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.. also known as a "depression".
Don't need a spiffy new term here.
http://www.rgemonitor.com/roubini-mo...liquidity_trap
I have been warning since January 2008 that the biggest risk ahead for the US and the global economy is one of a stag-deflation, the deadly combination of an economic stagnation/recession and deflation.
Let me discuss the details of this toxic mixture of deflation, liquidity trap, debt deflation and rising household and corporate defaults:
We Are Close to Deflation and Stag-Deflation
First of all, signs of stag-deflation now are clear: we are in a severe recession and now the recent readings of both the PPI and the CPI are showing the beginning of deflation. Slack in goods markets with demand falling and supply being excessive (because of years of excessive overinvestment in new capacity in China, Asia and emerging market economies) means lower pricing power of firms and need to cut prices to sell the burgeoning inventory of unsold goods; slack in labor markets with sharp fall in employment and sharp rise in the unemployment rate means lower wage pressures and lower labor cost pressures; and slack in commodity markets – that have already fallen by 30% from their summer peaks and will fall another 20-30% in a global recession – means lower inflation and actual deflationary forces. Given a severe US and global recession deflation will soon be a reality in the US, Japan, Switzerland, UK and, down the line, even in the Eurozone and other economies.
The Risk of a Liquidity Trap
When deflation sets in central banks need to worry about it and worry about a liquidity trap. Take the example of the 2001 recession: that was a mild 8 months recession in the US and over by end of 2001. But by 2002 the US inflation rate had fallen towards 1% (effectively 0% or negative given imperfect measurement of hedonic prices) that the Fed was forced to cut the Fed Funds rate to 1% and Ben Bernanke - then a Fed Governor – was writing speeches led “Deflation: Making Sure “It” Does Not Happen Here” meaning it would not happen in the US as Japan was already in a deflation at that time. So if a mild recession – that was not even global – led to deflation worries how severe deflation could be in a recession that even the IMF is now forecasting to be global in 2009?
When economies get close to deflation central banks aggressively cut policy rate but they are threatened by the liquidity trap that the zero bound on nominal policy rates implies. The Fed is now effectively already in a liquidity trap: the target Fed Funds rate is still 1% but expected to be cut to 0.5% in December and down to 0% by early 2009. Also, while the target rate is still 1% the effective Fed Funds rate has been trading close to 0.3% for several weeks now as the Fed has flooded money markets with massive liquidity injections; so we are effectively already close to the 0% constraint for the nominal policy rate.
Why should we worry about a liquidity trap? When policy rates are close to zero money and interest bearing short term government bonds become effectively perfectly subs utable (what is a zero interest rate bond? It is effectively like cash). Then further open market operations to increase the monetary base cannot reduce further the nominal interest rate and therefore monetary policy becomes ineffective in stimulating consumption, housing investment and capex spending by the corporate sector: you get stuck into a liquidity trap and more unorthodox monetary policy actions (to be discussed below) need to be undertaken.
The Costs and Dangers of Price Deflation
Before we discuss the monetary policy options in a deflation and liquidity trap let us consider the costs and dangers of deflation.
First, if aggregate demand falls sharply below aggregate supply then price deflation sets in (and indeed there is already massive price deflation in the US in the sectors – housing, autos/motor vehicles and consumer durables – where the excess inventory of unsold goods is huge). The fall in prices and the excess inventory of unsold goods forces firms to cut back production and employment; the ensuing fall in incomes leads to further fall in demand and induce another vicious cycle of falling prices and falling production/employment/income and demand.
Second, when there is deflation there is no incentive to consume/spend today as prices will be lower tomorrow: buying goods today is like catching a falling knife and there is an incentive to postpone spending (consumption and investment spending) until the future: why to buy a home or a car today if its price will fall another 15% and purchasing today would imply having one’s equity in a home or a car fully wiped out in a matter of months? Better to postpone spending. But this postponing of spending exacerbates the vicious cycle of falling demand and supply/employment/income and prices.
Third, when there is deflation real interest rate are high and rising in spite of the fact that nominal policy rates are zero. If the policy rate is zero and there is a 2% deflation the real short term policy rate is actually a positive 2% that further depresses consumption and investment; and real long-term market rates are even higher with deflation – as discussed in detail below – as market rates at which firms and households borrow are much higher than short term policy rates.
