Mish's Global Economic Trend Analysis |
- Reader Mailbag: I Want a House, Should I Buy One?
- Durable Goods Orders Downside Surprise; Details Range from Weak to Abysmal
- "Contained Depression"
| Reader Mailbag: I Want a House, Should I Buy One? Posted: 25 Aug 2010 09:15 PM PDT Here is an email from "Living With Parents" who wants to buy a house and move out. Should she? LWP writes ... Hello MishHello LWP If your job is stable, you want a house, and you can afford a house, why not buy a house? I have a house. There is nothing inherently wrong with houses per se. However, please don't think of your house as an investment, at least in the classic sense. Robert Kiyosaki author of the bestselling book Rich Dad Poor Dad maintains houses (except rental houses) are a liability not an asset. I do not go quite that far, especially if a house that has equity. Regardless, too many people bought houses as a "can't lose investment" then subsequently lost their ass because that paid too much, used too much leverage, or just plain played the "greater fool's game" and got burnt. Even from where we are now, prices could easily drop 20% or more and take a decade to recover. The key in your situation is the home you are looking at sells for less than rent would cost. That means (if you are correct), you have at least a reasonable starting valuation. One sign of bubble pricing is if home prices are way out of line with rental prices or wages. Moreover, as I see it, there are considerable advantages to moving out. I would want to move out. There is a lot to be said for personal freedom! However, financially speaking, you have a sweet deal living at home. Those are the points and counterpoints that only you can decide. Please consider your priorities, and as long as they are reasonable, then do what is likely to make you happy. If you are prepared for home ownership, and that's where your priorities are, by all means go ahead. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific. 
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| Durable Goods Orders Downside Surprise; Details Range from Weak to Abysmal Posted: 25 Aug 2010 11:15 AM PDT Spending on durable goods rose slightly in July but only on the back of an unsustainable spike in aircraft orders. The rest of the data ranged from weak to abysmal. As has been the case recently, economists missed the mark by a mile. Economists expected a 3% rise, what they got was a .3% rise. The Washington Post discusses the situation in Durable goods orders disappoint in latest sign of economic weakness Overall, orders for durable goods rose 0.3 percent, the Commerce Department said Wednesday, well below the 3 percent that analysts had expected. But even that slight rise was driven by a spike in aircraft orders, a volatile category. Excluding transportation, durable goods orders fell 3.8 percent.Detail Digging Inquiring minds are digging a bit deeper into the Advance Report on Durable Goods Manufacturers' Shipments, Inventories and Orders July 2010. New OrdersInventories Up Orders Down Note how inventories have risen seven consecutive months, while new orders, especially capital goods and non-transportation orders have tanked. Who Couldda Thunk? Flashback July 14, 2010: Expect Second-Half Housing and Durable Goods Crash Those who think manufacturing is going to lead the way to a sustainable recovery need to think again. Data suggest durable goods sales are about to collapse.Intel New Low Intel printed a new low for the move today.  Blowout quarters are one thing, sustainability of them and what's already priced are clearly different things. Across the board, from computers to electronics to home appliances to capital spending in general, durable goods have peaked. Moreover, I believe it was obvious. Recent Surprises
Stack up another huge miss, this time with durable goods. Can someone please tell me what is going on in the minds of economists to continually blow forecast after forecast after forecast when the weakness is easily transparent? Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific. 
