Help with economical analysis

[eugenekop]

Just when it comes to the fundamentals, I believe we have a second round of debt deflation coming. As soon as all of the pumped into financial markets enter the economy and cause general inflation, we will see a stock market crash as cash leaves the stock markets, a banking crisis as banks overexposed to stocks go under, and a general financial panic as investors pull out because of fear and high uncertainty. The resulting fall in the velocity of money will cause price deflation, especially in the valuation of assets like stocks and real estate.

We could also fall into a liquidity trap if the federal government becomes over-indebted, which is in itself a possibility. If debt exceeds over 100% of GDP, which looks like it will soon, investors might not be willing to buy T-bills at the current low rates. But since the Fed and other central banks will keep US Treasuries and T-bills at low rates, we could see a classical liquidity trap where monetary pumping ends up in bank reserves and under beds as creditors become too afraid to lend to anyone.

But after the second deflationary wave, it looks like we'll have major, double digit inflation in the cards.

krazy kaju wrote the text above in another thread, and I'm trying to understand it. I have a few questions if you'll be kind enough to answer.

1.


As soon as all of the pumped into financial markets enter the economy and cause general inflation, we will see a stock market crash as cash leaves the stock markets

Can you please explain why would cash leave the stock markets in that case?

2.

a banking crisis as banks overexposed to stocks go under

I though banks invest most of their money in stocks, so aren't they all "overexposed""?

3.

The resulting fall in the velocity of money will cause price deflation, especially in the valuation of assets like stocks and real estate.

What causes a bigger price deflation, lower supply of money, or fall in money velocity in the same proportions?

4.
Why price deflation would be especially bigger in stocks and real estate?

5.

we could see a classical liquidity trap where monetary pumping ends up in bank reserves and under beds as creditors become too afraid to lend to anyone.

Why big government debt creates a liquidity trap?

6.
Creditors will be afraid to lend because of high uncertainty, despite the fact that the interest rates are 0%. Is that what is called a liquidity trap?


Thank you for your time!

[Zippyjuan]

I would disagree with Kaju's assesment. First, I don't see inflation picking up to high levels for several years. Why? Unemployment and consumer demand. "All that money" won't start to flood the economy until there is a demand for it. Banks are sitting on about $1 trillion in excess reserves right now. Companies won't be borowing to expand their capacity until they see the demand for their goods and services increase- and even then they will be cautious about expansion to see if it is "real" or just a blip. Which in turn means that things depend on consumers.

Consumers have hunkered down on their spending because of economic uncertainty and the unemployment issue. Even if they are not themselves unemployed, they have cut back in case they do find themselved in that position. This is mostly a question of consumer confidence and a bit of a Catch-22. Consumers won't spend like they used to until unemployment goes down and unemployment won't go down much until consumers start spending (giving employers a reason to hire more people). That means that the unemployment picture will probably not change much for several years. That also means that consumers will not be borrowing and spending money- the other way "all that money" could get out into the system.

And that in turn brings us back to the first issue- the money the Fed has (and says they will continue to) added to banks. For the reasons I just listed, I don't think we face the inflationary risk from that money for several years also.

So what might happen when the money does eventually start to flow. As I pointed out, the reason the money flows is because the economy is growing. If the economy is growing, there is no reason for the price of stocks to collapse. In fact, they should be rising. So if stocks are not collapsing then the rest of the scenario is not likely either.

Just my opinion of what may happen.

[hugolp]

I would disagree with Kaju's assesment. First, I don't see inflation picking up to high levels for several years. Why? Unemployment and consumer demand.

Stagflation. High unemployment and rising prices.

Keynesians predicted it was imposible, the 70's prove the wrong. The theory that high unemployment does not allow for wages to rise is false. Workers are not interchangable. They have a different set of skills each, therefore an unemployed worker is not necessarily competition for an employed worker, and he can demand and get a raise. F.e. a construction worker that has been unemployed due to the end of the housing boom, does not affect a google engineer when negotiating a raise with his employer. There can be lots of unemployed construction workers and that wont stop the google engineer from getting a raise (you can see the less skilled workers are the ones who are going to suffer most from the mad money printing).