The Deadly Deeds of Debt Deflation
Fourth, deflation also leads to the nightmare of debt deflation, a situation well analyzed by Fisher during the Great Depression. If debt liabilities are in nominal terms (D) and at a fixed long term interest rate (i) a reduction in the price level (P) increases the real value of such nominal liabilities (D/P goes up); so debtors that are already distressed in a recession and deflation become even more distressed as the real burden of their liabilities (D/P) sharply rises.
Another complementary way to see the perverse effects of debt deflation is to notice that the ex-post – as opposed to the ex-ante –real interest rate faced by borrowers sharply rise. Suppose you are a firm or household that had borrowed – say a 10 year mortgage or a 10 year corporate bond – at an interest rate (i) of 5% at the time when inflation (dP/P) was expected to remain at 3%; then the real ex-ante real cost of borrowing (r= i – dP/P) was only 2% (the difference between 5% and the expected inflation of 3%). Now suppose that, ex-post, the economy falls into a deflation trap and prices are now falling at 2% annual rate and expected to fall as much for a number of years. Now the ex-post real interest rate (r= i – dP/P) on that borrowing rises from 2% ex-ante to an actual ex-post 7% (5% - (-2%)). Thus, ex-post unexpected deflation sharply increases the real interest rate faced by borrowers or, equivalently, sharply increases the real ex-post value of their real liabilities (D/P).
Things are even worse if the debtor had borrowed to finance the leverage purchase of assets whose prices is now falling. Suppose you are a household who borrowed at a 5% mortgage rate to purchase a home whose price is now falling at an annual rate of 15%. Then the effective real interest rate that you are facing on your debt is not 5% but a whopping 20% (the sum of the 5% mortgage rate plus the 15% fall in the price of the underlying asset) that soon leads you into the depth of negative equity into your home. Thus, leveraged purchase of assets whose price is falling is an even more deadly form of debt deflation.
In all of its forms and manifestations debt deflation sharply increases the risk that borrowers will be forced to default on real obligations that they cannot service. Thus, debt deflation is associated with a sharp rise in corporate defaults and household defaults that creates a spiral of deflation, debt deflation and defaults.
High Market Real Interest Rates and Costs of Borrowing in a Deflation/Liquidity Trap
In situations of deflation and liquidity trap traditional monetary policy becomes pathetically ineffective. Consider now why monetary policy is ineffective. The real long-term interest rate faced by borrowers (say a mortgage holders who has a 10 year fixed rate mortgage or a corporate who issues a 10 year nominal rate bond) is given by the following expression:
Real Long Term Market Rate = (Nominal Long Term Market Yield – Inflation Rate) = (Nominal Long Term Market Yield – Long Term Government Bond Yield) + (Long Term Government Bond Yield – Fed Funds Rate) + Fed Funds Rate - Inflation Rate
Similarly the real short-term interest rate faced by borrowers (say a mortgage holder who has a variable rate mortgage or a consumer with credit card debt or a corporate who issues short term commercial paper) is given by the following expression:
Real Short Term Market Rate = (Nominal Short Term Market Yield – Inflation Rate) = (Nominal Short Term Market Yield – 3 month Libor rate) + (3 month Libor rate – Fed Funds Rate) + Fed Funds Rate - Inflation Rate
The first expression above shows clearly that even if the policy rate (the Fed Fund rate) is 0% the long term real interest rate faced by market borrowers can be very high for three reasons:
1. For any given nominal market rate there is deflation that increases real rates
2. The spread between the nominal market rate and the long term nominal yield on safe government bonds (representing the credit spread) can be high and rising
3. The spread between the nominal government bond yield and the policy rate (the yield curve spread) can be high and rising
A similar three-part decomposition holds for the short term real market rate that depends on deflation, on the spread between market rates and the short –term Libor rate and the spread between short term Libor and the policy rate.
