Everything is Deflating, Not Just House Prices

There is considerable discussion as to whether we are in, or entering into, a period of inflation or deflation. It’s important to know which one it is and why, to be able to plan effectively.

It’s deflation, and we’re already in it.

The simplest working definition of inflation and deflation is an expansion of the supply of money and credit in the case of inflation. Deflation is the opposite, a contraction of money and credit. Despite recent price surges in food and oil, prices are declining across the board, and even those two headline-inflation items are down from recent highs. An interesting explanation of how this happens is on Mises.org: If the price of a good goes up (in the absence of an increase in the money supply), consumption must be reduced on some other good. This sounds more like common sense than economic theory, especially after the recent run up in gasoline prices.

The rule of thumb in deflationary environments is cash is king. This is no time for major purchases or unnecessary expenditures. Why buy today when the price will be lower tomorrow?


Stock Markets
Here’s what’s been happening in the Dow for the trailing 12 months.

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This performance has had dire consequences throughout the economy. As one example, at the beginning of October, retirement plans had lost as much as $2 trillion — or about 20% — over a15 month period, according to Congress's top budget analyst .“The upheaval that has engulfed the financial industry and sent the stock market plummeting is devastating workers' savings, forcing people to hold off on major purchases and consider delaying their retirement,” said Peter Orszag, the head of the Congressional Budget Office. Savings across the board, even Harvard’s endowment, have taken a hit.

The US markets haven’t been the worst performers. “World equity markets lost an estimated $5.79 trillion during October, the biggest monthly loss ever,” according to Standard & Poor's Index Services. “The October loss eclipsed the previous record, which was set just one month earlier, when 52 global equity markets lost a combined $4 trillion. Through the first 10 months of 2008, world markets have lost about $16.22 trillion.”

Commercial Real Estate
Due to store closings and company bankruptcies, losses in commercial real estate are mounting. On Tuesday, General Growth Properties, one of the largest mall operators in the country, announced that it is near bankruptcy. Its stock closed at 35¢ today. Its only hope now is to become a bank holding company.

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Residential Real Estate
Residential real estate losses are unrelenting and the magnitude of losses is staggering.
Here’s the latest from Case-Shiller.

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The Deficit
OK, here’s something that’s up, the national debt, which reached $10.6 trillion the other day. The increase year over year since 2005 isn’t all that much.

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However, if you look at the increase over a several-decade period, it looks like this.

(Picture on http://blownmortgage.com/ scroll down to 11 13 08)

Unemployment
CNNMoney.com reports that “The government reported more grim news about the economy, saying employers cut 240,000 jobs in October, bringing the year's total job losses to nearly 1.2 million. According to the Labor Department's monthly jobs report, the unemployment rate rose to 6.5% from 6.1% in September and higher than economists' forecast of 6.3%. It was the highest unemployment rate since March 1994.

These figures notoriously underreport unemployment, but the trend is clear.

I hope everyone has a few bucks in the house, at the very least enough for groceries and gas.

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Just how much money has the Fed, aided and abetted by the Treasury, spent this year? Numbers are all over the place, but it could be around $3.8 trillion. They spent $650 billion in the last six weeks alone. And it’s all money they don’t have, by the way. And it has yet to be financed; that’s ahead of us.

The $700 billion authorized by Congress—to buy illiquid securities from banks—has been spent. Not on illiquid assets, though. It’s been spent on: capital infusions to large US banks, whether they want it or not; regional banks, they’ve all want it; US insurance companies, whether they “need” it or not; and on short-term funding including commercial paper for US industrial GE. This week’s brand-new recipients of the Fed’s largesse are the central banks of emerging market countries, plus the central banks of New Zealand, Australia and the EU. Yes, that’s right, further direct lending from the Fed to foreign central banks. The only thing this group has in common is credit risk so high that only the Fed will lend to them.

This bill, the Emergency Economic Stabilization Act of 2008, was passed by Congress less than a month ago and they are about to go back to the well for another $600 billion.
On Oct. 30 Bloomberg reported that the Fed “agreed to provide $30 billion each to the central banks of Brazil, Mexico, South Korea and Singapore, expanding its effort to unfreeze money markets to emerging nations. The Fed also created a $15 billion swap line with its New Zealand counterpart and removed limits this month on four existing swap lines, including one with the European Central Bank. The Fed set up a $10 billion arrangement with Australia's central bank last month and then tripled it to $30 billion.

“The swap lines will help unclog the liquidity pipeline and that action is boosting markets even more than'' the Fed's rate cut, said Venkatraman Anantha-Nageswaran, head of research at Bank Julius Baer & Co. in Singapore. “It's a step in the right direction and prevents things from getting worse.”

Worse than what; these actions reveal a previously unthinkable level of desperation.
Last week banks borrowed $368 billion per day, up from $188 billion per day the week before (source: Federal Reserve Bank of St. Louis via http://www.itulip.com/forums/showthread.php?p=52281#post52281).