Frugality Trumps Quantitative Easing

Once again, deflation has a firm grip on Japan. Symptoms include falling wages, rising unemployment, weakening consumer demand, and falling prices.

Please consider Japan Logs Record Wage Fall, Bonuses Sink.

Japanese wage earners' total cash earnings tumbled 7.1 percent in the year to June, the biggest annual drop on record, which could hurt consumer spending and add to deflationary pressure on the economy.

Weakening household demand for goods is playing an increasing part in pushing the world's No. 2 economy deeper into deflation, with core consumer prices falling a record 1.7 percent in the
year to June.

The Bank of Japan is already forecasting two years of deflation, so price falls alone are unlikely to push it back into full-blown quantitative easing, which in Japan involved flooding the banking system with cash to meet a specific monetary target.

But weak wages, coupled with a rise in the jobless rate to a six-year high in June, may heighten uncertainty over the central bank's forecast for a gradual economic recovery towards early next year, and put on hold any exit from its unconventional monetary policy steps.

"This puts downside pressure on prices, and deflation will worsen for the next one year. There is no way the central bank can move in this situation," said Masamichi Adachi, senior economist at JPMorgan Securities in Tokyo.

QE Checkmate

Earlier this decade Japan invoked a policy of Quantitative Easing to inject cash into the economy. It did not work as planned. However, Japan's QE policies did unleash the mother of all carry trades as investors borrowed in Yen to invest in higher yielding currencies.

Now, with US interest rates at 0 to .25%, UK interest rates at .5%, and the ECB with Eurozone interest rates at 1%, borrowing Yen at 0% to invest in other currencies does not make a lot of sense. All Japan succeeded at was driving up national debt via ridiculous Keynesian spending programs.

Moreover, with rising unemployment, and massive government debt, Japan does not want its interest rates to rise (which they would should inflation take hold). Thus, it's checkmate for Japan in regards to QE.

The UK and US are now embarking down that very same road but the result will be the same because Consumer Frugality Trumps Quantitative Easing.

Was the Fed Successful?

David asks:

Mish,

Love your blog, but I’d like to clarify one thing with you.

You often dismiss the notion that inflation is not a plausible scenario in the short / mid-term. You’re right to point out that house and other consumer goods are tanking, thus leading to deflation. But don’t you think the fact that prices don’t fall as much as they should – due to inflationist policies by the Fed – is, in itself, inflation?

Without the actions of the Fed prices of cars, houses, shares, commodities, etc would be lower. They’re not, which means we are currently experiencing inflation.


Don’t you think?

David

The Fed's effort to increase money supply have indeed had short-term impacts (at great long-term costs). However, most of those changes are still of a second derivative nature. Note that in regards to consumer spending, bank lending, jobs, and housing prices, the situation is still worsening, albeit at at a decreasing pace.

Note that Obama has promised to save 3.5 million jobs. But even if he has (which no one believes), the economy is still shedding jobs and consumer prices are still falling, especially when one properly factors in housing. Please see What's the Real CPI? for details.

It's Not About Prices!

That aside, inflation is not about prices at all but rather the expansion and contraction of credit.

Falling prices do not constitute deflation. However, they are a likely but not mandatory symptom of it.

In a credit based economy, the key issue is expansion and contraction of credit. Credit is clearly contracting. And credit marked to market (which is what matters most) has dwarfed Central Bank expansion of money supply to counteract it.

Given that the Fed and the accounting board have suspended market to market accounting it is a guess as to whether credit marked to market is expanding or not. However, the latest reports still show a contraction in bank lending as well as tightening of lending standards.

And yes the Fed has pumped up money supply. But if money just sits there as excess reserves (and this is indeed what is happening) then it does not affect prices.

Short-Term, the Quantitative Easing efforts by the US, UK, and ECB have stabilized the markets. Long-term all the governments have done is pile on more debt that must be paid back (with interest), and that will act as a huge drag on the economy at a later time.

Note that US and European banks are still reluctant to lend because of massive overcapacity everywhere. Consumers are still reluctant to borrow. The savings rate is rising.

Chinese banks are a different story. China is a command economy and if the government says lend, Chinese banks lend. One must not confuse rising commodity prices on account of China or on account of inventory replenishment in the US and Europe as a sign of a sustainable, renewed credit boom by consumers or businesses.

Demand for Credit is Weak

Moreover, the $14 trillion effort by the Fed has not done a thing for jobs, nor will it. And without jobs, credit card writeoffs will soar along with foreclosures. Congressional policies like "cash for clunkers" merely pushes demand forward while adding to debt that must be repaid via higher taxes.

In the "Recoveryless Recovery" Bernanke will continue to be stymied by consumer and business frugality. Demand for credit is weak and so is bank willingness to extend it. Thus, inflation is not yet in the picture, and when it does arrive, it will be far less than most expect.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Thoughts On The "Recoveryless Recovery"

In response to Military vs. Non-Military Durable Goods in Pictures where I suggested the "bottom may be in", many people asked "how so?"

For example "They Stole My Country" writes:

Mish,

Most of the deflation blogs I lurk at here and there are pretty adamant that things are going to get worse. You always seem to hedge that the "bottom might be in." When I look at all I have learned from you and others regarding the state of the economy, I just can't hold out hope the bottom might be in. The jobs are not coming back. Why do you feel the need to qualify?

