The ‘Flations

The incessant debate of whether the economy is inflating or deflating suffers from a vocabulary problem. This is as it must be since some (Federal Reserve Chairman Ben S. Bernanke) discuss deflation as falling prices of stuff while others concentrate on the debt deflation of an overleveraged economy. The latter is what matters.

This debate often fails to address the important question of “what does it matter to me?” What matters most is the changing relationship of prices. For a worker who pays $3 instead of $2 for eggs, “inflation” is his greatest worry. If, at the same time, the worker receives a 20% pay cut, there may be many causes, and it is at least symptomatic of “deflation.”

The “inflation” and “deflation” debates (at least, in the major media) are of limited interest when they take an either/or approach. In fact – back to “what does it matter to me?” – both conditions are present and moving towards a chaotic conclusion. This should be expected when the Main Street economy is appended to a financial economy, which by its nature (and high-frequency trading) is more unstable than a production economy. Since money-printing is still ascendant, more violent changes in price relationships are certain.

The Bernanke, Geithner, and Summers economy (that is, the economy of the United States) is following the historical script to hyperinflation, total war or social disintegration. In War and Peace, Tolstoy describes the prelude, those halcyon days in Old Moscow: “in those brightly colored rooms – with the music, flowers, dances, the Emperor, and tables set for eighty … The mirrors on the landing reflected ladies in white, pale-blue and pink dresses, with diamonds and pearls … In the first hall were the nobility and gentry in their uniforms … In the noblemen’s hall was an incessant movement and buzz of voices.”

The atmosphere was about to change, as some knew but many chose to ignore: “On the arrival of the news of Austerlitz, Moscow had been bewildered. At that time the Russians were so used to victories that on receiving the news of defeat some would simply not believe it, while others sought some extraordinary explanation of so strange an event.” Chairman Bernanke chose (circa 2004) to believe such odd-ball theories as “the great moderation” and “the global savings glut,” both extraordinarily inept descriptions of a world about to turn over.

Today, still ignorant of the debt deflation that plagues the deleveraging economy, Bernanke gabs before senators of a fanciful world, akin to a shell-shocked survivor raving before the Muscovite cognoscenti of the great Russian victory at Austerlitz. The beautiful people find this reconstruction most pleasing, so choose to trust it. (This is also a simplified version of how the most (not best) educated Americans – who dominate government, the media, think tanks, Wall Street, universities and wherever else they bray – came to ignore Alan Greenspan’s grave deficiencies and to deify him.)

The best families in Moscow held the most possessions and prestige, so they, as is true of their current-day American counterparts, were the least likely to acknowledge Russian weaknesses. Respected Muscovites of title and pedigree were trusted by many of lower rank, and understandably so. Since princes and counts had the most to lose if Napoleon invaded Moscow, and, the aristocrats were privy to insider information from the very top, surely it was wise to follow their bettors’ example.

Alas, those who were surest of their own invincibility were the least prepared for Napoleon’s invasion. Tolstoy wrote of simultaneous inflations and deflations, vast redistributions of wealth, sometimes accumulated over generations, lost in a matter of hours: “Prices that day indicated the state of affairs. The price of weapons, of gold, of carts and horses kept rising, but the value of paper money and city articles kept falling … Peasant horses [ed. note: a humble breed] were fetching five hundred rubles each [ed. note: a life savings] and furniture, mirrors and bronzes were being given away for nothing.”

Not to be neglected are the recriminations. Said the Countess Rostov: “Listen to me Count, you have managed affairs so that we are getting nothing for the house…. You said yourself that we have a hundred thousand rubles worth of things in the house…. Look at the Lopukhins opposite, they cleared out everything two days ago. That’s what other people do. It’s only we who are such fools.” Live and learn, Countess. That’s what happens when you marry the decaying order.

Currently, inflation is present in the money supply, price of gold, and the U.S. stock and bond markets. These are old themes here, so will be held in abeyance to discuss an acute deflationary threat. That is income. It is falling and prices are rising.

David Rosenberg, economist at Gluskin, Sheff, an investment advisory firm in Canada, calculates that “private incomes” (non-government jobs and transfers) in the United States have fallen from $8.7 trillion in the third quarter of 2008 to $8.2 trillion in April 2010. Americans lived beyond their incomes for years. The main source of overconsumption was consumer credit which fell at an annualized rate of 3.75% in the second quarter of 2010. This demonstrates ingenuity on the consumers’ part given that “the big six issuers have trimmed total credit available to their customers by 25 percent, partly by shrinking credit lines and not renewing expired cards,” according to an analyst at Credit Suisse.

Again, there were other sources of spending for the consumer, such as home equity withdrawal (HEW). In 2005, homeowners cashed out over $800 billion of HEW. In the second quarter of 2010, this fell to $8 billion. It was hardly worth filling out the forms.

