Rosenberg: “We are certainly in a deflationary state”

Fueled by overcapacity, shrinking credit, reduced corporate spending and falling consumer demand, Deflation is taking root in global economies.

Consumer prices fell at their fastest clip ever last month in Japan, which has been fighting a losing war against deflation for much of the past two decades. Germany, Europe's biggest economy, has now suffered through four consecutive months of sliding prices, and the rest of the region that uses the euro is not faring much better.

That deflation should be such a threat may run counter to market fears that inflation will quickly follow the massive, and costly, global effort to fight the financial crisis. But many observers see deflation as the greater threat.

“We are certainly in a deflationary state,” said David Rosenberg, chief economist and strategist with Gluskin Sheff and Associates in Toronto. “Of that, there's no doubt. I think people still have no clue as to just how weak the economy is,” Mr. Rosenberg said.

Remove the “impressive medication” administered by governments, and most economies are at a virtual standstill.

The U.S. economy faces a decade of stagnation, he said. “That's a perfectly plausible scenario.”

If and when it does hit, “deflation will last until we see the next secular trend of expanding household balance sheets, and that is some time away,” Mr. Rosenberg said.

I concur with Rosenberg except on his apparent definition of deflation. He seems focused on prices which is only one of many symptoms of deflation.

One confusing aspect in the article is that on one hand he says “We are certainly in a deflationary state” on the other he says If and when it does hit...

There is no if.

The odds that deflation hits are 100% given that we are in deflation now and have been for some time. Moreover, a "decade of stagnation" with the US hopping in and out of recession/deflation is not just a possibility but rather a likelihood.

From a practical standpoint, the debate about deflation should be over. On December 11, 2008 in Humpty Dumpty On Inflation I listed a perfect scorecard of 16 items one would expect to see in deflation and all were happening.

The only debate comes from those using impractical measures of inflation and deflation. As a prime example, please consider Daniel Amerman vs. Mish: Reflections on the Great Inflation/Deflation Debate.

Moreover, it should have been clear we were in deflation as early as March 17, 2008. Three factors made it clear: a collapse in treasury yields, a collapse in asset prices, a collapse in credit marked to market. See Now Presenting: Deflation! for additional details.

Yesterday inquiring minds were reading Bill Gross Bets On Deflation. However, when it comes to Bill Gross, a reasonable person must always be concerned how much he is talking his book, hoping to unload it.

Some Learn Nothing From History

Some people never learn a thing from history. One such person is Arthur Heinmaa, managing partner with Toron Capital Markets in Toronto, who told the Globe "To prevent a deflationary outcome, policy makers have to stop worrying about how they'll rein in future deficits and start persuading the public that they'll do whatever it takes to keep the pumps primed and cash savings nearly worthless."

Stop the insanity please! The lesson of Japan is that Japan went from being a creditor nation to a government with debt 150% of GDP by foolishly attempting to defeat deflation.

Here's a clue for everyone. Making cash worthless is insane. It will do nothing but exacerbate the problems of the unemployed and those on fixed incomes.

Rosenberg further discusses deflation in Wednesday's Breakfast with Dave.

The bond bulls can only hang their hat today on the knowledge that the world is still awash with deflationary pressures — as Euroland reported that the region’s CPI deflated 0.3% YoY in September from -0.2% in August and the fourth month now in negative terrain. So, we have Euroland at -0.3%, the U.S.A. at -1.5%, Canada at -0.8%, Japan at -2.3%, and even China at -1.2% — even in the face of this year’s commodity price rebound. That tells you something. Imagine where these deflation figures line up when economic activity begins to slow down next year. This puts fixed-income product in a very positive light, we might add, because real yields in most jurisdictions, whether in the government or corporate sector, appear very attractive.

Does This Make Any Sense?

Since June 10, the yield on the U.S. 10-year Treasury note has plunged 70 basis points and at the same time the S&P 500 has rallied 14%. The bond market is telling us that we still live in a deflationary world, yet the equity market is at this juncture pricing in over $80 of operating earnings, which would be double from the current four-quarter pace.

The real question is, if we in fact do have this sustained reflation trade going on, which is actually necessary to justify the earnings expectations embedded in equity valuation, why it is that the yield on the 10-year Treasury note isn't north of 5.0% already? Instead, it is 3.3%. And history shows that when bonds and stocks do diverge, as was the case in the summer of 1987, the fall of 1994, the summer of 1998, the winter of 2000 and the summer of 2007, it is the former that proved to be prescient.

Bank Credit Still Contracting

The monetary base has surged at a 51% annual rate over the past thirteen weeks, and that has churned out less than 3.0% growth in M1 and -4.0% in M2 over that period. This is classic ‘pushing on a string’ monetary policy. The Fed hasn't really fixed anything per se — the Fed, along with the FHA and other government agencies, have basically supplanted the banking system with taxpayer-funded credit. Bank lending to the private sector plunged some $40 billion in the week ending September 16 and to put this in a certain context, the decline over the past three months has exceeded 16% at an annual rate, which is unprecedented. And, the contraction in credit is very broad based — down 5.3% for consumer loans; -9.4% for real estate credit; and -20.4% for business (C+I) loans.

The banks are still sitting on over $1 trillion in cash assets, and they are putting the proceeds to work in the government bond market, snapping up over $20 billion of Treasuries and Agencies so far this month — 22% at an annual rate over the past thirteen weeks. This may be one reason — from a flow-of-funds basis — as to why the yield curve is flattening right now. This and the nagging notion among some very important bond investors, such as Pimco, who see the U.S. economy as we do … deflationary.

Pied Pipers of Debt

Rolfe Winkler is writing about Krugman and the pied pipers of debt.

Investors are celebrating an incipient “recovery,” but the interventions that were responsible for it are sowing the seeds of a more violent contraction down the road. The problem, quite simply, is debt. We’ve accumulated record amounts, yet many economists tell us we need more.

Leading the charge is Paul Krugman. He exhorts us to borrow our way back to prosperity, but he doesn’t acknowledge that his brand of Keynesian economics ignores the consequences of debt.

Krugman dismisses deficit “hysteria,” arguing that we can grow our way out of debt. “We did it during the Clinton administration,” he told me when he visited Reuters last week.

But we didn’t. While Clinton balanced the federal budget, Americans plowed through their savings. We kept growing because, in the aggregate, we were still accumulating debt.

Today, private debt is a suffocating 300 percent of GDP, making more public debt that much harder to pay down.

As Krugman warned in 2003: “My prediction is that politicians will eventually be tempted to resolve the (fiscal) crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar.”

Still More Paul Krugman, Then and How

Please consider Paul Krugman: "Deficits Saved The World"

Dateline August 27, 2009
Paul Krugman: "Deficits Saved The World"

Dateline November 3, 2004
Paul Krugman: "[The Budget Deficit] is comparable to the worst we've ever seen in this country. It's bigge[r] than Argentina in 2001."

Whether or not budget deficits are irresponsible seems to depend on whether a Democrat or a Republican is in the White House. Such is the "Conscience of a Liberal".

Meanwhile, the treasury market and bank lending are both flashing huge warning signals. Are you paying attention?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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