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The Sound of One Hand Clapping - What Deflationists May Be Missing

Friday, October 9, 2009, 7:19 AM

This is a piece that I wrote in response to a request for a guest post over at ZeroHedge. It ran there yesterday garnering some nice attention and a diverse range of comments beneath.

Based on some of those comments, this article represents nothing more than my attempt to find an explanation that matches the data.


My central thesis to this crisis, developed a few years before it even hit, is that the economic troubles are the symptoms, while the money system itself is the cause.

My views on this are expressed in the opening of an article that I initially penned in 2006 but updated in 2008:

Within the next twenty years, the most profound changes in all of economic history will sweep the globe. The economic chaos and turbulence we are now experiencing are merely the opening salvos in what will prove to be a long, disruptive period of adjustment. Our choices now are to either evolve a new economic model that is compatible with limited physical resources, or to risk a catastrophic failure of our monetary system, and with it the basis for civilization as we know it today.

In order to understand why, we must start at the beginning. While it was operating well, our monetary system was a great system, one that fostered incredible technological innovation and advances in standards of living, two characteristics that I fervently wish to continue. But every system has its pros and its cons, and our monetary system has a doozy of a flaw.

It is this: Our monetary system must continually expand, forever.

The article above provides the big-picture backdrop that drives my long-term vision and thinking.  I raise it now so that you'll understand that I principally view the economic world through a monetary lens.

The hot topic of the day is "Inflation or Deflation?" and the camps are firmly divided into groups of inflationistas and deflationistas.  When asked which camp I am in, I reply "Yes."  Some would say that puts me in the confusionista camp, but I actually have an explanation for why are living in a world encompassing both.

From a technical perspective, we are absolutely in one of the most powerfully deflationary periods in history, yet, besides housing prices and a few over-produced consumer goods, we find that stocks, bonds, and commodities are all well-bid at the moment.

While we can ascribe some of this to the artificial wall of liquidity (come to think of it, is there any other kind?) currently being thrown into the financial market(s) by the Fed, it leaves hanging the question of why that money is not being completely swallowed into the bottomless black hole that the deflationist camp says lies at the heart of our current financial system.

And they are right; there is a black hole at the center.  If we treat the credit doubling that occurred between 2000 and 2008 (from $26 to $52 trillion) as a normal bubble that will follow the same pattern of decline as numerous historical bubbles, then we might reasonably predict that some $26 trillion of debt will somehow "go away" over the next 6 years.  This is indeed a massive black hole.

Yet everything just keeps perking along.  What gives?

The answer, I believe, requires us to ask a Zen-like question along the lines of, "What is the sound of one hand clapping?"  That question is, "If nobody recognizes a defaulted debt on their balance sheet, does it exist?"

Suppose, for the sake of argument, that there is a world in which banks are allowed by their regulators to pretend their default losses simply do not exist.  And, even more outlandishly, some of these banks are allowed to sell heavily damaged loans to their central bank at nearly their full original price.

What does "deflation" mean in such a world?  Not much, as it turns out.  At least from a monetary perspective, because money is not being destroyed at nearly the rate that would be expected or predicted by the size and rate of the defaults.

This is the world in which we currently live.  Trillions in probable and provable losses quietly exist, out of sight, on the balance sheets of the Federal Reserve and other financial institutions.  If they ever come out of hiding and onto the books, I think the deflationists will be proven correct beyond all doubt.

But let me ask this:  What prevents the authorities from simply storing them out of sight forever?  Or at least long enough to allow the wave of liquidity to work its inevitable magic?  So far, much to my great surprise, they've managed to do exactly that, with hardly a squeak from the mainstream press (although the blogosphere is on the job, as usual).  I am now wondering if they cannot keep this up indefinitely.

So from a purely monetary perspective, money can only be "destroyed" if banks and other financial institutions are compelled to recognize the losses and take a hit to capital.  If the loss is not recognized, no money is destroyed.  At least it is not recognized as gone.

Perversely, when a bank sells a ruined loan 'asset' to the Federal Reserve, it is a double shot of money to the system - the money initially created upon the issuance of the original loan, which is still out there in circulation, and a second bolus when the Fed creates money out of thin air to buy the failing 'asset' from the bank.  One blob of money into the system when the loan is made, another when it is bought by the Fed.  One loan, two blobs of money.  Many have failed to recognize this feature of the Fed's asset purchase programs.

So from this perspective, we could even argue that by employing the 'pretend and extend' strategy, coupled with an aggressive Fed purchase policy, it is possible that more money is being created than destroyed right now.  Which means that from a strictly monetary perspective, I am not yet sold on the idea that money is being destroyed at the rates sometimes implied by the deflationary arguments.

Also, the data is not really in support of that notion either:

Of course, this money needs willing lenders and borrowers, which brings us back to the matter of price deflation.

Out in the real world, where consumers and producers exist, the bursting credit bubble has severely cut off consumers' access to and desire for new credit, and producers have dialed back excessive capacity and cut their prices in order to attract business and survive.

