Play devil's advocate with me

[laurence]

So the below article talks about the crash landing we are heading towards wrt. our national debt:

http://www.msnbc.msn.com/id/9377813/

And I'm nodding my head, thinking, "Inflation comes! Ask not who inflation comes for, it comes for thee!", but I don't want to develop a blind spot. Can somebody provide an argument (not involving aliens) to say high inflation is not in our future? Not looking to argue, trying to expand my thinking.

 

[retire@40]

The best argument I can think of is that long-term rates are still low.

 

[Marshac]

Increased productivity from lower-cost areas like China.

I don't believe it, but hey... why not.

 

[brewer12345]

No argument from me.  At some point, we are going to get taken out to the woodshed.  When it happens, the dollar will drop, interest rates (long term) will rise, and the cost of pretty much everything will spiral upwards.  Only a matter of time, at the rate the gummiint is spending.

What to do?  Buy commodities, non-USD denominated assets, and floating rate or short duration bonds.

 

[SteveR]

Having lived through the '70s and '80s with rampant inflation, price controls and shortages I believe high inflation will happen again in most of our livetimes.   The economy is a cyclical and anyone that has used FIREcalc will attest to that fact.  What goes up will come down...what is down will go up... it is all about when and not if.

 

[Michael]

The fed has a policy of constant inflation, so that is what we will get. Lowered prices on televisions imported from China will be balanced by deliberately increased prices for anything produced in the United States, such as health care.

 

[wabmester]

What to do?  Buy commodities, non-USD denominated assets, and floating rate or short duration bonds.

And TIPS. And keep working, since wages will track inflation better than just about anything else.

 

[uncledrz]

Another scenario (which I don't necessarily support), the dollar loses all allure as a store of value to foreign banks, who go to a basket of currency. To support the deficit, interest rates must shoot way up, causes business borrowing to be squeezed out, results in less growth. At the same time, real estate, a large store of value for the individual, goes down in value because carrying cost is no longer 5%, but significantly higher. Consumers, without income, without large store of value to borrow against, slow down purchasing, causing business to decline, etc, etc, etc,
This would result in deflation rather than inflation.
Just one scenario.
Uncledrz

 

[vinhmen]

If you can wade through his columns, Bill Gross at PIMCO seems to think deflation is the greater threat.

Good thing we have one of those fiscally conservative Repubs in office, huh  :

 

[Nords]

If you can wade through his columns, Bill Gross at PIMCO seems to think deflation is the greater threat.

It's about as much of a threat as his other nemisis, DOW 5000. But gosh do they sell newsprint!

 

[Cut-Throat]

And TIPS.  And keep working, since wages will track inflation better than just about anything else.

The keep working thing certainly worked in the 70's and early 80's. This time around we have such a pressure on wages (to remain low).

This is the primary reason given for low inflation. Wage pressures will continue to be low.

 

[Marshac]

It's about as much of a threat as his other nemisis, DOW 5000.  But gosh do they sell newsprint!

A lot of economists have been fearing deflation as a result of a 'credit event', so it's not just Bill sounding that alarm.

 

[Nords]

A lot of economists have been fearing deflation as a result of a 'credit event'...

I think the Fed can run the printing presses faster than we can slam our wallets shut.

 

[Marshac]

I think the Fed can run the printing presses faster than we can slam our wallets shut.

If this were truly the case, then why has Japan been in a deflationary environment for the past 7 years? The Yen is fiat, just like the USD. Japan entered into a liquidity trap, there is no reason why we couldn't do the same, especially once the consumer credit hangover kicks in.


English explanation of a liquidity trap-

The way the Fed lowers interest rates is to expand the money supply by buying bonds from the public - in this way money moves from the Fed's vaults to people's pockets.

Suppose that the Fed wants to lower interest rates, say because there is a recession. Normally, people have to be enticed to give up their bonds because they pay interest. So, to increase the money supply, the Fed must offer people a higher price for the bonds the public owns - thus lowering the interest rate for new borrowers (all in order to make bonds less attractive for the public to hold.)

In a liquidity trap, however, people are willing to part easily with their bonds, since they pay little or no interest and are hence roughly equivalent to holding cash; and so only a very small change in price is needed to buy the bonds - even if the Fed is buying lots of them. As a result, there will be very little change in interest rates. In the extreme, the Fed may not be able to have any significant impact on interest rates, and hence may not be able to help stimulate the economy.

 

[Nords]

If this were truly the case, then why has Japan been in a deflationary environment for the past 7 years? The Yen is fiat, just like the USD. Japan entered into a liquidity trap, there is no reason why we couldn't do the same, especially once the consumer credit hangover kicks in.

