07/30/10 Paris, France – What does an economist think…when he adjourns to the local bar…or is hauled away to the asylum? In the dead of night or the quiet of a confessional, does he laugh sourly at having fooled most of the people most of the time? Or does he curse his trade and feel like hanging himself?
The thing economists said was nearly impossible actually happened last week. Yields on 2-year US debt hit a record low just as the Treasury prepares for another record-setting deficit. The supply of Treasury debt and the demand for it hit new highs – together. Stranger things have happened. But the strangeness of this event has caused a furor loquendi amongst economists. Usually, there are only two major ways of misunderstanding current events. Now there are at least four of them.
Party economists take the party line; whenever the party flags, get out more gin. Now, they say the recovery is proceeding, thanks to adroit demand management. Unsurprisingly, since they are the authorities, they claim that record low Treasury yields mean investors have confidence in the authorities. Deficits don’t matter, they add.
Another group – the Paul Krugman, Martin Wolf, Joseph Stiglitz wing of the neo-Keynesian faction – fear the recovery may stall, as it did in America in the ’30s and Japan in the ’90s. They say deficits do matter; they wish there were more of them. Low bond yields are cheap gin to them.
In opposition is a large group of “inflationistas.” (Marc Faber, Jim Rogers…). They believe the authorities have already added too much monetary juice. And now they’re afraid the feds will run bigger deficits and add even more monetary inflation. Along with tightened supplies and demand pressure from the emerging markets, this will cause consumer prices to rise more than expected. The dollar and bonds will be crushed.
A small group of ‘hardcore deflationists,’ meanwhile, believes falling yields prove the economy is sinking into a deep hole of debt destruction and depression. (Robert Prechter, Gary Shilling) These Jeremiahs expect the main US stock index – the Dow – to lose 95% of its value and the bond market to continue to rise.
Yet another school of thought confines itself to this Daily Reckoning. It acknowledges that nobody knows anything, but it doesn’t mind taking a guess. Herewith is its view, beginning with a critique of its opponents. Fair-minded reader, you be the judge.
Mainstream opinion is contradicted by the facts. Fewer people are employed today in the US than when the stimulus program began. Sales are down. Growth is falling. Credit is contracting. Even hairstylists and cab drivers know something is wrong.
As for the ‘inflationistas’ view, it makes sense. The feds add money. Prices should rise. But in Europe and America, the rate of consumer price inflation is generally ebbing. That’s what low bond yields are really telling us; they signal deflation, not inflation. Maybe the inflationistas will be proven right, eventually. But for the moment, prices in the developed world are going down; they should remain weak until this phase of debt reduction is largely complete.
Meanwhile, ‘hard-core’ deflationists could be right too. A big credit expansion typically gives way to a big credit contraction. The past is not prologue, it is an account payable. Now it’s due. But there’s room for negotiation. If the ‘hard-core deflationists’ are right, credit will contract back to ’70s levels and asset prices will correct as much. But a lot has happened since the Carter era. There’s much more demand, for example, coming from all over the world. China is now a bigger energy consumer than the US, and a bigger auto buyer too. Demand for just about everything is growing. This new demand is bound to boost prices.
The supply side, too, puts a brake on deflation. The easy, cheap oil has already been pumped. Other resources – including food and water – require huge new capital investments before supplies will increase. Domestic inflation rates in China and India are already increasing. It’s just a matter of time before the exporters put inflation in a shipping container and send it west.
But we don’t need to rely purely on guesswork. We have an example right in front of us – Japan. The island has been de-leveraging its private sector since 1990 – complete with ultra-low bond yields. Consumer prices fell. Between real estate and stocks, investors lost an amount equal to three years’ total output.
Economists misunderstood it completely and gave consistently bad advice. And the authorities took the advice and squandered a whole generation’s savings. But the world did not come to an end. Japan de-leveraged while the rest of the world went on a buying spree. Now, the entire developed world de-leverages, while the emerging world continues to shop.
Nobody knows anything. But readers should expect a long, soft correction just the same.
Regards,
Bill Bonner
for The Daily Reckoning
Bill Bonner
Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning. Dice Have No Memory: Big Bets & Bad Economics from Paris to the Pampas, the newest book from Bill Bonner, is the definitive compendium of Bill’s daily reckonings from more than a decade: 1999-2010.
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Maybe all the indications mean simply that large-scale malinvestment continues … and our financial system is afloat with counterfeit savings. The four groups that Bill describes all are futilely attempting to predict the future when all anyone really can do is make a reasonably educated guess about the present. And a pretty good guess is that at present, less is saved in the bank than appears.
The solution is to find a store of wealth that has not been adulterated by excess liquidity. This is not easy, because if it was a recognized store it would have been bid up by hot money. The target store of wealth would be efficient, durable, and have intrinsic value, yet it would yield nothing and would be difficult to leverage. The menu is not large although it may simply be a case of being more difficult to leverage than a house.
Right on Bill!
Shall we then propose to eliminate post-graduate economics degrees from universities?
Ask the Nobel Committee to no longer grant economics prize?
And force all current holders of PhD in economics to rename themselves: PhD in Voodoo Money?
The world will definitely be a much better place.
“Three Out of Four Economists are Wrong.” 100 percent of people think they are right all the time. 100 percent of people think they could be wrong some of the time. 100 percent of the people are wrong all of the time. So three out of four ain’t bad. Just do not under any circumstances listen to anyone, ever. They will be wrong at least three out of four times. Why spend your precious time because life is short and trying to figure out who is right one out of four times or at all is not important. Go for a walk instead. In a very short time it will not matter anyway.
The subtitle of a book of you from 2003 reads SURVIVING THE SOFT
DEPRESSION OF THE 21ST CENTURY.
Well, obviously there is one field where we can already find inflation… However, maybe the story which is being played out before our eyes is too big to bear a little name tag.
How come no mention of Modern Money Theory? MMT’s sectoral balancing consistently produces better results on macro forecasts than all of the others.
Economics is a dismal science. The bottom line is this, the American consumer drove the global economy with borrowed money. Now its over. Where were these expert economist when the great bubble was expanding?
Bill, (Re:-Three out of Four Econbomists are Wrong (30/07/2010)
The theory holding that ‘expanding demand in the developing world will replace or offset falling demand in the developed-world’ seems pretty feeble in my view. The big ‘developing-economy economies (the so-called ‘BRIC’ group) seem to me all more likely to crash sometime in the coming few years that to maintain high and growing rates of economic growth. They are all (more or less) instable, autocratic, and currently overheated. When the music stops — the party is over.
“The bottom line is this, the American consumer drove the global economy with borrowed money.”
Yes, but where did they get the borrowed money? We are not talking mere billions. We are talking trillions.
Did they get it from their savings, which they control? No. From selling their assets, which they control? No. They got it from the banks, and the banks got it from two sources: huge corporate profits stashed away, and huge amount of credit from that infinite creator of credit – the Fed. Both of these sources are not controlled by the borrowers. They are controlled by the banks. Who wants to loan out the debt because it is so very profitable.
So the whole thing is not economics. It’s about the wealthy class feeding the working class maximum debt. And it’s about the working class playing the fool and becoming the slave. In the end, both blew themselves up. Good show!