Roubini Discusses the Double D's, Deflation and Depression

YahooFinance has an interesting article on Roubini called Rate Cuts Reduce Crash Risk, But Dow 7,000 Likely 'Sometime Next Year'


.... The financial market crisis has unfolded even quicker than Roubini expected (which is saying something), and the economist now thinks the Dow and S&P will suffer 50% declines from last October's peak vs. 40% previously.

In other words, the Dow is going to 7,000, but over the course of months vs. days if Roubini is right, as -- unfortunately for bulls -- he mostly has been for the past two years.

Because of growing slack in the global economy, Roubini says deflation is going to become a much bigger threat in the next six months vs. inflation. In such an environment, cash, Treasuries and gold are the only safe bets he says -- provided your holdings are within the FDIC's new $250,000 insurance cap.
Given that deflation is here right now, I concur that deflation is the bigger threat, except that "threat" is the wrong word. Necessity is more like it, because the malinvestments and excesses of the previous cycle must be purged and the pool of real savings replenished before there can be a sustainable recovery.

My views on treasuries and gold are as noted in Treasury Bull Alive And Kicking, written on September 5th.

Deflation Models

I had several models for how deflation might play out. Here they are.


Everything but treasuries sink
Everything but treasuries and gold sink
Gold sells off initially then rallies with treasuries

Yes, this treasury bull is extremely long in the tooth. And yes there will be a time to short treasuries. But there has not been a bull market in history, in anything, that ended with that asset class being nearly universally despised.

And make no mistake about it, treasuries are despised. Foreign central banks do not count because they are not buying treasuries to make a profit, and they are relatively unconcerned about losses.
See the above link for the case for deflation right here right now.

Risk Of Severe Global Depression

The YahooFinance article quoting Roubini was written on October 8th. A second article written by Roubini on October 9th warns of a global systemic financial meltdown and a severe global depression.

The US and advanced economies’ financial system is now headed towards a near-term systemic financial meltdown as day after day stock markets are in free fall, money markets have shut down while their spreads are skyrocketing, and credit spreads are surging through the roof. There is now the beginning of a generalized run on the banking system of these economies; a collapse of the shadow banking system, i.e. those non-banks (broker dealers, non-bank mortgage lenders, SIV and conduits, hedge funds, money market funds, private equity firms) that, like banks, borrow short and liquid, are highly leveraged and lend and invest long and illiquid and are thus at risk of a run on their short-term liabilities; and now a roll-off of the short term liabilities of the corporate sectors that may lead to widespread bankruptcies of solvent but illiquid financial and non-financial firms.

The crisis was caused by the largest leveraged asset bubble and credit bubble in the history of humanity were excessive leveraging and bubbles were not limited to housing in the US but also to housing in many other countries and excessive borrowing by financial institutions and some segments of the corporate sector and of the public sector in many and different economies: an housing bubble, a mortgage bubble, an equity bubble, a bond bubble, a credit bubble, a commodity bubble, a private equity bubble, a hedge funds bubble are all now bursting at once in the biggest real sector and financial sector deleveraging since the Great Depression.

And in a world where there is a glut and excess capacity of goods while aggregate demand is falling soon enough we will start to worry about deflation, debt deflation, liquidity traps and what monetary policy makers should do to fight deflation when policy rates get dangerously close to zero.

At this point the risk of an imminent stock market crash – like the one-day collapse of 20% plus in US stock prices in 1987 – cannot be ruled out as the financial system is breaking down, panic and lack of confidence in any counterparty is sharply rising and the investors have totally lost faith in the ability of policy authorities to control this meltdown.

When in markets that are clearly way oversold even the most radical policy actions don’t provide rallies or relief to market participants you know that you are one step away from a market crack and a systemic financial sector and corporate sector collapse. A vicious circle of deleveraging, asset collapses, margin calls, cascading falls in asset prices well below falling fundamentals and panic is now underway.

At this point severe damage is done and one cannot rule out a systemic collapse and a global depression.
So far, none of the liquidity measures taken by the Central Bankers have worked. The reason is simple: You Cannot Patch a Busted Dam With Water no matter how hard you try.

Mike "Mish" Shedlock

http://globaleconomicanalysis.blogspot.com/2008/10/roubini-discusses-double-ds-deflation.html

How can wages and prices continue upwards forever?

I live in North Jersey. A million dollar home is nothing special. I remember when a $100K home was.
A $100K salary is not considered high. I remember when $45K was big money. This goes back 30-40 years, an eternity. Since then we've had nothing but inflation and rising debt, personal and public.

It just defies common sense to think markets, prices, and wages can all continue to rise. And to what end? A $2,000,000 handyman special requiring a family income of hundreds of thousands of dollars?
A new car costing $30K, $50K and more. There are quite a few cars with a cost that approaches what I paid for my house 25 years ago. It is insane.

The banking system is built on unending inflation. When inflation exceeds population growth (about 0.5% at this point), this makes it easier to extend credit, since such credit is essentially borrowing from the future to pay for the present. Thus credit is only potential money. The problem with potential is that there must in fact be sufficient future earnings to pay for that potential money. We are all potential millionaires, but in point of fact few of us actually achieve this potential.

What is at the root of the crisis now is the dawning awareness that there is no cohesive mechanism by which all of this potential can be realized, and with it the realization that a huge amount of the money in the system now doesn't actually exist and may in fact never exist. The banks sold people on the notion that you could get something for nothing - just let us borrow your money and we'll make it work for you. Yet rather than those investments going into capital production, most of them went into arbitrage, creating complex bets based upon fluctuations in the semi-random generator known as the stock market.

The market will overcorrect - it always does, because money, like most forms of energy, has momentum, and prices for everything will eventually contract. This is just beginning in the housing market (I see housing dropping 30% in prices, maybe more, before rising again to about 25% below its highs). Cars are already contracting, due initially to high gas prices, now due to the poor economy forcing dealers to sell with significant discounts. The sticker prices might not actually change much, but before this is over with don't be surprised to see "Discount Sales" of up to 50% on new models. Wages at the low end will likely not change much, but as businesses fail, and people later become employed, they will do so likely at lower salaries, and with regulatory reform brought about by anger in business practices, boards of directors will have much less opportunity to create oversized CEO compensation packages that serve to further the imbalance in wages.

Fear means that people are less confident about the future, and when people are fearful, they hoard their money against the possibility of having none - i.e., they save. As people save, banks will eventually price in a higher interest rate for loans, and this will in turn also boost savings rates, but the banks will be considered too risky for investing purposes. That savings will in turn become the new capital base, but only once the outstanding debt obligations are negotiated away.

Interesting point about the relationship of inflation and population growth. I think the reason immigration (legal and otherwise) is so encouraged is that we would have a far different (smaller) economy without the 100 million people added over the past 30 years or so. Weather we'd be better off or not is an interesting question to ponder.

(S)tocks slide sharply amid shattered confidence
Dow industrials recover from earlier plunge that pushed index below 8,000



http://www.marketwatch.com/news/story/us-stocks-tumble-shaken-investors/story.aspx?guid=%7BC902D7A5%2D33DA%2D4E7E%2D952F%2D9082B4401FEA%7D

He's been on Charlie Rose twice over the last month or so.
http://www.rgemonitor.com/blog/roubini/