Tuesday, August 19, 2008

Alice's bubble wrap

LIBOR rising again

"The key rate at which banks lend to each other in dollars hit its highest level in two months on Monday, suggesting there could be more turbulence ahead for the financial system."

But I thought that things could only get better? Can you feel it? Something bad in banking is about to happen.

Where is the deflation?

It hasn't happened yet....

"US wholesale prices rose twice as fast as expected last month as new home construction plunged, government data showed on Tuesday, offering little reason for optimism on the outlook for either inflation or the ailing housing market."

Big Picture

Covers the same story; "The latest Producer Price Index for Finished Goods is out, and its screaming hot: It advanced 1.2% in July (seasonally adjusted). 1.2% headline and 0.7% core vs consensus estimates of 0.6% and 0.2%. "

Econbrowser on falling oil prices

Lower oil prices will take one full percentage point off the US CPI. That still leaves the US with a five percent inflation rate and negative interest rates. It still puts the US economy a long way north of deflation.

Times guide to London property

"The Royal Borough tops the list with an average price over £1.4 million followed by Westminster at over £1 million. Why would I pay an average £412,023 to live in Hounslow?"

I have a passing acquaintance with Hounslow, it is not so bad.

Worst of the credit crisis still to come

Don't tell me that!

Why UK house prices could fall by 50%

Someone must have looked at my recent "short history of UK house prices" slideshow. However, I discovered one interesting thing from this post:

"According to Rightmove, the average estate agent now has a record 78 unsold properties on its books. That represents a seventh consecutive monthly increase in the amount of unsold stock. "

Stumbling and mumbling

On why Polly Toynbee is wrong. Is she ever right?

A Chinese perspective on the UK economy

At least we are picking up a few medals in China.


  1. Alice,

    You are kicking a corpse here. The deflation story is dead. The inflation data killed it.


  2. Alice,

    The deflation vs. inflation debate takes place on different planes. The deflation folks see falling asset prices (stocks & houses) as proof of deflation. Credit expansion or contraction is their litmus test. This view has merit.

    The inflation folks use cost of living as their measuring stick (CPI in the U.S.). This view certainly has merit too. Especially for the majority that have limited means.

    I happen to believe that both views are simultaneously correct.

    Inflation in needs, deflation in wants.

    P.S. Deflation is magnified by leverage - except for those with no skin in the game.

  3. Mab, exactly... that's why I'm a biflationist - all be it one who thinks asset prices are more important than commodities.

    Kenneth Rogoff rocks, doesn't he? The BBC reported this prediction with a bit more of an edge than the Telegraph.

    Maybe you could run a sweepstake - Ken reckons it is a "whopper" - which I think we can assume to mean top-10, at least. Who are the biggest 10 banks and investment banks operating in the USA?

  4. asteve,

    Thanks for the wiki link. I have never heard of biflation.

    As far as banks go, without fed & gov't support, many big banks will fail. Fannie, Freddie, Wamu, Wachovia, Lehman and Merrill are all on death row praying for a stay of execution. One will likely be a sacrificial lamb though.

    Even Goldman looks vulnerable. Consider that a mere 7% drop in the value of Goldman's level 2 & 3 assets wipes out their equity entirely. For Merrill, only a 4% drop would zero out the equity.

    What are these level 2 & 3 assets? Can't say for sure. But we can say they are not liquid and readily tradeable assets such as treasuries, public stocks or bonds.

    It's not a stretch to believe the entire financial system has negative equity right now.

  5. Deflation is not a fall in asset prices. It is a fall in the prices of goods and services. This is what happened in the US during the early 1930s.

    Asset prices fell in real terms. throughout the 1970s. However, no one would seriously suggest that this was deflation.

  6. Mr Rogoff said... "The financial system has become very bloated in size and needed to shrink."

    Yes indeed.

    As has been said on this site by some: You can't have a prosperous economy by selling each other houses, bonds, and mortgages and coffee... you have to make things.

    The crises so far: The UK property bust '89'-96, Savings and Loan in US, Lloyds Spiral in London, Enron, Sub-prime all over the place now, with the worst still to come...

    ...do we need another to learn that too many not very skilled brokers taking commissions on financial transactions equals bubble, not lasting wealth creation?

    Sack them all and make those who can do engineering degrees; the rest will just have to clean houses and streets and cook and serve for minimum wage in restaurants to survive.

    And please, let no one use the word 'innovative' in relation to banking again, or argue that we need deregulation to allow 'innovation' it to happen.

    B. in C.

  7. Alice,

    FWIW, Bernanke claims the 1930s' deflation resulted from a collapse in aggregate demand. To me that sounds plausible. But if we accept that thesis, we should take it a step further and try to figure out why demand collapsed. I'd posit that a combination of wealth concentration, rampant speculation, a false belief in ever rising asset values, perceived fraud and excessive leverage rapidly eroded FAITH in the system. Very similar to today.