There is no doubt about this process, but here I would argue that falling prices are currently as much a matter of supply and demand as they are a monetary issue.  In other words, the price deflation that we are currently seeing is not a pure monetary phenomenon.

Which means I think we are in a bizarre hybrid world, where deflation should be the order of the day, but it currently is not, because its impacts are being held in abeyance by the simple expedient of pretending the losses do not exist.

My current outlook calls for productive capacity to continue to fall out in the real world, even as the Fed conjures more money into existence in the make-believe world of 'high finance.'  (What are they smoking over there?).

Is this not a recipe for eventual inflation?  More money, but fewer goods and services?  History says 'yes.'

All that said, I would not disagree with the notion that there's another year or three of grinding along (where stock and bond prices are concerned), possibly down, but maybe not, before the monetary/goods imbalance comes charging out of the chute ready to throw off the unwary and trample them in a blistering round of inflation.

But it could be sooner than that.  Or later.  The point here is that we really don't know, and because our monetary system operates on faith, it means that we have to be prepared for the fact that a shift could happen at any time.  Nobody can predict when a school of fish will suddenly turn to the left.  Who knows what final trigger will cause a critical minority to suddenly determine that they'd rather hold things other than paper?

For now, while I understand and appreciate the deflationist argument, the only thing that would convert me fully to that camp would be a sudden return to rigorous application of honest accounting.  If you derisively snorted at that last sentence, then we share the same assessment of the likelihood of that happening any time soon.

In order to answer the main question of this article, we regretfully have to turn to Dadaism* to develop an appropriately absurd non-sequitur:

"What is the sound of one hand clapping?   Insanely high stock and bond prices."


* Dada was a protest by a group of European artists against World War I, bourgeois society, and the conservativism of traditional thought.  Its followers used absurdities and non-sequiturs to create artworks and performances which defied any intellectual analysis.

The founders included the French artist Jean Arp and the writers Hugo Ball and Tristan Tzara.  Francis Picabia and Marcel Duchamp were also key contributors.

The Dada movement evolved into Surrealism in the 1920's. 

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44 Comments

teoj's picture
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Re: The Sound of One Hand Clapping - What Deflationists May ...

This seems to be a plausible conclusion to what is going on. This was a very good read!

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Re: The Sound of One Hand Clapping - What Deflationists May ...

"Which means I think we are in a bizarre hybrid world, where deflation should be the order of the day, but it currently is not, because its impacts are being held in abeyance by the simple expedient of pretending the losses do not exist."

One hand clapping

IF you shake your hand rapidly back and forth, it will make a noise. Keep it up and something will break

Do they actually think that two wrongs make a right? Fighting deflation by dishonest bookkeeping and a 24 hour printing press. A sorcerers potion of fire and ice? 

I think the beaker's going to explode

Even the Mishflationist hears an insane dichotic formula brewing:

"With that in mind, one might even wonder if the statements by Bernanke and the other Fed members are nothing more than an attempt to appease both the hawks and the doves simultaneously via conflicting and/or ambiguous signals, hoping to buy time.

Regardless of what they are trying to do (if indeed they even know), Bernanke in particular, and central banks in general are clearly juggling a lot of balls. In light of global and domestic crosscurrents, it is questionable how much longer this high-wire juggling act can last."

http://globaleconomicanalysis.blogspot.com/

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Re: The Sound of One Hand Clapping - What Deflationists May ...

Deflationists still exist? LOL. They should check out this chart of the Continuous Commodity Index.

http://futuresource.quote.com/charts/charts.jsp?s=CI%20A0

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Re: The Sound of One Hand Clapping - What Deflationists May ...

I need to point out that I am in debt to Machinehead for making me aware of Dadaism in the first place.

My sincere hope is that MH will re-start and restore this important movement to its proper place in these ludicrous times.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

But Bernanke is going to get the Noble Monday for economics.

Obama got a Noble for doing nothing.  Bernanke will get it for doing too much.

Odd world we live in today, isn't it?

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Re: The Sound of One Hand Clapping - What Deflationists May ...

I totally agree, but I think the wake up call will come sooner than you expected, I have written in the following article that US is an IMPORTING country. The government can pretend the default does not exist, but the only way to do that is to print money and that will make import cost to go up. Eventually, retailers will go bankrupt because consumer doesn't have money/credit to pay higher price and then the bankruptcy shock of major retailer and the chain reaction that goes with such bankdruptcy will FORCE us to adopt honest accounting. Unless Americans are like Zimbabwean that we rather choose to let government destroy everything we have. Remember in hyper-inflationary world, income is destroyed FASTER than your debt is destroyed, otherwise, Zimbabwe will be the richest country in the world.

http://wcvarones.blogspot.com/2009/09/macro-economics-3-keynesian-stimulus.html#links

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Re: The Sound of One Hand Clapping - What Deflationists May ...

All Art movements died when Art was bought out and consumed by the establishment.  Can anyone name an Art movement since the 1960's?  Dada is just another commodity these days.  But George Grosz is still relevant.

http://www.austinkleon.com/2007/12/09/the-drawings-of-george-grosz/

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Re: The Sound of One Hand Clapping - What Deflationists May ...

