FTSE scraping 5000

Generali

Let us not forget that so far we've had very little in the way of rising unemployment or companies going bust (Lehmans and XL excluded of course).

There's a world of hurt out there waiting to be felt and deflation looks to me to be increasingly likely as credit is destroyed and oversupply in Chinese industry causes some real cut throat competition.

WTF?_2

Generali wrote: »

Let us not forget that so far we've had very little in the way of rising unemployment or companies going bust (Lehmans and XL excluded of course).

There's a world of hurt out there waiting to be felt and deflation looks to me to be increasingly likely as credit is destroyed and oversupply in Chinese industry causes some real cut throat competition.

I think a lot of stuff simply won't be manufactured in the event that they can't turn a decent profit on making it.

As for other stuff, well making it in China will remain massively cheaper than making it ourselves so they may well figure that they can raise their prices and we'll still buy it.

Then they will want to do what governments traditionally do in a recession - start spending public money on infrastructure projects to create employment and get money flowing. And there is lots of money earned during the good years to go around.

Plus the Chinese citizens are much better savers than us in the West and I would bet that their govt. will work on cultivating domestic demand. All the time buying up raw materials with the hundreds of billions of dollars that they are currently sitting on.


Don't forget that all the cash that was magicked into existence during the boom decade is still out there. Defaults on debts mean that the creation of new credit by banks is affected but the 'defaulted' cash has 'escaped' and is in the system. That has to be worked out of the system and in the meantime it will likely be used to create asset bubbles.


I think that the average Western consumer is definitely going to experience deflation in their personal cashflow but I can't see that it's going to translate into things getting proportionally cheaper to buy. In fact, we may well see essentials getting more and more expensive.

I don't think that governments will simply sit back and let the money supply deflate - they'll pump out as much new fiat currency as they think is needed. The problem is that they can't control where it goes and my guess is that it will not end up in the pockets of the people.

dopester

!!!!!!? wrote: »

I don't think that governments will simply sit back and let the money supply deflate - they'll pump out as much new fiat currency as they think is needed. The problem is that they can't control where it goes and my guess is that it will not end up in the pockets of the people.

I agree with you on China stoking domestic consumption and demand, but I can't understand why you think there is some kind of remedy in pumping out paper money to the sheeple.

If printing money was the solution to it all, we need not bother to work for value. And governments wouldn't have counterfeited one another's currencies in war time as acts of economic sabotage.

If stopping deflation were as simple as turning on the presses, then a question immediately arises: "Why was there ever deflation?" Printing presses are an invention of the fifteenth century. Every country in the 1930s had access to high-speed presses that could have cranked out paper money in any denomination. It would have been just as cheap and easy to print ten-thousand-dollar bills as it was to print one-dollar bills. Yet deflationary depression swept the world. Why?

To understand the danger of deflation you need to pose the right question. It is not whether governments have the power to print money. It is: "When do the benefits of printing money exceed the costs?"

If political authorities could benefit only from inflation, and not be harmed, they would obviously print more money in higher denominations than they do.

Those who estimate the chance of deflation at zero are missing several facets of a complex situation:

1. As we have emphasised, they have misunderstood the nonlinear character of the economy as a complex system. Nonlinear systems typically operate through stages or cycles, with rapid phase transitions from one period to the next. This is a characterisitic of the economy in practice, if not in theory.

2. They are too readily dismissing the relevance of past experience. The chronic inflation since World War II is a historical anomaly. There have been ups and downs since the beginning of time. The Book of Genesis tells us that seven lean years followed seven bountiful years. It would be truly remarkable if the cycle of boom and bust has been eliminated.

3. They ignore the costs of runaway inflation, which exceed those of deflation. In advanced economies, the damage done by destroying the bond market is greater than the stimulative effect of eliminating all debt. Only countries without advanced capital markets like those in Latin America and Africa dare to have runaway inflations. The market is a potent deflationary feedback mechanism for countries that borrow in their own currencies.

The idea that government can easily interrupt of suppress economic cycles is more a civic myth than a fact. The claim made by John Kenneth Galbraith and others that the Great Depression emerged because the U.S. government in 1929 was content to allow the market to operate without intervention is simply untrue.

Indeed, it is remote from the facts. President Herbert Hoover intervened vigorously but without success. Even a massive stimulus program and an "easy money" policy that led to negative T-bill rates in 1933 did not prevent deflation.

It is all too simple to think that central banks have magic powers. They don't. They can create liquidity by creating debt. But this is not the same thing as creating capital. Any time a central bank monetises an asset by buying it, in essence, with printing-press money, it also creates a liability. Only the market can create capital by valuing assets above liabilities. Turning on the printing presses at a higher speed destroys more wealth than it creates.

A high financial interrelations ratio reflects the capital that a society can create when inflation is controlled. The gain in wealth is tremendous. But this added wealth is at risk if inflation is allowed to run wild. That is why inflation at runaway levels is rare in advanced countries. Hyperinflation, however, is much more common in backward countries that do not borrow in their own currencies. A hyperinflation that would wipe out the bond market is much less costly in a country that has no bond market.