    While prices of consumer goods did indeed fall during the depression, affordability did not (especially for the 25% that were unemployed).

    Actual output of goods and services in terms of quantity seems to be the key to a healthy economy. Asset prices are fickle and subject to pschology - not a good foundation for an economy. Output of real goods & services is the proper foundation - that's why we have a CPI. Every time we come to believe in assets over actual output all hell breaks loose - 1929, 1970s nifty fifty, 1980s commercial real estate, tech stocks, now housing. The asset based economy is "ass" backwards imo.

    Super cool blog. I dig it!

  8. MAB

    Thanks for the kind words re: the blog.

    My take on the great depression is that you need some absolutely huge levels of unemployed resources to generate falling prices. You also need the a credit contraction where a huge percentage of your money supply contracts. As bad as things are at the moment, we are a long way from a 1930s scenario.

    The mid-1980s had huge levels of unemployment, yet inflation never came close to zero. Again, for me the deflation argument falls down on the magnitudes needed to get such effects.


  9. Alice,

    Here's the U.S. CPI data since 1913:


    Prior to 1913 (the year the fed was formed and the income tax was established) falling consumer prices in the U.S. were the norm. In fact, prices continually fell from 1776 to 1913. Even after 1913, a falling CPI was normal. In general, only periods of war were inflationary. After FDR & Nixon killed the gold standard things changed in a BIG way. We went on an inflation standard. No joke. You could bank on inflation - and we did, with ever increasing leverage.

    When you understand that inflation is manufactured, it makes it very difficult to stomach, especially when it is being used as a lifeline for reckless lenders and borrowers.

    At this point, I don't fear collapsing output for essentials, at least in the U.S. I do fear that inflation will steal my savings. If we continue to inflate, even the prudent will have trouble affording their houses and raising their families. Where is the logic in that?

  10. Alice: "Where is the deflation? It hasn't happened yet...."

    Alice, it is not apparent yet, not on the high street, not yet. But it is apparent if you know where to look, you have flagged it up on this blog. Housing asset prices have declined in the UK by as much as 10%, do you think that is all that will happen? No, I don't think you do.

    Northern Rock represents a huge (for the UK) asset bubble deflation, I know someone who happened to take out a 110% no down payment loan with them. They will never recover the money on that deal. Bradford & Bingley, cannot raise capital in the market, principally because nobody wants to put their cash in a bank. They won't want to do so for another decade either.

    Inflation yes, everyone on the high street sees it, but Deflation is following behind, and I think will soon come to the forefront...

  11. Alice:" My take on the great depression is that you need some absolutely huge levels of unemployed resources to generate falling prices."

    No. falling prices are not necessarily an indication of 'deflation'. Falling prices can be an indicator of a well functioning capitalist economy. Economies of scale, more people moving away from subsistence, increasing disposable income leading to increasing demand and more falling prices, perhaps accompanied with high levels of personal saving too, these are not indicative of deflation, rather prosperity.

    Deflation, is what you get when you get a massive contraction of credit accompanied by decrease in asset prices. In fact what we are witnessing here now!

    Deflation represents the opposite of the prosperous economy, low savings rate, high indebtedness, falling incomes, leading to a falloff in demand for goods and services, falling asset values reduced credit, who will extend credit if you are unlikely to get your capital back? These are all indicitive of deflation.

    Stand by for huge levels of unemployed resources!!

  12. Alice: "Deflation is not a fall in asset prices. It is a fall in the prices of goods and services. This is what happened in the US during the early 1930s."

    I disagree. First, I do not think that deflation (the depression) was a fall in the prices of goods and services - though I agree, this was a consequence. The same goes for other consequences - such as unemployment, starvation and WWII. The deflation was when the money supply shrank by ~30%... and it took time for the price of commodities to fall in line with this. I think that 1929, just like 2007 saw a speculative bubble burst - the bubble was traded debt.

    I think we can draw a lot of similarities between what is happening now and what happened in 1929. Today is not a replay, however, it is unique - because the world today is decidedly more complex than it was in 1929. Today we're looking at more leverage; more communication and more organisation than at any time in history. The scale of deflation today looks set to significantly eclipse that of 1929... the human consequences, however, are less clear. Maybe we'll avoid repeating the worst of the human costs. Maybe not.

    I think that part of the problem with deflation is identifying what is deflating. It most certainly isn't defined by the price of commodities, services and goods. It is defined by contraction of money. It was obvious what that meant back in 1929... but it is less obvious today. The boundary between contracts, bonds, shares, bets, insurance, futures, cash, credit and assets is very blurred. Rest assured, however, the western world is experiencing a deflation. Money - defined as that which will be used to pay for things - is contracting. Time will tell if the abundance of material wealth today will help us weather the storm ahead any better than our great grandparents did in 1929. Our history is not yet written.

  13. As Hounslow includes Chiswick, where prices routinely top the £1m mark, you've got to wonder what keeps the average down as low as that.