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Monday, December 31, 2007 9:59 AM

Things That "Can't" Happen

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Minyan Nimesh Writes:

For almost thirty years, count them, for almost thirty years people like you have predicted that our economy will collapse and the end of the consumer. Throughout all of those years, it didn't happen. No matter how many logical arguments the "gloom and doom" crowd has made, it hasn't happened.
Nimesh, I have only been on the deflation bandwagon for a few years, not thirty. However, you are correct about one thing: Some notable people have indeed been calling for a collapse for nearly thirty years. However, that does mean an economic collapse can’t happen, now does it?

Chronology Of Things
That Can't Happen
  • One of the reasons the Fed was created was to manage the economy and prevent further depressions. Guess What? The biggest deflation in history, the great depression, happened 17 years later.
  • At one time economists thought that inflation and recession could not happen at the same time. It happened anyway. A new term was coined for it “Stagflation”.
  • Deflation supposedly couldn't happen in a fiat regime. Japan proved otherwise.
  • If you asked anyone in Japan if housing prices could fall for 18 straight years, they would have said "It can't happen". It did happen.
  • For 30 years people have said US housing prices would never again decline on a national scale. They were wrong. It happened.
It is the very nature of the market that it takes the convincing of nearly everyone to believe that something cannot happen, to actually cause it to happen. Consider housing. Everyone became convinced that housing was a one way ticket north, that all housing was local, and housing would not decline nationally.

This mass belief in a faulty housing premise in spite of evidence to the contrary in Japan is what helped form the US housing top. Greater fools everywhere who came to believe that faulty theory eventually rushed in to speculate in housing. That made the top. Even the rating agencies got into the act.

Please consider Fitch Discloses Its Fatally Flawed Rating Model. As amazing as it might seem now, Fitch disclosed as recently as March 2007 that their model for rating CDOs assumed low to single digit home price appreciation forever into the future. They even admitted their model would break down if home prices were flat for an extended period of time. There is a shocking conference call discussed in the above link where Fitch described those fatally flawed assumptions.

Fitch placed so much faith in their models (as did Moody's and the S&P) that the biggest financial speculation in housing history took place. Greenspan and the Fed cheered the miracle of derivatives most of the way. Such foolishness has already cost Citigroup (C) and Merrill Lynch (MER) their CEOs. It may cost Citigroup its entire company. See More Writedowns Force Citigroup To Sell Assets.

Housing speculation is likely to cost both Ambac (ABK) and MBIA (MBI) their companies. See Buffett Signs Death Warrant For Ambac & MBIA for more on the demise of the guarantors.

It's Different Here

All of the above are casualties of the bursting of a housing bubble, a bubble that until last year people denied even existed. Instead of looking at Japan for what was about to happen, all we heard was "It's Different Here. The US is Not Japan".

The above image thanks to The Best of Five Things You Need to Know.

Housing prices rose three standard deviations above norm in relation rental prices and wages yet excuses were made as to "Why it's different this time". Now, in spite of all the evidence to the contrary, most still insist that "Deflation Can't Happen Here". The entire argument rests on one or more of the following faulty premises.

Faulty Premises
  • It's Different Here.
  • It's Different This Time.
  • The Fed won't let deflation happen.
Belief in the third point above goes well beyond amazing to the point of being nearly universal. Yes, there are a handful of us that see deflation coming, but as Nimesh writes "For almost thirty years people like you have predicted that our economy will collapse and it hasn't happened."

That is precisely the sentiment that it takes to make a top (or a bottom). Many predicted the demise too early and are now discredited. Those hopping on the bandwagon near the top are compared to the early visionaries. It becomes guilt by association even though there is no real association.

Mocking of the early visionaries is part of the topping process. Group think sets in and is reinforced over the years. Risk premiums drop as the long term trend reaches the peak. That takes time. Memories fade. Does anyone fear another great depression? Heck, does anyone even remember it, let alone fear it?

Where Prechter Went Wrong

Since everyone knows the early visionary we are talking about, we may as well openly discuss his name. Robert Prechter ignored and/or did not foresee many things that could keep the credit bubble expanding. Let's start with a flashback to conditions of the 70's and 80's.

Why The Credit Bubble Lasted For Decades
  • Single household breadwinner became two household bread winners
  • Interest rates were at 18% headed to 1%
  • Internet revolution provided tremendous numbers of jobs
  • Lending standards declined
  • Housing boom provided jobs
  • Rising asset prices supported consumption
Every one of those things allowed the credit bubble to keep expanding. Many of those factors took years to play out, decades in aggregate. The decline in interest rates alone made housing more affordable for quite some time, at least until things went extremely loony a few years back. And when housing prices went loony, progressively lower credit standards kept the expansion going. The madness ended when there was no one left to buy, and no way to keep that portion of the credit bubble expanding.

Sadly, people still give Greenspan credit for his role in keeping the economy expanding. Greenspan deserves absolutely no credit. All Greenspan really did was accelerate the existing trend. Furthermore, he did so in a way that was completely reckless. The only reason the economy did not collapse under Greenspan was the ability of consumers and businesses to take on credit had not yet peaked.

Major Bubbles Fueled By Greenspan
  • Greenspan fueled an overall stock market bubble by bailing out banks exposed to Long Term Capital Management. For more on LTCM please see Genius Fails Again.
  • Greenspan fueled a dotcom bubble in 1999-2000 out of irrational fear of a Y2K crash. Greenspan embraced the productivity miracle and was worried about the economy overheating just months before it imploded. The story is documented in FOMC minutes.
  • Greenspan fueled an even bigger bubble between 2003-2006 by embracing ARMs and slashing interest rates to 1% to bail out his banking buddies caught up in bad loans to dotcom companies and bad loans to countries like Argentina.
In a sense, Greenspan was the luckiest Fed chair in history. He had a tailwind of productivity at his back that helped keep consumer prices low while he fueled bigger and bigger and bigger credit bubbles when each of several smaller bubbles popped.

Greenspan has now left an unsolvable mess for Bernanke to cleanup. This time, there is no bigger credit bubble to be blown.

What They Were Saying And When
  • In 1999-2000 people were saying "The Nasdaq hasn't crashed yet so it's not going to".
  • In 2006 Lereah wrote: Why The Real Estate Boom Will Not Bust. Ironically, it already had.
  • In 2007 many are writing me with reasons why the credit bubble will not bust. It already has. However, just like housing in 2006, the implications have not yet been fully felt.
The party is over once the ability and willingness of banks to lend, or ability and willingness of consumers and businesses to borrow is exhausted. Those signs in place today for all but ostriches.

One thing I want to be clear on is that I am not calling for another "great depression". We could have one, but I am inclined (at least right now) to doubt it. Japan went through 18 years of deflation and the world did not end. The US will survive deflation as well.

However, we are likely to see something the US has not seen since the great depression: a falling standard of living and a declining middle class. Many things will be A Matter Of Choice but no one alive knows exactly what choices government will make.

One thing I am sure of is the more money we waste in Iraq and the more money we waste attempting to be the world's policeman, the worse off we will be.

Can The Fed Inflate Out Of This Mess?

There is enormous and unwarranted belief in the Fed's ability to "inflate out of this mess". It's all an illusion. Greenspan presided over an economy that added enormous numbers of internet jobs followed by enormous numbers of housing related jobs and enormous numbers of jobs related to the buildout of commercial real estate.

This was not "success"; This was forestalling the day of reckoning by repetitively blowing bigger bubbles. Greenspan appeared successful only because the ability and willingness of consumers and businesses to take on more debt was not yet exhausted.

Bernanke, on the other hand has no dotcom boom to bail out the economy. Nor does Bernanke have a housing bubble to look forward to that will bail out bad bank lending practices and provide jobs to the economy.

Problems Bernanke Faces
  • Falling real estate prices
  • Subprime housing mess
  • Alt-A mortgage mess
  • Pay Option ARM mess
  • Sharply rising unemployment
  • Rising credit card defaults
  • Commercial Real Estate implosion
  • Global wage arbitrage
  • Falling US dollar
  • Overheating China
  • Slowing global economy
  • Tapped out consumers
  • Implosion of $500 trillion in derivatives
  • Solvency issues at banks
  • Forced unwind of massive Yen carry trade
  • Boomer retirement
  • Pension plan assumptions in an economy starving for yield
  • Rising corporate defaults
Greenspan never had to deal with anything remotely close to that set of problems. It's a lethal combination of things given that solvency issues at banks that will restrict lending. It is also a lethal combination in the face of consumers and businesses that are unwilling to expand because consumers are tapped out. In addition, rising unemployment sure is not going to do anything about consumer's willingness or ability to take on more credit.

Yet because of Greenspan's so called success, many came to believe in the magic of the Fed. The idea was further enhanced by one of the most ridiculous Fed speeches ever Deflation: Making Sure "It" Doesn't Happen Here.

Trends Do Not Die Easily

With Bernanke's speech, came the near universal belief that Bernanke would succeed in fending off deflation as well. However, near universal belief in a flawed idea is a necessary but insufficient condition for a primary trend exhaustion.

The housing boom morphed into merger mania, leveraged buyout speculation, buyout bingo and all sorts of other nonsense including covenant lite deals where debt was paid back not with interest but with more debt.

There were not really any more players because there was no one left to convince. Rather the players involved just got greedier and greedier. Even as housing died, credit expansion looniness continued for two more years.

Chuck Prince Dances At the Top

When everyone acts as if every risk no matter unsound will go unpunished by the Fed and the market, it fosters the environment where the greedy participants (and even some innocent bystanders) are going to be tremendously punished.

It is fitting that Chuck Prince marked the top of the insanity in July of 2007 when he announced No End Soon To Buyout Boom. Chuck Prince resigned in disgrace four months later.