We are having deflation at the same time as inflation. 

Which seems like it's impossible unless you understand that there can be barriers placed up between the two (at least initially).  That's what I believe is happening.  ALl these trillions of dollars are going into certain things, and being mopped up so to speak.  It's not filtering down into the regular economy because it's simply staying at the top and trying to shore up their derivative losses. Which I belive is around an average of 40 trillion per big bank -Citi, wells, bofa, goldman, etc.  Of course this is also just what we know about.  The numbers could be bigger.

But the EFFECT of doing this is leading to dollar debasing, and thus inflation.  Now it isn't as pronounced because, this isn't liquidity inflation by the average consumer, this is liquidity inflation by the big banks needing trillions of borrowed money to stay relatively solvent.  (even though they are ALL broke -derivatives).  Mark to fantasy and the glut of homes not on the market (inflating house prices via less supply) are the only things keeping things going, and probably not for long.

Additionally it only takes one of these big mortgage holding banks to unleash a wave of their foreclosed homes on the market at low prices to stay solvent.  They may want to hold onto them, but if they are about to go bust, I can see one of these banks throwing 500k homes onto the market overnight.  Can anyone guess what that does to average home price? How that would then in turn create book losses in the trillions for every other bank that is holding onto mortgages but not selling them?  One bank doing this could literally bankrupt them all - or start the wave that does so - but initailly would probably still collapse a few banks immediately.

Now of course some of the hot money printed may indeed filter out and cause inflation the more natural way of having more dollars in more people's hands.  But if this happened it would doom the current plan, thus they are trying to keep inflation down by keeping all the 'printed money' in the banking/financial system.  [They're basically trying to only inflate what was made worthless by the crash] Of course that's pretty much impossible.

Of course we are seeing asset bubbles in some things coming back up, which means to me, some of the money is getting out. This is dangerous because everyone sees the stock market go up, but doesn't see that it's no gain in wealth, and is just one step away from this hot money inflating everything else around it until we're once again paying bubble prices for everything.  (but still being paid in 1997 wages, the few who are still working)

But overall when you look at things...here is what is happening.....

Deflation in the physical economy - you know real people, tangible goods, brick and mortar

Inflation in the financial economy - banking industry, derivatives, mbs/cmbs,  trillons of dollars transfered around in seconds via cyberspace

So everything tangible is decreasing at an accellerating rate

But everything financial/monetary are exlpoding in inflation and probably soon into hyperinflation

One could almost say we are doing the most extreme 'trickle down economics', and it's all getting dammed up at the top.  So their things are inflating, while the rest of the economy deflates.  The inbetween is the stocks/commodities.

The sad thing is that at some point, the hot money will fully infect everything and the costs of everything will rise, but everyone will be making less and cannot afford it.  This will be a huge problem.  So prices are going to skyrocket, as no one can afford a computer at it's new 10,000 price, so we need to raise it to 25,000 and sell much fewer.  All for something that is worth say 2,000 now.  That's what we're facing happening everywhere and for everything we buy.

I agree CM that if you don't destroy the money from all the 'crap', it not only keeps things inflated with a larger money supply, you set the stage for more inflation when 'bailouts' occur. It's like double counitng the money.

It's not just similar to your viewpoint CM, it's also one espoused by Lyndon LaRouche. He too claims it's a problem of 'the system', yet obviously delves into 'the who' is pushing the system, and all the politics of it.  You on the other hand are just looking at things from a financial perspective. (which is refreshing)

Me as an outside observer thinks I'm simply watching shakespeare being performed in two different languages.

If you want to conceptualize it think of a baseball pitching machine on it's side.  One of the wheels is spinning upward (inflation at the top), the other wheel is spinning downwards (deflation at the bottom).  If these two highly energetic spinning apparatus touch each other, watch out.  That's a big part of the coming crisis, when these two things meet, what is the effect? It's not pretty I'm sure.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

"But Bernanke is going to get the Nobel Monday for economics.

Obama got a Nobel for doing nothing.  Bernanke will get it for doing too much."

... if Bernanke does;   Bernanke has outright lied to the Congress and the American people countless times, and Obama has broken every campaign promise he' made. What a travesty  the Nobel has achieved this year.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

A very nice analysis chris,

Helps me decipher the puzzle, some at a time. I have a question that perhaps someone can answer.

One blob of money into the system when the loan is made, another when it is bought by the Fed.  One loan, two blobs of money.

When Fed buys those defaulted loans from banks, does it  give these banks real money by printing it. Can the banks use that money to create still more cheque book money ?

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Re: The Sound of One Hand Clapping - What Deflationists May ...

Those who think the fed will do this forever and introduce hyper-inflation forgot an important fact. If any fed chairman introduced hyper-inflation, even on commodity or imported goods, he will be tried for crimes to against humanity and labeled as a devil in history textbook. Hyper-inflation destroy bank, the fed, and all middle-class Americans. You guys REALLY think Americans are THAT stupid and will allow it to happen when it becomes more and more clear that print money by fed won't work? I think the mounting political pressure will change the policy some day, and it is probably sooner than you think.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

Accounting's Role in Financial Crisis

http://www.cnbc.com/id/15840232?video=1289714369&play=1

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Re: The Sound of One Hand Clapping - What Deflationists May ...

eeeck double post!

