Monday, September 13, 2010

Deflation and Peak Oil Imports

The U.S. and the industrialized nations are deep in the grip of Deflation. No amount of wishful thinking is going to wind this process up in the near term. I had previously mused that perhaps another year or 2.... I am as guilty of wishful thinking as the next guy. That credit has peaked needs no better indicator than that student loan debt has exceeded credit card debt.

To understand this best, one MUST read the Federal Reserve Act in its entirety. Mike Shedlock put it best in a posting on his excellent blog today - that the Fed cannot force borrowers to borrow nor lenders to lend or in his words:

To understand how powerless the Fed is, one needs to understand the difference between credit and money, how much the former dwarfs the latter, and what the Fed's role is in getting banks to lend. I discussed those ideas in Fiat World Mathematical Model.

Unlike Congress, the Fed has no power to give money away. Nor would they do so if they could.....

As noted above, the Quantitative Easing will not cause hyperinflation. Moreover, it is doubtful the Fed can cause it at all. The Fed cannot give money away nor can the Fed force banks to lend or consumers to borrow. Those who disagree must still address the difference between theory and practice.

Unlike the Fed, Congress could give money away.

I do not know if giving everyone in the US $60,000 would do it or not, but announcing a plan to give everyone $60,000 a month indefinitely would sure do it.

How likely is that?

The answer is 0%. Congress struggles right now extending unemployment insurance. There is little political will for more stimulus. The next Congress is a guaranteed bet to be more conservative.

To be sure, more stimulus and more Quantitative Easing are coming but the latter does not matter and the former will be in insufficient quantity.
The critical line is that only Congress has the power to give money away. The Fed was not vested with that power - I read The Act and that authority just ain't there.

We can argue over just how aggregate debt gets back to whatever we determine "normal" or "sustainable" is.... but get back there it will. Yes, the government is going to continue to deficit spend, and yes this will be less than the contraction in aggregate debt - ergo, we are going to be stuck for sometime in this deflationary environment. In the end, the folks willing to sell us their manufactured goods ON CREDIT (which gives us our trade deficit and them their U.S. reserves and Treasury Bonds) will stop doing so... that will be the end of the trade deficit, and BY NECESSITY, the end of Oil imports into the U.S., the end of a pretense of "growth", etc..., etc...

In the past, I was as guilty as the next blogger of the fallacy of misplaced concreteness... or that all things being equal, then.... but as we all know, all things are NOT equal. Things change, policies change, opinions change, data change... s**t happens. The U.S. is not going to default on its bonds! That would harm the rich, the powerful, the influential, and the political classes... that would make NO sense given that these folks run the train set. Nope. The U.S. will default on Social Security, Medicare, and Medicaid... and as an impartial chess enthusiast... that is the right thing for the U.S. to do. The Republic MUST go on, no matter how f***ing stupid past administrations and Congresses have been.

That's the politics of it... the economics of it will needs be figured out on the personal level.


14 comments:

bureaucrat said...

Gee, Shedlock is gonna find himself with his own prime-time TV show if his totally contra-predicting style starts to turn even the most hardcore inflationist around. Did I mention he lives close to Chicago? :)

I've been following Mish since 2007. Back then, I was going gaga over "inflation" (storing provisions in my basement before the prices lept up) given the quantity of cash that the Fed was putting into the system. I think it even was a surprise to Shedlock when all that money ended up getting parked and usused on account for all those banks. No increase in money supply = no inflation.

Shedlock could not convince people how credit is 10xxx more important to the U.S. money supply than actual cash. When the banking system destroyed $20 TRILLION of CREDIT in 2008, it didn't matter one iota that the Fed. Govt. was stimulating by the hundreds of BILLIONS. There would be no inflation. We would instead have the first DEFLATION in 75 years, as the money supply shrunk by huge numbers.

Shedlock has also noted that what we now have is a massive debt overhang post-orgy, with $50 trillion in debt sitting out there, just in the US vs. $14 trillion in GDP in service it. 360% debt to GDP, and it isn't getting worse, but it isn't getting much better either. And all over the world (Japan and UK -- the developed economies mostly), the debt orgy is now impairing economies from one end of the Earth to the other. We are gonna be stuck in this for years, if not a decade or longer. :( Only time and bankruptcies can fix this.

A Quaker in a Strange Land said...

Bur:

I quit the inflation camp in 2008. Its day simply will not come if SS, medicare, and medicaid are no longer funded as they currently are.

