Buckle Up, We're Nowhere Close to Done With This

Buckle Up, We're Nowhere Close to Done With This
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The great euphoria surrounding the May 2020 payroll report didn’t even last a week. It should never have taken place. There is a meaningful difference between people getting back to work they had been prohibited from attending, and people who have no work to go back to. The May employment numbers were entirely the former kind.

We’ve yet to truly grasp the other.

It was John Maynard Keynes who wrote that deflation was the worst evil. There had been plenty of experience for believing this when he said so in 1923, though it really didn’t hit home (literally for tens of millions) until 1930. This behavior in market prices is distinguished from others which are often given the same name; falling commodity prices, for example, by themselves might be deflationary but not necessarily deflation.

What is this thing Economists all fear? And why should we all rightly be afraid of it, too?

To begin with, the official dread over the mere possibility explains most if not all of what central banks do. Inflation targeting, for one, is a blatant attempt to dispel deflation before it can ever begin.

By promising to “print” as much “money” as needed so that the economy produces a mild but steady rate of general consumer price increases, enough to be measured by the PCE Deflator, for example, registering 2% per year, the Federal Reserve believes it is creating a margin of error should the situation ever arise when it would be needed. These Economists believe that by being so explicit about it, real economy participants will anchor their inflation expectations to that target thereby making outright deflation less likely to come about.

If you believe the Fed’s your inflationary friend, when the world turns bad you still have the printing press in the back of your mind to, theoretically, prevent you from doing something highly deflationary.

But in the US case, Ben Bernanke transitioned the inflation target to an explicit promise in early 2012…and then promptly watched while American consumer prices went into highly embarrassing disinflationary rut that lasted just about five years. A disinflationary state which also included a massive, deflation-ish commodity price crash toward its end (Euro$ #3).

No outright deflation, however. Was that a success in anchoring, or merely the beginning?

If we examine inflation expectations by decomposing yields in the TIPS market, we find evidence for only the latter probability. Around the middle of 2014 when the oil market began its speedy descent, inflation expectations dropped, too, more importantly having never recovered. Not even all that 2017-18 overheated wage talk could prop them up so far.

Survey-based measures of inflation expectations have likewise dropped since mid-2014, neatly corresponding and thereby corroborating fully the direction the Treasury market has taken. Long before 2020 began, markets and consumers had both expressed grave, persisting doubts as to whether our central bank, or any other around the world, could “print” the “money” necessary to induce mild inflation even during ostensibly growth periods (or, in the case of the last decade, multiple years at best lacking outright recession).

What John Maynard Keynes wrote in 1923 was, “the fact of falling prices injures entrepreneurs; consequently the fear of falling prices causes them to protect themselves by curtailing their operations.” Thus, the labor market is by default left to absorb the most pain from falling prices.

And it is why central bankers fear falling prices the most. They’ll do anything to avoid the possibility.

By 1930, US Labor Secretary James J. Davis, otherwise optimistic for the economy’s recovery prospects, lamented what he called “unfair competition” which was “ruining business of the country by forcing men to sell under cost of production.” Secretary Davis saw only too well the symptoms without, apparently, having read Keynes’ prior diagnosis of the exact problem.

And therefore why, with so much selling under the cost of production taking place at that time, Davis and everyone else should have known in 1930 no one was moving toward recovery; everyone was still in very big trouble. The world’s labor force would be further decimated by nearly three more years of destructive deflation.

One problem with this topic, in general terms, is that you have to go all the way back to the Great Depression to find and use examples. Even 2008-09 only very briefly fell into the danger zone. Most of the negative pricing behavior was of the financial variety rather than more completely consumer prices.

For as much as business activity fell off during the Great “Recession”, it hadn’t quite reached that unknowable threshold between fierce but otherwise normal business cycle processes and the self-reinforcing devastation Jim Davis was witnessing in the early depths of the Great Contraction. At some point, the desperation for liquidity had meant, for 1930, an all-out fire-sale of goods and services to the point the selling price was less than the cost needed to produce the good or service.

We aren’t to that point yet, but the signs (and symptoms) of deflation, true deflation, are beginning to show up and multiply for us in 2020.  Fortunately, we have a competent central bank confidently standing guard, ready to act effectively at a moment’s notice?

Oh right, inflation expectations since 2014. And that whole thing in March 2020.

Furthermore, monetary authorities themselves don’t really believe what they are trying to sell you; that’s why they are trying so hard right now to sell you. If QE worked at all reasonably well, there’d be no need for the constant harping upon insinuations. Press conferences and TV interviews all with a purpose to sell you inflation that, was it actual money printing, it wouldn’t require another peep out of Jay Powell’s mouth.

And what about inflation, speaking currently? The Bureau of Labor Statistics (BLS) reported this week on the US CPI. Widely criticized in many circles, the very idea of being able to precisely measure all consumer prices in a massive, complex market economy sounds ridiculous.

On top of that, many Economists and most central bank officials (redundant) like to strip out volatile food and energy prices from the index’s basket. Their justification for doing so rings hollow, as if consumers don’t need to eat and fill up at the pump above everything else.

Far be it for me to defend them, but there are legitimate reasons for focusing on this “core” inflation rate. For one thing, on the downside at least, it does correspond very well with the worst of times. Because of its nature, especially the seasonally-adjusted version, the CPI ex food and energy rarely ever experiences a monthly decline. And that makes sense: you wouldn’t expect anything but the more extreme situations to produce a detectable short run impact on general price behavior.