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Re: The Sound of One Hand Clapping - What Deflationists May ...

daveweng wrote:

Those who think the fed will do this forever and introduce hyper-inflation forgot an important fact. If any fed chairman introduced hyper-inflation, even on commodity or imported goods, he will be tried for crimes to against humanity and labeled as a devil in history textbook. Hyper-inflation destroy bank, the fed, and all middle-class Americans. You guys REALLY think Americans are THAT stupid and will allow it to happen when it becomes more and more clear that print money by fed won't work? I think the mounting political pressure will change the policy some day, and it is probably sooner than you think.

I think the whole point of this conversation and this entire website is to raise awareness of the consequences of heading down the same path we have been regarding our management policies for all three Es. It is sites like these that help mount the political pressures to make the required changes, at least that's what we hope.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

Great forum! Good discussion items!

In response to mayankpj's question:

"When Fed buys those defaulted loans from banks, does it  give these banks real money by printing it. Can the banks use that money to create still more cheque book money ?"

First, we do not know if the Fed is actually buying defaulted loans (securities).

The majority of the Fed's securities it is buying are U.S. Treasuries, Agency owned Mortgage Backed Securities (MBS), and Agency debt. When the Fed purchases any of these securities, it purchases the securities out right by utilizing electronic payment. During these transactions, the Federal Reserve creates "money out of thin air," but does not necessarily "print money." The majority of the purchases of securities during the past year have been financed through what the Federal Reserve calls Deposits with the Federal Reserve. This account, Deposits with the Federal Reserve, is not physically printed money and during the past week this account has risen to its all time high.

When the bank receives these electronic payments from the Federal Reserve, the bank has options for what it wants to do with the electronic payments. They may want to pay out high bonuses, they may hoard it as a deposit with the Federal Reserve, or they may lend it out, which creates more cheque book money. Currently, we observe the banks massively hoarding the electronic transfers.

Money is a confusing concept for many, and the media does not serve the general public well by referring to the Fed as "printing money." This statement immediately places the image of Federal Reserve Notes (physical currency) being processed on an industrial line. During this entire crisis, the Federal Reserve has never ordered the U.S. Treasury to print Federal Reserve Notes at an abnormal pace. Actually printing the Federal Reserve Notes is not being done because the general public does not demand the Federal Reserve Notes (physical currency). The Federal Reserve is creating "money out of thin air" electronically because that is what the public demands at this time.

For an expanded look at the Federal Reserve Balance Sheet, visit http://www.economiccrisiswatch.blogspot.com/

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Re: The Sound of One Hand Clapping - What Deflationists May ...

siesta000000 wrote:
Money is a confusing concept for many, and the media does not serve the general public well by referring to the Fed as "printing money." This statement immediately places the image of Federal Reserve Notes (physical currency) being processed on an industrial line. During this entire crisis, the Federal Reserve has never ordered the U.S. Treasury to print Federal Reserve Notes at an abnormal pace. Actually printing the Federal Reserve Notes is not being done because the general public does not demand the Federal Reserve Notes (physical currency). The Federal Reserve is creating "money out of thin air" electronically because that is what the public demands at this time.

I find this thread very interesting, and it is just getting better and better. This posting above, together with the initial posting from CM could be a good explanation to reflect what is going on. Lets just say for the sake of the argument that that this is exactly what is happening. Where are we heading, then? If money is being created but not printed, it seems they could control or balance the forces which want to pull in direction of deflation / inflation. How long can it go on, then? Can they keep it running stable or are they just postponing the correction of this situation?

Why don´t our governments try to explain just why they think they can avoid the natural corrective actions and keep everything going on as if it could go back to how it was? So many people have disbelief in the actions taking place and if governments can keep it running and keep it balanced like this then why not explain it to us then?

Is the situation really controllable?  If not, I have the feeling that everything is going to pile up and the result will be much, much more severe. Or maybe not at all, since all the crated but not printed money is just like monopoly money anyway? Would they really be willing to risk much graver results if they didn´t have a bullet proof plan? I want to know the plan!:-D  

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Re: The Sound of One Hand Clapping - What Deflationists May ...

daveweng wrote:

Those who think the fed will do this forever and introduce hyper-inflation forgot an important fact. If any fed chairman introduced hyper-inflation, even on commodity or imported goods, he will be tried for crimes to against humanity and labeled as a devil in history textbook. Hyper-inflation destroy bank, the fed, and all middle-class Americans. You guys REALLY think Americans are THAT stupid and will allow it to happen when it becomes more and more clear that print money by fed won't work? I think the mounting political pressure will change the policy some day, and it is probably sooner than you think.

You have a good point there.. This leads me to believe that they really think they can control the situation.. But can they? I´m confused.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

Yes, you are right that actual money doesn't need to be printed. I can see that when US government is doing an auction for the treasury note, all the primary dealer probably has account with the Fed, so all that happened was the move their money in the Fed account to treasury account with the Fed. And when fed wants to buy back the treasure, it just take the treasury back and credit primary dealer's account again.