Likewise "VaAppraiser" asks:

Mish, I also am wondering what bottom you keep referring to? I do not like gloom and doom predictions but I am in the camp with all the others that we not seeing spring here (re: green shoots). Looks more like the end of fall... but I am no expert in the larger matters. What I do know and have expertise in is the housing markets I cover. I have written on some other sites that there is no way any of the markets I cover have reached their bottom.

In the best markets, they still have just under 6 months inventory and we are about 75% of the way through our selling season. If this were the inventory going into the season, yes...we could be bottoming but we are getting ready to go into our slow season...not the bottom by far. I believe inventory will shoot up to 9-12 months pretty quickly. Then prices drop, especially with short sales and REO's having such a big percentage of the market.

Recovery? What Recovery?

Before we can address the question "is the bottom in?" we must answer the question: "the bottom of what?" Moreover, we must also state a timeframe. The latter is critical.

• In general, when I say the bottom may be in, I am speaking of the GDP. Yes, GDP is a very flawed measure, but given all the economic stimulus, it is highly likely the GDP will rebound for a quarter or two, perhaps more.
  
• In regards to the recession, expect to hear announcements that the recession is over coming soon.
  
• In regards to the stock market, I have repeatedly said "the bottom MAY be in". Personally I doubt it. But it could be.
• In regards to unemployment, there is no way the bottom is in.
• In regards to housing prices, the same applies. The bottom is not in.
• In regards to housing starts and permits the bottom is probably in.
  

Now, assuming "the bottom is in" for the GDP and the recession will soon be over, the next question is "for how long?"

Most know that I am in favor of an "L shaped recession", but that definition includes a "WW" or even a "WWW" where the economy slips in and out of recession for a decade, as happened in Japan.

There is no reason to think that consumers are going on huge, sustainable shopping sprees soon. However consumer spending needs to to be balanced with the government throwing money around like crazy, not just in the US, but also the Eurozone, the UK, and especially China. Moreover, an inventory rebuilding process will occur at some point. It may have already started.

However, given that unemployment is likely to rise for another year, this is likely to be a "Job Loss Recovery" or as "Michael" commented on my blog a "Recoveryless Recovery". Indeed, if one is waiting for a recovery in jobs then a recover is a year away at least. However, the NBER will focus on improving GDP and various other factors and not just jobs when deciding the end of the recession.

Whether or not the stock market has bottomed depends on the US dollar. If the US dollar sinks to new lows, the bottom in the stock market is likely in. If the US dollar manages a major new high, I surmise the bottom is not in.

No one really knows. What we do know is currency debasement is not just a US phenomenon. Global currency debasement by central bankers everywhere is underway. And since things are relative, one should NOT be surprised to see the US dollar make new highs. However, my favored scenario is the US dollar will fluctuate in a wide trading range which makes it touch and go as to whether the stock market bottom is in.

At this point, the market has priced in a strong recovery, something that is not going to happen. And even IF the bottom is in, the market is likely to do nothing from here (at best), for quite some time.

This is also the "pain trade" in many ways for many people. For example, pension plans still have lofty as well as unreasonable market expectations going forward, jobs will remain difficult to find, and boomers headed into retirement hoping for a return to new market highs to "get even" will be frustrated time and time again. Things are shaping up as that have in Japan, with "two lost decades".

In short, the bottom may be in, but lock up those party hats because most will not see it in terms of jobs, wages, home prices, and the stock market. From many angles, the most likely scenario is a "Recoveryless Recovery".

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Is the Housing Bottom in, or is this just a Seasonal Uptick?

Inquiring minds are pondering a few charts from my friend "TC" who has plotted the Case-Shiller price history since 1995 for 20 cities. Please click on any chart to see a sharper image.

Absolute Price History 10 Cities



Absolute Price History 10 Additional Cities



Relative Price History 10 Cities



Relative Price History 10 Additional Cities



May 2009 vs. April 2009



Thoughts From "TC":

Much has been made about prices "hitting bottom" and the market showing signs of stabilization. However, when one dives just a bit deeper into the numbers, it appears the increases are not much more than seasonality.

Another reason for the small price incline on a month-over-month basis is that May 2009 data is the first full month of data since the Federal $8000 Tax Credit took effect (the bill actually passed in mid-February, so March was the first complete month, but escrows aren't typically closed and sells recorded until May).

In order to showcase how small these price increases actually were in dollar terms, I've included a new chart which the price differences of May 2009 vs. April 2009 for all 20 cities tracked by Case-Shiller. The changes range from a gain of $5,800 in San Francisco to a continued drop of $1600 in Miami - no city experienced an increase any where near the $8000 Federal Tax Credit.

Median national prices have now fallen 32% peak-to-trough over the past 3 years or $80,000. In the 20 cities that Case-Shiller tracks prices have fallen from 8% in Dallas to 55% in Phoenix. Price declines are highest in CA, NV, AZ, FL and Detroit. In nearly all of the cities prices have now declined back to early 2000 prices and thinly traded futures data points to a bottom occurring in the next 12 months.

It is important for readers to know that Case-Shiller uses a Repeated Sales Methodology (RSM) which provides the most accurate housing data available. Additionally, there are two newer columns titled "Price Level" which show both the last time prices were at the current level and what price level prices are projected to decline to based upon the CME Futures market.

Once again included absolute and relative price charts. The relative charts are based upon a year 2000 equal point for the 20 cities and the absolute price chart helps to show the current price declines.

Thanks TC!

At some point housing will bottom. The key question is "what then"?' I surmise in real terms housing will be negative for a decade given the last bubble is never reblown. Look at the Nasdaq for a prime example.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List