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Thursday, October 30, 2008


the most important chart in the world

the 2q2008 update of the ned davis research chart that i've previously cited as marc faber's chart 10 and an attachment to frank veneroso's analysis has been circulating -- most notably as an attachment to hayman advisors recent letter. via clusterstock:

if this gets going -- and it does appear that's the likelihood -- what we have in front of us is unimaginable. deflation continues to be very probable from here. if you needed confirmation in spite of crashing prices in assets ranging from houses to financial instruments to commodities, today's 3q GDP report -- with its massive contractions in durable goods, nondurable goods and consumer spending -- demonstrates pretty conclusively that it is well underway.

the question over the likelihood of a policy inflation will rage for some time -- in the latest installment, jim hamilton thinks an extended deflation nearly impossible -- but what is certain is that we have deflation now.

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I'm curious as to your take on Jim Hamilton's arguments?

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here's the comment i appended, hbl:

JDH -- destroying the dollar to create an inflation may be possible, but i think we would discover that it is not the less painful method of correction.

beyond mr. waldman's valid points on specific ability -- let's imagine the fed was successful in engineering rising prices with radical quantitative easing. what it could not do in such a situation would be to compel lending, which is very risky for banks in a steeply rising inflation.

given that, and given what would surely be very high initial unemployment as a precondition of heavy quantitative easing, wages would likely not rise with prices.

i encourage a rethinking of the problem facing the united states along the lines of james livingston's recent essay. this economy suffers from a long-term decline in real wages at a time when consumer growth has become increasingly essential to the economy. levering the consumer masked the effect for 20 years, but now the bill is coming due.

if the fed were to engineer a further decline in real wages by pushing prices higher in a stagnant wage environment, i fail to see how the problem is rectified. indeed, it may be severely aggravated -- to the point where the social fabric may not hold together. this must be a consideration.

deflation, for all its difficulties, can be addressed with compulsory debt forgiveness and debt-to-equity swaps. that may be painful for capital, but results in a workable consumer economy with real purchasing power on the other side, does it not?

to be sure, hbl, i think that hamilton's mechanism works better as an abstraction than it could in practice. waldman's criticisms re: the stability of such a program are salient. and the political will to empower the fed to buy anything and everything unsterilized is likely to be hard to amass - congress and/or treasury could and would step in to prevent it, i'll wager. and then there are the consequences of success.

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I'm a bit skeptical myself. Anywhere the Fed would inject money via buying assets would go to those (banks & the wealthy) with the least propensity to spend or loan the new dollars. On the other hand, new money targeted toward recipients who would contribute to a higher money velocity (e.g., the unemployed) would require Congress and face political limits.

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i think so much time has been spent on the mechanical debate -- modeling how it could happen -- that the essential fact that this is a political question has been overlooked. the question isn't so much could as would, in my view.

i'm naive to the domestic politics of japan post-1990, but i'd be interested to know what role political obstruction played in limiting reflation efforts (which were, as in the 1930s in america, very considerable).

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