Now, when government is paying for cash for clunker program, all it does is the money moved from the treasury to the bank of the car dealer that deposited this treasury check of $4000 car purchase credit. It is all done ELECTRONICALLY. However, with more and more money governement spent that goes into the market, we can start to have a commodity bubble because most of the government spending is on infrastructure that needs steel, aluminum, ...etc. Moreover, those hedge fund manager will still have access to credit and they can easily use the free money from the fed to push the equity and commodity derivative price up, and you don't need to print physical money to do this. However, at the same time, consumer gets nothing from it (so no demand of real physical money), except those workers who may avoid being laid off for a few months more because of the government stimulus.

Notice the root cause of inflation is the GOVERNMENT SPENDING. If Fed simply increase every bank's account balance by buying back the agency bond, it is not going to cause inflation because bank will hoard the money since there are few credit worthy consumer to lend to. However, when government is SPENDING, then it is different story because the money actually goes into circulation and the HOPE that government brings to people will make wall street to become more greedy and helped pushing up the price of the raw material on whatever items government wanted us to buy.

So, can government keep spending on thin-air created money forever? Like I said in the link of my previous posts, unless government really wants to save every single business in the US (that will be hyper inflationary), eventually some inefficient retailer will go out of business with increased importing cost, the liquidation sale will wake up everyone and send us back to super depression. Of course, if US congress is stupid enough, they can make government to nationalize Macy's, Nordstrom, ..etc. Then we will for sure have hyper-inflation.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

I might add that those trillions of dollars held by foreigners are another source of inflation as foreigners repatriate them for commodities.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

One way to look at short term deflation is the liquidation of excess existing stock.  When demand and sales plummet, prices of existing product can and does fall below cost as companies (and entire industries) cut losses. However, after existing stocks are depleted and industries adjust to new lower demand levels (by squeezing out the least competitive companies), new products will be supplied only at levels to meet above-cost demand.

This level could be (will be) far less than we have been used to. In addition, prices can be far hIgher, simply due to reduced scale efficiencies, even in the absence of monetarily generated inflation.

It will be interesting to watch auto prices and volumes in particular, since pre-crash inventories are now reportedly nearing depletion.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

So, it people asking why government is doing all these even it doesn't seems to be working? I personally think the answer is:

TO BUY MORE TIME, and why?

Because if we can have a major techonology breakthru, for example, if we can all in a sudden discovered the secret of safe nuclear fusion power plant that makes electricity cost only 1/3 of current price, the NEW demand and increased productivity will increase everyone's income. When everyone's income is increased, the economy is saved because with more income, people can start to borrow and spend again.

And then Bernanke will earn Nobel Prize in economics!!

However, I think the expectation to have major tech breakthru everytime we screw up the economy is very dangerous.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

taylmj wrote:

One way to look at short term deflation is the liquidation of excess existing stock.  When demand and sales plummet, prices of existing product can and does fall below cost as companies (and entire industries) cut losses. However, after existing stocks are depleted and industries adjust to new lower demand levels (by squeezing out the least competitive companies), new products will be supplied only at levels to meet above-cost demand.

This level could be (will be) far less than we have been used to. In addition, prices can be far hIgher, simply due to reduced scale efficiencies, even in the absence of monetarily generated inflation.

It will be interesting to watch auto prices and volumes in particular, since pre-crash inventories are now reportedly nearing depletion.

yes, at that point of time, GM and Ford will need to lay off again and add more people to unemployment list, or one of them may simply need to close for business.  The continuing increase of unemployment will lower the demand further more, and cause second round of bankruptcy and liquidation.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

So the big question is: can the Fed and the government keep the bad assets locked up in the basement as it were?  And if not, when will these losses finally be realized (i.e. pokes their monstrous heads out of the basement and scare the daylights out of the partygoers in the main house Wink), and in what manner?  I admit when I pondered something along these lines before I didn't give it enough thought, because I just did not figure that they could keep these losses from being realized for this long.  But perhaps the lesson here is that the average person's capacity for self-deception plays as much a part in keeping the lie going as the deceiver does (a lot of us are very much invested with the status quo after all), and thus the deception persists far longer than any reasonable person on the outside would imagine.

I still don't think they can keep the game up forever, simply due to the highly fluid and unstable nature of current economic and political events around the world.  The gov and Federal Reserve have incredible amounts of influence in the world, but neither they nor their counterparts in other nations can control everything or TELL people exactly how to spend their money (at least not without ruining the whole game).  Heck, seems to me if you can't even see what is coming, how can you possibly control the outcome?  Perhaps if all other things remained static they could keep the losses hidden forever, but IMO too many things are in a state of constant change and there are too many other players in the game.  Perhaps the real danger lies in not only the inflationary wave that Chris mentions when the money flies out the gates, but rather when this happens in conjunction with the final realization of some or all the trillions in losses.  I like jmc8888's baseball pitching machine analogy.... getting something far worse than a deflationary spiral or an inflationary wave.  Instead the whole apparatus just flies apart, which is only fun to watch at a safe distance. 