Dating back to January 1961, when the BLS refined its monthly numbers for the core measure, it had only been negative month-over-month seven times out of the 708 months before 2020. One in one hundred qualifies as rare; sufficiently rare enough that it should raise your eyebrows when it does happen.

Two of the seven were in the back-to-back months of November and December 1982 – the tail end of what had been the worst postwar economic contraction in the US before 2008. Two more negative months would show up related to the Great “Recession”, also at its end and immediate aftermath (December 2008 and January 2010).

Before those, the biggest monthly negative had been posted for July 1980 – also at the tail end of what had been a particularly nasty, if ultimately short, recession.  Again, whatever the CPI’s faults, you can’t deny these compelling correlations.

Starting March 2020, three more monthly negatives have been observed including the monthly change in April which was the worst on record. Once highly rare, this consumer price deflation unrelated to separated oil and gasoline prices has suddenly become common.

In fact, May’s negative number was also a record. For the first time in more than six decades of data, three minuses in a row. That had never happened before, and only once, the last two months of 1982, had there been back-to-back minuses.

You might take that one of two ways; perhaps a good sign, the COVID-19-forced-shutdowns were severe but now are at an end. Like those prior recessions and brief deflationary outbreaks cited above, this one maybe much nastier still but the deflation only pops up once more as it is finishing. For as bad as it was, it’s all “V” from here.

Or, you might look at March-May 2020 as just the beginning of this thing rather than the whole thing. And if that was even remotely possible, wouldn’t it just terrify central bankers into embracing all kinds of seeming money printing insanity? Deflation right from the start, not 1930 deflation perhaps, just small flecks of it (for now) by comparison to that Big One, though certainly more than enough of the Big D to be palpably uneasy about it, desperate to sell the public an inflation story.

Any inflation story.

That’s also the part they’re not telling you; a lie of omission, if you will. Central bank officials are disclosing everything, of course, they’re just choosing to move and hold the public’s attention in other places. Such as magnificent QE, big, bigger, and biggest. A whole alphabet of abbreviations filled to the brim with “liquidity.”

Even, for the first time, outwardly embracing the stock market bubble. Where before March 2020 the Fed, in particular, would intermittently complain about “elevated” share price valuations, Jay Powell don’t give a damn about them anymore. Things have changed.

Not temporarily, mind you. All of the mainstream forecasts that have been produced in the past few weeks are terrifyingly the same. This is the part authorities do absolutely disclose - before quickly transitioning the discussion to the fun stuff, that “money printing” puppet show. Be happy about massive QE, lest you realize the danger we’re in because of the damage we’ve already suffered.

What’s propped up the equity market most, beside fund managers receiving and then reacting to the signal the Fed Chairman has sent specifically to them, is the belief in the full “V.” Sure, the non-economic shutdown was horrible but because it was non-economic once it’s over it’s over. Back to normal. Back to work.


No. Think Secretary Jim Davis and what he was seeing. Think Keynes (as hard as it is to set aside all the rest of his doctrine). Think jobless claims which, for yet another week, was more than double the prior record high.

The mainstream models are all preprogrammed to be wildly optimistic. That’s their very nature, in large part because they are biased in favor of “stimulus.” A central bank does something, anything, and every DSGE immediately spits out a plus sign whether there’s an empirical basis for it or not (in terms of QE, empirically the thing is dead, buried, gone).

Yet, all of the mainstream projections that have been issued lately, taking into account the massive “stimulus” thus far unleashed, they all look the same in their lack of recovery. That’s not how they are being spun, obviously, playing up the positive numbers on the upside, like last Friday’s payroll report, so long as you don’t understand just how much smaller they are when compared to the more massive negatives.

To be blunt; not a single one of these forecasts predict the US, European, Japanese, or global economy will have recovered by the end of next year. BY THE END OF NEXT YEAR. All of them expect whichever economy will remain substantially below its Q4 2019 peak, let alone that much farther below where these economies should have been growing, even meagerly, had governments properly dismissed blatantly awful statistical models in econometrics and epidemiology.

The irony, huh? The models got us in this mess and now they say we aren’t getting out of it without more economic damage than we sustained during the Great “Recession.” That’s the part disclosed but never discussed. Look at the S&P!

Lest you think that these models being all wrong maybe they’re being too pessimistic this time, that’s just not how these things work. The lack of recovery they’re indicating and that I’m describing is our best-case hope; econometric models are all overly optimistic, most times egregiously so, and nothing’s changed so far as that goes.

In other words, if it all goes perfectly, as the regressions predict, we’ll still look back at the Great “Recession” as if it was a minor affair. If the Fed’s QE’s and alphabet programs actually turn out to be useful and efficacious this time for the first time ever, then our reward for Jay Powell doing his job for once is a situation that is as long and significantly deeper than what transpired 2008-09.

And what are the chances of that happening?

Inflation expectations since 2014.

You can, I hope, see why central bankers are panicking. They’ll take a stock bubble because all the conditions for the Big D are right here, right now, right at the beginning of this thing that even the optimistic models all say is just getting started. We may have made it past the shock, the COVID shutdowns, and there will be big positive numbers over the coming months, but these will be hugely misleading.

If you aren’t too distracted by the puppet show to appreciate it.

The labor market will bear the brunt of the damage, which, despite the payroll report for last month, the data already shows that it is. Fear of falling prices, as Keynes said, causes businesses to protect themselves by curtailing operations and slashing costs, especially labor costs, to the bone. A terribly unusual three-fer in consumer prices. We’ve got this in the numbers already.

Standing opposite is only Jay Powell and a bunch of letters. Buckle up. We’re nowhere close to done with this.

Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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