“Wall Street, central bankers, economists, politicians – and most investors too – are betting on a soft landing,” said a friend from New York. “A slowdown in world growth has taken the pressure off commodity prices. Slower growth will help keep inflation down, generally. And as long as inflation is no problem, the Fed doesn’t have to raise rates – which will keep the slowdown from hitting too hard.”
Monday’s International Herald Tribune echoed the good news:
“World economies catch US malaise…pain of slowdown spreads far and wide, threatening businesses and growth.”
The world was growing at about a 5% rate in 2007. It’s expected to slip below 4% next year, with the U.S. economy at less than 1% growth. Since the U.S. population grows by more than 1% per year, this means a lower standard of living for the average person – at least in theory.
Of course, Americans need to accept a lower standard of living anyway. They’ve been living beyond their means for a long time; now they need to live beneath their means to correct the situation. In an economy dominated by consumer spending, this practically guarantees a long period of sluggish growth or recession – no matter what.
But it would be a lot easier to correct the mistakes of the past in a growing economy. Rising incomes would give consumers more room to cut back without too much suffering. Cutting back on falling incomes, on the other hand, is doubly painful.
A correction is unavoidable. The question for us, here at Markets and Money, is: what kind of correction it will be? Will higher prices reduce the value of the dollar – reducing Americans’ incomes, savings and their burden of debt? Or will recession reduce their incomes and the value of their assets?
Whenever we have posed those questions in the past, the answer we have always given was: yes – Americans will get hit both by the jabs of inflation and the haymaker of deflation. So far, that is exactly what has happened. Prices are rising while asset values and incomes are falling. The average consumer is staggered by the blows.
The latest inflation figures show consumer prices rising at 5.6%. And the latest figures for producer prices show them going up at nearly 10%.
What is remarkable is that even with these numbers staring them in the face, investors still buy 10-year Treasury notes yielding less than 4%. Typically, bond investors are the most sophisticated investors. They’re looking at the global growth figures and believe that inflation rates will go down too. Average Americans may expect rising prices for food and fuel. But investors seem to have no worries on that score. You’d think they’d want at least enough yield to protect their capital. But at present rates, an investor in a 10-year Treasury will lose about 1.6% per year. Apparently, he regards that as a small price to pay for protection from falling asset prices.
Oil has already fallen from $147 down to $112. Gold dropped below $800. And with a sluggish world economy, there will be little push from labor rates, he reasons. Bond investors are betting that inflation rates will go back to where they were a couple of years ago – around 2%.
They may be right. But to us, it looks like a bad wager. Where is the margin of safety? What if inflation moderates to an annual rate of 2%? The long bond investor – were he to hold to maturity – would still make only 2.4% on his money. On the other hand, if he is wrong and inflation stays above 4.4%, he earns nothing. If it goes higher, he could be wiped out in a matter of weeks. We’re just guessing here…but the odds that sometime in the next 30 years inflation will rush up above 6%..or 7%…or 10%…are probably greater than the odds that you’ll be able to collect 4.4% for 3 decades and come out a winner.
We’re looking at the big picture…trying to see the large trends before they’re history. We’ve never quite mastered the art of seeing things before they happen, but we’re still squinting, trying to do it…
What we see coming, one way or another, is a fall in living standards. It can happen in one of two ways: either people lose their jobs and their incomes in a deflationary slump, or inflation makes their incomes and savings worth less.
So far, “both” has been the right answer. Our guess is that it will continue to be the right answer.
Monday, we saw a big drop in the Dow, more than 200 points. Worldwide, equities have lost about 17%.
More evidence of the slowdown appeared in Atlanta – where unemployment has hit a 16-year high – and in Southern California, where luxury houses in San Diego and Los Angeles haven’t fallen so much in 10 years.
Even more telling, bank lending has jelled to the point that the money supply is no longer increasing at the pace it had been. Until April, it was running at about 20% per year. Then, suddenly, the river dried up. Currently, the money MZM (a measure of the money supply) is only increasing at a 5% rate.
These circumstances have changed the headlines. Inflation is no longer making the news; now deflation is the story every paper tells. Inflation is yesterday’s news. Deflation is today’s.
For tomorrow’s headlines…we’ll have to wait a day…
*** Joe Biden. We don’t follow politics. Money is our beat. But even through our green eyeshades…and across the broad Atlantic…it looks to us as though Obama has made a mistake.
The problem for Obama is that he has gotten his frauds mixed up. His message to the American public was that he was a breath of fresh air…a new man…for a new day…with a new program – “change,” he promises. Of course, it was all humbug; but after so many years of Bushes, Cheneys, Rumsfelds, change seems like a good idea to many voters.
But now that Obama has practically got the keys to the White House in his hands, he thinks he needs to reassure voters that he won’t change things too much. So he’s turned to the old hack, Biden, to signal to the nation that in an Obama administration things will go on as they did before.
The trouble for Obama is that voters are likely to get the message. And they’re likely to think that if it’s change they want they’ll be better off with McCain. The Republican candidate is a hack too, but he has the reputation for being unreliable. We know he’s capable of change. He’s already changed many of his positions in order to pander to the right wing of the Republican party. Once he no longer needs them, he’s likely to change back.
*** Central bankers got together in Jackson Hole, Wyoming over the weekend. As we reported yesterday, the confab was disturbed when an uppity Brit dared to say the obvious – that the Greenspan Fed had erred.
But the champagne flowed and soon salved over the abrasions. When it was over, the bankers were of one mind again. All we know is that the financial world is one “enormous uncertainty,” said one them.
It has been a year since the credit crisis began. By the look of things, it is far from over. JP Morgan, for example, said it was going to take an $800 million loss from its preferred shares in Fannie Mae and Freddie Mac.
More bad news is coming…
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