- Nickbert

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Re: The Sound of One Hand Clapping - What Deflationists May ...

Just brilliant.. ;)

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Art Movement

Oh...oh...oh. I can name that art movement.

'Conceptual Crap'

Modernism ushered a whole host conceptual nonsense. Like Thomas Wolfe said art went from 'seeing is believing' to 'believing is seeing'. I would argue that all art movements live when consumed by the establishment.

George Grosz, Ben Shahn.....yawn.

Dutch Flemish painters rule!

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Re: The Sound of One Hand Clapping - What Deflationists May ...

Daveweng

They have already done it. The trigger has been pulled and the bullet is in flight. It doesn't matter what the FED does now we are just waiting for the impact.

Viva la keynesian economics!

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Re: Art Movement

Johnny Oxygen wrote:

Oh...oh...oh. I can name that art movement.

'Conceptual Crap'

Modernism ushered a whole host conceptual nonsense. Like Thomas Wolfe said art went from 'seeing is believing' to 'believing is seeing'. I would argue that all art movements live when consumed by the establishment.

George Grosz, Ben Shahn.....yawn.

Dutch Flemish painters rule!

Dada was the first anti-art movement -- it was a reaction to World War I and the world of the machine -- an engagement and reflection of what the Dada artists saw at that time.  It was not invented to be consumed.  The same with Pop art.  True that the conceptual art movement was invented to be consumed by museum and dealer spaces.  True also that all of us work on being successfully consumed as consumers.  That's all that is left for Art.

Dutch Flemish painters... yawn.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

I run a small business and have seen sales shoot up about 2-3X in the last 4-6 weeks - absolutely crazy and very bubbly!  Most of the products we make are about 90% US content but we also buy some components from China.  The price for the Chinese components have not changed by one penny since 2003.  This is incredible given that the dollar has fallen 40% since 2002, the Fed has almost tripled the monetary base (I know the ruan is pegged to the dollar - but still), and the unsustainability of the US economy has been exposed for all to see.  Nevertheless, Asians keep intervening in their currencies no matter what.  Maybe we can print our way to prosperity after all!

That said, I recall linking to an article from the Daily Digest about a month ago saying that China has warned the Fed that they must stop their QE by the end of October.  They are giving them until early November to wind things down and start withdrawing the liquidity.  The assumption was they would go nuclear otherwise - sell their bonds and unpeg their currency.   Has anyone seen anything more on this?  I have heard reference to the possibility of a market crash on Nov. 9th which would coincide with this timing.  Anybody have any thoughts?

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Re: The Sound of One Hand Clapping - What Deflationists May ...

Banana Ben wrote:

I run a small business and have seen sales shoot up about 2-3X in the last 4-6 weeks - absolutely crazy and very bubbly!  Most of the products we make are about 90% US content but we also buy some components from China.  The price for the Chinese components have not changed by one penny since 2003.  This is incredible given that the dollar has fallen 40% since 2002, the Fed has almost tripled the monetary base (I know the ruan is pegged to the dollar - but still), and the unsustainability of the US economy has been exposed for all to see.  Nevertheless, Asians keep intervening in their currencies no matter what.  Maybe we can print our way to prosperity after all!

That said, I recall linking to an article from the Daily Digest about a month ago saying that China has warned the Fed that they must stop their QE by the end of October.  They are giving them until early November to wind things down and start withdrawing the liquidity.  The assumption was they would go nuclear otherwise - sell their bonds and unpeg their currency.   Has anyone seen anything more on this?  I have heard reference to the possibility of a market crash on Nov. 9th which would coincide with this timing.  Anybody have any thoughts?

Is your product consumer product that is related to either cars or housing or anything that government tried to subsidize and stimulus? if that is the case, then I am not surprised that it gets some sales boost. Another thing I said is that when government is printing more money, the retailer/producer will get squeezed. Therefore, if chinese continues to peg Yuan to dollars, then they will be squeezed instead of US retailers. When commodity goes up, and consumer can't spend more money, it is the producer OR retailer that will get squeezed, for now, it seems like Chinese is suffering because they have fixed exchanged rate, but if they keep taking our thin-air created USD that keeps losing value, eventually the USD they get won't even be able to pay for the resource (oil, iron, etc) they need to produce the item. Some of them will need to go bankrupt and the whole thing will then explode.

This is why I think Chinese governement is about to say: ENOUGH, stop printing!!!

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Re: The Sound of One Hand Clapping - What Deflationists May ...

No - we are suppliers to semiconductor equipment OEMs like Applied Materials.  This is about a private private sector as it comes - i.e. no govt. contracts here!  There is no question that they are ramping up considerably.  Then again, everything was going crazy back in 2000 when the bottom fell out!

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Re: The Sound of One Hand Clapping - What Deflationists May ...

Chris -

I want to thank you for addressing my question about the position over at TAE where they contend that inflation cannot happen in the short-term (less than a year).

