Japan-Style Deflation & The PP

[barrett]

Anyone here feel that a Japan-style deflation is becoming more likely here in the US and/or worldwide? Having been born in 1958, I grew up learning to always fear inflation with the mantra being that cash on the sidelines is a terrible idea because it is always losing value. It seems that Europe has pretty strong deflationary fears at the moment. Growth is slowing in China. A strong downward move in the US stock market (let's just say that it's a random event for the sake of starting this discussion) would definitely put a chill on the US consumer engine. With stocks down we would have the opposite of Alan Greenspan's "Wealth Effect."

Any input on how we here in the US are similar to or different from the Japan of 25 years ago? Obviously input from the Canadians, Europeans & Indians (Hey krod16) on here is welcome as well.

[MachineGhost]

Any input on how we here in the US are similar to or different from the Japan of 25 years ago? Obviously input from the Canadians, Europeans & Indians (Hey krod16) on here is welcome as well.

It gets tougher to put on a brave smile, but I still think the USA doesn't have the kind of persistent structural imbalances that Japan, Europe and China do.  And the rest of the world knows it, which is why they're going to flee into US cash, stock and bonds.

It's not for lack of trying...  Obama seems hell bent on Eurozing us.  The guy is either an outright knave or he is part of a conspiracy to destroy the middle class.  Don't ask me to pick a side.

[Lowe]

I think there will be deflation or at least low inflation through the developed world because, to grow at a good pace, the credit markets need the number of productive people in developed countries to increase.  That number is not increasing now, but moving sideways or down slightly.

Without credit expanding as fast as the population total does (not just productive people, but everybody) how can the money supply keep up with the population?  Don't think it can.  Consumer loans don't create money the way commercial loans do.  Consumer loans are once and done.  Commercial loans create the need for more commercial loans, by building more capital.

One good thing about the PP is its holdings in cash and credit-risk-free bonds.  Those will perform well in a period of sustained low deflation, so no worries.  Of course it helps that foreigners will probably pour into those assets, since the US looks so stable when compared to Europe.

[Libertarian666]

I see no risk of deflation in the US, as the Federal Reserve will print unlimited amounts of "money" to prevent it. The fact that they will destroy the "dollar" in the process is not something they care about, assuming that they understand it.

[MachineGhost]

I see no risk of deflation in the US, as the Federal Reserve will print unlimited amounts of "money" to prevent it. The fact that they will destroy the "dollar" in the process is not something they care about, assuming that they understand it.

This relies on perception though, not reality, since there's no transmission mechanism from the Fed to the real economy.  So if QEternity since 2011 hasn't been enough to increase inflation perceptions, what will?  Literal helicopter drops of currency?

[barrett]

I see no risk of deflation in the US, as the Federal Reserve will print unlimited amounts of "money" to prevent it. The fact that they will destroy the "dollar" in the process is not something they care about, assuming that they understand it.

This relies on perception though, not reality, since there's no transmission mechanism from the Fed to the real economy.  So if QEternity since 2011 hasn't been enough to increase inflation perceptions, what will?  Literal helicopter drops of currency?

Not to mention that pumping Yen into the economy hasn't worked for the Japanese either.

[barrett]

Obama seems hell bent on Eurozing us.

MG,

I think the correct term is "Euro-Hosing."

[Lowe]

@ tech

Other posters have already addressed this, but there's no indication the Fed has that power, or would take it.  They don't literally print money.  They replace treasurys with dollars.  I guess that's meant to encourage people to start small businesses, and banks to finance them, but does it work?  Has it worked?  It seems like it just encouraged savers and banks to buy equities.

Japan did the same thing, right?  How has that worked?  Apparently it couldn't even prop up their stock market.  Sooner or later demographics wins, is the lesson I get from this.  Fewer people who can make things is a recipe for the doldrums.

If the central banks or the treasury ever did start printing money, literally, that would create a loss of confidence in those institutions, which be bad for everything but gold.  Why would the Fed or the treasury do that, though?  They're smart people; they don't want to dissolve their credibility, and that of their successors.  I can only see something like that coming from congress, or an overreaching president.

[MachineGhost]

Other posters have already addressed this, but there's no indication the Fed has that power, or would take it.  They don't literally print money.  They replace treasurys with dollars.  I guess that's meant to encourage people to start small businesses, and banks to finance them, but does it work?  Has it worked?  It seems like it just encouraged savers and banks to buy equities.

