Friday, 6 March 2009

An Update On Inflation And Economy

As I have been saying there is no risk of high inflation for at least two years. It does not mean that the situation will change after that but instead it will depend on whether or not the economy and financial systems have been stabilized.

Let's hear what Mr Jean-Claude Trichet, president of the European Central Bank, had to say, and he is the only banker that I think can be listened seriously - the other are just reckless and only aim to make a quick fortune, rip off investors and shift the risks to their client and finally to the taxpayer-.

So Coming back to Mr Trichet, - after a few seconds anti stress banker punching- ...

As you know, the ECB has reduced the interest rates to 1,5% which is historic, it has never been so low - that tells you how serious is the situation-. The ECB has as well hinted that they will continue decreasing the base rate: my guess is that they will push it to 1% this june and they will wait at this level for a quite long period.

Here is the fact that make think they have not yet finished with rate cuts:

"As I said, we did not decide ex-ante that we were at the lowest level. If justified by facts and figures, if some of the risks that I mentioned are materialising, I clearly won’t rule out the main policy rate being changed, indeed going down. That is clear."

Let's examine key points of the ECB statements:

"Overall, inflation rates have decreased significantly and are now expected to remain well below 2% over 2009 and 2010.

This outlook for inflation is due to the fall in commodity prices and diminishing domestic price and cost pressures, reflecting the severe downturn in economic activity."

So you can expect to have interest rates to stay at 1% for until at least end of 2010. They cannot add more debt on top of an ever growing debt burden in a deflationary environment.

"Looking ahead, the Governing Council expects that both global and domestic demand will decline in 2009 but thereafter recover gradually.

This assessment is also reflected in the March 2009 ECB staff macroeconomic projections for the euro area, which place annual real GDP growth in a range of -3.2% to -2.2% in 2009, and between -0.7% and +0.7% in 2010."
I suppose they ought to be optimistic for 2010. You cannot hide the fact that 2009 will be the worse economical episode witnessed since a very long time. They denied it last year, now they state the fact otherwise they will lose their credibility.

Having said that I have to highlight that the ECB has had a very good track record on their economical forecasting (contrary to the finance ministers around the world, which after all are political branches, that mislead openly their client i.e the citizens).

Of course it supposes that the measure they have taken and government stimulus around the world, are the right one and see their effect in 2010.

So 2010 will be a key year , such as was 1990, 1980, 1970 ... 1940, 1930 etc... looks like every decade the lesson learned vanish to be replace by greed and can't help it, it is the human side.

Of course the ECB will fight hard the fact that they will achieve price stability, which in our context mean, the risk of deflation:

"We are looking very carefully and constantly at the possible risk of deflation.

The conclusion of the international institutions in general is that such risks are very minimal in our case.

And one of the reasons why they are very minimal is that, to substantiate deflation, not only inflation on the basis of the CPI observed during a sufficiently long period of time must be negative but must it must also drive inflation expectations themselves to be negative, so that you have the downward spiral that characterises deflation.
I still think that the risk of a deflation spiral is far bigger than the contrary hence the reason that central bank around the world have cut rates to around ZERO percent (UK,US,Japan, Canada, Switzerland etc...)

In such conditions, investing large amount of money in one asset is foolish, risky and could jeopardize your stress balance.

I would like to highlight that most probably, the stock market will start a rally (from Monday?) for few weeks if not months, so maybe there will be a good opportunity for small investment and make some small profits - not taking big risks. This is the opinion of an amateur and this is no way a recommendation to be followed (see you bank adviser...sorry, better to avoid them...maybe ask the taxi driver or the barber, they might not know more but at least they are honest and not interested in sucking your capital). It is just an idea, a speculative one.

But bear in mind, the stock market has not yet bottomed and who knows when it will. The stock market up to now has already priced a very bad 2009 amid massive deleveraging, and has price a bad 2010. So my guess , is that the stock market will rally with the view that 2010 will not be as bad...but to only to be deceived and will continue its bloody correction at some the reversal could be quite fast so the risk in being in the stock market.

In any case, cash is king. Staying away from any investments is probably the best strategy for the time being if you are risk averse and do not understand the stock market. And personally I will never invest more than 30% of my savings in stocks or anything else.

This crisis is far from being finished and interest rates cut will not be the cure.

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Billpete002 said...

Also, the EU is in much dire straights than the US - the US has 1 currency and 1 central bank and 1 treasury.

The EU doesn't completely have a single treasury and each country has its own treasury or banking system this makes 700$ billion bailouts impossible.

Also, Germany is now taking the stance of not bailing out the Balkans and Eastern Europe (what it has done in the past) so this spells the doom for many of these countries financial or even political systems in the near future.

Interestingly, even though the US may have caused this recession/depression/regression (whatever you wanna call it!) it is poised to actually be the best country to come out of it!

