Wednesday, August 19, 2009

Stealth Inflation?

Itulip had a very interesting update yesterday. I wanted to start with a few comments on the markets before I get into it:

First of all, I apologize for not discussing the markets too much this week. At this point in time I see no sense in doing so. The recent moves both up and down have been pretty much meaningless because there is no volume behind them. This lack of confirmation means that you must take them with a grain of salt.

The market is basically flat for the week after today. I haven't seen much T&A that has been particularly helpful in the last few weeks. Technical analysis without volume is a very dangerous game to play in a market like this.

The way I see it: The bears and bulls are both frustrated at this point. The bulls want a pullback because the entry points at these elevated levels are too pricey for even their expensive tastes. The bears also want a pullback because they are bears!

The light volume as both sides wait for a pullback has resulted in a market that is about as exciting as watching paint dry.

Stealth Inflation

Lets get back to the Itulip data. Eric made some great points around inflation over there. Is the deflation we all believe we are seeing actually a mirage? Stealth inflation is the idea that you make products of lower quality and sell them at the same price as previous higher quality products.


Could it be that we are slowly sinking into third world living conditions as the quality of our products deteriorate in order to make them affordable for our battered consumer?

Are the 12oz steaks that we enjoyed last year slowly being replaced by 10 oz steaks at the same price? Or will the quality of beef eventually deteriorate without the consumer knowing it as prices remain the same. I have been hearing rumors that certian so called "Prime Steakhouses" are now buying choice beef and pricing it slightly below prime without telling their patrons.

Another question around inflation:

Will a dramatic drop in supply as factories go BK actually force prices higher as products become more scarce?

These are all excellent questions, and stealth inflation in the form of cheaper made knockoffs and smaller portions may be a serious part of the equation.

I have to believe that the fight between the deflationist's and the inflationist's will end up ending somewhere in the middle.

I compare this situation to politics. Each side makes great points but neither side is always right. The far left Democrats and the far right Republicans are both a bunch of loons. As a result, most bills that get done in Washington end up somewhere in the middle.

Here are a few graphs that support the idea that we are in a period of disinflation versus deflation(similiar to periods of the '70's):

Here is the CPI during deflation of the 1930's:

Here is the CPI in our current collapse:

My Take:

The way I see it, four months is not a long enough period for the inflationist's to declare victory. To their credit, the Fed has not let them down yet as they create trillions of dollars in order to keep this bubble afloat. However, if they cannot sustain these shenanigans, will we see the collapse like the one seen above from the '30's?

One thing is certianly becoming more and more clear to me. Our living standards will steadily drop in either scenario. If we cannot afford price inflation, then we will likely see inflation via cheaper goods replacing superior goods at the same price.

I am seeing signs of the new third world America right now. Outback now has a 6oz steak for $9.99. Five years ago, America would have laughed at them if they tried to call this a "steak dinner". Today, its a reality.

The inflation/deflation debate will rage on long after I finish this post. However, I thought that Itulip made some great points today around a potential lack of supply as well as the quality of supply.

The falling dollar, a deflation obsessed Fed, and changes in quantity as well as the quality of supply are all compelling reasons to see the inflationary side of this equation.

On the flip side, bankers always lose in severe inflation because all of those dollars they own become worthless. As a result, the bankers and the Fed want some inflation but not TOO much inflation. They may decide that deflation is the only exit where they remain rich because the dollar would rise in such a scenario.

Its a tough argument folks! This is why a well diversified portfolio should be prepared for either scenario.


CT-Hilltopper said...

Been in a supermarket lately?

The half-gallon of ice cream you buy isn't a half-gallon anymore, but you're still paying the same price.

They've done the same thing with crackers, cereal, milk...there are many other items that I am just forgetting to mention.

I still believe when the rubber meets the road we will have the boiled frog scenario. Small changes enacted slowly, changes like these, where people might notice and comment initially, but then move along and forget.