Now, in a situation of a liquidity trap all three factors described above keep real long term market rates high and rising in spite of falling policy rates (that end up with the Fed Funds rate down to zero). First, the credit spread has widened for high yield corporates from 250bps in June of last year to a whopping 1600bps in recent days; even the credit spread for high grade corporate has gone from 50bps to 400-500bps. Second the spread between long term government bonds and the Fed Funds rate has sharply increased as the Fed Funds rate has been reduced from 5.25% to 1% (soon 0%) while long bond yields have fallen very little (about 100bps). Third, inflation is sharply falling and deflation is over the horizon.
The same holds for the sharp increase in real short term market rates since the beginning of the liquidity crunch in money markets and short term debt markets: a rise in the spread between market rates (say credit cards or commercial paper) and 3 month Libor; a rise in the spread between 2 month Libor and the policy rate (or variants of the same such as the TED spread or the Libor-OIS spread); a fall in inflation and the onset of deflation.
“Crazy” Monetary Policy to Address the Liquidity Trap and a Severe Liquidity and Credit Crunch
To address the increase in real short term market rates the Fed and other central banks have already undertaken quite unorthodox monetary policy moves. To address the even more severe increase in real long term market rates the Fed and other central banks will have to undertake even more radical and unorthodox policy actions.
The widening of the real short term market rates has been addressed by creating a whole series of new liquidity facilities (the TAF, the TSLF, the PDCF, the swap lines with foreign central banks, the new commercial paper facility). Some of these facilities have been aimed at reducing the sharply rising TED spread, Libor-OIS spread, Libor-Fed Funds spread. While other of these facilities – such as the new commercial paper facility (that has the acronym of ABCPMMMFLF) have had the aim of reducing the sharply rising spread between short-term market rates (such as commercial paper rates) and the policy rate (or the 3 month T-bill rate). Flooding money markets with massive amounts of liquidity and with a massive swap of illiquid assets sitting on the balance sheet of banks and broker dealers (MBS, etc.) for safe Treasuries has finally started – after 12 months of rising spreads – to reduce such Libor versus safe assets spread.
Indeed, the Fed and other central banks that used to be the “lenders of last resort” have become the “lenders of first and only resort” as banks don’t lend to each other, banks don’t lend to non-bank financial ins utions and financial ins utions don’t lend to the corporate and household sectors.
However, in spite of the Fed becoming the lender of first and only resort (even the corporate CP market is now being propped by the new Fed facility) there are still major problems that remain seriously unresolved in short term money markets and short term credit markets:
- Such Libor spreads are rising again in recent days; and they are still very high – at the 3 month maturity – compared to what they were before this liquidity crunch;Even “Crazier” Policy Actions Are Required to Reduce Long Term Market Interest Rates
- banks and other financial ins utions are still not lending to each other in spite of lower spreads as they need the liquidity received by the Fed and they worry about the solvency of their counterparties;
- only banks and major broker dealers have access to these facilities and thus most of the shadow banking system does not have access to this Fed liquidity;
- market spreads as still rising and the availability of short term credit is becoming tighter as banks increase interest rates on credit cards, student loans and auto loans and make such loans in scarcer supply;
- only rated investment grade corporate have access to the commercial paper facility leaving millions of speculative grade or non-rated firms in an even bigger liquidity and credit squeeze;
- securitization of credit cards, auto loans, student loans is currently dead.
This is why now a desperate Treasury is starting to think about using the remaining TARP funds to directly unclog the unsecured consumer debt (credit cards, student loans, auto loans) market and the securitization of such debt. Desperate times required desperate and extreme actions.
But even more desperate or “crazier” monetary actions are needed to address the increase in real long term market rates. These actions are needed to prevent deflation from setting in, to reduce the credit spread (the difference between long term market rates and long term government bond yields) and to reduce the yield curve spread (the difference between long term government bond yields and the policy rate).
There are a number of tools that the Fed could use to reduce the yield curve spread when the Fed Funds rate is already done to zero. First, the Fed could commit to maintain the Fed Funds rate down to zero for a long period of time: since long term government bond yields are – based on the expectation hypothesis – equal to a weighted average of current short term government bond yields and current expectations of what those short term bond yields will be for the foreseeable future a commitment to keep the Fed Funds rate down to zero for a long time will affect expectations of future expected short rates and could reduce long term government bond yields. Even this action may not be sufficient to reduce long yields on safe assets as such long yields also depend on liquidity premia and risk premia that will not be affected by expectation of future short rates. Greenspan discovered the “bond market conundrum” when raising the Fed Funds rate from 1% to 5.25% did not change much long rates and Bernanke rediscovered this conundrum when reducing the Fed Funds rate down to 1% failed to significantly reduce long rates. Such long rates depend in part on the global supply of savings relative to the demand for investment; thus they are not likely to be strongly affected by current and future expected policy rates.
