5/29/2013 5:30 PM ET|
Deflation, recession are in the cards
While the market moves ever higher, commodities and other signals suggest a washout is coming. Of course, that won’t matter in the near term if the market kicks into bubble mode this summer.
Never before in recorded human history has money been as cheap as it is now. And it keeps getting cheaper. Hungary cut interest rates by 0.25% to 4.5% Tuesday morning, becoming the 15th central bank to cut rates in May.
Those central banks are responding to weakening global growth and falling prices, a combination at odds with the U.S. stock market's string of new highs. Those new highs have investors in a frenzy -- and have made them willing to ignore the very real signs worrying the central bankers.
Why? Because investors believe the cheap money will keep forcing stock prices higher.
But away from the market, new developments challenge that view. The evidence is growing we could face a dangerous bout of deflation -- falling prices, including falling stock prices, in the context of an economic slowdown -- that could rattle investors' faith in the central banks.
When that happens, watch out. Here's why.
The commodity market, to list one example, is warning of trouble.
It's not just gold that's down. While the price of gold can fall simply because people feel better about the economy, there has been a wipeout in both industrial commodities, such as copper and aluminum, and precious metals. Agricultural commodity prices are down, too, and lumber prices are collapsing, down 28% since March.
With everyone mesmerized by the stock market's new highs, the bulls write all this off as a consequence of a U.S. dollar rising against the euro and yen. And they assume that lower commodity prices will be a net positive to the economy because they boost the purchasing power of consumers.
But it's also a sign that something's not right deep inside the economy. If growth is truly about to rev up again, as stratospheric consumer confidence measures reported over the past week would seem to suggest, commodities and inflation should be stronger. In fact, nominal gross domestic product -- real GDP growth plus inflation, and shown in the chart below -- is ticking down again.
Both inflation and real economic growth are so weak -- with real annualized GDP growth averaging just 1.5% over the last two quarters, while consumer price inflation is running at a 1.1% annual rate -- that this measure has fallen to levels that have been associated with outright recessions in the post-World War II era.
Inflation and growth are tightly linked. Without one, you tend to not get the other.
It's not just the commodity market sending a deflationary message; recent economic data has also been pointing toward lower prices and weaker growth. The Richmond Fed manufacturing index this week featured a deepening slide in new orders, the number of employees and wages. The price measures in the Kansas City Fed manufacturing survey reported last week have returned to recessionary territory, as shown below.
And deflationary pressures are coming from overseas as well, as global trade suffers from Europe's deepening recession, China's emerging slowdown and Japan's malaise. Import prices are falling at a2.6% annual rate and have been stagnant for more than a year, as shown below. Excluding energy, prices are down 0.3%. And as a reminder that the overall downturn is being driven by a pullback in business investment, prices of imported capital goods are down for three months in a row, for a year-over-year rate of -0.6%.
Again, this is all recessionary behavior.
Now you might be wondering, why would a drop in prices be a bad thing? In the context of productivity gains and technological change, it would not be. But in the context of a weakening economy and slumping demand, it is. And it's spiked by our deep indebtedness, since a period of deflation would increase the inflation-adjusted burden of household and government debts. You repay debts with money that's worth more, due to higher buying power.
In other words, deflation in a high-debt situation means you have to work harder, for longer, to pay down your debt.
What about the Fed?
All this seems at odds with the recent talk from Fed officials of slowing down its $85 billion-a-month bond purchase program, designed to push money into the economy.
The market is focusing on the sentiments of more "hawkish" Fed officials who are rightly starting to worry that a prolonged period of 0% interest rates and long-term bond purchases is encouraging investors and institutions to take too much risk. A few policymakers also worry that financial markets are becoming too buoyant, with a surge in the issuance of junk-rated bonds and bonds with fewer restrictions on collateral and payment terms (so-called "cov-lite" bonds), according to the meeting minutes.
Overall, Fed policymakers also seem to be much more optimistic about the state of the economy -- an optimism shared by consumers, but not by CEOs, who are lowering their predictions for second-quarter earnings at a pace not seen since 2001.
The optimism is misplaced, but the hawkishness is right on. It's time for the Fed to admit it's done all it can, withdraw stimulus and force Washington to fix the structural impediments to growth via infrastructure investment, tax reform and health-care cost control.