Unsound Beliefs Foster Unsound Actions

Few have stopped to consider that credit conditions only got as insane as they did because of fundamentally unsound belief the Fed cannot fail. Similar beliefs marked the top of the housing boom in the summer of 2005. Yet in spite of the housing implosion, everyone acted (and most still do) as if there is no risk of deflation. Most still fail to see that it was unsustainable credit expansion that fueled not just housing, but the economy in general.

Ironically, it is the unvarnished arrogance by Bernanke in conjunction with greater fools who believe in his untested academic wizardry, that fostered the very extreme risk taking attitudes towards credit that makes deflation inevitable.

Things that can't happen, are about to.

Mike "Mish" Shedlock
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Sunday, December 30, 2007 11:56 PM

Shiller Warns Of Japanese Style Recession

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The Times Online is reporting Shiller Says America could plunge into Japan-Style Recession.

Losses arising from America’s housing recession could triple over the next few years and they represent the greatest threat to growth in the United States, one of the world’s leading economists has told The Times.

Robert Shiller, Professor of Economics at Yale University, predicted that there was a very real possibility that the US would be plunged into a Japan-style slump, with house prices declining for years.

Professor Shiller, co-founder of the respected S&P Case/Shiller house-price index, said: “American real estate values have already lost around $1 trillion [£503 billion]. That could easily increase threefold over the next few years. This is a much bigger issue than sub-prime. We are talking trillions of dollars’ worth of losses.”

He said that US futures markets had priced in further declines in house prices in the short term, with contracts on the S&P Shiller index pointing to decreases of up to 14 per cent.

“Over the next five years, the futures contracts are pointing to losses of around 35 per cent in some areas, such as Florida, California and Las Vegas. There is a good chance that this housing recession will go on for years,” he said.
Well I certainly am not arguing with that forecast. A Japanese Style Recession is consistent with what I have been proposing for quite some time.

When does Peter Schiff hop on board that train of thought? Please see Not Your Father's Deflation: Rebuttal or Peter Schiff Replies to Deflation Rebuttal for alternative viewpoints and a rebuttal of those viewpoints.

Mike "Mish" Shedlock
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1:41 AM

More Writedowns Force Citigroup To Sell Assets

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According to Goldman, Citigroup, Merrill Face More Writedowns.

Citigroup Inc., JPMorgan Chase & Co. and Merrill Lynch & Co. may write down an additional $34 billion in securities linked to the collapse of the subprime mortgage market, according to Goldman Sachs Group Inc.

Citigroup, the biggest U.S. bank, may reduce the value of its holdings by $18.7 billion in the fourth quarter and cut its dividend 40 percent, Goldman analyst William Tanona said in a Dec. 26 report on the New York-based companies. JPMorgan Chase & Co., the third-largest U.S. bank, may write off $3.4 billion, double Goldman's previous estimate. Merrill Lynch & Co. may reduce its holdings by $11.5 billion, he wrote.
My Comment: By the time Citi is done shoring up its balance sheet it is highly doubtful it remains the largest US bank. It is possible it does not remain an independent US bank at all.
"It will be a couple of quarters before the current credit crisis is fully digested by the markets," wrote Tanona, who has a "sell" rating on Citigroup's stock and a "neutral" rating on JPMorgan and Merrill. "Given the magnitude of the writedowns we assume and Citi's remaining exposure, we believe the firm has a serious need to preserve or raise additional capital."
My Comment: Tanona is an optimist. It can easily be two years (not quarters) before the credit crisis is "digested". Heck, it could be much longer than that judging from what happened in Japan. No one is counting on a hard recession, an implosion in commercial real estate, sharply rising unemployment, and huge defaults on credit cards. I think all four of those will happen.
Citigroup tumbled 8.1 percent on Nov. 1 after CIBC World Markets analyst Meredith Whitney said it may have to trim its dividend. Deutsche Bank AG analyst Michael Mayo also predicted a dividend cut, saying the investment from Abu Dhabi is ``probably not enough'' to absorb credit losses.
My Comment: A dividend cut is all but guaranteed.

MarketWatch is reporting Citi, HSBC eye sales of branches, divisions.
Banks including Citigroup (C) and HSBC Holdings (HBC) are considering sales of everything from branches to entire units, The Wall Street Journal reported Friday, citing analysts and unnamed executives. Citi could sell 80%-held Student Loan Corp (STU), its North American auto-lending unit, its 24% stake in Brazil credit card operation Redecard (RDCL) and the bank's Japanese consumer finance business, the report said.

New Citigroup CEO Vikram Pandit is considering laying off as many as 20,000 employees and shedding business lines, the report continued, citing people familiar with the matter. HSBC may sell its auto-finance business, the report added.
Citigroup Forced To Sell Assets

Some thought I was a little over the top with Citigroup Fighting For Its Financial Life back on November 5th, and Question of Solvency at Citigroup on November 1st but here we are.

Citigroup is not considering these actions because it wants to, it is so capital impaired that it is forced to. The same can be said for a reduction in force. 20,000 jobs (assuming the number is correct) is quite a lot. Where are those who are let go going to find jobs in this market?

The problem for Citigroup and other lenders is that housing is just the first of the tsunamis that is going to hit shore. An implosion in commercial real estate, sharply rising unemployment, and huge defaults on credit cards are all on the way. Furthermore, the housing tsunami is not even played out yet. Two more waves of the housing tsunami are on the way: Alt-A and Pay Option ARM resets.

If Citigroup survives it will be a mere shadow of its former self.

Mike "Mish" Shedlock
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Saturday, December 29, 2007 10:39 AM

Consumer Survey on Payment Delinquencies

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I am reading an interesting report from ORCC on Payment Delinquencies Spanning All Industries from December 2007. Here are a couple of charts:

Consumers Are Overextended

Households across the country are finding it harder to meet financial obligations now than they did just twelve months ago. Of the households surveyed, 43 percent report that it is harder for them to meet their financial obligations, including bills, loans, mortgage and debt, than it was 12 months ago.

click on chart for sharper image

Reasons It Is Harder To Meet Obligations vs. 12 Months Ago

More than half of households chose multiple reasons why they are finding it harder to meet their financial obligations. The most popular reason—and the only one cited by more than half of respondents—is increased energy costs. As further evidence that troubles are not limited just to the mortgage industry, only 19 percent of households report that their mortgage is a reason why it is harder for them to meet financial obligations.

click on chart for sharper image

This is one of those times when I sit back and wonder about the small sample size and methodology.
Two separate online surveys were conducted to understand consumer and biller collections. The consumer household survey was conducted in conjunction with MarketTools, Inc. Survey responses were collected from October 5, 2007 until October 25, 2007. Survey respondents were recruited and invited to participate by MarketTools, Inc. Survey invitations were sent via email with a link to a website containing the survey questions. To encourage participation, MarketTools, Inc. offered respondents 50 bonus points they could redeem for prizes. Responses were received from a nationally representative sample of 1,006 online households.
Questions About The Survey
  • Is that sample size valid?
  • Did "bonus point" skew the results?
  • If you have to pay people to take a survey what kind of respondents are you going to get?
  • Do consumers simply not want to admit their house is their problem?
  • Is the psychological impact of seeing gas prices tick up and up and up a constant irritation?
I do not know about the sample size but I think the winner is number 5.

Weekly US Gasoline Prices

click on chart for sharper image
Chart courtesy of the Department of Energy.

Note that the survey was taken in October. A quick glance at the above chart shows huge gasoline price dips in previous years but not 2007. In addition, some 30% of the population does not own a home so mortgage related problems do not apply.

Given that Homeowners Protest Property Taxes one might have expected to see that reason on the list except perhaps it is typically only paid twice a year for some and lumped in with mortgage payments for others. And what about food prices?

The key number is the dramatic 43% rise in those finding it harder to make payments for whatever reason. Looking at that number, it should not be shocking to see Credit Card Defaults move to Forefront of Deflation Debate. If unemployment shoots up in 2008 as expected, things are going to get very ugly.

Mike "Mish" Shedlock
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Friday, December 28, 2007 12:56 PM

Buffett Signs Death Warrant For Ambac & MBIA

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MBIA (MBI) hit a new 52 week low today and Amback (ABK) is giving back much of its recent gains as Buffett Starts Up Bond Insurer business.

MBIA Inc. and Ambac Financial Group Inc., the two largest bond insurers, fell in New York Stock Exchange trading after billionaire investor Warren Buffett said he plans to start a rival company to guarantee municipal debt.
My Comment: OK suppose you want your debt guaranteed. Are you going to go to capital impaired companies or Warren Buffett?
MBIA, based in Armonk, New York, fell as much as 17 percent and Ambac dropped 15 percent, the most in two months. Buffett, chairman of Omaha, Nebraska-based Berkshire Hathaway Inc., told the Wall Street Journal his bond insurer opens for business today in New York. New York State Insurance Department Superintendent Eric Dinallo said the agency expedited Buffett's license request.

Berkshire, which gets half its profit from insurance, is challenging the bond insurers as they struggle to retain the AAA credit ratings that allow them to guarantee about $1.2 trillion of municipal bonds. The rankings of MBIA, Ambac and other guarantors are under scrutiny amid concern they don't have enough capital set aside to cover potential losses on bonds they insure that are linked to subprime mortgages.
My Comment: Insurance from MBIA and Ambac is Worthless. Neither Ambac nor MBIA come remotely close to deserving AAA ratings. Everyone knows it, but Moody's, Fitch, and the S&P all pretend otherwise.
"Investors might feel more comfortable investing in bonds insured by Buffett than those backed by an insurer with the legacy of the credit crisis hanging over them," said Matthew Maxwell, a London-based credit analyst at Calyon, the investment banking unit of Credit Agricole SA. Bond insurers "are hurting, so now is a good time for Buffett to be getting into the market."
My Comment: Might feel more comfortable with Buffett? Is there any doubt here?
Buffett, 77, told the newspaper that Berkshire Hathaway Assurance Corp. will also seek permission to operate in California, Puerto Rico, Texas, Illinois and Florida. David Neustadt, a spokesman for New York's insurance department, said Berkshire will get a license by Dec. 31.

