Wednesday, February 20, 2008

The Great Deflation

Yves Smith at naked capitalism points us to an article on the coming Great Deflation:

People borrowed money because they had to. Income growth simply did not keep pace with prices in housing, health care, transportation, energy and food.

Good grief.  People did not run up $20k on credit cards because the price of rice and beans had skyrocketed.  People did not take out 40 year loans on land yachts because Saudi transportation moguls bid 10-year-old cars through the roof.

They did it because of their psychological state.  Material goods became cheap, plentiful, and fabulously diverse.  Money became as easily borrowed as a library book, a chit among gentlemen rather than a serious duty.  These trends were not merely obvious, they perceptibly accelerated while you watched.  Many people observed these facts and concluded that they were now living in a post-scarcity economy.  With no everyday evidence to the contrary, they gradually developed a contempt for scarcity.

And if the goods had come from a self-maintaining robot factory in Montana, they'd have been right.  The only constraints would have been their imaginations and the universe's limited supply of ergs and atoms.  That sort of technological mastery would upturn society and open bewildering vistas of possibility, a utopia of science.  United Federation of Planets, here we come!

But there is no robot factory.  The cheap goods came from foreigners working damn hard for little return, held in peonage* to conventional factories.  A lot of domestic production (housing, agriculture) was even done by foreigners, legal and otherwise.  The easy money was the purchase price of those goods shipped right back to the First World as the foreign central planners held inflation in check.

What seemed to be a new permanently-high plateau was actually a situation balanced on the edge of a knife.  Trade imbalances cannot continue forever; the exporter either implodes in a revolution, or completely industrializes.  Either way, the imbalance stops.  Borrowing cannot continue forever in any economy; it stops when debt exceeds future income, whatever artifice delays the day of reckoning.  Financial derivatives cannot be infinitely re-derivatized; eventually their behavior becomes so opaque that dynamic stability cannot be maintained and the whole web unwinds, maybe in white knuckle trading, maybe in a crash.  The boom in non-exportable labor (housing, services) was nothing more than the pent up labor from the off-shored jobs finding an outlet.  Like the rest of the universe, economies are governed by unavoidable natural laws.

Like natural laws, ingenuity can harness the laws of economies, make them work for our long-term benefit.  Alas, in this matter many of the public and the leaders have chosen by default to be kites instead of making themselves into airplanes, tossed by the wind instead of setting their own course.  Yeah, the ride starts out more exciting, but what of the storms?

Many will say to me in that day, Lord, Lord, have we not prophesied in thy name? and in thy name have cast out devils? and in thy name done many miracles?
And then will I profess unto them, I never knew you:  depart from me, ye that work iniquity.
Therefore whosoever heareth these sayings of mine, and doeth them, I will liken him unto a wise man, which built his house upon a rock:  And the rain descended, and the floods came, and the winds blew, and beat upon that house; and it fell not: for it was founded upon a rock.
And every one that heareth these sayings of mine, and doeth them not, shall be likened unto a foolish man, which built his house upon the sand:  And the rain descended, and the floods came, and the winds blew, and beat upon that house; and it fell: and great was the fall of it.
       — Warren Buffet

*In peonage for now.  It's a long, hard road that leads to industrial prosperity, but the road does get there.  The ephemeral nature of mercantilism is a trap for the idle importers, not for the laborers.

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Sunday, February 03, 2008

"Reserves"? You keep using that word.

I do not think it means what you think it means.

This comment on The Financial Ninja points out that the Fed has redefined how the NFORBRES data (net free or borrowed reserves) are calculated:

"Notes:  Prior to 2003-01-01, the data are calculated as excess reserves minus total borrowings plus extended borrowings.  From 2003-01-01 till 2007-11-01, the observations reflect excess reserves minus total borrowings plus secondary borrowings.  From 2007-12-01, the definition changes to excess reserves minus discount window borrowings plus secondary borrowings."

This would appear to mean that the proceeds of loans from the Fed's Term Auction Facility (TAF) are being accounted for as income to the banking system.  Before this change, the reserves graph had gone negative to the tune of over $10G.

Tick.  Tick.  Tick.

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