Add together enough of these changes, and you have the US turned into a third world nation, and the sad thing is that people aren't protesting it at any point along the line, just accepting it.

Because is it really worth protesting because they took that little bit away from us? Nah.

Jeff said...


Tulip used the boiled frog example in their article.

I laughed when I read it.

Save your money folks. Your going to need it!

Jeff said...

Hey All

I just wanted everyone to know that I am now on Seeking Alpha as a contributor.

Here is the link! Thanks for all of your support:

EDC said...


First of all, itulips argument for using the CPI is ridiculous. They changed the calculations during the clinton admin and every did more revisions during the bush admin.

If the CPI actually accounted for housing costs as it should it would be continually going down from here. See Mish for the CPI that includes the Case Shiller. During the last boom of housing, they said inflation was very moderate. Obviously those who said that didn't do the shopping at the store. Nor did they notice that the total supply of freshly created credit was going parabolic, why because of quarterly bonuses.

As far as itulip goes.... One they cant' even define inflation. It isn't rising prices, don't ever get caught up in a debate of rising prices because that by itself is not inflation. It is the increase of money supply and credit chasing goods and services.

Companies are downsizing to save on their bottom line and for their profit margins. The article doesn't understand since the company is now ordering less product to complete the finished good, THIS IS DEFLATIONARY.
Either way they will now have less sales because there is not enough money and credit being created to chase goods and services.

always two sides to a coin and dag namit...
inflation has a ways before it will be their story once again.
sheeesh. besides tulip is nothing more than an inflation scaring publication. stinks.

SPECTRE of Deflation said...

How you can draw inflation from this scenario is beyond me:

From July 2008 to July 2009, prices for finished goods fell 6.8 percent, the index for intermediate goods decreased 15.1 percent, and crude goods prices dropped 44.8 percent, all of which are record 12 month declines.

•The consumer price index is down 2.1% year over year.

•The Federal Government current receipts are down negative 10+%; the rate of fall has not been this great in almost 60 years.

•Federal tax receipts on corporate income is down 40+% year over year; not since 1930 has the collapse been this great.

•State and local government sales tax receipts are negative for the first time since the beginning of World War II.

•Corporate profits after tax have experienced the most severe collapse in history.

•Net corporate dividends again have an historic collapse.

•Compensation of employees wages and salaries accruals - go back to 1949 to find the same level!

•Personal income is negative 2.5%, as is disposable personal income year over year.

•Personal consumption expenditures continue to dive off the cliff, as does personal consumption for durable goods.

•Total personal consumption expenditures is negative for the first time in modern history!

•Final sales to domestic purchasers, negative for the first time in modern history!

•Final sales of domestic products is, you guessed it, negative for the first time in modern history.

•Personal savings rate continues to skyrocket, now approaching $600 billion, as the general populace continues to deleverage at a feverish pace.

SPECTRE of Deflation said...

How about stealth deflation? The banks, like Colonial, are all carrying pure crap on their books at par or close to it. Karl Denniger makes clear that all these loans must be marked to market in order to clear said market:

Props to Calculated Risk on the break here and the WSJ for its description:

Colonial faced loan losses that were too big to absorb. In doing the deal, BB&T is marking down Colonial loans and real-estate collateral by 37%, a number that reflects a large amount of estimated losses. The biggest mark is on construction loans; BB&T is cutting their value by 67%.

Thirty-seven percent markdowns from where they were being carried by Colonial?

Folks, this is outrageous. Here is the BB&T Presentation on the "merger" and its salient terms:

Let's go through it. Its a good deal for BB&T, as one would expect (someone had to be basically bribed to that this trash -and boy, was it trash!)

As you can see from the above the entire covered portfolio, some $14 billion in assets, could be charged off (that is worth zero!) and BB&T would eat nothing. The FDIC would eat it all. The original mark recognizes $5 billion, so they're buying at a discount at that number. Nice eh?