Credit-default swaps on MBIA, which rise as perceptions of credit quality drop, rose 30 basis points to 610 basis points, the highest ever, according to CMA Datavision in London. Ambac increased 10 basis points to 620, the widest in three weeks.

MBIA, as well as Ambac and FGIC Corp. of New York, are trying to convince Moody's, Fitch and S&P that they deserve to keep their top ratings.
My Comment: While the shameless pretending By Moody's, Fitch, and S&P continues, the real question is not about being rated AAA but how far into junk those ratings should be.
Fitch has given MBIA and Ambac less than six weeks to raise $1 billion each or face losing their AAA ratings. Moody's and S&P earlier month placed MBIA's ranking on negative outlook. MBIA on Dec. 10 said it will get $1 billion from private-equity firm Warburg Pincus LLC to bolster its capital and Ambac took out reinsurance on $29 billion of securities it guarantees.

"MBIA and Ambac are probably going to be able to get through this and raise the capital needed to retain their AAA ratings," said Rob Haines, an analyst at CreditSights Inc. in New York. "But it hurts them."
My Comment: As of the November 11 2007 10-Q MBIA had $6.96 billion in working capital. They have guaranteed $30.6 billion in CDOs and have other questionable exposure as well. Who would want that exposure and why?

Buffett smells an opportunity here and he is likely correct. Furthermore he is not going to make the mistake that both Ambac and MBIA made in insuring CDOs, subprime mortgages, and other toxic waste. It was pure greed that will end up sinking Ambac and MBIA.

The realization that guarantees from Ambac and MBIA are worthless is finally dawning on state and local investors as the following Bloomberg headline shows: Muni Insurance Worthless as Borrowers Shun Ambac.

Three Choices For Municipalities
  • Have Buffett guarantee the debt
  • Forego insurance
  • Go to the well with Ambac and MBIA
No matter how you look at it, the only possible way MBIA and Ambac can compete in that model is by undercutting Buffett in price while hoping municipalities do not select option 2. This will obviously pressure margins at the very time MBIA and Ambac need to increase margins. Furthermore, given the huge question about the value in Ambac's and MBIA's guarantee, price competition alone is unlikely to be the factor that generates business.

This looks like a smart long term move for Berkshire Hathaway (BRK-A) if Buffett is careful about what he insures (and I am betting he will be). On the other hand it is likely the death warrant for Ambac and MBIA unless they can find a white night that wants to compete against Buffett and take on CDO and subprime exposure on top of it.

Mike "Mish" Shedlock
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10:43 AM

A Matter Of Choice

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Minyan Peter is discussing The Courage to Choose.

I believe that in time, historians will define the last twenty years in America as the “Age of Aspiration” where, thanks to unprecedented levels of credit, Americans could become anything they wanted. Where, thanks to zero percent down debt and a seemingly robust economy, we could own bigger homes, fancier cars, and more lavish vacations – where our bounty was limited only by the boldness of our wants.

Well, I, for one, believe that our Age of Aspiration is ending. And, with its conclusion, we must, for the first time in almost a generation, begin to reconcile our wants with our means. We must choose what to do without, rather than what more to do with.

When anything is possible, everything is possible. Few of us have really had to choose. And, like it or not, all of us will need to return to our vocabulary a simple phrase that I believe has been lost over the past twenty years: “I can’t afford that.”

So as we approach 2008, I wish the Minyanville community the wisdom to prioritize well, the courage to make the hard, and often painful, choices, and, most of all, the strength and conviction to follow through.

Minyan Peter
Peter is one of the best reads on the Ville. In case you missed it, please click on the above link and read his entire message about choices for 2008.

I certainly agree with Peter but would like to add that people are going to be forced to make choices whether they have the courage to make them or not. Where courage comes in is making the right choice, not a choice.

Let's take a look at some major choices.

Governor Schwarzenegger Considers Major Cuts In Services

Schwarzenegger will declare a fiscal emergency.
Gov. Arnold Schwarzenegger is expected next month to seek immediate major cuts in state services, including a plan to take back $1.4 billion budgeted for schools this year and a proposal to slash the prison population by releasing tens of thousands of inmates.

When the governor reveals the details of the cuts, the state's interest groups are "going to be squealing beyond belief," said one official, who spoke on condition of anonymity because budget discussions are confidential.
My comment: Interest groups can squeal all the want but choices still have to be made: cut services or raise taxes.
The official described Schwarzenegger's approach as: "Don't talk about taxes. Talk about services. Make the public say, 'I want the prison system funded. I want education funded.' He won't talk taxes until there is a consensus that these services are what the state wants."
My Comment: Schwarzenegger's choice seems to be to force the public to choose. Unfortunately both Schwarzenegger and the public chose irresponsibly when confronted with previous choices.
The governor's fight on education, which represents 40% of the budget, is likely to be fierce because school districts are still nursing the wounds of 2004, when the governor deferred pledges to restore education funding that they agreed to surrender.

Scott Plotkin, executive director of the California School Boards Assn., said his group will not agree to any cuts until the Legislature begins a discussion of increasing revenues through taxes. "This is too big a problem to be solved solely through cuts," Plotkin said. "We've been down this road before, and we got burned."
My Comment: So now the California School Boards Assn. does not trust the governor. This is what happens when you make promises that cannot be met. Interestingly enough one group will not consider spending cuts unless tax increases are discussed first, while another group will not discuss taxes unless all spending cuts are considered first.

In these kinds of situations, the choices are put off until the last moment and no one is happy with the result. Nonetheless choices must be made.
The governor's plan to cut $1.4 billion from this year's money for schools is based on new estimates of what is guaranteed under Proposition 98, a constitutional provision that determines the minimum of state revenues that must go to education. The formula is based partly on state revenues, which have plummeted since education funding was allocated last summer.
My Comment: California voters are going to be facing lots of choices about various propositions, many of which are downright silly such as $2.9 billion in affordable housing programs and $3 billion for general obligation bonds to fund stem cell research. Both are complete nonsense and a huge waste of taxpayer money. Getting rid of such waste should be the easy choices.
Kevin Gordon, a lobbyist for hundreds of school districts, said $1.4 billion is "almost insurmountable as a number for districts to really give up."
My Comment: It's a good thing he said almost insurmountable.
Cuts would inevitably fall heavily on the Los Angeles Unified School District, which, with about 700,000 students, receives about 13% of the state's education dollars. The school board was already weighing at least $100 million in cuts anticipated for next year. It also faces a restive teachers union, which is demanding raises.
My Comment: Ah yes, raises. The unpleasant choices here are: grant raises and raise taxes, grant raises but fire teachers and increase class size, don't grant raises and face a strike. When the strike comes, review the choices and make one.

The Party Is Over In California

On December 16th in Turn out the lights California, I made the following observations:
Schwarzenegger Has 3 Choices
  • Cut Spending and Services
  • Raise Taxes
  • Attempt to float massive amounts of bonds in a hostile debt market
The crisis is coming to a head and choices must be made. Arnold, it's your move. What's it gonna be?

Michigan Has Choices

I discussed Michigan recently in Why Michigan is a Basket Case. If you think Michigan's problems are all auto manufacturing related think again. Click on the above link to see Michigan's legislative process in action. It was an amazing set of choices they just made to rob Peter to pay Paul then Paul to pay Peter ending up accomplishing nothing.

Ohio Has Choices Too

There is a giant Credit Squeeze In Ohio.
Cleveland Mayor Frank Jackson said today that he and top advisers are working to stave off a money crunch that could jeopardize large capital projects on the horizon. Such projects, ranging from roads and bridges to developments such as Bob Stark's $1.5 billion plan for the Warehouse District, rely on the city's ability to borrow money.
Maryland vs. Virginia

Inquiring minds might also want to consider Maryland computer firms anxious over new tax.
“I’m being asked to levy a hefty tax on my clients, and the thing that really aggravates me is that Virginia computer companies won’t impose this on their Maryland clients,” said Matthew Shapiro, president of Rockville-based networking and integration firm Design One Corp. Shapiro doesn’t want to physically move, but he does want to consult with a lawyer about setting up a subsidiary outside the state.
Hmm. There are choices and there are consequences to those choices. Imagine setting up subsidiary outside the state to avoid tax consequences of staying in the state. Who is the winner? I know who the losers are: anyone spending money to avoid taxes, and the state that loses the taxes.

What About Florida?

The epicenter of real estate fallout has to be Florida. A 25 member committee is now addressing Florida Taxation and Budget Reform. Good luck with that.

This quick review clearly shows that Minyan Peter was spot on with his assessment that 2008 will be a year of choices: personal choices, household choices, city choices, state choices, and even national choices.

At the national level, a big presidential election is at stake, with consequences that can affect the US for decades to come.

Choose Wisely.

Mike "Mish" Shedlock
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Thursday, December 27, 2007 2:08 PM

Commercial Real Estate Transactions Plunge

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A Credit Downturn Hits the Malls, as commercial real estate transactions plunge.

The credit crunch triggered by the downturn in the housing market is creating problems in commercial real estate, driving down prices of office buildings, shopping malls and apartment complexes, and leaving some owners scrambling for cash.