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| Posted: 25 Aug 2010 02:46 AM PDT Kevin Feltes, an economist for the Jerome Levy Forecasting Center, solicited my opinion on a couple of their recent articles. Levy comes down on the side of deflation, as do I. However, the devil is in the details, as always. I will go through one of their articles in a point-by-point fashion, stating where I agree and disagree with their analysis. This is a long post. Please give it some time. Please consider Widespread Fear of the Wrong Kind of Price Instability. Levy: It is not inflation but more disinflation and ultimately deflation that lie ahead in the 2010s.Mish Response: I like the concept of a "contained depression". We are certainly in a depression. However, 40 million people on food stamps as of August 2010, masks that depression. The cost of the food stamp program is on schedule to exceed $60 billion in fiscal 2010. For comparison purposes, there was just over 11 million on food stamps in 2005. Please note there are 14.6 million unemployed, but of them 4.5 million of them are receiving regular unemployment benefits and another 4.7 million are receiving extended benefits. Thus 63% of those unemployed are receiving benefits. Being paid while not working also masks the depression. In addition, there is massive underemployment with 8.5 million working "part time for economic reasons" and another 2.6 million "marginally attached" workers who want a job but are not considered unemployed because they have not looked for 4 weeks. This is "containment" of sorts, as the official numbers mask the depth of the unemployment problem. Finally, countless millions have not paid their mortgage for months or even a year without being foreclosed on. Free from mortgage expenses but having a place to live certainly makes life a lot easier. Missing the Boat on Labor-Induced Wage-Price Spirals I disagree with Levy when it comes to the issue of wage price spirals. Levy's statement "Labor cost inflation will remain subdued or even negative as long as unemployment remains high" is not true as evidenced by the stagflationary 70's and 80's complete with Nixon's wage-price controls that were dismantled as a failure in 1974. The following three charts will prove my point. Unemployment Rate 1960 to Present  CPI 1960 to Present  Annualized Wage Growth 1960 to Present  Clearly there is no consistent relationship between the unemployment rate, the CPI, and wages. Nonetheless, I believe Levy is correct about labor costs, for different reasons. My reasons include global wage arbitrage, boomer demographics, and overcapacity in the face of secular changes in consumer psychology (the willingness and ability of consumers to take on more debt.) Those forces will act as a huge damper on consumer demand for goods and services, a damper on business' ability and desire to expand, and in turn a damper on both wages and prices, regardless of what the Fed tries to do. The critical factor in that list is consumer psychology - the willingness and ability of consumers to take on more debt. In the 70's, households went from one wage earner to two, increasing the ability of households to take on debt. Interest rates falling from as high as 18% to where they are today increased the ability of consumers to take on debt. Belief that rising asset prices (especially home prices) would guarantee a nice retirement increased the willingness of consumers to take on debt, and debt they did take on in the form of second mortgages, home equity lines of credit, etc. Now, it's payback time for a global credit boom of epic proportion, now gone bust. Greenspan vs. Bernanke Note the huge difference in the problems of Greenspan as compared to Bernanke. Greenspan had the winds of rising productivity in conjunction with an internet boom, followed by the winds of housing and commercial real estate booms, blowing at his back. The internet boom and the housing bubble both provided an enormous source of jobs. In contrast, Bernanke has a gale force breeze of a secular change in social attitudes towards debt in conjunction with unfavorable boomer demographics, blowing briskly in his face. There is no source of jobs now, only the hollow shells of vacant commercial real estate standing as testimony to the blatantly foolish policies of the Greenspan and Bernanke Fed. Inflationists simply do not understand the importance of these secular shifts in consumer attitudes and demographics. Luck of the Draw Greenspan was "lucky" in the sense that the credit booms fueled asset prices as opposed to consumer prices. Greenspan never had to act to contain "inflation" because he failed to see any even though it fueled a massive asset bubble in housing and commercial real estate. Here is a chart from Case-Shiller CPI Now Tracking CPI-U that shows what I mean. CS-CPI vs. CPI-U  click on chart for sharper image The above chart compares CPI-U vs. CS-CPI, the latter formed by substituting the Case-Shiller home price index for OER (Owners' Equivalent Rent), in the CPI. Home prices were relatively stable in the mid-to-late 90's as the real cost of borrowing was high. However, note what happened when Greenspan held rates low in 2002-2006. Real interest rates (subtract CS-CPI from the Fed Funds Rate) were as low as NEGATIVE 5% in 2004. Is it any wonder asset prices soared? This is one of many reasons why Bernanke's 2% "inflation" policy is preposterous. The Fed simply has no control where liquidity flows, or for that matter if there is a flow at all. Note that real interest rates as measured by CS-CPI hit POSITIVE 6% in 