Fed exchanges it with bank reserves which is internal accounting fiction money.  It doesn't really do anything other than improve the bank's balance sheet.  This is how the Fed repaired the banks back during the S&L crisis fallout during the recession of the early 1990s.

Japan did the same thing, right?  How has that worked?  Apparently it couldn't even prop up their stock market.  Sooner or later demographics wins, is the lesson I get from this.  Fewer people who can make things is a recipe for the doldrums.

Japan has also been directly buying billions worth of stocks and REIT's each month.  I guess they're trying for the minuscle wealth effect.

[Libertarian666]

I see no risk of deflation in the US, as the Federal Reserve will print unlimited amounts of "money" to prevent it. The fact that they will destroy the "dollar" in the process is not something they care about, assuming that they understand it.

This relies on perception though, not reality, since there's no transmission mechanism from the Fed to the real economy.  So if QEternity since 2011 hasn't been enough to increase inflation perceptions, what will?  Literal helicopter drops of currency?

Sure, why not? Or for a more ecological alternative, how about depositing $1 million into every checking or savings account?

[Lowe]

Other posters have already addressed this, but there's no indication the Fed has that power, or would take it.  They don't literally print money.  They replace treasurys with dollars.  I guess that's meant to encourage people to start small businesses, and banks to finance them, but does it work?  Has it worked?  It seems like it just encouraged savers and banks to buy equities.

Fed exchanges it with bank reserves which is internal accounting fiction money.  It doesn't really do anything other than improve the bank's balance sheet.  This is how the Fed repaired the banks back during the S&L crisis fallout during the recession of the early 1990s.

Japan did the same thing, right?  How has that worked?  Apparently it couldn't even prop up their stock market.  Sooner or later demographics wins, is the lesson I get from this.  Fewer people who can make things is a recipe for the doldrums.

Japan has also been directly buying billions worth of stocks and REIT's each month.  I guess they're trying for the minuscle wealth effect.

The Fed open market operations don't exclusively trade with banks, right?  That is mostly who they are trading with, but not exclusively.  The objective is to encourage lending, right?  Are you saying its only purpose is to make banks seem solvent?  I'm not sure about that.

[bedraggled]

Greetings, All, 

An exercise in deflation (futility, if you wish).

I recently calculated a deflation scenario where VTI and SGOL fall over 3 years, TLT rises, and SHY increases incrementally, all based on late day 1/20/15 prices.

The following is conjecture.  Whereas the DOW fell 90% by 1932, I think this example has VTI descending 70%.  (The first year, I had VTI drop a bit extra).  Also, I assume SGOL would not do well in deflation.  The good news is this rendition of the 4x25 PP ended down only 16% after 3 years:  $83,949, after starting from $100,000.  I think HBPP is a big winner, relatively.

This was  all quickly done but I think the arithmetic is OK.  Rebalancing occurred after years ! and 3, implemented on that particular January 20.  Let me know….

To Begin:
              1-20-15                            $
SGOL      126.65                      $25,000
TLT          134.96                        25,000
SHY          84.84                        25,000
VTI          104.17                        25,000
                                              --------------
                                              $100,000        (1-20-15)

Year 1
            1-20-16                          $                                                                                                $
SGOL        88.66  (-30%)        $17,500                                                                        SGOL    $22,625
TLT        175.45  (+30%)          32,500                    REBALANCE:                                TLT        22,625
SHY          86.54  (+2%)            25,500                                                                        SHY      22,625
VTI          62.50  (-40%)          15,000                                                                        VTI        22,625
                                              -------------                                                                              --------------
                                                $90,500                                                                                  $90,500                      (1-20-16)


Year 2
            1-20-17                            $                                                                                                $
SGOL        62.06  (-30%)        $15,838                                                                      SGOL      $15,838 
TLT        228.08  (+30%)        29,412            NO REBALANCING                              TLT          29,412
SHY          88.27    (+2%)          23,078                                                                        SHY        23,078
VTI          43.75    (-30%)        15,838                                                                        VTI          15,838
                                            --------------                                                                                ---------------
                                              $84,166                                                                                    $84,166                      (1-20-17)


Year 3
            1-20-18                            $                                                                                              $
SGOL        43.44  (-30%)        $11,087                                                                      SGOL      $20,987     
TLT          296.50  (+30%)        38,235                REBALANCE:                                  TLT          20,987
SHY          90.04  (+2%)        23,540                                                                      SHY          20,987
VTI            30.63  (-30%)        11,087                                                                        VTI          20,987
                                              ------------                                                                                  -------------
                                              $83,949                                                                                    $83,949                        (1-20-18)

Subsequently, I did a portfolio of TLT 40%, SHY 30%, SGO 10% and VTI 20% and I believe the result on 1-20-18 equaled roughly $1,080,000.