Second, the Fed could do what it last did in the 1950s: directly purchase long term government bonds as a way of pushing downward their yield and thus reduce the yield curve spread. But even such action may not be very successful in world where such long rates depend as much as anything else on the global supply of savings relative to investment. Thus, even radical action such as outright Fed purchases of 10 or 30 year US Treasury bonds may not work as much as desired.
Next, the Fed could try to directly affect the credit spread (the spread between long term market rates and long term government bond yields). Radical actions could take the form of: outright purchases of corporate bonds (high yield and high grade); outright purchases of mortgages and private and agency MBS as well as agency debt; forcing Fannie and Freddie to vastly expand their portfolios by buying and/or guaranteeing more mortgages and bundles of mortgages; one could decide to directly subsidize mortgages with fiscal resources; the Fed (or Treasury) could even go as far as directly intervening in the stock market via direct purchases of equities as a way to boost falling equity prices. Some of such policy actions seem extreme but they were in the playbook that Governor Bernanke described in his 2002 speech on how to avoid deflation. They all imply serious risks for the Fed and concerns about market manipulation. Such risks include the losses that the Fed could incur in purchasing long term private securities, especially high yield junk bonds of distressed corporations. In the commercial paper fund the Fed refused to purchase non-investment grade securities. Even high grade corporate bonds are not without risk as their spread have massively widened in recent months from 50bps over Treasuries to levels in the 500bps plus range. Also pushing the insolvent Fannie and Freddie to take even more credit risk may be a reckless policy choice. And having a government trying to manipulate stock prices would create another whole can of worms of conflicts and distortions.
Finally, the Fed could try to follow aggressive policies to attempt to prevent deflation from setting in: massive quan ative easing; flooding markets with unlimited unsterilized liquidity; talking down the value of the dollar; direct and massive intervention in the forex to weaken the dollar; vast increase of the swap lines with foreign central banks (an indirect and disguised form of forex intervention) aimed to prevent a strengthening of the dollar; attempts to target the price level or the inflation rate via aggressive preemptive monetization; or even a money-financed budget deficit (an idea suggested by Bernanke in 2002 that he termed to be the equivalent of an “helicopter drop” of money in the economy). The problem with many of these “extreme” policy actions – as well as some of the ones described above to affect the relevant spreads – is that they were tried in Japan in the 1990s and the last few years and they miserably failed: once you are in a liquidity trap and there are fundamental deflationary forces in the economy as the excess aggregate supply of goods is facing a falling aggregate demand it is very hard even with extreme policy actions to prevent deflations from emerging.
Some very aggressive policy actions – such as letting the dollar weaken sharply – may do the job but they may also be beggar-thy-neighbor policies that would export even more deflation to other countries: a much weaker dollar would mean a much stronger value of other currencies that would reduce aggregate demand abroad and exacerbate their deflationary pressures as their import prices would sharply fall.
And indeed with global – rather than U.S. alone – deflationary forces setting in the global economy dealing with global deflation becomes much harder. The world economy has been massively imbalanced for the last decade with the U.S. being the consumer of first and last resort, spending more than its income and running ever larger current account deficits while creating a massive excess productive capacity via overinvestment; while China and other emerging markets have been the producers of first and last resort, spending less than their income and running ever larger current account surpluses. With U.S. spending (consumption, residential investment, capex spending) now faltering and structural rigidities to a rapid growth of domestic consumption demand in China and emerging market economies, a global glut of unsold goods may lead to persistent and perverse deflationary forces that may last for a longer time unless proper policy actions – mostly non-necessarily monetary – are undertaken.