One victim is Centro Properties Group, the fifth-largest owner of shopping centers in the U.S. The Australian real-estate company saw its share price fall by 90% in two days last week as it struggled to refinance short-term debt it took on to fund its $6.2 billion acquisition of New Plan Excel, one of the biggest owners of strip malls in the U.S.

Centro had planned to pay off the short-term loans by selling long-term debt via the commercial mortgage-backed securities market, but the lack of buyers forced it to get a two-month extension from its creditors. Commercial mortgage-backed securities, or CMBS, are pools of loans that are sliced up and sold to investors as bonds.
My Comment: The Asset backed commercial paper market is now dead. Centro is just another in the growing list of casualties.
In another high-profile case, the clock is ticking for Harry Macklowe, the New York developer, who is struggling to raise financing by February to replace $7.1 billion in short-term money he borrowed to finance his heavily leveraged acquisition of seven Manhattan office buildings this year.
My Comment: Harry Macklowe is likely to lose his his trophy property, the General Motors Building in midtown Manhattan that he put up as collateral. I talked about this in a Refreshingly Simple Commercial Real Estate Implosion.
"Where we're really in a fog is on the capital markets side," said Michael Giliberto, a managing director of J.P. Morgan Chase & Co., on a conference call last week about the state of the commercial real-estate market.
My Comment: Fog? There is no fog. Commercial real estate is in deep trouble and that should be crystal clear.
The CMBS market was the engine that drove the commercial real-estate boom. Over the past few years, the issuance of CMBS allowed banks to get rid of the risk on their books, lend with cheaper rates and looser terms and that made it easy for private-equity firms to do huge real-estate deals.

Between 2002 and 2007, CMBS issuance rose to an estimated $225 billion from $52 billion, according to Commercial Mortgage Alert, a trade publication that compiles its own statistics.

Real-estate investors aren't the only ones feeling the pain. Many big banks issued short-term loans to buyers and planned to sell them off later, much the way they do with loans made to private-equity buyout shops. But the banks have gotten stuck with an estimated $65 billion in fixed- and floating-rate loans on their books, according to J.P. Morgan. Some of the largest issuers have been Lehman Brothers Holdings Inc., Credit Suisse Group and Wachovia Corp.
My Comment: Plunging commercial real estate values are going to further impair the ability and willingness of banks to lend.
Lehman has said that about half of the $79 billion in mortgage debt it was holding at year-end is CMBS-related. Wachovia and Credit Suisse declined to comment.

Prices, however, haven't appeared to fall, though much like residential real estate, there is often a period where buyers stop buying but sellers refuse to lower prices.

There is "cognitive dissonance" between buyers and sellers, says Dennis Russo, a real-estate attorney for Herrick Feinstein. "There's a period of time in which the seller cannot psychologically move his price down. They haven't accepted what's happening in the market."
My Comment: This is exactly the same environment that preceded the housing plunge. Transactions dried up, inventories rose, and sellers waited patiently to get their price. They never did. The winners recognized conditions had changed and bailed for whatever they could get.
According to Real Capital Analytics, sales of significant office properties plummeted to $7 billion in November, a 55% drop compared with November 2006. So few deals are getting done that many market experts say they don't know how to put a value on many buildings right now -- but almost everyone is in agreement that the valuations are dropping.
My Comment: A poor Christmas retail season is not going to help valuations any.
Often, deals aren't done because financing either isn't available or is so expensive that buyers are insisting on price reductions that sellers won't accept.

For example, Ackerman & Co., a brokerage, just pulled a suburban Atlanta office building off the market after bids came in below estimates. Developer Michael Reschke has so far been unable to get financing for a J.W. Marriott planned down the street from the Chicago Board of Trade, despite his willingness to put more cash into the deal than originally planned.
My Comment: Ackerman & Co. is probably going to regret this decision. Odds of getting better offers than they have now are not very good.
Credit was so plentiful when Mr. Macklowe purchased his Manhattan office buildings from Blackstone, he only needed to put in $50 million of equity to secure $7.1 billion in debt, which included a bridge loan and the senior mortgage, people familiar with the deal say.

He is now looking for an equity partner, people said. A spokesman for Mr. Macklowe declined to comment.
My Comment: I smell a default on interest payments on that $7.1 billion. Who wants to step into this market right here right now?

Mike "Mish" Shedlock
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9:49 AM

How does one invest for inflation and deflation?

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Minyan Eric Writes:

I cannot tell you how much I enjoy your analysis. I have worked for the Fed in DC and hold a high level finance position in the private sector now. You have finally moved me over to the deflationary, Japanese scenario with your last post even though I know you've been on this for quite a bit. Would you be able to create a post about how you either 1) profit from this or 2) protect your assets as be head toward that scenario?

Thanks again,
Eric, Thanks for the kind words and the questions. I will do my best to address your questions below.

Before answering, the article to which Eric refers is called Not Your Father's Deflation: Rebuttal. A followup article was Peter Schiff Replies to Deflation Rebuttal.

Rather than looking at things just from a deflationary viewpoint let's consider investment themes for various scenarios.

Investment Themes For Hyperinflation
  • In hyperinflation the last place one wants to be is in cash.
  • Commodities in general are a standout.
  • Gold is a standout.
  • Precious metals are a standout.
  • Property is a winner.
  • Equities are a winner.
  • Treasuries are distinct losers if not an outright short.
  • Foreign currencies
  • Energy
The single best asset for a hyperinflation scenario is actually property. With housing or commercial real estate one can borrow with next to nothing down. No other asset class offers as much leverage. With no skin in the game one might amass $1 million dollars worth of property that might sell for an unbelievable amount in a few short years if not sooner.

Is there a catch? Why yes there is. One needs to be able to make mortgage payments on the loan. That means the timing of the hyperinflation better be spot on. It also means that property values better keep on rising from the moment the leverage is taken or income must rise enough to afford the mortgage if it does not.

Should ever one get in a position via excess leverage to not be able to sell the asset for more than one paid while not being to afford the mortgage payment, foreclosure or bankruptcy occurs. Losing a job ad being underwater on leveraged property is an instant enormous headache.

Leverage is obviously the biggest pitfall for the hyperinflationary investor. But even without excessive leverage, housing has been getting clobbered for two years, longer in Florida. Commodities, however have been on a tear. Commodities also benefit from what appears to be near insatiable demand from China.

Can anything go wrong with commodities? Actually yes. China and emerging markets could put on the brakes regardless of what happens to the US dollar. Furthermore, with the US headed into a recession, demand for base metals could collapse. Also note that treasury bears (except for nimble traders) have not exactly fared well to say the least.

Regardless of what happens to base metals or treasuries, peak oil just might keep energy prices high. Thus there are additional reasons to be bullish on energy regardless of the inflation/deflation debate.

Hyperinflation involves a complete collapse in confidence of a currency but with currencies there are always relative values. Commodity producing countries have strong currencies that hyperinflationists think have more room to run.

Is there a completely safe way to invest for hyperinflation? I think so but the ideas might seem rather boring to many. For example: Everbank has MarketSafe® Gold and Silver CDs. I talked about those products in A Safe Way to Own Gold and Silver.

The Everbank MarketSafe® products are principal protected CDs whose return is tied to the performance of gold and silver. Even if gold and silver collapsed, one's principal is protected as long as one does not exceed the FDIC limit. The products are suitable for investors with a safety first attitude, yet wanting a hyperinflation hedge.

A second safe way to play for hyperinflation is in Treasury Inflation Protected Securities. Here is a second article about TIPS.

Where are we now?

Collapsing property values simply are not synonymous with hyperinflation. So inquiring minds might be asking: Did we already have a hyperinflation (of credit) and is a hyperinflation by monetary printing going to follow? The articles above might help resolve those questions.

Regardless of what one thinks is coming, one look at millions of foreclosures happening right now suggests there is plenty of reason to be cautious here.

Investment Themes For Deflation
  • In deflation, debt is the enemy.
  • Risk is to be avoided.
  • Cash is raised.
  • Treasuries are sought out as a safe haven.
  • CD ladders offer a good investment structure.
  • Gold, acting as money does well.
  • Select equity shorts or PUTs are a standout.
  • Renting as opposed to owning a house should be considered.
  • Currency plays
One can see the effect of excessive risk with the housing implosion regardless of what one thinks is going to happen down the line. Rising unemployment and/or falling income with no way to pay the bills is the chief concern. Before even thinking of investing in a deflationary environment, one should pay off all credit card debt, live below ones means, and have a cash cushion equal to one year's salary to pay the bills.

After decades of inflation the overall deflation theme may be hard to take, but it is what it is. The single best performing asset in this environment might be equity puts. However, just like those overleveraged in housing found out, timing must be precise. Anyone shorting or buying puts on strong stocks have gotten killed. Even index PUTs and index shorts have fared miserably for all but nimble traders. On the other hand, those in housing related shorts have done well. Those in gold have also done well.

Inquiring minds will note that gold is in the hyperinflation category and the deflationary category as well. That is because of gold's unique property with a dual role as a money and a commodity. Gold is money. The case was made in Misconceptions about Gold. Money is hoarded in deflation so gold should act well in deflation.

Do not make the mistake of thinking that gold always does well. It does not. It fell from over $800 to $250 in a decade's long crash. There was positive inflation all the way. Thus gold is not an inflation hedge no matter what anyone says, except perhaps in the very longest of timeframes. The key here is that gold does well at extremes. Those extremes are severe inflation and deflation.

When it comes to housing, a huge case can be made for renting vs. owning. The bigger the bubble, the better the case. California is in a tremendous bubble. I would not be buying in California any time soon. Florida has already crashed but further declines are likely. Another factor is availability of rental houses. The area where I live has few rental choices. I own but do so with open eyes. I also expect to have the house paid off within 5 years or so. My current leverage is small.