I'd love to see an online discussion between yourself and Stoneleigh on this issue.

TAE is on record disagreeing with you on this point. Ilargi can sometimes be callous in his comments, but I do not think he means you any disrespect when he says:

"And no, Martenson is not paying attention, governments and central banks cannot simply elect to keep their debt obligations hidden in perpetuity."

I think he is saying that market forces and other external events will force governments/central banks to expose their debt obligations well before monetary inflation or hyperinflation occurs. In other words, outside events will flush these bad debt obligations out into the open (contributing to deflation) before inflation/hyperinflation can set in.

I want to emphasize to the board that the recommendations both Dr. Martenson and TAE make in these times of great change to reduce financial and physical risk to one's loved ones and oneself are virtually identical.

TAE are sticking to their guns regarding their statement that there is virtually no chance for inflation/hyperinflation to occur anytime soon. Here is another quote from Ilargi from Oct. 7:

"We will have inflation, we will have a much lower dollar, and we will have a much higher gold price. But we won't have any of these for now, and not for a while. I'd give it a minimum of two years."

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Re: The Sound of One Hand Clapping - What Deflationists May ...

Banana Ben wrote:

No - we are suppliers to semiconductor equipment OEMs like Applied Materials.  This is about a private private sector as it comes - i.e. no govt. contracts here!  There is no question that they are ramping up considerably.  Then again, everything was going crazy back in 2000 when the bottom fell out!

Could it be that what you supply is a rare product and they think we better stock up before you are out of business. The same way people buy emergency food supplies.

In my case i bought some extra stock of hard to make electronics, just to safeguard against a problem in the supply chain.

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What the Inflationists May Be Missing

The notion that today's bank reverses will one day flood the economy with inflation-producing credit-money is not technically correct. Steve Keen examined the process of money creation in his Feb 09 post: The Cavaliers of Credit

Two hypotheses about the nature of money can be derived from the money multiplier model:

1.    The creation of credit money should happen after the creation of government money. In the model, the banking system can’t create credit until it receives new deposits from the public (that in turn originate from the government) and therefore finds itself with excess reserves that it can lend out. Since the lending, depositing and relending process takes time, there should be a substantial time lag between an injection of new government-created money and the growth of credit money.

2.    The amount of money in the economy should exceed the amount of debt, with the difference representing the government’s initial creation of money. In the example above, the total of all bank deposits tapers towards $10,000, the total of loans converges to $9,000, and the difference is $1,000, which is the amount of initial government money injected into the system. Therefore the ratio of Debt to Money should be less than one, and close to (1-Reserve Ratio): in the example above, D/M=0.9, which is 1 minus the reserve ratio of 10% or 0.1.

Both these hypotheses are strongly contradicted by the data.

Testing the first hypothesis takes some sophisticated data analysis, which was done by two leading neoclassical economists in 1990.[3] If the hypothesis  were true, changes in M0 should precede changes in M2. The time pattern of the data should look like the graph below: an initial injection of government “fiat” money, followed by a gradual creation of a much larger amount of credit money:

(See source for chart)

Their empirical conclusion was just the opposite: rather than fiat money being created first and credit money following with a lag, the sequence was reversed: credit money was created first, and fiat money was then created about a year later:

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Re: The Sound of One Hand Clapping - What Deflationists May ...

Chris

What about the local and State Governments?  While the unforclosed loan on a house or shopping center might be maintained on a banks ballence sheet, or the Feds, if it is empty, it does not pay property taxes or provide money for local levels of government or schools.  There is a rapidly developing crises in local and States budgets here related to your one hand clapping.  What do you think?

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Mish's Reply: One Hand Clapping Theory Analyzed

One Hand Clapping Theory Analyzed by Mish

Also, Nate's Reply to this Post:

Chris Martenson: The Sound of One Hand Clapping

A great conversation has begun.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

FUNKYSPEC wrote quoting:  "We will have inflation, we will have a much lower dollar, and we will have a much higher gold price. But we won't have any of these for now, and not for a while. I'd give it a minimum of two years."

With the economic world having so many variables, I think it is dangerous to predict what may or may not happen in a given timeframe.  One variable that I believe is often overlooked is the Velocity of Money.  This can be a function of confidence in the dollar.  When and if all confidence is lost, then the Velocity of Money will explode.  The result will be a lot higher prices (whether you define this as hyper-inflation is up to you).  This may take a while to play out, or it could happen overnight.  We have already started to see the world dump the dollar.  The point is: economic models often miss the mark because they do not take into accout human emotions.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

Brainless wrote:

Banana Ben wrote:

No - we are suppliers to semiconductor equipment OEMs like Applied Materials.  This is about a private private sector as it comes - i.e. no govt. contracts here!  There is no question that they are ramping up considerably.  Then again, everything was going crazy back in 2000 when the bottom fell out!

Could it be that what you supply is a rare product and they think we better stock up before you are out of business. The same way people buy emergency food supplies.

In my case i bought some extra stock of hard to make electronics, just to safeguard against a problem in the supply chain.