But it's unlikely to work out that way. In a few months, Washington will be embroiled in another blood feud over the debt ceiling and the budget. And, as it has done over the past few years, the Fed will respond aggressively to any sign of deepening deflation and a stock market correction.
It just can't admit this emerging truth: Central banks -- not just the Fed, but those around the world -- still have the ability to juice financial markets, but they are losing their ability to create sustainable economic growth and fight deflation.
If we do fall into a new deflationary recession and bear market, this idea will be the driver of the fear needed to incite panic selling in the stock market. Faith in central banks is the one and only reason stocks have been ripping higher.
Central bankers won't easily admit they're losing control. Thus, they are getting more desperate and more aggressive.
Look at the European Central Bank's current discussion on the possibility of driving nominal interest rates into negative territory. Or the Bank of Japan's push to double its money supply over the next two years to create a 2% annual inflation rate -- at the risk of blowing up the market for its government bonds.
That's because the structural problem isn't that money is too expensive; it's that there is too much debt.
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Corporations are fudging their Earnings numbers via Massive Stock buybacks. They are still paying the CEO types bigger salaries and a fatter bonus while we chase after the crumbs left behind. The Main Reason none of this has worked concerning jobs, simply put, the majority of working folks are being ignored. Corporate America doesn't care about paying better wages, nor better benefits. When the Average Joe/Sue has more to spend, the economy grows and creates jobs. When only the top 10% benefit, the economy shrinks and the Global Feds have to keep printing endless amount of money, keeping the illusion of a Real Economy, alive.
You get darker and darker. I think we will know when it all hits the fan when it is dangerous to wall thru any financial center because of all the bankers and brokers jumping out the window.
The cheap money isn't going to main street as hopefully main street is paying off debt waiting for the crunch. I think businesses are doing the same, so I wouldn't criticize them for doing so.
Even at the low rates, if the crunch hits again, why would anyone want to pay the bank even 3% for something they could have saved for and paid in cash? Take some of the profits now from your stocks to purchase what you need and leave the bank paperwork at the bank unsigned. You will be better off in the long run operating debt free both as a business and as an individual family.
It's more likely that we're headed towards stagflation where unemployment remains high but prices on consumer products and precious commodities start to rise. The FED's done more than enough to get a normal economy going but it's having trouble making ends meet. If people start to realize that prices are starting to edge up on more expensive items while unemployment stays high then the Fed will have to moderate rates and the markets will respond very negatively. Gold could be a harbinger of things to come. We is all that cheap money going to go if equities start to go down?
Two types of people seem to follow these articles. Those who love to whine and complain, lovers of doom and gloom, and those with the poor me syndrome… as like attracts like. And then there are those of us who see these articles as a bunch of exaggerated nonsense, a writer who incorrectly predicts the market over and over again… the Chicken Little story sums it up nicely.
Therefore, the government will prod the Federal Reserve to print money and inflate. Deflation, if it occurs at all, will be short-lived and the impetus for more Quantitative Easing and inflation.
Roadhouse Blues, good point. Also, Corporations make up about 8% of our workforce.
All the state, federal, and other gov. jobs must account for more than 8%.
I think 65% of our workforce are small business, less than 50 employee's. So, why aren't we focused in Washington on small business breaks. Oh, ya, no big bucks for Washington there.- Did you all know that the Department of Defense gives childcare subsidies to gov. workers? This is all messed up...
Anthony is beginning to make sense it seems...The ability of QE money is not going to chance the picture at the main street level... that pic. shows the consumer still strapped with too much debt and not enough earning potential (via better jobs) to soon offset that debt load. The result for the near and long term I'm afraid will continue to be the same as now, add to it a case of too much "capacity" in the "global mfg. site" called China and things will remain as they are and tend to get worse
This "China Syndrome" of sorts will affect us and the Europeans and all others that bought the siren's song of "letts make stuff where it's cheap" and nevermind the impact on the consumers/workers at home...
The "chickens" of these decisions at home and abroad are beginning to come home to roost...
Deflation/stagnation will be here for a while and no amount of QE $ will lift the "consumer boat" into thinking that it is OK to begin to spend enough to make a difference in the economic growth "Gage".
Remember people that this US economy is based on consumer spending...at approximately the tune of 70%
Bust the consumer (spending) by sending his work offshore and you will bust the economy...
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