2009 in the wake of the housing crash. Ironically, talk of the town was "massive inflation". The above chart is from March 5, 2010. Although real interest rates are now negative by my measure, I do expect home prices as measured by Case-Shiller to start dropping this autumn, and for real interest rates to be positive once again, even at a 0% Fed Funds rate! Aftermath of the Credit Bubble Bust Greenspan and Bernanke both failed to spot the massive increase in inflation in the early 2000's because liquidity flowed into assets as opposed to wages and consumer prices. We are now in the aftermath of the credit bubble bust. Just as rising productivity and rising asset prices masked massive inflation of money supply and credit in the early 2000's, the reported CPI-U masked falling home prices (and high real interest rates) from 2006 on. With consumers deleveraging, boomer demographics, and no driver for jobs or economic growth, wages and prices are highly likely to be contained. Thus, Levy has the result correct (deflation) but missed the key reason why - a secular change in consumer attitudes towards credit and debt in conjunction with a secular shift in the attitudes of banks' willingness to lend. Levy: 2. Why Aggressive Monetary Policy Isn't Causing and Won't Cause Inflation Mish Response: Those four points above are perfectly expressed. In conjunction with secular changes in consumer attitudes, they form the very heart of the deflation argument. In spite of Bernanke's heroic efforts, banks are still capital constrained. The Fed can create reserves at will. It cannot create capital. Very few understand those alleged "excess reserves" are a mirage. They don't exist. More importantly, fewer still understand that reserves are not an issue at all and in reality, lending precedes creation of reserves. I discussed those concepts at length in Fictional Reserve Lending And The Myth Of Excess Reserves Lending Comes First, Reserves SecondSimply put, anyone who thinks those "excess reserves" are going to produce haunting inflation simply has no idea how the credit system even works. What about the "Liquidity Trap"? My only point of contention in the above section by Levy is in regards to the alleged "liquidity trap". The "liquidity trap" concept is a Keynesian artifact that presumes something needs to be done about falling prices and lack of credit expansion. The reality is falling prices are a good thing (they are only bad in the construct of a credit bubble bust where banks can't be paid back and the Fed feels obliged to steal from taxpayers to increase bank profits to make up for their losses). What causes asset bubbles? Why inflation of monetary supply and credit of course. A depression is a necessary aftermath of a credit boom. Japan attempted to fight deflation for 20 years and all they have to show for it is debt to GDP ratios of 200% and an enormous demographic problem staring them square in the face. Ad Hoc Policy of Inflation My friend "HB" aka Pater Tenebarum discusses the Fed's misguided policy The Ad Hoc Policy of Inflation Contrary to Bullard's hypothesis that rising prices are desirable, we tend to think that most consumers would probably be quite happy to see falling prices. Note here that producers need not suffer either from a fall in prices. What is important for producer profits are relative prices. If their input costs fall to the same extent as their sales prices, they will continue to be profitable.Also note, as I pointed out above, the Fed cannot control where liquidity flows or if it does at all. The housing bubble is proof enough. Thus, the idea that +2% CPI inflation is a good thing is doubly stupid. Levy: 4. The Rapid Increase In Public Debt Is Not Likely to End in DisasterMish Response: Levy was kind enough to produce a larger more up-to-date version of the above mentioned chart. Here it is:  click on chart for sharper image Note that net credit has been in contraction for 5 quarters! In spite of huge government deficits, private credit is contracting faster. Given that "excess reserves" just sitting don't do a damn thing, and given that TMS1 - True Money Supply is barely growing we have a rock solid case for saying deflation is here and now. True Money Supply For more on TMS1 and TMS2 please see
We Are In Deflation Here and Now Rising prices do not constitute inflation, they are at best a symptom of rising inflation. If you have not yet done so, please read Are we "Trending Towards Deflation" or in It? There is plenty of information in that article about how to spot inflation and deflation by looking at symptoms of inflation and deflation. Nearly every condition one would expect to see in deflation is happening, right now. The few that aren't are close at hand and likely. If all or nearly all the conditions one would expect to see in deflation are happening (the scorecard is close to unanimous), I suggest that those who say we are not in deflation have the wrong definition of the word. Inflation and Deflation Defined Bear in mind my definition of inflation is a net expansion of money supply and credit, with credit marked-to-market. Deflation is a net contraction of money supply and credit, with credit marked-to-market. Unfortunately, the Fed and the FASB have conspired to prevent mark-to-market accounting. However, it is relatively easy based on market reaction, credit expansion/contraction, and moves in interest rates to state that deflation started in 2007, continued through 2008, was interrupted in 2009, and we are back in it now, simply by looking at action in treasury yields in conjunction will all of the other indicator mentioned in the article. The reason I use "mark-to-market" accounting of credit in my definition is twofold. 