One possible currency play is the Yen. Leverage will be unwound in deflation and right now there is a massive leveraged carry trade in the Yen. The unwinding of that carry trade is likely to be very good for the Yen vs. the US dollar. I like the Yen here very much as a long term play.

A second possible currency play is related to the unwinding of leveraged dollar short positions as well as extreme anti-dollar sentiment, that fueled a mad dash into the Euro. I like the dollar vs. the Euro here.

Is there a completely safe way to invest for deflation? Yes, but once again the ideas are going to sound boring. CDs are still paying around 5%. One can build a CD ladder by buying 1, 2, 3, 4, and 5 year CDs and rolling over the proceeds into more 5 years CDs as each matures. The ladder can be for as long as one wants. It can be 3 years or 10 years, not just 5. The longer the duration the more risk there is but at least the principal is protected.

Once again, the super cautious wanting to protect against anything can try the MarketSafe® products mentioned earlier, or even TIPS.

There are other possibilities as well for those wanting more risk. If one accepts the peak oil argument, then energy should be a relative standout, at least compared to other commodities. And unlike homebuilders or banks, oil is not headed to zero and will eventually recover in a long enough timeframe.

Still another possibility are long/short funds that take on market risk when warranted and off when not. Sitka Pacific Hedged Growth strategy is one such option.

Sitka Pacific Hedged Growth was up about 10% after fees a few weeks back when the S&P 500 went flat for the year. It is still up about 10% on the year, even after this December rally. Volatility is low compared with the S&P. Currently the strategy is 33% cash, and market neutral (equal weighted longs and shorts) in the remaining portion. Bear in mind I have a vested interest in this idea given that I am a registered investment advisor representative for Sitka Pacific.

Hussman Funds
are another possibility. John Hussman decides to put on or take off risk based on his perception of valuation and market action. I am an avid reader of his weekly columns.

To some, 10% returns simply do not cut it. For others 10% returns with low volatility are fantastic. It all depends on one's risk tolerances. While, strategies can be debated all day long but there is never any guarantee. Risk takers often act as if there is. Certainly there seems to be an amazing belief in the Fed's ability here in spite of the horrendous and obvious mistakes the Fed has made. That faith is unwarranted in my opinion, but we shall eventually see.

Furthermore, it is one thing to take risks with one's own capital, and it is another to take excessive risks with OPM (Other People's Money). Bear Stearns (BSC) had two hedge funds go to zero. I am quite sure more hedge funds are headed the same way regardless of what happens.

The key now is survival. Opportunities are easier to make up than lost capital no matter which way you are betting. Look at Citigroup (C), Morgan Stanley (MS), Ambac (ABK), MBIA (MBI), E*Trade (ETFC), Merrill Lynch (MER), Countrywide (CFC) and all of the homebuilders for proof.

Mike "Mish" Shedlock
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Wednesday, December 26, 2007 3:02 PM

Peter Schiff Replies to Deflation Rebuttal

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In response to Not Your Father's Deflation: Rebuttal, Peter Schiff graciously responded in the comment section on my blog with the following three points:

1. I believe that eventually long-term interest rates will head much higher to reflect significantly higher inflation expectations, particularly here in the U.S. where a lack of domestic savings in the absence of willing foreign lenders will put even more upward pressure on rates.
My Counter: In long time frames I happen to agree. US rates will eventually head higher, just as Japanese rates will eventually head higher. The question is when and in what order. Long term rates in Japan fell to .25%. They can fall to that in the US. I am not saying will, I am saying can.

In shorter time frames there is an enormous pent up demand for US treasuries as treasuries are nearly universally despised domestically. Never before in history has everyone turned bearish right at a market top. Perhaps this is it. I doubt it.

However, let's assume Schiff is correct: Long term rates quickly start to rise because foreigners will not finance our debt. What would that do to default rates on housing, store expansion plans, hiring, wages, prices of homes, and prices of other assets? Unless and until consumer debt is wiped out, rising rates would massively increase default pressure as well as pressure asset prices.
2. Any credit the Fed provides will be spent. It is not necessary that the banks that originally borrow it loan it to Americans to buy houses or U.S. businesses to buy equipment. They can use it to buy oil, gold, wheat, foreign currencies or invest in foreign dividend paying stocks. As long as the Fed enables banks to borrow dollars below the rate of inflation, they will borrow all they can and invest the proceeds in appreciating or higher yielding assets. Then those dollars will be spent into circulation bidding up consumer prices.
My Counter: Citigroup (C), Morgan Stanly (MS), Merrill Lynch (MER), E*trade (ETFC), Ambac (ABK), MBIA (MBI), and Countrywide (CFC) are so capital impaired they all needed cash infusions, some from foreign companies, just to be able to continue operations.

We have not yet even seen the fallout from Alt-A or pay option ARM resets. And the fallout from rising credit card defaults has also not yet begun. For more on Credit cards please see Credit Card Defaults move to Forefront of Deflation Debate.

There is also the commercial real estate implosion and its aftermath to consider. For more on this topic, please see Commercial Real Estate Dominoes Collapse.

It is an enormous stretch of the imagination to think that banks are going to be rushing into wheat, foreign currencies, oil, or anything else, in light of the above.

For the sake of argument however, let's assume banks start speculating in wheat, corn, and oil. In that case, (assuming prices do go higher which is certainly not a given) prices of food and energy would be bid up still further beyond the average consumer's ability to pay for them. This would increase pressure on defaults and bankruptcies. Consumers are already having trouble enough right now. Foreclosures and credit cards are proof enough. On the other hand, should the speculation fail, banks would be still further capital impaired, possibly bankrupt.

The housing bubble at least provided jobs. Speculation in wheat would not create any jobs. In fact it would do nothing but increase the malinvestments that would blow sky high, sooner rather than later. Where are the jobs going to come from to allow people to pay back existing debt or keep buying stuff?
3. Yes, all currencies are troubled, but the dollar is unique in that the American have borrowed so much money that we can not afford to repay, and have a phony economy that can not function without access to low cost imported products and foreign vendor financing. In the coming crisis, the U.S. will enter a serious recession; the dollar will fall sharply, sending both consumer prices and interest rates soaring. There will be wide-spread unemployment, and assets prices, such as stocks, bonds, and real estate will fall (if inflation gets out of control, stock and real estate prices might rise in nominal terms, but in that case their real declines will be even greater.) I can assure anyone that if they think they can ride this out is in U.S. treasuries or by stuffing dollar bills under their mattresses, they will be very disappointed. Just ask anyone in Zimbabwe who might have reached a similar conclusion.

My commentaries are kept short for a reason and are never meant to constitute a complete argument. For a fuller explanation of my position I suggest reading my book, "Crash Proof".
My Counter: Now we are getting somewhere. Here is something I wholeheartedly agree with Schiff about: "American[s] have borrowed so much money that we can not afford to repay".

Debt that cannot be repaid will not be repaid by definition. It will be defaulted on. That is the very essence of deflation. Rising foreclosures and credit card delinquencies are already proof of concept.

Here is a second statement by Schiff that I wholeheartedly agree with: "There will be wide-spread unemployment, and assets prices, such as stocks, bonds, and real estate will fall."

Once again those ideas are central to the deflation debate. Rising unemployment will increase the number of defaults and bankruptcies.

Yet, somehow we are supposed to believe that in spite of enormous and growing capital impairments fueled by rising unemployment and falling real estate values, that banks will be speculating in wheat and other commodities. This just is not plausible.

However, should it happen, it would only add to the malinvestments to be defaulted on. The problem is there is no way for consumers to pay back debt, and there is nothing the Fed can do about it. The Fed cannot create jobs, build stores, or give money away.

As an aside, one argument I expected to see from Schiff but did not was the creation of government jobs. However, Japan tried that approach and it did not work. There are no guarantees it would be tried here, or if it was that it would work. After all, deflation is about willingness and ability to extend/take credit. Once sentiment peaks, like a pendulum it has nowhere to go but the other direction. Led by housing and now shifting into commercial real estate, leverage buyouts, mergers, and even retail spending, the pendulum has reversed course.

Because the Fed can encourage but not force lending, that shift in the pendulum affects the Fed greatly. The Fed can enhance the current primary trend (as it did in the creation of the housing bubble), but neither the Fed nor anyone else can reverse the primary trend.

Regardless of encouragement, who are banks going to be lending to when asset prices are falling and unemployment is headed higher? And those are conditions that both Schiff and I agree on. With enough defaults, banks will become so capital impaired they could not lend even if they wanted to! We are seeing signs of that in Citigroup already.

And as I have said before, the Fed is a private business. The Fed is not going to give away money any more than Pizza Hut is going to give away free pizzas for a year to all comers.

As far as Zimbabwe goes, Zimbabwe was massively running the printing presses. The situation in the US is drastically different. In the US, credit has far outgunned monetary printing (proof can be found by comparing M3 to base money supply). Printing does not work because it does not get money into the hands of those that need in debt.

Global wage arbitrage is a massive deflationary force putting huge wage pressure on US jobs. Rising unemployment will do the same. Rising unemployment will affect sales as well as prices. Prices of goods and services cannot rise above peoples willingness and ability to pay higher prices. That is a simple economic fact.

Already we are seeing massive price cuts by retailers this holiday season. See Blue Christmas for Target as an example. This is happening in spite of rising raw materials costs and energy costs. Good luck to stores that think they can raise prices. Perhaps some high end or specialty stores can. It's clear there is downward price pressure in nearly everything else but essentials like energy and food.

To date, I have not seen a single plausible all encompassing theory that started with massive consumer debt accompanied by rising unemployment and sinking housing prices that leads to hyperinflation prior to a deflationary collapse happening first.