It is important to realize that there is a difference between inflation, high inflation, hyperinflation... it will be quite some time before we have to worry about any of them.

Anonymous said...

What I find interesting is that the lack of skill in managing the economy may speed up Peak Oil consequences faster than the actual diminishing supply of oil.
It's almost like someone is saying "Just bring it on, bitchez"
That could have the effect of reducing the slope of the decline curve.
Of course, a nasty little war around the Persian Gulf could do the same thing, in that it would keep the oil in the ground.
And keep the serfs occupied at the same time.
What's not to like?
Tsarovich.

bureaucrat said...

I don't think inflation is all that dead and buried. While we can argue till the cows come home about Milton Friedman declaring that "inflation is always and everywhere a monetary phenomenon," (in other words, inflation depends solely on the amount of money in the system -- the money supply -- and little else), what if you have an indispensable, inexpensive item, like crude oil, that cannot be cheaply replaced, and it peaks in its production on planet Earth?

What happens in an oil-constrained world, where there is just no other cheap chemical on the planet like crude oil, that stores the most BTUs per pound, and no more oil can be created unless you have 90-150 million years at your disposal. That is a very new economic world.

Anonymous said...

Bur-

Demand-pull inflation results from a heated economy as hot demand drives prices up. Wages rise to keep up with prices. Prices rise with renewed buying etc. When inflationary psychology develops, individuals and businesses spend money quickly to beat the next prices rise.

Cost-push inflation or hyper- inflation results from a currency collapse situation and usually takes place in an environment of poor business conditions. The currency collapse drives prices from the bottom up when imported essentials skyrocket in response to collapse of confidence in the currency.

Can you find any manufactured product in Walmart that is not imported? USA no longer has the manufacturing base to substitute for Asian manufactures which may be skyrocketing in price.

Another factor in this scenario is the massive US debt pyramid which loses all stability with the dollar collapse. When the debt pyramid begins a deflationary collapse, the monetary authorities must either print and stuff dollars everywhere or sit by and endure a deflationary doomsday. And the end of their political careers.

The money printing however will not sit well with foreign importers into the US- think ME oil exporters. No more credit for you, Uncle Sam. Payment for oil in gold or Yuan only.

Just my viewpoint..

Best,Marshall

Donal Lang said...

Deflation is the devaluation of assets. Inflation is the devaluation of money. You can have both, they are not opposites.

Yes, assets are falling in value; you have internal deflation. But you are also printing quantities of money to compensate for the slower flow of money through the system, where people no longer want to spend of get credit.You're right that it's not hyperinflationary as long as that money is pulled out of the economy before normal economic activity picks up. But its still inflationary.

Also inflation can be external; the oil price can go up because China and India want more oil, the food prices can go up because Russian crops fail. That's inflation too.

But also the Fed is still printing money, and the RotW may view it as dangerous; China has already gone from a net buyer to a net seller.

You say America won't default on its bonds - there's an assumption there that it has a choice!

Its a brave man who will forecast where all the 'ups' and 'downs' will end up, but both inflation and deflation together are the worst possible combination; falling asset values, falling money exchange values, falling real wages, rising food and fuel prices, and no gov't mechanism for breaking the long downward spiral. Personally, I'd say that's what is next.

Anonymous said...

Gordon T. Long expresses the problem pretty well-

"We are all painfully aware that the US has not produced sufficient exportable product to support its standard of living for many years. Manufacturing in the US has been in steady decline since the 1960’s and the excess spending during the Vietnam War. It has been 50 years since the US had a balanced budget (forget Clinton's social security slight of hand). Over the last 10-15 years the US has seriously compounded this problem by accelerating the de-industrializaton of America without a strategy to replace salable export product. Corporate industrial strategies of outsourcing, downsizing, and off-shoring were never countered other than by an excess consumption splurge which fostered massive real estate and retail expansion distortions.

Simply said: A US Service Economy that is based on 70% GDP consumer consumption does not pay the bills!

For a brief period of time following the dotcom implosion, the US operated as a mercantile “Financial Economy” that turned out to have been nothing more than a historic illusion. "

Cheers, Marshall

bureaucrat said...

I guess all we can do is either wait for China to have its inevitable debt/economic blowup, or for the Chinese to demand American-level wages so that we can compete with 10 cent a hour (today) laborers.

I like my standard of living, dammit! :)

Donal Lang said...

