Deflation and you: The death of Inflation.

[[Update: As of 10/06 bonds yields have declined but have risen again and it appears that inflation is not under control. According to USA Today the fed's notes show that it is unlikely that inflation will decline just by recessionary pressures! This of course is a disaster for the housing market, as the fed cannot help those in need of refinance because if they do they will destroy the dollar. If the fed loses credibility then the bonds already held by foreign governments will greatly fall in value. This is a potential mega disaster.

As Jim Jubak of MSN has said: "The Fed hasn't succeeded in sopping up the flood of cheap money it created when it drove short-term interest rates down to 1% in June 2003 and kept them at that level until June 2004. Now all that cheap money is pushing up borrowing in the commercial real-estate market fast enough to worry bank and savings-and-loan regulators. And that isn't the only sector in the midst of a bubble." He goes on to say that the massive capital available to leveraged buyouts is a sign of a bubble as well.

It has also been reported that Wage inflation is still a threat to the economy. It appears that the housing market is tanking big time. Not only will adjustable rates and mickey mouse loans sink many people in the USA, It is possible that we could fall into recession with inflationary bubble breeding excesses.

Greenspan has left Bernanke very little wiggle room here. Greenspan kept interest rates low far too long, creating the housing bubble and doing what he could to get Bush reelected. We could have the twin problems of recession and defaults on existing mortgages. Read this most disturbing article which mentions derivatives, a debt instrument that Greenspan also cited as being of concern! http://www.resourceinvestor.com/pebble.asp?relid=16568   Another disturbing website looking into a historical perspective as well as into the pyramid or ponzi aspect of dangerous;loans, ie, last one in is left holding the bag is at: http://www.anthonypalmer.net/money/newsletter_great_bubble.html ]]

From Goldseek.com we have this report on Alan Greenspan's continued misspeak in his defense that the housing bubble was not his fault: The Financial Times reports:

""The former Fed chairman said the collapse of Communism in Eastern Europe and the shift towards more market-based economies in China and other parts of the developing world brought 'billions of cheap labourers onto the scene.'" "This," he said, "brought disinflation and lowered inflation risk premiums and long-term interest rates, creating a decline in real interest rates and equity-risk premiums." In consequence, "the real market value of assets increased faster than GDP".

There is undoubtedly some truth to what Greenspan says. But this is one of those occasions for which the word 'disingenuous' must have been invented. Yes, global integration probably has reduced inflation expectations, thus permitting lower interest rates and higher asset values. But without the active aiding and abetting of the Fed, which set the Fed Funds rate under 2% - i.e., below inflation - for 35 months, the boom in housing prices would probably never have turned into a bubble. And millions of Americans would still be solvent today. Globalization may have lowered inflation rates...permitting lower interest rates. But globalization didn't bring with it lending rates below the rate of inflation. Those negative lending rates were not imposed by Mr. Market, but by Mr. Market Manager Greenspan.

A negative lending rate is a marvel. It allows a speculator to borrow, knowing that he can repay less than he was lent. Negative lending is to the financial world what a negative-calorie dessert would be to Sara Lee or a negative-year prison sentence would be to a bank robber. You can imagine, dear reader, what mischief they would cause. Even at low real rates of interest, a borrower has to be careful. But what kind of care is needed when you are guaranteed to make a profit, merely by borrowing?

The actual effect of the Fed's sub 2% rate is now history...well, a history that is still being written, one painful page at a time. That it brought about a huge bubble in housing prices is beyond question. It also helped sustain the whole U.S. economy...and, by extension, the economy of the whole world. Goldman Sachs calculates that since 2002, American homeowners have been able to "take out" enough money from their houses to add 2.5% a year to real GDP growth - which was most of it. And now, it appears that the bubble is deflating. The Fed is no longer giving away money. And the housing market is no longer bestowing big gains on homeowners. The granite countertop business is slowing down...along with the rest of the housing-manufacturing complex.

If Mr. Greenspan were right, investors could expect high asset prices for a long time. Global trade, after all, is not likely to disappear any time soon. Why should house prices go down then? Or stock prices, for that matter? But now, even the Maestro concedes house prices are going down. Only, he says, it is because houses have become unaffordable. And he guesses that the worst of the housing slump is already behind us. And who knows? He could be right. But an investor has to play the odds. What are the odds of making serious gains in stocks at today's record prices? What are the odds of making serious gains in houses? What are the odds that Mr. Greenspan knows better?

We wait to find out."

I have a few thoughts regarding inflation and deflation that bear mentioning as a way to help people do the right thing, ie save and safely invest. It is my view that inflation is dying but that it is far from dead as of 2006. Now of course, if oil were to go to 200 dollars a barrel, we would have inflation. I believe inflation is primarily a result of loose money, and also the result of commodity prices going higher. Certainly, commodity prices have been going higher with China's use of raw materials in the rapid growth that we see there. But loose money may be coming to an end, as the fed is cracking down on "exotic" negative amortized loans. This could wreck havoc on the housing market, but is necessary as a battle against inflation, as is a firming of interest rates.

I believe that fundamentally there is a downward drag on prices. For example the prices at fast food restaurants have changed little over the years. The prices where base dollars are used have changed little, and the wages in the USA have stagnated. Unions have been busted and wealth has moved into the hands of the wealthy. The middle class has wealth only in the form of house appreciation, which may be paper gain only.

Therefore, it is important to note that a global competitive economy is going to exhibit deflationary pressures. It is also important to note that the massive stimulus of low interest rates and reckless lending practice allowed by the federal reserve have done little to stimulate inflation or wages or trickle down prosperity for all.  The only "prosperity" is paper prosperity, ie home values, that is at risk of deflationary pressure that is an international phenomenon. Ask Japan.

With consumers in the USA being up to their gills in debt, with a potential housing bubble in many areas of the country, it is possible that deflation will be the end result. See: http://housebubble.newcovenanttheology.com/ It is becoming clear to me that the trickle down of supply side economics, which may have been helpful in producing our way out of recession in 1981 is not doing what it should be doing in 2006. That is, supply side has given us too many houses, for example, that will prove to be way beyond demand. This "investment" has taken a toll on the middle class, as it will become difficult for them to sell homes and a serious deflation could result. Supply side created this bubble, and it is now necessary to tax the wealthy and give more breaks to the middle class who certainly need them. Supply side has ravaged the middle class at the benefit of the richest Americans.   

With all this economic uncertainty, it is then, important to be cautious more than ever in seeking out safe investments, and in saving money, and in getting out of debt. While we will leave this earth with nothing, it is important that we see the clouds on the economic horizon and seek to, more than ever, be careful with money and have good habits regarding spending and saving.Home