Gosh, where do we start...
- The Japanese govt is even more gridlocked, corrupt, & just plain inept than the U.S. govt.
- The Japanese bureaucracy sucks even worse at determining their country's CPI & PPI than the U.S. bureaucracy.
- The Japanese banking system engaged in even more fraud & deception with the Japanese govt (& stockholders) than the U.S. banking industry has ever dreamed of engaging in with the U.S. govt. Japan's bankers could probably sell classes on the subject to our bankers. (Shhhhh.)
- Japanese banks held a lot of their bad loans instead of securitizing them and selling them to other suckers institutional & retail investors like the U.S. banks do.
- Japan doesn't seem to have someone like Greenspan who's paranoid about avoiding deflation (in this case Greenspan's paranoia appears to be a good thing).
- In 1989 Japan's real estate values had risen to incredibly ludicrous highs by ANYONE's definition of a bubble. The collapse sucked all the equity out of every homeowner and left them underwater for over a decade. That contrasts with the average American homeowners who're easily able to get cheap home equity loans to further fuel their credit habits. Sure, why not? Because the American lenders are securitizing those HELs and probably suckering selling them to the Japanese banking industry...

 

[Marshac]

The point of my post was not to draw parallels between the state of our current affairs, and those of early-90s japan, but rather to illustrate the point that another prosperous country with fiat currency failed to avert, or even recover from, a deflationary environment, despite the power of the printing press. The situation that lead up to deflation in Japan is not the only viable recipe- there are many others. Perhaps the one we're currently working on here in the US with all its crazy hedge fund and deficit spending ingredients will lead to deflation... or perhaps inflation. Time will tell.

"The past does not repeat itself, but it rhymes."
--Mark Twain

 

[bpp]

I tend to agree with Marshac that just because there are some differences between the two countries, that doesn't mean that the printing press can't fail in the US just as it has in Japan. The BOJ has kept interest rates at 0% for years, and deflation still hasn't gone away.

Well, lately there are signs that a hint of inflation may be in the air, but not enough to inspire a slow down of the printing presses yet. And I'm also half-expecting that once inflation does get some traction here in Japan that it may well spiral out of control. But I've pretty much decided that it is folly to claim that anything can or can't happen as far as inflation and interest rates go, whatever the plausibility arguments say.

Bpp

 

[haha]

I tend to agree with Nords on this topic. I don't think it would be possible for the US to go into a really meaningful deflation. Our whole national psyche is built on inflation. Our politicians want it, our population wants it, and we have a growing population.

All this deflation talk is a misunderstanding due to the fact that cheap goods can be made in China. But can cheap medical care, schooling, college, vacations, travel, concert tickets, houses, apartments, etc ad infinitum be made in China?

Don't think so.

 

[Marshac]

All this deflation talk is a misunderstanding due to the fact that cheap goods can be made in China. But can cheap medical care, schooling, college, vacations, travel, concert tickets, houses, apartments, etc ad infinitum be made in China?

Personally, I don't believe that it will come from "Made in China", but rather from the erosion/contraction of the monetary base due to defaults.

As for medical services... you want India

 

[wabmester]

The point of my post was not to draw parallels between the state of our current affairs, and those of early-90s japan, but rather to illustrate the point that another prosperous country with fiat currency failed to avert, or even recover from, a deflationary environment, despite the power of the printing press.

Many think that Japan simply failed to use the power of the printing press. They tried to use rhetoric instead of inflationary monetary policy to fight deflation. In fact, they actually tightened the money supply in 2000, which was dumb.

 

[sgeeeee]

And TIPS.  And keep working, since wages will track inflation better than just about anything else.

Have you gone back to work, Wab? You've posted a couple of "keep working" posts today.

I know that I'm still keeping myself involed in technical/professional activities a little bit. Part of the reason is because I'm enjoying it. Part of the reason is that it seems like a healthy hedge against economic crisis in the future (like rampant inflation).

 

[wabmester]

Have you gone back to work, Wab?  You've posted a couple of "keep working" posts today.

I know that I'm still keeping myself involed in technical/professional activities a little bit.  Part of the reason is because I'm enjoying it.  Part of the reason is that it seems like a healthy hedge against economic crisis in the future (like rampant inflation).

No job for me (although I do get a few more free hours now that my kid is in preschool), but I guess as an ER, I feel a responsibility to scare people away from taking as much risk as I'm taking. Cutting the job cord at 40-50 could be a serious mistake unless you've got both a large cushion and a viable plan B. I don't think the Pollyannish talk about "life is short, quit your job" and "hey, I've been retired for three years, and my net worth is still rising" is a responsible message from ERs.

The reality is that a good income is hard to get from passive investing, and it may get much harder. I've seen people un-ER, and it's not pretty.

 

[markplus4]

Let's not get too alarmed over this journalist's "economic analysis." Consider this statement he made: "And borrowing is how we'll pay for the additional tax cuts that Congress is likely to consider next month." The data simply doesn't back up that statement. The facts are that the cut in marginal tax rates yielded a 14% YOY RISE in government revenues. That's why the deficit was actually shrinking vs. projections prior to Katrina. The opportunity is on the spending side...where Republicans have failed miserably. Maybe they'll find some intestinal fortitude and start slashing some of the pork they approved in the most recent session. The highway bill monstrosity is a good place to start.

With long rates so skinny (4+%), an argument could be made that financing debt at these levels is actually a good thing for the Feds. Don't see how the foreigners who buy our debt can come out ahead on that trade. Before someone tells me that long rates are destined to rise precipitiously, let me squash that by telling you I've heard that for the last 3 years, and it ain't happened yet.