Deflation Watch pt 153 - International Edition

Generali

Morgan Stanley reckon I'm wrong on deflation:

Key points
1. Investors are asking whether America and
Europe will follow Japan into deflation. We think not.

Japan fell into secular deflation because of a unique
combination of structural factors. These factors are
(a) high central bank independence with low
accountability, (b) advanced aging of the population, (c)
an electoral system that strongly over-represents the
interests of older voters, and (d) a current account
surplus that dulls the need for structural reforms.

2. Japan will likely remain in deflation, because none
of the structural factors is likely to change soon.

3. The US is unlikely to fall into deflation. The
Federal Reserve is more accountable and transparent
than the Bank of Japan. The US is young; the electoral
system does not over-represent older voters; the current
deficit increases pressure for structural reform.

4. Europe is less likely than Japan but more likely
than the US to fall into deflation. This is because
Europe lies between Japan and the US on the four
factors.

5. The best investment strategy is to seek yield and
monetary assets in Japan, and seek beta and real
assets in the US. Europe falls between the two.
Inflation linked bonds are attractive. They provide
protection in high inflation countries and high real rates
in low inflation countries.

6. Risk Scenario - Global Inflation: In the risk
scenario, where common global factors overcome
regional differences, all developed economies are likely
to tilt toward inflation. Nominal assets in all countries
would likely underperform, and real assets outperform.

Linkers would be attractive in most countries.

By Europe they mean the Eurozone. The UK I think goes some way to meeting conditions a) and c), misses b) and is nowhere near d). Can't link to it, sorry. I think it's password protected. The above is the summary.

michaels

Suggesting that central banks can prevent deflation takes us back to the pushing on a piece of string analogy.

Not sure about the current account argument either - surely a deficit is likely to be fixed using austerity which is generally deflationary?

Also given that there has been an asset price boom on the back of a credit expansion that is now being reversed I can't see that real assets as a class outperforming in the near future.

That only leaves global growth driving up the price of internationally traded items which we have already discussed is not 'real' inflation.

And lets not forget Morgan Stanley are not disinterested, they are a VI with products to flog.

sabretoothtigger

Global growth matters because of the trade balance. Probably the most important difference between Japan and the rest of us. Its real inflation if you want to buy it and it costs more, since usa imports so much of what it consumes thats inflation.

If they can turn lower house prices into cheaper factory output and produce for themselves even to an excess they might get deflation. The current plan seems to be to borrow & waste money not improve production or ongoing capacity

House prices were over inflated, then they fell. Thats a one off, people will buy land at some point.
The more important factor is ongoing costs, are rising or falling. If the country is externally funded and supplied then it doesnt seem to add up to say well its only going to get cheaper, why would it.
I dont care how much a usa home costs, you cant have my candy bar any cheaper sorry because I want it myself

Most arguments Ive heard on this use circular logic I think. They reference usa as being the decider of costs because they are the largest market.
Ok they have the highest PPI I think and its the largest single market but does this make sense that the buyer alone (with borrowed money) tells the seller the price, this isnt supply and demand as I know it. Governments set their own interest rates, they decide their own costs?

Im no genius in general but it seems wonky dodgy logic and an argument that serves itself not a solution. Free markets if they exist should not favour such things




The most deflationary thing I heard recently is USA now produces a greater % oil for itself then previously. Unfortunately obama banned drilling in their most successful area, that might be his most influential mistake this year.
And real americans protested this, democracy is kinda broken over there I think which is of greater concern then anything else but this would link it to japans case a little better if thats a positive?

All the talk of monetary policy doesnt seem to matter much compared to real action taken ( and effects)

ninky_2

Generali wrote: »

The mechanism by which an increase in the money supply causes inflation is pretty simple. The theory is that life is a bit like an auction with people bidding to buy scarce goods and services. If you give the people in the auction more money then they can bid more. If they can bid more, prices will end up higher. Prices increasing is inflation, close enough anyway (it is a little more complicated than that).

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have to say this thread is a bit over my head with all the talk of Ms etc. but surely the auction idea assumes that everyone is on a level playing field. this is clearly not the case. whilst there may be less money around the stuff there is can be concentrated in a few hands. they can still go on bidding for stuff, just the rest of the room can't afford it. so long as there are enough bidders who can go on paying the higher price the goods won't drop in price. i'm probably wrong - just trying to understand.:D

sabretoothtigger

I dont think anyone in the world understands this properly or they would have stopped all the silliness a while ago

Its not a level playing field, usa decides the worth of paper money for the world and produces that money for its own uses first. For global trade to exist it relys on paper money, a barter system would not exactly work If this is an auction it seems dollars gives a discount on the price paid

Generali

ninky wrote: »

have to say this thread is a bit over my head with all the talk of Ms etc. but surely the auction idea assumes that everyone is on a level playing field. this is clearly not the case. whilst there may be less money around the stuff there is can be concentrated in a few hands. they can still go on bidding for stuff, just the rest of the room can't afford it. so long as there are enough bidders who can go on paying the higher price the goods won't drop in price. i'm probably wrong - just trying to understand.:D

Happy to explain.