Wages can raise while there is high unemployment.


"All that money" won't start to flood the economy until there is a demand for it. Banks are sitting on about $1 trillion in excess reserves right now. Companies won't be borowing to expand their capacity until they see the demand for their goods and services increase- and even then they will be cautious about expansion to see if it is "real" or just a blip. Which in turn means that things depend on consumers.

The thing is commodity prices are already rising, or more like exploding. And that will start to transmit to consumer goods. In fact its already happening in food and (a little less) in energy. It will happen with the rest of the goods.

I recommend you this article by bloomberg news (http://www.bloomberg.com/news/2010-11-16/gap-wal-mart-clothing-suppliers-raise-prices-on-terrifying-cotton-costs.html). The chinese factories are already complaining that they can not keep prices because of the price of raw materials, like cotton. They are announcing rises in prices, because otherwise they would have to close.

Also you can check how they are starting to say that prices will only last one week due to the uncertainty of the price of commodities. They fear that if they give a price valid for one month or two month they will loose money in the next cotton price explosion. ¿Where is that price stability you are talking about?

Also, Nestle, the biggest food producer in the world, is reporting that 1'6% of their growth came from rising prices. Also they expect to keep passing input cost onto consumers: http://www.bloomberg.com/news/2010-10-22/nestle-nine-month-sales-growth-beats-estimates-confirms-full-year-outlook.html

Here you have similar case from Jones company: http://www.nypost.com/p/news/business/wash_and_weep_cDWcyRX8K4ABAEgMzkhP1J

Everybody is seeing how commodity prices are going to affect consumer good prices, but keynesians keep puting the head in the sand as if nothing is going to happen.


Consumers have hunkered down on their spending because of economic uncertainty and the unemployment issue. Even if they are not themselves unemployed, they have cut back in case they do find themselved in that position. This is mostly a question of consumer confidence and a bit of a Catch-22. Consumers won't spend like they used to until unemployment goes down and unemployment won't go down much until consumers start spending (giving employers a reason to hire more people). That means that the unemployment picture will probably not change much for several years. That also means that consumers will not be borrowing and spending money- the other way "all that money" could get out into the system.

And that in turn brings us back to the first issue- the money the Fed has (and says they will continue to) added to banks. For the reasons I just listed, I don't think we face the inflationary risk from that money for several years also.

So what might happen when the money does eventually start to flow. As I pointed out, the reason the money flows is because the economy is growing. If the economy is growing, there is no reason for the price of stocks to collapse. In fact, they should be rising. So if stocks are not collapsing then the rest of the scenario is not likely either.

Just my opinion of what may happen.

[Zippyjuan]

Companies will raise wages for workers if they cannot attract enough qualified employees. That does not seem to be a problem right now. These days most companies are looking for ways to reduce their costs- and labor is the biggest cost- so they are not likely to be looking to increase that buy increasing wages. What you say has indeed happened and is certainly possible, but not likely in my opinion at this time.

[hugolp]

Companies will raise wages for workers if they cannot attract enough qualified employees. That does not seem to be a problem right now. These days most companies are looking for ways to reduce their costs- and labor is the biggest cost- so they are not likely to be looking to increase that buy increasing wages. What you say has indeed happened and is certainly possible, but not likely in my opinion at this time.

Not in the present. I agree with krazy kaju that we are seeing a smaller second credit crunch like in 2008, but it will be short. Specially because Bernanke, with the help of the primary dealers, wont allow it. Bernanke wants stocks to go up. In less than a year you will see how commodity prices start to affect consumer prices and workers will start demanding higher wages.

[Zippyjuan]

I would agree that there certainly will (and probably will) be some further economic challenges (they happen even in good times- they just get noticed less). I do think it is difficult for employees to try to demand higher wages- afraid that their employer might decide to hire somebody else to take their job. What do you think about Kaju's theory of stocks collapsing and that in turn collapsing the banks? I think that is completely wrong.