The government has plugged some holes such as its army of make-work census takers. (It cost the government $15 to count each head in 2000 and $25 per scalp in 2010. This is the Information Age?) President Obama intends to extend make-work to the far abroad, or, at least he did on June 30, 2010, when he told an audience in Racine, Wisconsin: “When you look at a place like Afghanistan, or you look at a place like Iraq, so many of our military personnel are having to engage in work that really should be civilian. So what I’m trying to say is, don’t put all the burden on the military. Make sure that we’ve got a civilian expeditionary force that when we go out into some village somewhere…. let’s make sure that we are giving them the support that they need in order for us to be successful on our mission.” [Italics added.] Who said government workers have no imagination?

Over 40 million Americans used food stamps in May 2010, more than one-eighth of the population. According to Bill King (The King Report), U.S. government anti-poverty spending has risen 89% since 2000 – from $342 billion to $647 billion. This includes such programs as Medicaid grants, food assistance, housing vouchers, and child nutrition programs. Unemployment benefits have been extended several times in the past two years, to 99 weeks at present. The Labor Department estimates that 1.4 million workers have been unemployed for at least that amount of time. Nearly 46% of the country’s 14.6 million unemployed have been without a job for more than six months. Despite the fevered attempts to put money into hands of Americans, there were more house foreclosures in the second quarter of 2010 – 269,962 – than ever before. That was a 38% rise from the second quarter of 2009.

This has the feeling of a dyke about to burst. The government’s finger is forestalling the flood with Federal Reserve mortgage security purchases and government agencies that now issue over 90% of home mortgages. This does not put beer on the table which is a reason to think the housing market is going to topple again.

It is rare for beer sales to decline, yet, as described in the May 28, 2010, issue of Grant’s Interest Rate Observer: “In the 10 years to 2007, American beer shipments rose by an average of 1% a year. They rose by even less than 1% in 2008 and fell by 2% – a virtual collapse in beer terms – in 2009.” (There has been a drift to wine and spirits, but an attempt to find comparable sales data was unavailing.) In another land with stagnant incomes, or, at least where the sun seems to be perpetually setting – Japan – “Spending by Japanese businessmen on beer and sake is at an eight-year low as tighter household budgets squeeze their entertainment expenses. Salarymen go out drinking on average 2.9 times a month, spending about 4,190 yen ($46) each time, a 19% decline from a year earlier.” (Bloomberg, June 10, 2010). Cigarette sales are also falling in the United States, and, in Europe, cell phone usage dropped 4% in the first half of 2009. These trends indicate that “necessities” may be defined down as well as up.

Reduced circumstances will grow more acute as prices continue to rise. The U.S. government contends prices are not rising. Count Rostov could do a better job. Almost anyone who pays health insurance premiums (health costs are 16% of the economy but only 4% of the consumer price index); tuitions (Harvard’s are increasing 4% this year); utilities (“The Los Angeles Department of Water and Power is planning to boost the electricity bills of its customers by 37% over the next four years as part of its effort to cover steadily rising costs.” – L.A. Times, March 26, 2010); and cable bills (“Your cable bill is going up this year — and next year, and the year after that — with no end in sight.” CNN – January 9, 2010); and who buy food and gas are falling behind in relation to the nation’s income.

A food study might be most illuminating, but the reader will be spared such a discourse. It is worth remembering though, that food and energy are not priced in the United States. Brazil, which is booming, sends this reminder from a member of our happy Global Village: “Brazil is running out of beer cans and farmers are leaving crops in the field as surging demand and Chinese-like growth leads to shortages in Latin America’s biggest economy. Cia de Bebidas das Americas, the region’s largest brewer, had to import beer cans for the first time in its 125-year history after local supplies were exhausted. Acucar Guarani SA, the country’s third-biggest sugar producer by market value, left 10% of its crop sitting in the fields an extra 40 days because of a shortage of tires for its harvesters, even after the commodity hit a 29-year high in February.” (Bloomberg, June 8, 2010)

On August 3, 2010, Chairman Ben Bernanke told an audience in Charleston, South Carolina: “[R]ising demand from households and businesses should help sustain growth,” and consumer spending “seems likely to pick up in coming quarters from its recent modest pace.” Well, consumers will be spending more on sugar, beer cans, and cell phones (if they still use them) and Simple Ben’s money printing will ensure a chaotic, and impoverished, finish. The Countess Rostov should mop the floor with him.

About Frederick Sheehan 53 Articles

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009). He is the co-author of Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve.

Mr. Sheehan was Director of Asset Allocation Services at John Hancock Financial Services in Boston. In this capacity, he set investment policy and asset allocation for institutional pension plans. For more than a decade, Mr. Sheehan wrote the monthly "Market Outlook" and quarterly "Market Review" for clients.

He is a frequent contributor to Marc Faber's "Gloom, Boom & Doom Report." He also has written articles for "Whiskey & Gunpowder" and the Prudent Bear website, among others. He currently serves as an advisor to an investment firm and a non-profit foundation.

A Chartered Financial Analyst, Mr. Sheehan is a graduate of Columbia Business School.

Visit: Frederick Sheehan's Website

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