Indeed not everyone is on a level playing field, far from it.

Imagine you have a hundred people in a room and a 10 cars to sell. 10 people will pay up to £10,000 for the car, 80 can only pay £9,500 and 10 can only afford £9,000. The cars will sell for £9,501 or thereabouts unless the buyers are poor negotiators.

Now imagine there is a financial shock and now we have 10 people that will pay £8,000 for the cars, 80 that will pay £9,500 and 10 that are prepared to pay £10,000. Will the price of the cars change? I would argue that they would not. The 10 people that have gone from being able or willing (it's the same thing for setting prices) to pay £9,000 to £8,000 are outbid by more. That's the only thing to have changed.

Now imagine a situation where you are trying to sell 90 cars. In this case the price will change across the 2 cases. In the first case, the cars will sell for £9,001, in the second they will sell for £8,001: the price has fallen.

I hope that makes a little more sense. Basically what I am saying is that if you take money out of an economy prices might fall but it depends where you take the money out. If you take £100 from the people with £10,000 prices won't fall because they can still afford to be top bidders. However, if you take £600 from them, prices will fall because they can no longer make top price.

Of course in the real world it is more complex than that but this is to some extent how price discovery works. Sellers push up prices to see if they can get away with it, sometimes they can and sometimes they have to drop the price again.

Feel free to ask more questions; I enjoy this stuff.

Generali

sabretoothtigger wrote: »

I dont think anyone in the world understands this properly or they would have stopped all the silliness a while ago

Its not a level playing field, usa decides the worth of paper money for the world and produces that money for its own uses first. For global trade to exist it relys on paper money, a barter system would not exactly work If this is an auction it seems dollars gives a discount on the price paid

The market still decides what the US Dollar is worth. The US just gets more favourable terms than the rest. It may not be fair but very little in this life is fair.

ninky_2

but surely it depends on the profit margin and necessity of the goods in the first place? the people selling the cars might decide it's not worth it for the lower price and just stop making them. we would also expect to see secondhand car sales go up (actually i think this has happened?)

i can see deflation with unnecessary/luxury goods. not so much with food. in my mind people will just cut back on the extras in order to fund the necessities - whilst we have a significant number on the breadline most/more are above this to keep bidding up in this area. so we see inflation in key areas like food and clothing and the cost of non-necessities fall? i'm not sure if that would give overall inflation or deflation or just a generally readjustment of the relative cost of things (which seems to be my anecdotal experience at the moment). in this model life becomes more expensive for those at the bottom and cheaper for those at the top.

Generali

ninky wrote: »

but surely it depends on the profit margin and necessity of the goods in the first place? the people selling the cars might decide it's not worth it for the lower price and just stop making them. we would also expect to see secondhand car sales go up (actually i think this has happened?)

You're right, it depends on those things and many others in the long term. In the short term though you have to sell your stock.

Imagine you're a farmer growing spuds. They cost you 10p/kg to grow and you can sell them to any one of the supermarkets who are the bidders in the auction. If the highest bidder will pay 8p/kg then you will make a loss. The alternative is to end up with a store full of rotten potatoes.

Next year you'll grow corn or peas or go bust thus reducing supply but this year you need to sell what you've already made.

ninky wrote: »

i can see deflation with unnecessary/luxury goods. not so much with food. in my mind people will just cut back on the extras in order to fund the necessities - whilst we have a significant number on the breadline most/more are above this to keep bidding up in this area. so we see inflation in key areas like food and clothing and the cost of non-necessities fall? i'm not sure if that would give overall inflation or deflation or just a generally readjustment of the relative cost of things (which seems to be my anecdotal experience at the moment). in this model life becomes more expensive for those at the bottom and cheaper for those at the top.

It's all about supply and demand, in the end that's what sets prices along with the price discovery that we've been discussing. With food it is harder to buy less but even then I can change my diet to consume less expensive food: I can eat liver rather than steak for example.

michaels

ninky wrote: »

i can see deflation with unnecessary/luxury goods. not so much with food. in my mind people will just cut back on the extras in order to fund the necessities - whilst we have a significant number on the breadline most/more are above this to keep bidding up in this area. so we see inflation in key areas like food and clothing and the cost of non-necessities fall? i'm not sure if that would give overall inflation or deflation or just a generally readjustment of the relative cost of things (which seems to be my anecdotal experience at the moment). in this model life becomes more expensive for those at the bottom and cheaper for those at the top.

Strangely I find myself agreeing with Ninky on this one.

Imagine an economy with two goods, bread (essential) and Plasma TVs (a luxury), prices and incomes mean everyone can buy as much bread as they want and some can also afford TVs. Until there is a poor harvest and less bread is available. Everyone still wants to buy as much bread as before but as less is available the price increases until some are spending all their income on bread and still can't afford as much they were before. However now with everyone spending more on bread there is less money available for the TVs and the price of the TVs thus falls so that the remaining money can pay for all the ones produced. The statisticians crunch the prices and report inflation is low over the 'basket' of goods, however those spending most or all their money on the essential, bread have seen a considerable fall in their purchasing power.