Thus, dealing with this deadly combination of deflation, liquidity traps, debt deflation and defaults that I termed as global stag-deflation may be the biggest challenge that U.S. and global policy makers may have to face in 2009. It will not be easy to prevent this toxic vicious circle unless the process of recapitalizing financial ins utions via temporary partial nationalization of them is accelerated and performed in a consistent and credible way; unless such actions are combined with massive fiscal stimulus to prop up aggregate demand while private demand is in free fall; unless the debt burden of insolvent households is sharply reduced via outright large debt reduction (not cosmetic and ineffective “loan modifications”); and unless even more unorthodox and radical monetary policy actions are undertaken to prevent pervasive deflation from setting in.
Thus, while the Fed may pursue radical, “crazy” and “crazier” monetary policy actions the true policy responses to the risk of deflation may lie elsewhere: when monetary policy is in a liquidity trap a properly-targeted fiscal stimulus is more appropriate and effective; cleaning up the financial system and properly recapitalize it is necessary; and debt deflation and debt overhang problems are more directly and properly resolved through debt restructuring and debt reduction than by trying to reduce the real value of such liabilities via higher inflation.
.. also known as a "depression".
Don't need a spiffy new term here.
When I see Dr. Roubini on CNBC in the mornings, I always wonder why that mofo cannot tie a tie properly. The er looks like he jjust worked an 18 hour shift.
"a spiffy new term"
stagflation is an OLD term from the 1970s.
Agree, but depression has been a rather loaded term since, well, the last one we called a depression.
I keep reading that pumping so much $$$, $Ts, into the US money supply will typically lead to, when consumption creeps up, to hyper-inflation.
http://www.bloomberg.com/news/2013-1...on-danger.htmlWhile declining costs for everything from gasoline to coffee can be good news for consumers, disinflation makes it harder for borrowers to pay off debts and businesses to boost profits. The greater danger comes when disinflation turns into deflation, which leads households to delay purchases in anticipation of even lower prices and companies to postpone investment and hiring as demand for their products dries up.
“There is definitely a whiff of disinflation again taking hold globally,” Robert Sinche, global strategist at Pierpont Securities Holdings LLC in Stamford, Connecticut, said Nov. 5 on Bloomberg Radio’s “Bloomberg Surveillance.”
Federal Reserve Chairman Ben S. Bernanke and his central-bank counterparts are trying to avert the deflationary danger by pumping up their economies with lower interest rates and monetary stimulus. They have bet the run-up in stock and home prices they’ve engineered would boost consumer and corporate confidence and spur faster growth and higher inflation. Now they’re having to maintain or intensify their aid -- running the risk those efforts do more harm than good by boosting equity and property prices to unsustainable levels.
“You have a wall of liquidity” that’s “leading to asset inflation and eventually to bubbles,” Nouriel Roubini, chairman of Roubini Global Economics LLC, said Nov. 7 on Bloomberg Television’s “Street Smart.”
http://www.bloomberg.com/news/2013-1...-slowdown.htmlWorker productivity, a key component of an economy’s health, has risen at an annual clip of 1 percent during the last four years, as the U.S. has struggled to recover from the worst recession since the Great Depression. That’s less than half the 2.2 percent average gain since 1983, according to data from the Labor Department in Washington.
“Slower growth in productivity might have become the norm,” the central bankers noted at their Oct. 29-30 meeting, according to the minutes released last week. That’s a switch from past comments by Bernanke that the deceleration probably was temporary and would end as the expansion continued.
A combination of forces may be at work. Chastened by the deep economic slump, corporate executives have reduced spending plans for factories, equipment, research and development. Startup businesses have been held back as would-be entrepreneurs find it harder to get financing from still-cautious lenders. And out-of-work Americans have seen their skills atrophy the longer they’re without jobs.
“We’re in a slow-growth period of unknown duration,” said Edmund Phelps, a professor at Columbia University in New York and winner of the 2006 Nobel prize in economics.
but but but ...
Repugs said Obama's stimulus (too small by a couple $T), of 4+ years ago, will cause SOOPER DOOPER WHOPPER MEGA HYPER INFLATION!
Were Repugs LYING? LOL
Were Repugs denying economic growth and job creation JUST TO SCREW THE ECONOMY and WORKERS to cause Obama to fail and tatoo him with failure exclusively? LOL
How idiotic. The GOP isn't causing global deflationary headwinds.
How idiotic.
