Friday, August 7, 2009

The Deflationary Case

Hello All!

Since we discussed inflation yesterday, I thought today was a good time to lay out the deflationary case of how this crisis could possibly play out.

We got some data today that supported further deflation in the economy. The debt vs. GDP chart below(from 2006) was just updated data on Bloomberg today:

My Take:

As you can see above back in 2006, our debt as a % of GDP soared to 330% which dwarfed any other credit bubble including The Great Depression. Today, through masssive government spending, we have somehow found a way to outdue ourselves and blow this bubble even larger!

Bloomberg reported that Comstock has an update explaining that the credit bubble has now blown to a staggering 372% of debt vs. GDP:

"Aug. 7 (Bloomberg) -- The U.S. economy may be just as sluggish during the next 20 years as Japan’s economy was in the last 20, according to Comstock Partners, a money manager founded and run by Charles Minter.

Stimulus programs and a surging money supply aren’t likely to “solve a problem of excess debt generation that resulted from greed and living way beyond our means,” the firm wrote yesterday in an unsigned report on its Web site. “We could wind up with a lost couple of decades.”

The CHART OF THE DAY shows U.S. total debt and gross domestic product since 1952, along with the ratio between them, based on data compiled by Bloomberg. The ratio rose in the first quarter to 372 percent even as household borrowing dropped for a second straight quarter, an unprecedented streak.

Assuming that private borrowers pay down debt at the same pace as they did in Japan after its 1980s economic bubble burst, the savings rate will climb to about 10 percent in 2018, the report said. The estimate was made in a study by the Federal Reserve Bank of San Francisco that Comstock cited. It’s more than double the 4.6 percent rate for June."

Take Continued:

You can click on the link at the bottom of the chart for the updated version. Folks, you need to ask yourself this question:

How on earth is this sustainable? The only way we have been able to stave off the popping of this credit bubble is through massive government spending.

There is only one way that we can stave off a collapse at this point(for awhile at least): Printing aka: Monetization of the debt! The government is broke, and the world doesn't have the desire or money to continue and buy trillions of $$$ of treasuries year after year.

The feds are down to two choices the way I see it: 1) Monetize or 2)slash spending, raise taxes, and let this credit bubble burst.

The case for a deflationary collapse was supported by some new consumer spending data in June that was released today:

"WASHINGTON (MarketWatch) -U.S. consumers reduced their debt in June for the fifth consecutive month, the Federal Reserve reported Friday. Total seasonally adjusted consumer debt fell $10.29 billion, or at a 4.9% annual rate, in June to $2.502 trillion. Consumer credit fell in eight of the past nine months. Economists surveyed by MarketWatch expected consumer credit to decline by $4.5 billion. This is the longest string of declines in credit since 1991. In the subcategories, credit-card debt fell $5.04 billion, or 3.8%, to $1.59 trillion. This is the record 10th straight monthly drop in credit card debt. Non-revolving credit, such as auto loans, personal loans and student loans fell $5.04 billion or 3.8% to $1.59 trillion."

The Bottom Line:

As you can see, the consumer is collapsing as a result of being suffocated in debt. The savings rate has soared in the past year as consumers pay off their various debts. Bubblevision will tell you that this savings is actually bullish.

They explain this by saying its just a matter of time before this "cash on the sidelines" is thrown back into the market as the "new bull market" roars on. This is a crock of you know what.


Because the savings rate doesn't differentiate between what is being used to pay off debt and how much of it is actually being saved.

The bulltards also love to use the savings rate as proof that the consumer is now once again ready to spend. Good luck with that!

If this is the case then why is consumer spending collapsing? We have seen a record 10 straight months of dropping credit card debt. If the consumer feels so healthy after saving so much cash then why is their credit spending contracting month after month?

Lets face it folks:


If we do see a deflationary credit collapse then we will have a lost generation just like Japan did.

Housing in Japan costs the same or less in most areas today then it was back at the peak of their credit bubble.

The only way it doesn't end this way for us is if the government throws the dollar under the bus and tries to inflate out of this mess via a collapsing currency.