This discussion with Schiff has obviously not changed my mind. If anything, Schiff appears to be adding to the deflationary hypothesis by agreeing with my assertions that unemployment is going to rise, housing will continue to slump, and most importantly debt cannot be repaid.

Nonetheless, in case I am missing something I am going to read his book. This is a critical subject as far as how one prepares for the outcome so it is important to consider all points of view.

The reason the inflation/deflation discussion is important is because there is are dramatic differences in how one prepares for each outcome in terms of investment ideas. Many people have been writing to me wondering what to do. I will offer some ideas on how to prepare for both hyperinflationary as well as deflationary outcomes coming up shortly. Finally, I would like to thank Peter Schiff for taking the time to add to this discussion.


Is the Fed a Private Institution?

I need to make a clarification to one thing I have said above in referring to the Fed as a private institution. My statement was incorrect.

See Who owns the Federal Reserve? for this clarification: "The Federal Reserve System is not "owned" by anyone and is not a private, profit-making institution. Instead, it is an independent entity within the government, having both public purposes and private aspects."

That statement does not materially change arguments presented above or elsewhere about the powers of the Fed.

Mike "Mish" Shedlock
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12:06 PM

Blue Christmas for Target

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Reuters is reporting Target cuts Dec same-store sales expectations.

Target Corp (TGT) warned on Monday that its December same-store sales were below expectations and said it now expects sales at stores open at least a year in the range of down 1 percent to up 1 percent, adjusted for a calendar shift.

While more consumers came to its stores at the end of the third week of the month, the increase was not enough to make up for weak sales following Thanksgiving that carried over into December, the discount retailer said.

Given the lower forecast, Target said December sales are likely to fall "well short of the meaningful improvement" it had earlier said was needed to achieve fourth-quarter earnings-per-share growth.

Earlier this month, Target reported disappointing November results. It also said sales were soft in the last week of November and if weak sales trends continued, its December same-store sales would fall short of its forecast.

The discount retailer had forecast December same-store sales would rise 3 to 5 percent on a calendar-adjusted basis.
On an inflation adjusted basis these sales were exceptionally weak.

Professor Depew was noting Target Confirms What We Already Knew in point number 1 of today's Five Things.
Late on Christmas Eve, when few were looking, Target (TGT) confirmed what we already knew, that retail sales will likely decline in December as consumers cut back on shopping.
  • Target said same-store sales may post anywhere from a 1% decrease to a lower-than-expected 1% increase.
  • For perspective, Target had previously predicted a gain of as much as 5%.
  • Meanwhile, retailers left with perhaps more inventory than anticipated are busy slashing prices in the days after Christmas.
  • Price cuts of 50% to 75% are being promised by retailers such as Macy's (M), Kohl's (KSS), Bloomingdales and Saks Fifth Avenue (SKS).
  • On one bright note, however, not all retailers are slashing all prices.
  • According to the Wall Street Journal, Williams-Sonoma (WSM) and Limited (LTD) are debuting some new, full-priced merchandise.
Price cuts of 50-75% huh? Are stores making any money? Isn't that more important than same store sales?

Weak same store sales and huge discounts are signs of over expansion and/or too much competition. That explains why Target Corp. (TGT), Home Depot Inc. (HD), Wal-Mart (WMT), Lowes (LOW) and other big-box retailers are pulling the plug on new-store plans. See Commercial Real Estate Dominoes Collapse for forward implications of these cutbacks in planned growth.

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10:14 AM

Commercial Real Estate Dominoes Collapse

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Wal-Mart (WMT) has already scaled back 2008 plans twice. They are now cutting back further and it's not just Wal-Mart. Many big are retailers shelving plans to add area stores.

Target Corp. (TGT), Home Depot Inc. (HD), Wal-Mart Stores Inc. and other big-box retailers — buffeted by sagging sales and the housing slump — are pulling the plug on new-store plans in and around Chicago. The pullback is another sign of the darkening outlook for 2008, as retailers turn cautious on expansion.

"The economy is in the crapper. Housing is going down the chute," says Richard Kopczick, mayor of Morris, which had expected to gain more than $1 million in sales taxes from a planned shopping center that's lost its key big-box anchors. "Lowe's (LOW) backed off, and then Kohl's (KSS) said they wouldn't come without Lowe's, and the whole house of cards collapsed."

Wal-Mart Stores Inc. had plans to add stores in six Chicago-area suburbs. All have either been cut entirely or put on hold. Minneapolis-based Target is walking away from plans for new stores in Morris as well as Antioch, Arlington Heights and at 76th Street and Ashland Avenue in Chicago. Wal-Mart, of Bentonville, Ark., had stores planned for North Aurora, St. Charles, Crystal Lake, Elgin, East Dundee and Bradley; all have been either axed or put on hold.

And after Christmas, Atlanta-based Home Depot will shut down a chunk of the real estate department at its regional office in Arlington Heights and has told brokers it's not interested in new store plans. Home Depot has cancelled projects in Minooka and at Interstate 57 and 119th Street in Chicago. Target and Wal-Mart did not return calls. Home Depot would confirm only that it's laid off some Arlington Heights personnel.
This article appears to be about commercial real estate in Chicago. It's not. This same scene is going to play out in scores of cities across the nation. Richard Kopczick, mayor of Morris, called this a "house of cards". Indeed it is, but it is also one of the best examples to date of the domino theory in actual practice.

I have talked about the domino theory many times, most recently in Credit Card Defaults move to Forefront of Deflation Debate.

This is the commercial real estate domino effect. If one key player backs out of a commercial real estate development, then they all do: "Lowe's backed off, and then Kohl's said they wouldn't come without Lowe's, and the whole house of cards collapsed."

On the surface, this merely kills an individual mall (in other words a localized domino effect). But when the scene is repeated scores of times in various municipalities across the country, the cumulative effect cannot be ignored.

This is the final nail in the coffin for jobs prospects in 2008. Store expansion has been one of the key drivers for job creation. Look for unemployment to soar. Look for rising unemployment to trigger still more delinquencies in credit card debt and housing foreclosures. One by one, collapsing dominoes are picking up speed, and from multiple directions as well.

Mike "Mish" Shedlock
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12:40 AM

Homeowners Protest Property Taxes

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States, Cities Revise Strategy as Homeowners Protest Rising Levies.

Falling home values and rising property taxes in many parts of the country are generating the loudest complaints about property levies since the 1970s, forcing state and local officials to address the outcry even as the housing-market slump eats into many sources of their revenue.

Indiana residents held public protests this summer against a surge in property taxes and acted on their frustration by ousting the mayor of Indianapolis. Florida voters will decide next month whether to adopt massive property-tax cuts, in a debate that has pitted part-time residents against full-time Floridians.

In California, thousands of homeowners are having their assessments reduced under a decades-old state law, and lower tax revenue due to the weaker housing market is likely to force an emergency budget session.

Falling real-estate prices and turmoil in the mortgage market are expected to reduce property values for U.S. homeowners by a total of $1.2 trillion next year, according to Global Insight Inc., a research-and-consulting firm in Lexington, Mass.

Unless tax rates are changed, California could lose $2.96 billion in property taxes over several years because of the housing bust, the firm predicted. New York could lose $686 million; Florida, $589 million.
My Comment: California is indeed in serious trouble. I talked about this recently in Turn out the lights California, the party is over.
"In many cases, incomes were growing faster than property-tax bills in the 1990s," Mr. Prante says. "Recently, property-tax bills have grown faster than incomes, on average."

State and local property-tax collections increased 50% from 2000-06, according to Census Bureau data. During the same time period, the median household income rose 15%, before adjustment for inflation.
My Comment: This is one reason that helps explain massively rising foreclosures. Another reason is "skew". The distribution of wage increases was massively concentrated on the very upper end of the scale. The masses have been getting hit twice.
In Indiana, a spike in real-estate tax bills for Marion County, which includes the state capital of Indianapolis, caused a backlash this summer. In some neighborhoods, property-tax bills as much as doubled. Residents staged a rally at which they dunked a giant tea bag in a canal -- a reference to the Boston Tea Party -- and a July 4 protest outside the governor's mansion.

"I was holding a microphone and saying, 'I'm right there with you,' " said Michael Rodman, Marion County treasurer, who joined protesters after seeing his property-tax bill jump 80%.

In October, the governor released a plan that would cap homeowners' property taxes at 1% of assessed value, shift the full cost of school and child-welfare operations to the state, and require voter approval of major building projects. But voters could face a rise in the state sales tax to 7% from 6% under the plan, which the state legislature has discussed in committee hearings this month.
My Comment: Property taxes are blatantly unfair especially to those on fixed incomes. I suggest total elimination of property taxes as well as total elimination of interest rate deductions.

Heck, for that matter, I suggest balanced federal budgets, a totally flat income tax (or income/consumption tax), and elimination of all deductions period. This would allow the removal of at least 90% of IRS personnel. These ideas would likely have to be phased in over time but the sooner we start the better.
Despite efforts to address voter outrage, Indianapolis Mayor Bart Peterson, considered a shoo-in before the revolt, was defeated in a Nov. 6 election by Greg Ballard, a little-known Republican challenger whose campaign, as of mid-April, had reported less than $10,000 in cash on hand.
My Comment: I do not know enough about either the incumbent or the challenger to comment specifically, but if this is the start of a nationwide revolt against property taxes, I am all in favor of it.
In Florida, where the falling housing market has gouged the state's economy, residents are debating massive property-tax cuts that will be voted on Jan. 29. Implementing the proposed changes would require amending the state's constitution. The plan, which strongly favors longtime homeowners over new buyers and part-time residents, has sparked opposition.

