The Coming Deflation . . .

The breakdown of the housing market will appear to be inflationary, not deflationary. I don't mean that actual consumer prices will rise, but the CPI does not measure actual consumer prices. There are important flaws in CPI methodology that have understated inflation in the last 5 years and will overstate inflation as the housing market normalizes.

Since 1998 or so the CPI has extrapolated homeowners' housing costs from the rent survey. Even though only 6% of actual consumer expenditure is rent, the rent survey makes up a combined 30% of CPI. Home buying mania in the US has pulled money out of the rental market and driven rent down far below sustainable, break even levels. Rent increases have been running ~3% a year since 2001 despite real estate earning double digit capital gains.

Now that home buyers no longer have the prospect of instant capital gains, renting is coming back in vogue. 2006 rent increases are running at a 6% annualized rate, and there's no reason to expect this to abate unless there's a massive collapse in real estate. This is singlehandedly driving up the CPI even though rent is a small part of actual consumer expenditure.

Here's a little known fact. Core CPI excluding shelter has been essentially flat for 2005 and 2006. The shelter portion of CPI has been exploding in 2006, based almost entirely on the rent survey. No matter what happens to the price of bread and gas and lumber, inflation as measured by CPI is going up along with rent.

Martin
 
fwiw i think using 'rent equivalent' is the correct methodology... i look at my flat as an opportunity cost vs investing the money into another vehicle and paying a rent for an equivalent flat... at the mo' its a good investment - bought at tokyo's low, end 2004 -, but shld the arbitrage look like its likely to reverse, i wld just sell the flat... if ppl get screwed making poor investment decisions, i don't see why this shld impact CPI calc in any way!?? :confused:
 
I'm not saying it's the wrong methodology. I can't think of anything better off the top of my head. However, the fact remains that 23% of the CPI is a statistical phantom that can sharply diverge from actual consumer expenditures. In recent years there is no doubt that it has in fact diverged.

Martin
 
Lookatmoneysupplyforindicationofexpaningmoneysupply(inflation)orshrinkingmoneysupply(deflation).Pricesofthingsreflecttheirdemand/supplycurve.
 
Quote from Sparohok:

Here's a little known fact. Core CPI excluding shelter has been essentially flat for 2005 and 2006. The shelter portion of CPI has been exploding in 2006, based almost entirely on the rent survey. No matter what happens to the price of bread and gas and lumber, inflation as measured by CPI is going up along with rent.

Martin
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And this is appropriate, because for years when home price appreciation (especially in expensive coasts and cities) was occuring, none of this showed up in inflation #s.

But perhaps thats why the fed was willing to pause when energy was still high. They know how large a component of these new inflation #s are rent increases as backlash from decreased home buying demand.

They made it very clear they are willing to sustain the housing market at the expense of everything else.

China appears more interesting to me right now - they are export supported, but what if they ARE strong enough to come ahead as a response to our protectionist desires (either in the form of completely unpegging their currency or just accomodating possible import tariffs) ? Does China have enough money and buying power to economically defend its currency from an outright assault. The currency is the foundation; everything else follows.

Remember the southeast asian financial crisis of late 90s when currencies unpegged from the dollar, resulting in a simultaneous mass selloff of those currencies into dollar ? What makes China different?

Remember, China's 1 billion consumers is not the same as 1 billion US consumers would be (many are agri economy villagers/etc). So the population argument can't hold water, yet.

If China collapsed, you'd have inflationary pressure on prices of consumer goods, not deflationary. On the other hand, a suffering China with unused capacity would possibly alleviate short term oil demand = inflation easing.

I agree that the US and Japan debts are ridiculous, and I'm still surprised on how little relative impact its had on our dollar. But like trading, timing is everything, and perhaps we will inevitably crash down.

Until then, keep hedged and well stocked. :)
 
Quote from scriabinop23:


If China collapsed, you'd have inflationary pressure on prices of consumer goods, not deflationary.
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this is just so wrong. there's no historical precedent for a nation's goods getting more expensive for its trading partners after an economic collapse. goods coming from a collapsed economy are almost always cheaper in real terms, and the impact of this is deflationary on an importing nation's prices.
 
Quote from killATwill:

this is just so wrong. there's no historical precedent for a nation's goods getting more expensive for its trading partners after an economic collapse. goods coming from a collapsed economy are almost always cheaper in real terms, and the impact of this is deflationary on an importing nation's prices.
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hmmm... I see what you're saying and agree if China went through a massive currency devaluation. But the forces at bay seem quite the opposite ... at least in the immediate.

my logic was pointing to the more immediate occurence of either strong yuan or even worse high protectionist tariffs against China - this would make Chinese goods more expensive (inflationary).

what confuses me is how China would respond to an ensuing economic slowdown and lowering of external demand. For example, if your goods were made so unattractive to importers because of currency and tariff factors, what could China -actually- do? Forcing factories to run at full capacity and selling inventory at a loss doesn't seem sustainable - this would be the deflationary scenario you point to. What do you think?