What's better though are the marks:

This is an absolute outrage. How in the hell does a bank get to the point where its construction loans have a real markdown of 67% from par (!), its commercial property loans have a write-down of more than 30% from par, home equity is impaired by 21% and other mortgage loans are impaired by 18%, or 37% on a blended basis, radically exceeding the bank's capitalization, and yet this institution was not seized MONTHS AGO.

Remember, according to The FDIC, Colonial did not (yet) have a negative Tier Capital Ratio, unlike Guaranty and Corus, both of which do! The carnage there has to be at least as bad.

I have been repeatedly asked for hard proof that banks are intentionally misrepresenting asset quality. I have repeatedly pointed to the loss figures from the FDIC, which is hard proof that this has been going on.

Peter said...

I'm going to take the disagree with Tulip position. When I go to the market I see products that now have 25% more. I see sales on at least one brand of every item. I also see pretty thin inventory. CT, your statement about products being smaller is true but that is the result of last year's run up in commodity prices. Companies raise prices immediately but they lower them much slower, in the last few months I see them starting to lower them or increase sizes. By the way, where can I buy some boiled frog?

As for purchasing lower quality stuff I disagree with that. Really, we have been buying Chinese crap for years. Made like crap, breaks right away, basically it is all disposable. I would be scared to think the quality of things we buy can get any worse.

I rent a house that was built by one of these track developers maybe five years ago. At one point it was going for over half a million. This thing is a piece of sh*t. I can't imagine making a product any cheaper, cutting every corner to save several thousand on the cost of production. If it was made any worse the roof would fall in.

Jeff said...


I like to listen to all arguements.

Not saying Itulip is right, just offereing their view.

Like I said I think the answer may be right in the middle which would be some type of stagflation.

Jeff said...


Great points and I never said deflation is off the table.

Be careful looking at year on year inflation data right now because the data is VERY skewed as a result of oild going to $150 a barell last year.

I see deflationis't pouncing all over this data and its not relevant because prices have collapsed since then.

We need to wait for 3rd quarter data for a real comparison on prices.

As for the banks, couldn't agree more.

Jeff said...


Itulip's take on price drops is they will be severe but temporary as inventories shrink.

Its just a different take and I am all ears right now because I see so many price distortions on both the inflationary and deflationary sides.

Deflation rules right now as companies need to dump inventories as a result of the consumer disappears.

We will see what happens once this cycle completes.

Thanks for your thoughts and I see a lot of deflation out there as well!

Anonymous said...

Just think of your gas purchases:

A year ago, when gas fell from $4 to $2, it was clear deflation was ruling the roost.

In the year since, gas has risen from 2-2.60 or so, with no signs of going back to $2, or bursting far far below it as the deflationists like to think.

Im with you Jeff. The hyperinflationists and the deflationists are always the ones that scream "I AM RIGHT" the loudest.

That doesnt necessarily make either one of them true.

CT-Hilltopper said...

I am more in the deflationists camp also.

But also in deflation, because of the stimulus that the government keeps pumping in to keep things afloat, I believe that the boiled frog theory equally applies.

They're going to cook us long and slow.

You can take all these ideas, and crunch them in any manner, and label them with whatever label you might like to attach it it, and the end meaning will still come out the same.

The American consumer is being hosed, and has been for quite some time, and really hasn't been too terribly worried about it.

They're much more concerned to hear if Paula Abdul is going to be back on American Idol next year than they are about the fact that they are paying the same for less than a half gallon of ice cream as they did for a full half gallon.

Most of them didn't even notice the change.

Jeff said...


Yeah I agree.

I heard someone today that said anyone who sayd they KNOW what this market is going to do is someone you shouldn't listen to.

I think that is sound advice. There are too many variables in this market right now.

Nothing is clear in my view.

Jeff said...


I hear ya.

I am going to be watching prices very carefully from here on out.

Regarding the consumer, I found more evidence today around how screwed the consumer is getting.

It will be up tonight.