1. From a practical standpoint "mark-to-market" accounting better explains what is happening and why. 2. The model is predictive. Note the Levy chart for 2008 and 2009. Asset prices crashed in 2008 and rose in 2009 although total credit fell in both years. Why? The massive bailout of banks by the Fed and Congress hugely lifted the value of credit on the books of banks. In turn, asset prices rose, as did treasury yields, even though the real economy stagnated. One could not have predicted recent events (even in hindsight) simply by looking at the Levy chart. The Levy chart shows 2008 to be an inflationary year and 2009 a deflationary year. One could also not have predicted what would happen to treasury yields without an understanding of what collapsing credit would do. Time to Short Treasuries? Flashback January 20, 2008: Time To Short Treasuries? Kass: Inflation is still an issue. Despite the Bureau of Labor Statistics' readings, inflation remains elevated and is not reflected in the current level of interest rates. The expected fiscal and monetary stimulation in the upcoming months will only serve to exacerbate inflationary pressures.Note how useless the CPI and the price of oil were and still are, in predicting treasury yields. By the way, I love that Levy chart. Unfortunately, it is not possible to put together a chart of credit "mark-to-market". There is no such thing, on purpose. Neither the Fed, nor the banks want anyone to know true marks, and the accounting board has delayed "mark-to-market" accounting as well as rules that would require more off balance sheet transactions to be brought back onto bank balance sheets. However we can easily deduce the trend by a number of variables. Those variables suggest we are indeed bank in deflation after a short interlude in 2009. Levy: As revenues strengthen and social safety net spending eases, the deficit will tend to narrow rapidly on its own. As in the late 1940s and early 1950s, the debt-to-GDP ratio is likely to fall rapidly.Mish: The conditions in the 1940s and 1950s have absolutely nothing in common with the conditions now. Think of the baby boomer dynamics, population growth, etc. We now have a massive wave of boomers headed for retirement with a need to draw down savings. Unfortunately, those savings are nonexistent for a huge chunk of retirees and hugely insufficient for nearly all the rest. The Model is Japan NOT 1940 We have a model to look at and that model is Japan. Is debt-to-GDP rising or falling in Japan? I think we all know the answer to that. No doubt many will chime in "the US is not Japan" citing Bernanke's massive reflationary effort. Ho-hum. Please consider Bernanke's Deflation Preventing Scorecard and my followup post Are we "Trending Towards Deflation" or in It?. In spite of that massive effort by Bernanke the US is in deflation. Others will claim Japan is a nation of savers. What they really mean is Japan WAS a nation of savers. The savings rate in Japan is now under 1% while the US savings rate is soaring. Interestingly, a lack of savings in the US strengthens (not weakens) the deflation case. What cannot be paid back won't. What isn't paid back results in a collapse in credit (i.e. deflation). So yes, we are Japan, and no, this is not 1940. Headed For Disaster Levy makes another error in stating "The Rapid Increase In Public Debt Is Not Likely to End in Disaster" Assuming we stay on the same course, we are indeed headed for disaster. However, timing the disaster and the nature of it is the problem. We could be 5 years away or 10. There are too many variables to figure out, and too many ways the problem can change in the meantime. I think Japan faces disaster first. They are one cycle ahead. Levy: 8. Could the Economy Begin to Overheat When the Contained Depression Is Over, Leading to Rapidly Rising Inflation?Mish: Levy is back on track. I too suspect the "contained depression" may last as long as a decade. If it does, there is no reason to think the deficit will shrink. Japan's didn't, so why should ours? Interestingly, Levy hits the nail on the head with "Japan provides a graphic example of how an economy in contained depression can run huge deficits, accumulate massive government debt, and still experience disinflation and deflation" while stating something sounding way different in the preceding section. Conclusions I commend Levy for coming to what I believe is the correct overall conclusion. Levy did go astray on some minor issues as well as one major point, but overall I like their analysis. The report was well presented. One problem in reading the report is that at times Levy seems to confuse "price inflation" with "inflation". It is very difficult to draw correct conclusions about what is happening and more importantly what is likely to happen, unless one figures out where money supply and credit are headed, and why. If you have not done so, please consider Fiat World Mathematical Model. That Levy managed to come to what I believe is the proper overall conclusion stems from Levy's rock-solid case presented in section 2: Why Aggressive Monetary Policy Isn't Causing and Won't Cause Inflation. Thanks It is not often that economists ask me for an opinion on their works. I appreciate this opportunity by economist Kevin Feltes to comment on the works of the Jerome Levy Forecasting Center. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific. 
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