Check my work.  I thought this effort might be of some use.  Let me know, please.  Twenty-five years of this?  Gee whiz!

Thanks, Bedraggled

[barrett]

bedraggled, How low would bonds yields have to drop to return 30% for the next three years? I know they start to get turbo charged when rates are really low but I am wondering if you have those numbers. Thanks.

[bedraggled]

I do not have the numbers on the bonds or their rates.  Rates might go negative!?!?  Who would have imagined rates this low on LTTs.

If I can can answer any further questions, please ask.

[I Shrugged]

In the 1970s, my father subscribed to Harry's newsletter, and attended one or more conferences at which Harry spoke.  One of the key points Harry used to make was always bet against the government.  Now, is that good advice today?  I don't know.

The governments are all trying to stop or prevent deflation.  I kinda sorta feel that Harry's advice will ring true on this.

[MachineGhost]

The Fed open market operations don't exclusively trade with banks, right?  That is mostly who they are trading with, but not exclusively.  The objective is to encourage lending, right?  Are you saying its only purpose is to make banks seem solvent?  I'm not sure about that.

The Fed system is not open to the public, so they only exchange with its member banks and probably also the Primary Dealers, though that may only be on the Treasury side.  All the Fed essentially does is detemine whether the general public holds more or less currency or Treasuries via a crowding out effect.  If it is monetizing Treasuries via the Primary Dealers who are legally required to buy all Treasuries issued from the Treasury Department, then less is available for the public to save their money in and so the public will be forced to use more currency or private money.  Nothing changes in the aggregate, only the form.

I think you might be conflating the Fed with the private money supply that is created on demand by the member banks when a consumer/business wants a loan; theres no connection between that and the Fed.  The so-called reserve requirement is just marketing fiction leftover from the gold standard which is easily fixed every night by borrowing from the Discount Window (Fed direct) or via the Federal Funds Rate (other member banks).  Since the Fed's proprietary electron bookeeping money is limitless by definition, so are any so-called member's bank reserves.  And the reserve requirement only applies to checking accounts nowdays; it's been eliminated for other account types.

But yes, the core purpose of the Fed is to act as a lender of last resort and to bail out its member banks when they run into trouble from leveraged speculation (as they always do).  In other words, the Fed's mission is to prevent bank runs due to lack of liquidity as well as deflations due to lack of enough money.  Actual bank failures are handled by the FDIC.

Compared to our system, Japan does not have to go through the whole charade.  Their central bank directly monetizes Treasuries from their Treasury department.  What isn't crowded out, their Post Office buys up most of the rest as that is where people have all their savings accounts.

Deflation is a lack of confidence...  lack of confidence = no borrowing.  No borrowing = no lending.  No lending = no growth.

[Lowe]

Thanks for the explanation, MG.  However, I am not confusing this with anything to do with reserve requirements on banks.  I understand that open market operations are mainly transactions with certain big banks.  However this informational entry at the Fed website suggests they can and do trade with other people.  My emphasis is added.

The Federal Reserve Act specifies that the Federal Reserve may buy and sell Treasury securities only in the "open market." The Federal Reserve meets this statutory requirement by conducting its purchases and sales of securities chiefly through transactions with a group of major financial firms--so-called primary dealers--that have an established trading relationship with the Federal Reserve Bank of New York (FRBNY).

It also does not sound like there is a statutory requirement that the Fed stick with the primary dealers.  Is there a public record of all Fed transactions?

What you say about the Fed crowding out the public makes sense to me.  Also they would be crowding out the banks, if they buy up lots of treasurys.  But the end goal of that is to encourage lending of the currency, right?  Whether transacting with primary dealers or some other owner of a treasury (in that case, the person has to have an account with some US bank, which is necessarily connected to a bank that is a primary dealer... meaning the transaction eventually boils down to a transaction between the Fed and a primary dealer).

I have asked about this on this forum before, and never been sure about it.  QE was the ramping up of open market operations, right?  I understand there was concern in 2008-2009 that major banks were going to have bad balance sheets, and be deemed insolvent.  So was the main goal of QE to make the banks seem solvent?  Was encouraging lending a side goal?