Very interesting indeed..

HousingFinland said... in the 30's? however the ECB (ex-Bundesbank) has learned the hard lesson from the 30's...and of course the context was different, Europe at that time, had just exited the first world war...

Billpete002 said...

Dr. Ferguson puts it in perspective better than I can. He has a bunch of videos up on YouTube.

Anonymous said...

Nice clarification.

I copy here something for the other side of the reality. The problem is that US$ is sadly the base for any currency, including €. If US$ inflates, so does the others. What else can you do?


James Saft: Only way out is to inflate and default

Let Sleeping Shadow Banking Systems Lie

By James Saft
Friday, March 6, 2009

Rather than vainly trying to refloat the shadow banking system, the U.S. would be better off grappling with the inevitable ultimate solution -- debt destruction and inflation.

The common denominator of policies like the Term Asset-Backed Loan Facility (TALF) that was detailed on Tuesday, is that they try to solve fundamental problems with indebtedness by attempting to float asset prices high enough that they are back in proportion with the debt.

Even more, they use the same structures that worked out so poorly -- highly levered hedge fund like vehicles and securitisation -- but this time substitute government funding and leaves the taxpayer as main bag-holder if the deals go bad.

With up to $1 trillion, the TALF is designed to restart parts of the securitization market such as auto, business and student loans. This followed the plan to avoid foreclosures and further house price falls by cutting borrowers, many of whom made silly borrowing decisions, a break on their interest rates.

Next up: a public-private plan to buy up toxic legacy assets from banks, which should be detailed in the next two weeks. Again, that program will provide government money at sub-market rates to investors to entice them to pay more than the market price for assets that would otherwise sink many banks.

The higher the leverage supplied the higher the price hedge funds and other investors will pay for doubtful assets. After all, like a Florida condo flipper, if the asset declines in value they can just walk away and throw the metaphorical keys at the Federal Reserve and U.S. Treasury.

"We want to make sure that the prices of the assets that are purchased reflect true market values that are not overpaid. So the idea between the public-private partnership would be that there would be both public and private money involved and that the pricing decisions would be made by private-sector specialists, not by public bureaucrats," Fed Chairman Ben Bernanke told Congress on Tuesday.

"If the government is willing to provide longer-term lending, or leverage, there are many investors who presumably would be willing to buy under those circumstances who are unwilling to buy without the credit, without the lending they need to finance those purchases."

I simply cannot reconcile the first part of that statement with the second. What do we mean by "market values" in a situation where the government provides financing not otherwise available? Vary the leverage and achieve any price you like.

... Living in a cash-flow world

The TALF is slightly more defensible. There is a market failure when reasonably good credits can't raise money under any circumstances. But before we try to restart securitization and the shadow banking system, let's recall what the problems were in the first place. For one thing the TALF relies upon imprimaturs from the credit ratings agencies which have been found wanting. That's not yet changed, but government participation simply papers it over.

Even the obsession with banks almost seems beside the point.

"You won't revive the economy through debt," said Albert Edwards, global strategist in London at Societe Generale.

"Banks aren't the problem. They are a symptom of the problem."

The problem is that asset prices are out of line with their ability to generate cash flow. Falling prices do impose a risk premium but the real issue, for stocks or for houses, is that their prices are not in the proper proportion to the debts they carry and to their ability to generate cash. That happened in part because of the shadow banking system and was a mistake.

So what's the implication? Some debt will be repaid but a lot will just be destroyed via default. An organized writedown seems impossible. That will be a huge problem for the banking system and the country, and you can understand why the government does not wish to meet it head-on.

University of Oregon economics professor Tim Duy thinks the U.S. will ultimately end its romance with financial engineering and get down to working through unsupportable debt the old-fashioned way -- inflation.

"And therein lies the key to predicting when the Fed shifts gears: when Bernanke abandons the notion that proper credit market functioning is alone sufficient to restore housing values (asset values more generally) to their former glory and support acceptable growth," Duy writes.

"At that point, the Fed will again consider the wisdom of what it has defined as quantitative easing, an expansion of the balance sheet via a deliberate expansion of liabilities."

That is a dangerous and difficult-to-govern process, and the U.S. shows every sign of being willing to pay a very high price to avoid it.

But ultimately the price will be too great and we will have to inflate and default in some mixture.


James Saft is a columnist for Reuters.

HousingFinland said...

"debt destruction and inflation."

I do not believe one seconds that it will be the path followed.

I understand that lot of people are advocating this path either by self-interest or simply by not understanding the objectives of all central banks.

In any case, what we have is deflation (or around zero inflation at best) and it will be with us for least 2 years or longer. In the meantime no worry about this hyper inflation scare.