Bur; the maths of globalisation doesn't work like that. There's a billion of them working and only a couple of hundred million of you guys (if that), and your average wage is ten times theirs, so yours will fall about 80% (in real terms) and theirs will rise about 100% to meet it.
Most of the fall will be inflation/devaluation of the dollar so if you're working you'll still get your $40,000 a year (or whatever). Trouble is, it won't buy much!

Can't imagine where house and asset prices will end up. Let's just say real estate won't be an investment opportunity for a while yet! ;-)

Anonymous said...

Hey Greg,
I don't know if Resource Insights is part of your reading lists but his latest post made me think about what you're addressing here.

I agree with Donal, on the ground I'm seeing Stagflation. Does it mean an inevitable bond default, I don't think so... If bankruptcy means jettisoning SS, Medicare et al, well, my wife is already convinced that she'll never see any of those benefits... She's been right all along... Thank God she doesn't read this blog and its comments like I do or I'd never hear the end of it.

Anonymous said...

I think the key is in the federal deficit and monetization. The federal government, politically, cannot raise taxes or cut spending. From a practical standpoint, doing either will certainly make the economy worse in the short run, although cutting spending would help in the longer term.

Right now there is lots of demand for US government debt, as the rest of the world sees it as a safe haven. As Donal has indicated, this perception may not last in the face of monetization. The balance of trade deficit will end, as there will be no more external credit. Bonds will be paid back in almost valueless dollars. It is a type of default that may be beyond the ability of TPTB to control. The Piigs will go first. Once the market for sovereign debt is shaken by a few good sized defaults, anything can happen. It will come when we least expect it.

Having said that, the monetization that is happening now is directed toward taking bad debt off of banks' books, and is not necessary to fund the federal government. Things aren't too bad yet. Should sales of government debt falter, forcing the Fed to engage in monetization to prevent long term interest rates from rising out of control, it's all over but the crying.

Regards,

Coal Guy

Anonymous said...

I still find that despite the arguments and predictions about macroeconomics, that demand inelasticity for Oil/Food will be the key issues this decade. Oil inports decreasing or perhaps dropping of the map this decade due to depletion and geopolitical turmoil/wars in addition to systemic food production issues with the highly coupled industrial food production in America will just be the killing blows to whichever occurs--deflation/high inflation etc.

Ultimately, without a radical change in culture/society such as recapturing all phosphorous in sewage treatments and run-off collection from industrial farming, food is looking to be more and more unstable in the years to come. UG99 is already causing a lot of strife in the world, and Russia already took export measures for their wheat--even without the wheat rust. Redundancies are just plain lacking in some of these complex systems.

The solar flare activity predicted for 2013 alone could devastate telecommunications and depending on severity--ground based electronics. So it the question which shoe drops first the hardest--economic/geopolitical monetary woes, or the nuts and bolts of reality---Oil/water/Food? These realities already exist for billions of the human population. People in the US are just getting irritable that the magical status of the US empire as being exempt from the fate of other empires and other resource limited countries--even with technological know-how is coming home to roost. Supply and Demand and monetary policy aren't going to tackle these realities, and I don't believe that people will sit back and watch SS/Medicare etc. disappear--perhaps people would tolerate them being phased out, or greatly diminished, but if dropped in a short time frame--things will get crazy me thinks.
-Meiyo

Anonymous said...

Here is the latest just in from John Williams of Shadowstats-

"Now, as business activity sinks anew, much expanded supportive measures will be needed to maintain short-term systemic stability. Such official actions, however, in combination with global perceptions of limited U.S. fiscal flexibility, likely will trigger massive flight from the U.S. dollar and force the Federal Reserve into heavy monetization of otherwise unwanted U.S. Treasury debt. When that land mine explodes — probably within the next six-to-nine months, the onset of a U.S. hyperinflation will be in place, with severe economic, social and political consequences that will follow."

U.S. Economy. Already the longest and deepest economic contraction of the post-World War II era, the current downturn in the U.S. economy is re-intensifying, with no near-term stability or recovery on the forecast horizon.

U.S. Inflation. Risk remains exceptionally high in the next six-to-nine months for a combination of massive U.S. dollar selling and heavy Federal Reserve monetization of Treasury debt to boost inflation, and to open the early stages of a U.S. hyperinflation."

Best, Marshall

bureaucrat said...

For everyone's benefit, like I did with Matt Simmons's ridiculous oil predictions, I will make a copy of this blog entry for today, 9/14/10, and we will see in 6-9 months just how much "hyperinflation" and "U.S. dollar debasement" occurs, as well as note the economic, social and political consequences that will occur. I can hardly wait! ;)