...

I don't know much about the Japanese Central Bank.  Only that it is a central bank and functions similarly to the Fed.  Thanks for letting me know more about it.  So they seem to have broken out a more aggressive approach than the Fed, and yet they have seen low inflation and poor stock performance for many years.  I suppose it is possible that the more liberal immigration policy of the US gov't will help the US economy avoid this fate, but I am not convinced the new laborers are productive enough.  Maybe you can tell me what you think of this.

[MachineGhost]

It also does not sound like there is a statutory requirement that the Fed stick with the primary dealers.  Is there a public record of all Fed transactions?

Beats me.  But the way it works I'm thinking "open market operations" to non-primary dealers is primarily for disposing of their Treasuries, not buying since the buying is a well orchestrated charade between the Fed, Treasury and primary dealers.  From what I recall, that rarely occurs so its not a significant factor.  And I don't know why the Fed would ever do that because it would certainly spook the public if no one bought!  The smarter thing to do would be to raise the DR/FFR or interest paid on member's bank reserves (which are held at the Fed) to prevent disposition being needed.  All within a context of inflationary excess lending to consumers/businesses, of course.  Keep in mind the Fed returns 95% of all its profit back to the Treasury so they can afford to wait however long is necessary for their holdings to mature instead of disposing them (to non-primary dealers in this context).

But the end goal of that is to encourage lending of the currency, right?  Whether transacting with primary dealers or some other owner of a treasury (in that case, the person has to have an account with some US bank, which is necessarily connected to a bank that is a primary dealer... meaning the transaction eventually boils down to a transaction between the Fed and a primary dealer).

It still has nothing to do with any lending, whether of private money or demand for currency (currency is a minuscle portion nowadays).  I think you're still conflating this public Fed credits/reserves/whatchamacallit with private money.  Look at it this way.  The Fed operates internally to a member bank and the consumer/business lending operates externally to a member bank.  What drives the lending is the external demand, not internal knob twisting.  The private money is created into existence on the spot when someone wants a loan.

I have asked about this on this forum before, and never been sure about it.  QE was the ramping up of open market operations, right?  I understand there was concern in 2008-2009 that major banks were going to have bad balance sheets, and be deemed insolvent.  So was the main goal of QE to make the banks seem solvent?  Was encouraging lending a side goal?

All QE did was exchange the bad mortgage debt on banks balance sheets with Fed money, or directly monetize Treasuries to drive their yields down to "stimulate" the real estate market (mortgages are linked to those rates).  It's an accounting entry swap because banks cannot legally operate in the insolvent red without declaring bankruptcy as the Fed can.  Even though banks got mark to market rules suspended, its still all marketing fiction B.S..  So, yeah, when you take bad money off your balance sheet and replace it with good money, of course you appear publically solvent especially after the TARP required banks to take the money whether or not they wanted it.  "Encouraging lending" would be a bit of a weasle term because banks can't lend if no one wants to borrow; but certainly clearing the balance sheet of bad debt and improve capital ratios and all that accounting jazz they follow when it is convenient would help them stop being tightwads if there are no other constraints other than lack of demand (such as overly restrictive mortgage lending rules).

I don't know much about the Japanese Central Bank.  Only that it is a central bank and functions similarly to the Fed.  Thanks for letting me know more about it.  So they seem to have broken out a more aggressive approach than the Fed, and yet they have seen low inflation and poor stock performance for many years.  I suppose it is possible that the more liberal immigration policy of the US gov't will help the US economy avoid this fate, but I am not convinced the new laborers are productive enough.  Maybe you can tell me what you think of this.

I dunno.  My gut feel is I see America in the latter days of the glory of Rome, which means a long slow death from a thousand cuts of deflation.  But I'm also an optimist.  So I think a realistic outcome is that of the middle ground, where robots and automation will dramatically decrease demand for labor and immigration will become unnecessary; the gap between the rich and the poor will widen in nominal terms intra-country, but decrease globally; real returns to all productive investment will continue to drop as living standards continue to improve globally due to ever lower manufacturing and production costs.  Profit is only a function of fulfilling a demand by a need of society.  Perhaps we can speculate our way into endless financial bubbles as the real economy ceases to be meaninful?  It's all moving towards a post-capitalist, virtual reality anyway.  Is trading virtual "hard goods" between whoever in a VR world any less significant than what it used to be in the real economy?