Let's remind some point here. the people that have purchased a house in 1990, are only today breaking even at 20 years, for paying the mistake of buying at the wrong timing..of course some lost they house since unemployment then soared to about 20% at peak.

At the same time you had until 1990, a soaring inflation that turned into deflation in 1993 and disinflation for about 20 years.

Today we might be at this juncture.

Anonymous said...

Yes, the 90's story is a good example. Though, that was the little brother Finland's own story. At that time, the big brothers had not that same problem, and they lectured (or forced actually) Finland to follow the big brother's so-called free market rule. The result was certainly that way. But now, the "rogue" is the big brother himself, and the problem of the gambling and the potential gain of smashing the gambling table are so great. The "rogue" has started to change the so-called free market run already. I would like, but not sure if we could still follow the 90'2 story this time.

HousingFinland said...

"I would like, but not sure if we could still follow the 90's story this time."

The 90's scenario (Disenflation) is more likely than the 70's one (inflationnary).

One has to understand how the monetary policy will be conducted to really grasp how the economy will evolve in the next decade to come...instead of listening to certain media that were clearly unable to warn about this drastic correction and are now claiming to understand how the situation will evolve...

So I have no doubt with regard to inflation in the short term (2-5 years), after it's another story, we will see then.

That's the reason as well to think about taking a 20-25 years loan, that's just crazy... and I think with the current regulation coming it will not allow any more reckless banks to put family into targeted problems, without any cushion in case of an economical downturn.

Finland will start see the economical shockwave from mid this year and until most probably 2011 or 2012 if not longer due to the ticking retirement time bomb (no wonder that politicians are trying to buy time by pushing retirement age by few about having retirement at 150 years, that will resolve Finnish pension problem for sure).

And finally all around the world, debt will be erased ...through hard work. The heavily indebted will have to repay their debt though hard work...that's how you erase debt, and it will take time thus the sluggish growth in the year to come.

...and forget the housing market, growth will not exceed 1-2 % most probably for the generation but in the meantime a correction is on his way and will bring us to level compatible with the beginning of this decade: that's called cycles.

Rui said...

Finland's housing bubble is not that bad. Bring interest down to 0, then the total price loan + interest will be quite reasonable.

Compare with income level, if both man/woman has ok job, paying 200K loan is not a big problem. And right now, the average house hold housing loan in Helsinki in only 80K.

It is only 80K really !!! I see the figure from some news paper more than once, I was surprised by how little it is.

Anonymous said...

Rui, I understand you. Yes, if some one likes to have own house to live. One can buy it with whatever who like to pay, if one can really keep the dream with any costs. Though, housing for investment? Not for me now. I see the huge bubble there. I guess a telescope (even just x2) would help people to notice that. By the way, the Finnish elite have been very good to transfer all the shit as different heavy TAXes onto the normal people here, while they may not be powerful enough to put the shit to the € yet, even if they would like. I remember it is the little fox who enlightens the wolfs the idea of so called "good and bad banks." The Finnish elite take the good bank, and the normal people take the bad bank? What a wonderful game in the dream! Fortunately, the € can leave here easily, but not the highly floated bricks...

Rui said...

Price before 2005 was very ok. The bubble period is only from 2006 - 2008.

In 2003, in Helsinki you can buy a brand new 45 square meter apartment, with Sanna. with 90K. Right now price is crazy, same apartment they ask for 136K. 50% increase!

I believe the price will fall to 2003 - 2004 level. Not lower than that.

HousingFinland said...


Where Could housing Price Fall?, have a look at this link it gives you some hint to what we could have.

HousingFinland said...


As I said I took some position last monday, and now taking all the the bounce is a little bit too euphoric. I was expecting 10-20% in few weeks not days.

So I liquidated all my positions to be completely liquid as again the market is going ahead of itself.

That was just a trading update.

Rui said...

Too late, you should took all money out of stock market alreaday at 2007 end.

look at this ...

Anonymous said...

HousingFinland, Very nice, you predicted the recent "dead-cat-jump" rally. How do you predict it and its lasting period? With what kind of data and experience? Thanks advance!

HousingFinland said...

Regarding the timing of this rally... the market was oversold (RSI) and stocks such as Nokia have been sold quite severely in the past few a rebound had to happen and will push the overall market up.

Now if you combine that with the level of pessimism at that time (ratio put/call in the option market - CBOE) it gave a good signal that the bounce would happen whatever the news.

Then at the same time, you had critical banks that had reach multi year low : Citigroup + Bank of America...

Having said that,I would be very cautious now to stay longer in the market. So if you have made 10%-20%,you should be happy for the
short term...greed can punish you hard ;-> ...

And as you rightly say, this is only a "sucker rally", its length can vary from days, weeks or months, to suddenly reverse and take you by surprise..and they will be surprises.

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