In Washington state last month, legislators held a special session to reinstate a cap on property taxes that would limit the growth in property-tax revenue from the existing tax base to 1% annually. Earlier in November, the state Supreme Court threw out a 2001 referendum on the cap, saying voters weren't adequately informed about what they were choosing.

Across the U.S., concerns about property taxes have reached levels not seen since the passage of California's Proposition 13 in 1978. That landmark law capped property taxes at 1% of assessed value and said the base assessment on a home couldn't increase more than 2% a year until it is sold. A companion initiative, Proposition 8, allows homeowners to get assessments temporarily reduced during a weak housing market, until home prices recover.
My Comment: Bring on the tax revolt.
In several states, there has been a push against sharp property-tax reductions. The most extreme plan was floated in Georgia, where House Speaker Glenn Richardson last month proposed eliminating all property taxes. But after touring the state to get feedback from residents, he has scaled back his plans and hopes to eliminate property taxes over time, starting with a few measures that he presented to the state House last week. He would offset the lost revenue by eliminating sales-tax exemptions on lottery tickets and groceries, and by adding taxes to consumer services.
My Comment: This is hopeless reporting. There was no sharp push against property-tax reductions. Rather there was a push to phase in the idea of elimination of property taxes.

Tax Squeeze

In the interest of fair reporting, I feel obligated to point out that I live in a horrendous area as far as property tax burdens fall. However, what's fair is fair. No one should get a break. Elimination of mortgage deductions need to go as well. In fact all deductions should be eliminated. There should neither be an incentive nor a disincentive to own vs. rent. Going one step further, there should not be government incentives or disincentives on any economic activity. Rather there should be a fair playing field for everyone.

Mike "Mish" Shedlock
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Tuesday, December 25, 2007 2:46 AM

Credit Card Defaults move to Forefront of Deflation Debate

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A wave of defaults and foreclosures hit residential real estate. That was followed by a significant weakening in commercial real estate, and now Unpaid Credit Cards Bedevil Americans.

Americans are falling behind on their credit card payments at an alarming rate, sending delinquencies and defaults surging by double-digit percentages in the last year and prompting warnings of worse to come.

An Associated Press analysis of financial data from the country's largest card issuers also found that the greatest rise was among accounts more than 90 days in arrears.

Experts say these signs of the deterioration of finances of many households are partly a byproduct of the subprime mortgage crisis and could spell more trouble ahead for an already sputtering economy.

"Debt eventually leaks into other areas, whether it starts with the mortgage and goes to the credit card or vice versa," said Cliff Tan, a visiting scholar at Stanford University and an expert on credit risk. "We're starting to see leaks now."

The value of credit card accounts at least 30 days late jumped 26 percent to $17.3 billion in October from a year earlier at 17 large credit card trusts examined by the AP. That represented more than 4 percent of the total outstanding principal balances owed to the trusts on credit cards that were issued by banks such as Bank of America and Capital One and for retailers like Home Depot and Wal-Mart.

At the same time, defaults - when lenders essentially give up hope of ever being repaid and write off the debt - rose 18 percent to almost $961 million in October, according to filings made by the trusts with the Securities and Exchange Commission.

Serious delinquencies also are up sharply: Some of the nation's biggest lenders - including Advanta, GE Money Bank and HSBC - reported increases of 50 percent or more in the value of accounts that were at least 90 days delinquent when compared with the same period a year ago.

Until recently, credit card default rates had been running close to record lows, providing one of the few profit growth areas for the nation's banks, which continue to flood Americans' mailboxes with billions of letters monthly offering easy sign-ups for new plastic.

But what is coming into sharper focus from the detailed monthly SEC filings from the trusts is a snapshot of the worrisome state of Americans' ability to juggle growing and expensive credit card debt.

In the wake of the jump in defaults on subprime mortgage loans made to borrowers with poor credit histories, banks have been less willing to allow consumers to consolidate credit card debt into home equity loans or refinanced mortgages. That is leaving some with no option but to miss payments, economists said.

Investors also are backing away from buying securitized credit-card debt, said Moshe Orenbuch, managing director at Credit Suisse. But that probably has more to do with concerns about the overall health of the U.S. economy, he said.

"It's been getting tougher to finance any kind of structured finance - mortgages, automobile loans, credit cards, student loans," said Orenbuch, who specializes in the credit industry.

Capital One Financial Corp. reported that delinquencies and defaults are highest in regions where troubled mortgages are concentrated, including California and Florida.

Among the trusts examined, Bank of America Corp. had the highest delinquency volume, with overdue accounts valued at $5 billion. Bank of America defaults in October were almost 200 percent higher than in October 2006.

A spokesman for Charlotte, N.C.-based Bank of America declined to comment.

Other trusts - including those linked to Capital One, American Express Co., Discover Financial Services Co. and those containing "branded" cards from Wal-Mart Stores Inc., Home Depot Inc., Lowe's Companies Inc., Target Corp. and Circuit City Stores Inc. - also reported striking increases in year-over-year delinquency and default rates for October. Most banks and other financial institutions holding credit card debt on their own books also reported double-digit increases in delinquencies.

"You're looking at more and more distress - consumers desperately trying to preserve their credit lines, but there's nowhere else to go," said Robert Manning, director of the Center for Consumer Financial Services at Rochester Institute of Technology. "It's like a game of dominoes."
Here is the key sentence in the above article: "It's been getting tougher to finance any kind of structured finance - mortgages, automobile loans, credit cards, student loans," said Orenbuch, who specializes in the credit industry.

The attitude towards risk is changing. It started with rising lending standards on home loans but has now spread into autos, credit card, and student loans. Decreasing willingness of lenders to lend and consumers and businesses to borrow is part of the psychology of deflation.

In response to Insurance from MBIA and Ambac Worthless someone asked me if municipal bonds would be the domino to trigger a massive chain reaction. My response was: "I doubt a re-rating of municipal bonds by itself would do it unless it triggered a cascade of defaults." Having said that, more dominoes keep falling and one of them is eventually going to matter.

The Current Picture
  • Residential foreclosures are enormous
  • Commercial real estate is heading south
  • Credit card delinquencies are rising sharply
  • REOs will dramatically increase once the wave of Alt-A and pay option ARMs hits
  • Ambac and/or MBIA are in serious trouble with funding
  • Ambac and MBIA put municipal bond ratings in jeopardy
The current picture is not pretty nor is there anything remotely inflationary with it. It took a while, but now credit cards can be added to the growing list of problems. Rather than a single domino triggering a collapse, perhaps there is simply a sudden out of the blue implosion caused by too much debt with no possible way to service it.

Mike "Mish" Shedlock
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Monday, December 24, 2007 10:53 AM

Not Your Father's Deflation: Rebuttal

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Peter Schiff argues it's Not Your Father's Deflation.

Among those rational enough to perceive the looming economic downturn, a heated debate has arisen that centers on whether the slowdown will be accompanied by inflation or deflation.

Those in the deflation camp believe that money supply will collapse as a natural consequence of the implosion of the biggest credit bubble in U.S. history. As loans go bad, assets, which collateralize these loans, will be sold at fire sale prices to satisfy creditors. It is also argued that a recession will reduce consumer discretionary spending, causing retailers to slash prices to move their bloated inventories. This is the way the situation played out in the 1930's and this is how many expect it to happen today.
My Comment: Indeed that is part of the debate but by no means all of it. Schiff misses many deflation arguments in that simplistic analysis. We will get to them momentarily.
There are several key differences between then and now, which argue against the classic deflationary scenario. In particular, the Fed's ability to pump liquidity into the market in the 1930's was limited by the gold backing requirements on U.S. currency. No such limitations exist today. This distinction is critical. When credit was destroyed after the Crash of 1929, the Fed was not able to simply replace it out of thin air. Today however, the Fed will likely print as much money as necessary to prevent nominal prices from collapsing. In fact, in the infamous speech that spawned his "helicopter" sobriquet, Ben Bernanke explained how the printing press can be used to stop deflation dead in its tracks.
My Comment: Schiff makes a false assumption that the Fed can replace credit out of thin air. The Fed is simply not in control of credit at all. The Fed can encourage borrowing but it cannot force it. The second failure by Schiff pertains to monetary printing. There are constraints on the Fed that he ignores. For example the Fed cannot simultaneously target both money supply and interest rates. Should the Fed pursue a massive printing campaign, interest rates will rise. Think of the consequences for housing and commercial real estate. Schiff ignores the consequences of interest rates on existing debt, much of which is variable rate. Furthermore, think about what rising rates would do to future expansion plans of businesses.
To fully understand the way inflation and deflation affect prices, we need to differentiate between assets, such as stocks and real estate, and consumer goods, such as shoes and potato chips. If we measure prices in gold, as we did during the 1930's, both asset and consumer goods prices will fall, with the former falling faster than the latter. So in that sense the deflationist are correct. However, in terms of today's paper dollars, this outcome is completely impossible. During deflation, money gains value, so prices naturally fall as fewer monetary units are required to buy a given quantity of goods. In the coming deflation, real money (gold) will gain considerable value, so prices will therefore fall sharply in gold terms. Paper dollars however, which have no intrinsic value at all, will lose value, not only as the Fed increases their supply, but as global demand for the currency implodes.
My Comment: While it makes sense that the demand for currencies other than gold fall, it is important to understand that it is not just the US dollar we are talking about. There is no major country on the gold standard so it is relative demand between other competing currencies that will determine how fast they fall in relation to gold.

In addition, we no longer have a US or even a Western world economy. Global wage arbitrage puts enormous downward pressure on wages. That pressure will not go away no matter what the Fed does.