[hugolp]

I would agree that there certainly will (and probably will) be some further economic challenges (they happen even in good times- they just get noticed less). I do think it is difficult for employees to try to demand higher wages- afraid that their employer might decide to hire somebody else to take their job. What do you think about Kaju's theory of stocks collapsing and that in turn collapsing the banks? I think that is completely wrong.

I agree that we are seeing a second credit crunch. That is all.

I also dont understand much of his banking collapse theory. I would need to hear the whole reasoning behind to give an opinion.

What do you thing workers will do when the prices of food, energy, clothes, etc... raise due to raising commodities? They will sit idle and accept it, while the company is earning more due to higher prices? I dont think so. You can see how Google just raised 10% to all its employees (10% raise to all its employees its a lot, a lot!). Its not going to happen, its already happening: http://online.wsj.com/article/SB10001424052748703523604575605273596157634.html?m od=WSJ_hp_LEFTWhatsNewsCollection#ixzz14t7pVMbB

[Zippyjuan]

Google's profits were also up 32% and revenue was up 26% in the third quarter so they could easily afford the raises. http://www.guardian.co.uk/technology/2010/oct/15/google-profits-rise There are certainly some industries which require more specialized labor and face competition for those workers but probably most jobs can easily substitute labor (technology improvements has lowered the required worker skills needed to perform a job in many industries).

With unemployment being high, I think the power of the employees to "demand" higher wages is pretty low. Consumers will have to again shift what they spend money on. If people do start to try to demand higher wages to try to keep up with higher inflation, that only serves to increase the rate of inflation further (which we have seen in the past).

[eugenekop]

f people do start to try to demand higher wages to try to keep up with higher inflation, that only serves to increase the rate of inflation further (which we have seen in the past).


Can you explain the mechanism behind this?

[Zippyjuan]

Companies raise prices for two reasons- assuming they can. One is to increase profits. The other is to cover rising costs of producing goods. Costs of production include both raw materials and labor. If labor is demanding more money, that increases the costs of production so the company will raise their prices to cover those higher labor costs.

[hugolp]

If people do start to try to demand higher wages to try to keep up with higher inflation, that only serves to increase the rate of inflation further (which we have seen in the past).

And with Bernanke printing machine sending commodity prices up and up, what are workers supposed to do? Sit and see how they become poorer and poorer? Just stop eating meet and only eat rice?

Rising prices do not come from rising wages. Rising prices and rising wages are just effects of the money printing. I can show you crisis that did not solve through money printing and they had deflationary recoveries as productivity increased.

[eugenekop]

But rising prices can also come from larger money supply, right? If people stop hoarding money and start spending it, the demand for goods will go up and so the prices will go up. All this without money printing.

[hugolp]

But rising prices can also come from larger money supply, right? If people stop hoarding money and start spending it, the demand for goods will go up and so the prices will go up. All this without money printing.

The ultimate source of higher prices in the long run is always an increase in the money supply. The discussion is more on how an increase of the money supply is going to affect the market and how and when the rise in prices is going to manifest. It can take years for the full effects of monetary policy to appear in the market, specially in this economic times because the banking system is bankrupt and credit is not flowing.

[Zippyjuan]

And with Bernanke printing machine sending commodity prices up and up, what are workers supposed to do? Sit and see how they become poorer and poorer? Just stop eating meet and only eat rice?

Rising prices do not come from rising wages. Rising prices and rising wages are just effects of the money printing. I can show you crisis that did not solve through money printing and they had deflationary recoveries as productivity increased.

How do you think people will be able to react? If prices go up by ten percent a year can they demand a ten percent raise from their employer? Will their employer be forced to give it to them? If he does give them a raise, will he take that cost out of his profits or try to pass it along in the form of even higher prices which means more inflation?

[Zippyjuan]

The ultimate source of higher prices in the long run is always an increase in the money supply. The discussion is more on how an increase of the money supply is going to affect the market and how and when the rise in prices is going to manifest. It can take years for the full effects of monetary policy to appear in the market, specially in this economic times because the banking system is bankrupt and credit is not flowing.

I agree with you here.