Remember that each product has LONG production chain, and when there is a bubble in commodity, those who are closer to the "raw material" side will benefit the most. Someone ALWAYS benefit when there is a bubble.

So, i can see that you are a supplier that is closer to raw material side because applied material is still far from consumer end on electronics. In my analysis, I already mentioned that commodity price will increase while the consumer end does not have the additional purchase power to maintain the same demand if price is increased, so someone in the middle will get squeezed, it can be the Chinese factory, or the US retailer. However, if  you are the raw material supplier, you are likely to get a boost in earning, just like Alcoa (and notice their earning increased with 18% increase in aluminum price while the revenue only went up 9%!) and this earning boost is not going to increase the earning of average Americans because the quantity sold may go up for awhile, but it is still far from the "growth" level that is required before we can get a raise in salary.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

hanlin wrote:

{snip}

However, if  you are the raw material supplier, you are likely to get a boost in earning, just like Alcoa (and notice their earning increased with 18% increase in aluminum price while the revenue only went up 9%!) and this earning boost is not going to increase the earning of average Americans because the quantity sold may go up for awhile, but it is still far from the "growth" level that is required before we can get a raise in salary.

...or a new job is created.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

machinehead wrote:

Deflationists still exist? LOL. They should check out this chart of the Continuous Commodity Index.

http://futuresource.quote.com/charts/charts.jsp?s=CI%20A0

You're right, that chart is interesting.

But it's even more interesting when shown in context -- look at this longer-term one:

http://futuresource.quote.com/charts/charts.jsp?s=CI%20A0&o=&a=W&z=800x5...

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This is what happened to Iceland....

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=awXzaHHx8T6M

Stagflation should not be ignored as well....

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Re: The Sound of One Hand Clapping - What Deflationists May ...

(With respect to stagflation) IMHO if the dollar tanks we are going to be talking more about banana "republics".

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Re: The Sound of One Hand Clapping - What Deflationists May ...

It seems like what could happen, IMO, is there is going to be a period of deflation, before we have a sharp period of inflation. We are in a time like never before, and I think we will have a situation of violent choppyness in markets

I would think people would agree that we are in for another leg down in the stock market, and as that happens, it will have a similiar effect to what happened prior, with falling commodoties(initially, of course they are very bullish, and will remain that way in the long term) Chris does a great job of forecasting what is going to happen in the long run, but I think we might see a downturn before inflation realy sets in, and people really start dumping the dollar.

Thoughts?

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Re: The Sound of One Hand Clapping - What Deflationists May ...

The massive inflation will only occurs if government keeps spending and nationalize/subsidize more and more private business. Will this happen? it depends on American's wisdom. We can choose to live thru deflation by paying down our debt and tax the wealthy Wall Street people to death on the bonus they received with bailout money they got, or we can choose to destroy everyone by print more money and government use that money to give to people as credit for housing, cash for clunker, cash for beer, ...etc.

It is the choice of AMERICANS.

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Re: The Sound of One Hand Clapping - What Deflationists May ...

siesta000000 wrote:

In response to mayankpj's question:

"When Fed buys those defaulted loans from banks, does it  give these banks real money by printing it. Can the banks use that money to create still more cheque book money ?"

First, we do not know if the Fed is actually buying defaulted loans (securities).

The majority of the Fed's securities it is buying are U.S. Treasuries, Agency owned Mortgage Backed Securities (MBS), and Agency debt. When the Fed purchases any of these securities, it purchases the securities out right by utilizing electronic payment. During these transactions, the Federal Reserve creates "money out of thin air," but does not necessarily "print money." The majority of the purchases of securities during the past year have been financed through what the Federal Reserve calls Deposits with the Federal Reserve. This account, Deposits with the Federal Reserve, is not physically printed money and during the past week this account has risen to its all time high.

When the bank receives these electronic payments from the Federal Reserve, the bank has options for what it wants to do with the electronic payments. They may want to pay out high bonuses, they may hoard it as a deposit with the Federal Reserve, or they may lend it out, which creates more cheque book money. Currently, we observe the banks massively hoarding the electronic transfers.

This is true but I have a theory about why this may be so.  I suspect that the large increase in Fed deposits since the summer of 2008 is not unexpected ... at least not by the Fed.  It is my belief that a condition of the purchase of these assets by the Fed was that the funds remain on deposit for a stated period of time.  This could have been accomplished with a repo agreement (explicit or implicit).  This would have accomplished exactly what the Fed wanted ... to get the assets off the balance sheets of the banks where they must be audited (even with the recently watered down FASB rules) onto the Fed balance sheet that is unaudited and opaque.  It is irrelevant whether these assets are in fact defaulted loans or not.  The banks were way over leavered by any sensible measure so even taking their good assets off their books helps immesurably as long as they can continue to mark the "bad" loans to their fantasy numbers.  So bottom line and in answer to mayankpj's question ... no, do not expect to see this new money levered up by the banks.  As CM points out this charade can last a lot longer before it eventually blows up in their faces.  And what will cause it to blow?  The ultimate defaults of thousands of loans, mortgages and derivatives.

My solution to this mess?  AUDIT THE FED!

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