I run hedging and MIS for a mid-size nationwide mortgage bank. I'm pretty bearish on mortgage banking, by the way ... we may have a cycle left (very slight probability of two), but I think the industry is likely near a peak unless the Fed pulls out all the stops ...
For the inflation / deflation debate. Not saying deflation CAN'T or WON'T happen, but all the reasons given about WHY it will happen don't make sense. Here's the article "Some Questions For My Inflationist Friends" and the response:
"I keep getting e-mail responses to my articles telling me why I am wrong about deflation. I also keep seeing posts, like the following one, explaining why inflation is inevitable. This recent post from "Wendy" on The Motley Fool is typical:
"It's clear from this that the same factors that threaten to pop the U.S. real estate bubble would also pop a worldwide real estate bubble. Like the popping of Japan's real estate bubble in 1990, this could lead to long-term recession.
"I believe that the world's central banks would flood the world with liquidity to prevent this from happening. Both Japan and China have already done this, with the central banks 'creating' hundreds of billions of dollars worth of their own currencies, which they used to buy U.S. Treasuries.
"This is a major reason that I believe that the economic problem of the future will be inflation, not recession." "OK, Wendy -- or any other inflationists out there -- it's time to step up to the plate. Here are the questions I would like you to address:
"1. Can you please define the ending point in your cycle? Does the cycle end when everyone has three houses and no renters? Twenty houses and no renters?
>>> When there are no more believers in deflation. All the talk of deflation has increased the ability to push money into the system. The Fed can generate disinflationary impulses which cause people to carry money balances. The Fed will attempt to adjust public expectations so that people are forced to hold cash, even though it is losing value. The limit is when enough people find a way to avoid the depreciation (thus decreasing the demand for cash) and the Fed no longer can force currency into the market without accelerating inflationary expectations. There's a big difference between the insiders (able to avoid inflation by borrowing and investing in a broad variety of assets) and the rest of us (unable to avoid the effects of malinvestment, income cycles, discoordination, and earn a consistent real return).
"2. Can the government print money from now until the end of time to forestall a recession? If it's so easy to prevent a recession by printing money, why do we ever have them?
>>> We will have disinflationary recessions, but inflation will likely continue. There's always a chance that some event causes the need for so much deficit spending and monetization that the market won't take the money or the treasury bonds and then we WILL have deflation. But we are not there yet. The problem is the deflationists may be right in the longer run, but 50 years of being wrong and most investors already died poor ...
"3. Is there no end to the demand for credit regardless of wage growth, outsourcing, and loss of union and other jobs?
>>> There does not need to be any demand for credit for inflation to continue. There is enough credit in existence for the Fed to indirectly monetize (budget deficit, holding up current debt, and then monetization). With trillions in debt available to monetize, the Fed has the ability absolutely to generate inflation. That would be worse than deflation, not better, but they CAN do it until the market goes into "anticipatory inflation".
"4. Can Japan keep printing money and buying U.S. Treasuries until U.S. Treasury rates hit zero? What then?
>>> Treasury rates hitting zero is not the "lower bound". Japan is offloading it's inflation into the US by buying treasury bonds with printed Yen and holding the dollar / Yen rate steady rather than allowing the Yen to appreciate. The receivers of Yen (selling treasuries or agency debt) buy imports. The Japanese exporters receiving the new Yen then buy treasuries and agency debt. The Yen never "leaks" into the general Japanese economy. The new money will not "hit goods" UNTIL there is shortage of consumption goods forcing the Japanese exporters to offset their losses in Dollar denominated debt ... and then the "deferred inflation" is revealed as greater and greater quantities of Yen currency are needed to offset the collapse of the depreciating dollar.
>>> The Japanese government has a large market for it's debt and cannot become insolvent unless rates RISE. Rates will rise when there are shortages of needed consumption goods which Japan is now beginning to feel. They have subsidized our consumption and our pillaging of our capital base which will impede our ability to make consumption goods. The lack of consumer goods drives the psychology of hyperinflation. There is no regular or specific "mechanism" by which this happens except to note the general process: first an expansion of credit, THEN a lack of consumption goods (deferred sometimes significantly from the credit inflation, other times hardly at all), THEN a response by the authorities to continue to hold interest rates too low.
"5. Can home prices keep climbing exponentially if wages do not support prices?
>>> Home prices are not the limiting factor. It might be that a collapse of home prices would push the Fed into going "all-out" or finally pulling back and letting us take the lumps we should have taken in 1998, 2000, etc. Hopefully they pull back and let the market work because with every deferment the cost rises. But that doesn't mean they CAN'T inflate.
"6. How are people going to pay property taxes and medical expenses unless wages pick up?
>>> They won't. More people will work for the government directly or indirectly (budget deficit). The consistent credit expansion ends in communism if followed to its final logical endpoint.
"7. Is GM about to offer unions more money?
>>> I doubt it. But that won't stop inflation. People don't have to earn squat to have inflation (look at Africa for Pete's sake).
"8. Is outsourcing to India and China about to stop?
>>> Probably not, but it is irrelevant to the constraint which determines the inflation / deflation question.
"9. Are telecom mergers -- slated to destroy 20,000 jobs this year -- going to reverse?
>>> Also probably not, but it is irrelevant.
"10. Are bank mergers and other mergers that will destroy jobs going to stop?
>>> Also probably not, but still it is irrelevant.
>>> The question is what the MARKET will accept. The government will socialize the costs and hurt productivity. But if it comes to a point where the market will not take additional Treasuries OR "monetized treasuries" as money, THEN we will have deflation *** or *** risk hyperinflation (possibly an even larger deflation after hyperinflation if finally the Fed pulls back hard ). I think the authorities are trying to get China into a position so that they "have to use" US Treasuries for some time thereby offloading the losses onto China and Asia (and they've helped by being so crazy in the 90s with their credit booms and busts, losing their reserves on the way). But Asia won't comply forever... THEN it will be deflation or risk hyperinflation. As an aside, the Fed can LAG the interest rate increases and consistently feed a diet of inflation as long as they punctuate the extremes by disinflation, causing people to have to hold cash.
"11. Is productivity going to fall off a cliff so that more workers will be needed tomorrow than are needed today?
>>> I have no idea what will happen to productivity. It might be that young workers will offset the demands of the elderly (I doubt it). My guess is that the "mobile producer" will have tremendous earning potential and the AARP will fight to the death (literally) to extract from their own children what they are "due". Hopefully we can come to a middle ground. I don't want to see masses of elderly poor, but they also are reponsible for the plight.
12. Are wages and employment going to rise while outsourcing, mergers, and productivity are increasing?
>>> No. The Fed will have to offset the credit losses with cash. A big, painful, long restructuring will take place (made worse by inflation).
"13. Is the demand for housing infinite regardless of price?
>>> No. Irrelevant.
"14. Is the willingness to supply credit for housing infinite regardless of price and regardless of the credit worthiness of borrowers?
>>> No. But the money comes from a monetized deficit, not private credit expansion. It might be that the Fed is unwilling to collateralize private credit with public debt ... if so then deflation will happen. But it is a political choice.
"Can ANY inflationist out there please address all of those questions in a single, coherent post and tell me how-- with falling wages and stagnant jobs -- the demand for money AND the willingness to lend it can be infinite?
>>> Done. Enjoy.
VP Secondary Marketing / MIS
Dollar Mortgage Corporation (DMC Capital Markets)
30 June 2005