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Notes to myself, possibly of interest to others.
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Friday, June 18, 2010

Rosenberg Daily - Deflation the norm; Inflation the exception

Go back and read the Homer and Sylla classic on the History of Interest Rates. Outside of wars, deflation is the norm, not the exception. The exception has been the experience of the post-WWII era.

The U.S. inflation rate peaked in 1980 at nearly 15%. By the summer of 2007, it was down to 3%. It had gone from 15% to 3% even though the baby boomer balance sheet exploded. The aggregate nonfinancial debt-to-GDP ratio surged from 135% to 220% over this timeframe, and yet the inflation rate collapsed by 12 percentage points. The reason was due to classic supply- related shocks — globalization, capital deepening, massive gains in technology, productivity, freer trade, lower marginal tax rates, which spurred the trend towards secular disinflation.

However, in mid-2007, the secular credit contraction came to a thundering halt. Deleveraging is the new secular trend, and since we entered the other side of the credit mountain, the inflation rate is down to 2% and the core rate of inflation is 90 basis points south of zero. Imagine that when the oil price was at $10 a barrel back in 1998, the core inflation rate was 2.5% and today, at $75 a barrel, the rate is below 1%. Now that is a deflationary stylized fact, if there was one.

The situation now is one of debt destruction, not debt expansion, and it is only a matter of time before we see prices in the aggregate start to deflate. We are not talking about 10% or 20% price declines — more like 2% to 3%. Enough to jeopardize the lofty earnings estimates embedded in equity market valuation, enough to thwart the progress needed to resolve our intractable deficit and debt problem and enough to take bond yields back down to their 2008 microscopic lows.
---Rosenberg, 6/18

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