The Repugs blocking a stimulus of the size necessary to address the Banksters Great Depression would have made the US economy an engine pulling along other economies, like Europe, as it has in the past and even as has Germany.
a stimulus that size never got proposed. blame Obama for keeping it too small: he could have proposed on big enough to do what you say could have been done; he didn't.
the Repugs, tea baggers, VRWC, Fix The Debt (austerity lovers) billionaires, Fox, the entire right wing hate and lie machine was screaming "HYPER INFLATION JUST AROUND THE CORNER DUE TO OUT-OF-CONTROL govt spending and if the a large stimulus was passed. The too-small stimulus barely passed anyway, was all that was politically possible. And the Repug propaganda has since foreclosed on any possibility of another stimulus of any size.
Last edited by boutons_deux; 11-29-2013 at 01:57 PM.
the Dems gave up on it; you don't even hear them talking about it.
Typical Dems, intimidated by the crazy-ass, spittle-spewing. constipated Repugs.
NOBODY in DC is talking about stimulus or jobs or the upcoming disaster of the next round of sequester cuts, which the Repugs and tea baggers WANT to happen to continue to make the economy as bad a possible for the '14 and '16 elections (didn't work in in the years before '12).
http://www.reuters.com/article/2013/...0JG0DZ20131201An American who won this year's Nobel Prize for economics believes sharp rises in equity and property prices could lead to a dangerous financial bubble and may end badly, he told a German magazine.
Robert Shiller, who won the esteemed award with two other Americans for research into market prices and asset bubbles, pinpointed the U.S. stock market and Brazilian property market as areas of concern.
"I am not yet sounding the alarm. But in many countries stock exchanges are at a high level and prices have risen sharply in some property markets," Shiller told Sunday's Der Spiegel magazine. "That could end badly," he said.
"I am most worried about the boom in the U.S. stock market. Also because our economy is still weak and vulnerable," he said, describing the financial and technology sectors as overvalued.
He had also looked at "drastically" higher house prices in Rio de Janeiro and Sao Paulo in Brazil in the last five years.
"There, I felt a bit like in the United States of 2004," he said, adding he was hearing arguments about investment opportunities and a growing middle class that he had heard in the United States around the year 2000.
The collapse of the U.S. housing market helped trigger the 2008-2009 global financial crisis.
"Bubbles look like this. And the world is still very vulnerable to a bubble," he said.
Bubbles are created when investors do not recognise when rising asset prices get detached from underlying fundamentals.
blowing bubbles is how the financial sector rapes the rest of us.
online advertizing bubble:
http://www.chaosisgood.com/2013/11/t...n-valleys.html
http://blogs.reuters.com/jackshafer/The speed with which Google transitioned from a university research project to a media colossus impels the belief that the complete eclipse of traditional media is unstoppable. In about a dozen years, Google has reordered the media cosmos: It will take in 33 percent of all global digital ad revenue — approximately $38.6 billion — this year, six times that of the first runner-up, Facebook, according to eMarketer. It will also collect more than 50 percent of all mobile advertising. Its annual ad revenues now surpass those of the entire newspaper industry (as well as the entire magazine industry), as Business Insider recently informed us. “The growth of internet advertising revenue has outpaced other media every year since 2005,” Marketing Land reported earlier this year, with the Internet vying with domestic broadcast TV for ad revenue primacy.
http://www.cnbc.com/id/101235633Margin debt—a measure of how much market participants are borrowing to buy stocks—has soared to $412.5 billion on the New York Stock Exchange. The number represents a 13.2 percent gain from the beginning of 2013 and is fully 50 percent higher than the level in January 2012
and if the stock market declines deeply (say, the next round of sequester cuts hits very hard), the margin calls will destroy the leveraged participants.
http://jaredbernsteinblog.com/in-dow...-last-quarter/I’ll get into the weeds later in the day, but here’s a bit of a shocker: real GDP grew only 0.1% in the first quarter of the year, according to this morning’s report from the Commerce Dept. That’s a huge deceleration from last quarter’s 2.6%, and well below analysts expectations of around 1.2%.
Remember, that 0.1% is an annualized number–the actual, quarterly percent growth of GDP was 0.03%, meaning that the real level of the value of goods and services in the US economy was essentially unchanged in the first three months of the year. That’s unusual and alarming, if it’s correct.
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