exporting countries to the US have been exporting for a purpose, namely to acquire dollars. Their machinery over there is geared to produce goods in exchange for dollars and thus if the US fails to purchase the production, their business models fail.
The comparison to Japan is really deep. In todays society, savings and debt are bedroom cousins of each other. I am not sure what savings is, but to say that according to statistics, the corporations in the US made record profits in comparison to the GDP, the highest since 1929. Debt in the US is well over 300% of GDP, yet we owe foreigners an amount in the area of 50% of GDP. The other roughly 300% came from somewhere. Someone saves that money to create the loan and the more saved, the more debt accumulated.
If I had to make a guess right now, we are going to a short period of inflation talk followed by some bankruptcies, followed by a collapse in consumer spending. Consumer spending crashes won't be pleasant for the developing world or for parts of Europe. It is the US consumer floating China, not the relending of money to the US that is floating the US consumer. The consumer stops spending and expanding the economies of Asia as soon as the US consumer has no more credit. Then the money supply implodes in on itself, causing a scramble for market share in a variety of world commodity producers. Those that are liquid and poised to pick up some bargains in commodities will make a lot of money, while those caught speculating long are going to be crushed by the debt deflation.
Here is the problem with calling for deflation. The current mess created by the bailout of the financial system under the guise of floating bad funds under the auspices of the international banking community, we have the appearance of run away prices. The big point here is that the dollar recyclers are also commodity consumers on a grand scale for the first time and rather than lend the money back, they went shopping. Thus the prices for commodities everywhere are being pushed by demand from areas not seen since the 1970's. The 1970's commodity price spirals were also created by the third world being loaned money at that time to consume, together with a large war, the launching of social programs in the US and the removal of gold backing from the dollar. Throw in the maturing of the baby boom generation born between 1945 and the early 1960's and we have a huge demand for everything. People don't remember deflation because deflation is something avoided at all costs and the ones that saw it are dead. The people that saw the last gas crunch are the ones running the money now and they recall that very well. Thus, we have dead people that remember the deflation and a huge generation that remembers the inflation. Thus, we will eventually move to fight inflation, not even having a clue as to what deflation is.
But, it is deflation that will win. Everyone scoffs at it and I am a contrarian and I believe it will happen. They won't lower prices until their warehouses are so piled with crap that their bankers are calling the loans if they don't liquidate. People don't know how to make money and they understand losing it even less. Once they start holding out for their money, they are going to find that debt is consuming money so fast that yesterdays rock bottom price is a sellers bonanza today. In many cases selling is going to mean bankruptcy and not selling is going to mean bankruptcy. We are already seeing this in the financial circles, as you can't sell your CDO's at this price so wait. Wait and you keep taking lower prices, as word gets out this stuff is mainly toxic. The car business is more than just gasoline, as the sales apparently started to dive last July, not after the price run up in gasoline. It is just that the automakers are all trying to sell what brung them, not what they can't make presently. We won't see that demand return when the price of gasoline falls because people just won't have the money this time around. It is one thing to wait around for a deal, but it is another to have your money or credit disappear in the meantime. There is going to be a lot of this.
The problem cannot be solved in the conventional sense that a normal recession happens. It can't be solved because it is a debt problem that must be wiped out in a liquidation. They don't wipe it out and either the economy drags into a long term down cycle or the deflation pressures are worse next time.