Regardless of what anyone thinks, prices can only rise to the extent that people can afford to pay for goods and services or that banks are willing to extend credit. Without a driver for jobs, and with downward pressure on wages for the jobs we do have, prices will be constrained. If somehow prices rise above people's ability or willingness to pay for them, there will be not be buyers. Look one step ahead: Think of the consequences for jobs if people stop spending because they cannot afford to pay for things. Take still one more step: What does that do to the existing pile of consumer debt? Schiff fails to look ahead at what he is proposing.
The way I see it there are only two possible scenarios. The more benign outcome would we be one where asset prices fall, even in terms of paper dollars, but consumer goods prices continue to rise. This would be the stagflation scenario.

The more catastrophic scenario is one where asset prices hold steady or even resume their ascent, while consumer goods prices rise even faster. This of course is the hyper-inflation scenario, and is the worst possible outcome. I see no possible scenario where consumer goods prices fall in term of paper dollars.
My Comment: Schiff sees only two possibilities because he ignores a half dozen variables as well as downstream consequences of those variables.
  • Banks are unwilling to lend
  • Consumers and businesses are unwilling to borrow
  • Consumers stop buying goods they cannot afford
  • The Fed attempts to print but rising interest rates put an end to it
  • Global wage arbitrage
  • Jobs
I will add to the list in the recap at the end but for now let's continue with more of what Schiff has to say.
Many mistakenly believe that when the U.S. economy falls into recession, reduced domestic demand will lead to falling consumer prices. However, what is often overlooked is the fact that as the dollar loses value, the rising relative values of foreign currencies will increase consumer demand abroad. As fewer foreign-made products are imported and more domestic-made products are exported, the result will be far fewer products available for Americans to consume. So even if the domestic money supply were to contract, the supply of goods for sale would contract even faster. Shrinking supply will be a major factor in pushing consumer prices higher in America.
My comment: Once again Schiff is making an assumption. That assumption is the US dollar drops. It is a dangerous place to be when 90% think a certain something will happen. I suggest anti-dollar sentiment is indeed that bad even though the Euro is massively overvalued vs. the US dollar as is the British Pound. The fundamentals in the UK and EU are as bad as in the US and the property bubbles just as big. As an aside I do expect the dollar to sink vs. the Yen.

Even ignoring currency issues, Schiff is making another huge assumption about the of supply of goods. Take away the US market for goods and China and Japan have massive overcapacity. Without exports to the US and Europe, China would crash. This situation might change 10 or so years down the road, but export economies are not remotely close to being able to ignore the US consumer, at least not now or anytime soon.

Let's now turn our focus to stagflation. When someone says stagflation I am not sure what they really mean. It's important to have definitions so I will repeat mine. Inflation is the expansion of money and credit. Deflation is the contraction of money and credit. Stagflation does not really fit in to the discussion per se. By context though, it seems as if Schiff is talking about prices. For more discussion on the definition of inflation and deflation please see Inflation: What the heck is it?

I concede the prices of imported goods can rise as Schiff suggests and one of the ways is by tariffs. However, remember what Smoot-Hawley did to the great depression: Tariffs forced import prices higher, killed trade, and worsening the Great Depression. Was that "stagflationary" or "depressionary"?

There are other ways prices can rise and one of them is the effect of peak oil. Peak oil in and of itself simply does not belong in the inflation/deflation debate at all.

Schiff continues:
In addition, since trillions of dollars now reside with our foreign creditors, even if many of these dollars are lost due to defaulted loans, those that are not will be used to buy up American consumer goods and assets. As a result of this huge influx of foreign-held dollars, the domestic dollar supply will likely rise even if the Fed were to allow the global supply of dollars to contract, forcing consumer prices even higher. In fact, a contraction in the domestic supply of consumer goods will likely coincide with an expansion of the domestic supply of money. The result will be much higher consumer prices despite the recession. So even though Americans will consume much less, they will pay much more for the privilege.
My Comment: once again Schiff ignores wages, jobs and the ability of people to pay for massively rising prices. Furthermore, any influx of foreign dollars will likely be in the form of convertible deals like that we have seen between Bank of America (BAC) and Countrywide (CFC), Citigroup (C) and Abu Dhabi and Morgan Stanley (MS) and China Investment Corp. Those deals all involved shareholder dilution, none of them did a thing for US jobs or wages, and none of them is going to force any prices higher on anything, especially consumer goods that Schiff is talking about.
The real risk of course is that the Fed gets more aggressive as it realizes that the additional credit it is supplying is not flowing where it wants. If the Fed drops enough money from helicopters it will eventually reverse the nominal declines in asset prices.

Unfortunately, that road leads to hyper-inflation and disaster. No matter what, even if the Fed succeeds in propping up nominal asset prices, they can do nothing to sustain their real values. Consumer goods prices will always rise faster, leaving the owners of those assets poorer no matter how high their nominal values climb.
My Comment: This is where Schiff goes off the deep end. There is no risk of the Fed "dropping money out of helicopters". Schiff ignores the fact that the Fed is a private business. The Fed is no more apt to give money away than Pizza Hut is apt to give away free pizzas for a year to all comers.

At best, the Fed can provide liquidity. Yes, the Fed will do everything it can under the sun to get consumers to borrow and banks to lend. However, in the end the Fed cannot force either.

Ultimately the Fed will be constrained by ZIRP (Zero Interest Rate Policy), just as Japan was. Given massive overcapacity in housing, commercial real estate, restaurants, nails salons, etc there is simply no reason for businesses to want to expand business. Nor is there any reason for banks to be willing to extend credit to all but the most credit worthy borrowers. Rising defaults may even impair capacity to the point many banks are unwilling or unable to lend at all. The only reason expansion got as carried away as it did is the psychology at the time suggested residential and commercial property would forever rise. That psychology changed. More on psychology in a bit as it is a key factor.

Liquidity from the Fed is in reality nothing more than a loan. Liquidity is not the same as free money and the Fed will not be giving away the latter. Furthermore, liquidity is a coward. In the face of rising defaults spreading to commercial real estate, home equity loans, and even credit cards, the Fed's attempts to add liquidity will go straight down the drain.

Things ignored by Schiff
  • The Fed is a private business unable to give away money
  • The Fed would not give away money even if it could. Ultimately it would destroy their own wealth and power.
  • The Fed can provide liquidity (loans) but not capital (money). However, liquidity is a coward in the face of rising defaults.
  • The Fed can encourage but not force banks to lend or consumers of businesses to borrow.
  • The Fed can at most control either interest rates or monetary printing.
  • A massive printing campaign that actually found its way into the market would cause interest rates to rise, further putting deflationary pressures on both residential and commercial real estate.
  • There is rampant overcapacity in housing, commercial real estate, and autos, so there is no reason for businesses to expand.
  • Global wage arbitrage is an enormously deflationary force.
  • The Fed cannot create jobs or force wages higher.
  • Even if the Fed found some back ended way to give money to banks, and they actually carried that plan out (both are doubtful) it would not help cash strapped consumers pay back loans.
Starting with one faulty assumption that lack of a gold standard changes things, Schiff ignores 10 major things that remain the same. Here is a bonus 11th: velocity. Let's discuss velocity through the eyes of Japan:

Some argue that Japan never went through deflation. One basis for that argument is that "money supply" as measured by M1 never contracted over a sustained period. The other argument is that prices as measured by the CPI never fell much. Once again we have a flawed argument about consumer prices and a flawed argument that only looks at money and not credit.

Although Japan was rapidly printing money, a destruction of credit was happening at a far greater pace. There was an overall contraction of credit in Japan for close to 5 consecutive years. Property values plunged for 18 consecutive years. The stock market plunged from 40,000 to 7,000. Cash was hoarded and the velocity of money collapsed. Those are classic symptoms of deflation that a proper definition incorporating both money supply and credit would readily catch. Those looking at consumer prices or monetary injections by the bank of Japan were far off the mark.

In the end, one factor alone is going to seal the fate. That factor is called the psychology of deflation. Simply put, the Fed cannot force consumers or businesses to borrow or banks to lend.

The lesson from Japan should be crystal clear on this. If Schiff's argument held any water, Japan would not have been in deflation for 18 years. An argument that the US is not Japan is a red herring. Schiff's thesis is that lack of a gold standard somehow prevents deflation. That thesis has already been blown out of the water.

Finally, the massive consumer debt overhang in the face of global wage arbitrage and rising unemployment increases, not decreases, deflationary pressures in the US. If one is looking for differences, there is no internet boom to look forward to provide jobs and cushion the deflation blow as happened in Japan. Another difference is the savings rate. Japan had savings to draw from. The US does not. Once again this increases deflationary pressures in the US. Debt is deflationary when it hits the point it can no longer be serviced.

A careful examination shows there was only superficial analysis made by Peter Schiff when he argued It's not your father's deflation. The housing boom has gone bust. A commercial real estate bust follows. Consumer psychology and bank attitudes towards risk taking are changing slowly but surely. The rate of change will pick up rapidly once unemployment starts to rise.

In the final analysis, deflation is all about risk taking and psychology (the ability and willingness of consumers to borrow and the ability and willingness of banks to lend) not about the gold standard.

Addendum: For continued discussion please see Peter Schiff Replies to Deflation Rebuttal.

Addendum #2:

Is the Fed a Private Institution?

I need to make a clarification to one thing I have said above in referring to the Fed as a private institution. My statement was incorrect.

See Who owns the Federal Reserve? for this clarification: "The Federal Reserve System is not "owned" by anyone and is not a private, profit-making institution. Instead, it is an independent entity within the government, having both public purposes and private aspects."

That statement does not materially change arguments presented above or elsewhere about the powers of the Fed.

Mike "Mish" Shedlock
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