So how does this all end folks? Too soon to tell. I think we will likely see a combination of both at the same time. Most likely in the shorter term we will see price inflation in necessities along with asset deflation in housing.

One thing seems pretty clear to me: The government appears fully prepared to blow its head off trying to bailout their pigmen buddies and the rest of the economy. Bernanke seems obsessed with trying to prevent a deflationary depression that we saw in the 30's.

I can't help but think US default because we appear to have lack of ability to allow anything to fail. How can you come to any other conclusion when you watch the continuing onslaught of massive debt issuances via treasuries and a weakening dollar(minus today)?

I still plan on holding onto plenty of dollars as a hedge in case the Fed wakes up and realizes they need to let this credit bubble collapse via deflation.

This is a very dangerous market and the speculation I am seeing in the markets makes me think BUBBMANIA is back.

We all know how this ends.


getyourselfconnected said...

just a quick note:
I sent you mail about a wild day I had, you may find it interesting. I am working on a post right now and will check back later for discussion. Any music requests?

Anonymous said...

It is getting much harder to hang on to the bear sentiment. The market has rebounded strongly after the March low. Even Freddie reported a quarterly profit in the AH.

The unemployment rate dropped amazingly today. Thus it is getting much harder to stay away from the market. The feeling of missing out on a big run is killing me inside.

Could we the minority just be very wrong with our bear sentiment?

Jeff said...


Freddie's earnings were boosted by a $4 billion write up on assets. The credit markets have loosened up and its effecting the marks on the banks and Fannie/Freddie's balance sheets.

Be careful reading too much into that earnings report. It is bullish short term but its based on fantasy values.

It is frustrating after the move has already been made.

You don't need to be short here. You can be bearish and avoid the markets if you don't believe the fundementals are there.

I continue to build up cash and bond positions. I refuse to buy without one solid fundemental reason other then pure gambling/specualtion.

Jeff said...


You got any Beetles? "Yesterday"

How about some old Springsteen! Born to Run?

getyourselfconnected said...

don't get me started! Do not listen to Watchtower, he is a trouble maker!

Anonymous said...

If you still strongly believe that the economic fundamentals are busted, then do you strongly believe that our US government from top to bottom is morally corrupted right?

Otherwise, why isn't anyone speaking out about the recent Fed purchase on the 7-yrs Treasury notes last week? Not even the media mentions about that except for the bloggers.

If such activity is wrong and goes against what the Fed stated to the public, why isn't anyone challenge it? Congress is too blind to know or too corrupted?

Jeff said...


Great questions.

IMO its because they are all in on it together. The political and financial elite are all one family.

Wall St sends billions to DC for lobbying and to support political campaigns.

Regarding the 7 year, there is some controversy around that small print.

Many are arguing that it wasn't a big deal because the amount of money involved was small and it was the easiest way for the Fed to clean up the auction.

Naked capitalism and Adler were all over the bloggers for this.

I have a problem with the fact that its illegal regardless of the amount involved.

getyourselfconnected said...

Anon asks:
"then do you strongly believe that our US government from top to bottom is morally corrupted right?"

I missed the question!?

Anonymous said...


I was asking Jeff why no one has challenged the recent Fed action in purchasing the 7-yrs Treasury notes. They said they would never do such thing. And then they did it.

Anonymous said...

Anon- I feel your sentiment but you can be right and it may take years to be proven so when it comes to the market, this is where market timing comes into play, being a trader. I agree with a lot of Jeff's points, in the grand scheme of things does it make sense to keep printing money, then selling the debt to foriegners, which are starting to question our ability to pay this in the future as now our country's leverage ratio's are beyond reasonable. Seriously, what is our long term strategy for keeping this country great? The only way I see out of this is a big increase in tax's & a war. I definately missed an opportunity to make some serious $$ but everyday the market goes higher it really does not make sense, are earnings really expanding and from what point now that expectations have been lowered to the floor. The only thing I will say that keeping a diversified portfolio (cash, stocks, bonds, real estate & commodities) and dollar cost averaging do work over the long term. I just don't always follow my own advice as like Jeff, I have been building up cash as I feel this runnup is built on paper legs.

Jeff said...


Couldn't have said it better myself.