In more advanced countries, the market stops politicians from inflating wildly because people who have financial assets like bonds that would be harmed by hyperinflation can sell them.

For example, if it appeared to everyone that the U.S. government intended to rapidly inflate away the national debt, then most holders of U.S. Treasury bonds would dump them, driving up interest rates. The effect would therefore be just the opposite of what the politicians would wish. The stronger the appearance that authorities are following an inflationary policy, the higher rates will go, and thus the more rapidly capital will disappear.

This, of course, does not mean there cannot be hyperinflation in rich countries. But it does mean that the economic and political gains of such a policy are likely to be more than cancelled by its high costs.

Indeed it is possible that the attempt to counter deflation by political expedients has the effect of increasing the strength of the impulse making for contraction - just as attempting to prevent forest fires only postpones and enlarges the ultimate conflagration.

The notion that easy money is a magic tonic that can counter the forces of contraction is likely to seem more alluring as an argument than it proves to be a fact. In 1929, neither the Federal Reserve not the Bank of England could overcome the worldwide forces making for contraction just by manipulating numbers on their balance sheets.

If lavish spending accompanied by inflation could have prevented economic decline, Rome would still rule the world. Higher spending and more inflation were tried over and over, until inflation reached levels that can be considered remarkable for an economy with metallic money.

Reay Tannahil wrote, "Money was so seriously devalued that a measure of wheat which, in Egypt, had cost six drachmai in the first century A.D, cost two million shortly after A.D.344.

Indeed a willingness to spend, with or without resources to meet the bills, has been such prevalent behaviour among political authorities through all times that the more interesting question is not, "How is it that it took governments until the twentieth century to discover the magic of deficit spending and inflation?" Rather it is, "What are the factors that have prevailed in prosperous countries that account for the rare rectitude of political leaders who did not spend money out on an empty pocket and inflate the currency?"

The Great Reckoning - William Rees-Mogg, James Dale Davidson

Generali

There seems to be a lot of complacency around in investment circles that the Fed can 'inflate its way out of trouble'. It's not worked that well in Zim has it?

WTF?_2

dopester wrote: »

I agree with you on China stoking domestic consumption and demand, but I can't understand why you think there is some kind of remedy in pumping out paper money to the sheeple.

The money will be pumped out to the markets. Simply inflate away the balance sheet debts.

Meanwhile, people are going to be strapped for cash because the banks won't be lending it to them in the teeth of a recession/depression. Just look at Japan - 0% rates yet if you were a Japanese person looking for a loan from a Japanese bank, good luck.

Look at all the cash pumped into the banks. Tens of billions in just the last few days - see any of that getting into public hands? Libor is at amazing spreads.


Yes, inflation is a dumb idea but the pressure will be there to do it and it's a nice quick fix. Then worry about what to do about the consequences.

If printing money was the solution to it all, we need not bother to work for value. And governments wouldn't have counterfeited one another's currencies in war time as acts of economic sabotage.

What work was done to justify the trillions of dollars of 'wealth' created by the derivatives market? Didn't stop the market from going on for years and no-one complained when things were going well.

Over the course of a decade we have had trillions of dollars of more money being created than goods/services to justify it in the economic system. If things get really bad, and I think they will, then faced with the choice of a deflationary economic bust and financial system collapse vs more inflation the governments will go for yet more money printing.

It didn't work in the Great Depression and I don't think it will work when they try it this time, but it won't stop them from trying it. With globally linked markets and money now mostly 1's and 0's representing a spreadsheet stored in a harddrive somewhere who knows what the effects will be? I foresee massive wealth consolidation and a massively increased gap between rich and poor with many, many formerly 'well off' people becoming poor almost overnight. Think Argentina.

dopester

It is possible, given that politicians don't like to admit defeat even when weighed upon by contracting economic forces. They will try and try again to re-inflate until defeated by the forces of contraction, but like you say, they may not admit defeat and take it all the way.

It is so destructive though. Your outcome, to me, would see wealth driven in to hordes of gold, or tangible stuff like land that would still be worth something. Or a bartering system come in for trade, and a near end of real commerce. You probably wouldn't be able to access your goldbullion.com account (or whatever it is called). I don't like that outcome.

Although deflation is definitely no easy ride either, and comes with great pain, drops in living standards, and risk of significant civil unrest, and probably much political instability along the way.

neverdespairgirl

Baz wrote: »

Like house prices, it doesn't matter unless you need to sell. It doesn't matter what the FTSE is doing unless you need to sell your investments.

What about if you are leveraged on the stock market and have a margin call?

Sir_Humphrey

Just dipped under 4900. :eek:

wolfman

Yep, looks like it could be another "in the red" day despite having been positive all day. Just shows there's still a lot of uncertainty. Still got a fair way to go though before it hits mid 2002 levels when the FTSE went below 4000.

Treadmill

Didn't take long to get from 6000 to 4850, I reckon we'll see under 4000 in less than three months.

Bang goes the pension