My idea - alternatively, if China played the same game as the US, they could attempt to force a radical weakening of currency by printing more yuan and bring interest rates to zero, inducing their own hyper inflation. This would once again give their export economy the strength they need.

Of course, this would come at the expense of reducing their buying power for imported commodities, consumer goods, etc. In the end, it would still slow down or stop all growth, and would point to an end of boom times for a while. All the more reason a country like China needs to get energy independent all the sooner, as they might see this coming.

Sounds kind of like the things we worry about in the US.

PS - my scenario is hyperinflationary for China. So please tell how you can describe a deflationary one.
 
more thoughts:

deflation can have similar net effects to hyperinflation. but what may be missing from all arguments is the large impact commodity prices play into both pictures. think about it:

deflation: debtors are killed (individuals and businesses alike) because they're assets become worth less and they're debts remain the same while they're wages decline. On the other hand, since wages decline past living costs, buying power is REDUCED.

inflation: debtors are fine. BUT - high commodity demand/prices causing living costs to outpace wages has a similar effect: buying power is REDUCED and can even squeeze people from making their house payments (ie $200 oil would make it difficult to afford the house versus driving to work). cash holders miss the boat on growth of asset classes (real estate on stocks) that truly matches inflation.

Also, I believe -non leveraged- index fund (non specialized, that is) investors and real estate investors are fooling themselves into believing they can make a killing. At best, they mildly beat inflation. Leveraged speculators (real estate, stock, bond, etc) and lucky stock pickers are another story. Look at the dow or any similar index matched to inflation, and you'll see what I'm saying.

In the end, its all the same: in high commodity price and inflation environment, it seems the dollar is worthless, and in deflationary environment, it seems the asset is worthless. Regardless, for the weak in the economy, the person suffers in BOTH environmental extremes. Worthless dollar with no real buying power means you can't eat. Worthless asset eventually means you can't eat (ie businesses suffer, wages go down, and you make nothing, so you can't afford food).

Ideally, those who do great in deflation environments are those with no assets and all cash savings.

Those who do best in inflationary times have plenty of assets with little cash in hand.

So thinking about it like this, fundamentally it appears we're already on the verge of (albeit) deflationary environment masked as an inflationary one. Cash is king right now; home asset devalution is threatening markets; high commodity prices are threatening buying power; and wages are not really growing too much to catch up.

Currency and economic collapse has a similar net effect, but everyone hurts, including those in all cash.

Questions: what happened to US currency value during the great depression? also, what was the general picture of commodity (food, cotton, oil, steel, etc. etc) demand and affordability (in relation to the pre-crash times) like during the great depression? All I know are stories of people so poor that tomato soup was ketchup and water. I assume this was because lack of work. How did the gainfully employed do?

High commodity prices in post-crash era don't make sense to me, though, because lower labor costs (ie cotton pickers make less post depression times) and lower demand (extra remaining capacity from decreased business activity) would likely pass through to commodity prices.
 
for most emerging economies, china included, deflation is by far the biggest threat right now. the reason is that these economies are entireley leveraged upon the consumption of the US consumer, which is in turn very tied to the price of us housing (housing related employment, home equity withdrawals, flipper income).

all those products you see in walmart...the 3rd world producer's profit margins for these goods are pretty slim. a demand dip in the us leaves them with too much product, too many plant workers - over capacity. they gotta liquidate goods and in there own economy the layoffs hurt aggregate demand. deflation hits em.

also, the domestic demand of most emerging economies is relatively weak. the rich guys and gals in emerging nations are right now playing the same real estate speculation game that Americans were playing in Miami and San Diego 6 months ago. yes most 3rd world markets have larger down-payment requirments and no option ARMs, but someone forgot to tell the "investors" that there just aren't enough rich people and expats in Rio, Shanghai and Mumbai to buy up the properties that are lining the skylines. A GOOD job in Shanghai for a Chinese national pays $5000, yearly, a bad job about $800 (yes, this is USD). The ultra rich in these developing nations are plowing money into RE developments waiting for godot to come and buy their property at profit. ain't gonna happen.

so there's huge potential on the domestic demand-side of developing nations for serious wealth destruction. far worse than san diego or miami condos in my opinion, because these economies are not as adept as the US at weathering a downtown.

for the countries that like to interfere with currencies (you know know which country i'm talking about), i can see them trying to put in price controls to set a floor for housing prices if a frenzied liquidation by housing investors starts. this is a true longshot, but would not be good at all for the currency.

All signs point to price cuts there and here for all sorts of goods, especially housing: deflation.

in my opinion, in a globalized world, it's realy dumb to bet on inflation after the Fed has stopped raising rates and the yield curve has inverted. but we'll see. check back in 2009.
 
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