04 October 2009

Mish is right on deflation, but wrong on the cause

Mike Shedlock has posted another interesting article on the likelihood that severe deflation lies just ahead for the economy. Over-all, I agree with his points.

Travakoli makes six points about deflation. I concur with all of them. Here
are three of them.

  • Our fundamental financial and economic problems, i.e. overleveraging, lack of transparency, have not been solved.
  • Since 2008, capacity utilization has plummeted; businesses have no pricing power; U.S. lost 6.7 million jobs but numbers are underreported; personal income tax receipts are down 21%; corporate tax receipts are down 58%; U.S. deficit will exceed $1.8 trillion; govt. spending is now 185% of tax receipts; 13% of mortgages are seriously delinquent and/or in foreclosure; huge decrease in personal net worth; 15 million mortgages exceed the home value. We’re on a massive debt spending spree.
  • Income on all levels is not sufficient to make debt payments.

However, I disagree with the explanations for the cause of the current crisis. Mike agrees with Travakoli’s condemnation of bankers and regulators for imprudent, and immoral, behaviour.

At its core," Tavakoli observes, "the mortgage crisis is no more sophisticated
than a schoolyard swindle, and the SEC is the principal."

The debt bubble was a broad societal phenomena, in which everyone played a role. Bankers took on imprudent risks, and regulators let them. At the same time, however, investors were willing to turn their heads to obviously questionable dealings of the firms they put their money into, and consumers were also willing to gorge at the debt troughs, taking on mortgages that they knew they couldn’t pay, in the hope of getting rich with asset appreciation. It is so eye-opening to read about how many of the investors in Bernie Madoff's investors knew he was up to something since the returns were too good to make sense, but they kept their money with him because they simply figured he was breaking the law by getting access to insider information or such like.

The old adage of con-men, about how you can only cheat a crooked person, is very apt. The crazy schemes of the bubble era only worked because there were SO many people willing to knowingly participate in scams. Even if individuals didn’t understand the full depth of the malfeasance that was taking place, they knew full well that something was up. The janitor who got a million dollar loan to purchase homes with 100% financing knew full well that there was no rational reason for the people giving him the loan to do so unless they had some sort of scheme up their sleeves.

My disagreement as to the cause of the debt bubble, and resulting crash, is critical. If my belief is true (that the bubble was a result of a societal wide psychological delusion), then there really isn't anything wrong in the structure of the economy, or regulatory bodies, per-se. We may simply be dealing with nothing more than the ebb and flow of long-term cyclical swings in societal attitudes.

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