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Drums of inflation are playing in the main stream media. People are asking when the FED is going to increase the FED rate. First and foremost, FED follows the treasuries. When the treasury rates go up, FED will follow. But the treasury rates may not go up because of inflation. Immediate concern is deflation. Here is why:
Signs Of Deflation
Yes, You Heard Us Right
May 14, 2010
Everywhere you look, the mainstream financial experts are pinning on their "WIN 2" buttons in a show of solidarity against what they see as the number one threat to the U.S. economy: Whip Inflation Now.
There's just one problem: They're primed to fight the wrong enemy. Fact is, despite ten rate cuts by the Federal Reserve Board to record low levels plus $13 trillion (and counting) in government bailout money over the past three years -- the Demand For and Availability Of credit is plunging. Without a borrower or lender, the massive supply of debt LOSES value, bringing down every exposed investment like one long, toppling row of dominoes.
This is the condition known as Deflation.
The following market analysis is courtesy of Bob Prechter's Elliott Wave International. Elliott Wave International is currently offering Bob's recent Elliott Wave Theorist, free. Bob Prechter uncovered more than a dozen "value depreciating" developments underway in the U.S. economy as the two main engines of credit expansion sputter: Banks and Consumers. Off the top of the Theorist's watch list are these "Continuing and Looming Deflationary Forces":
- A riveting chart of Treasury Holdings as a Percentage of US Chartered Bank Assets since 1952 shows how "safe" bank deposits really are. In short: today's banks are about 95% invested in mortgages via the purchase of federal agency securities. Unlike Treasuries, IOU's with homes as collateral have "tremendous potential" to fall in dollar value.
- Loan Availability to Small Businesses has fallen to the lowest level since the interest rate crises of 1980. In Bob Prechter's own words: "The means of debt repayment [via business growth] are evaporating, which implies further deflationary pressure within the banking system."
- An all-inclusive close-up of the Number Of Banks Tightening Their Lending Standards since 1997 has this message to impart: Since peaking in October 2008, lending restrictions have soared, thereby significantly reducing the overall credit supply.
- Both residential and commercial mortgages are plummeting as home/business owners walk away from their leases at an increasing rate.
- The major sources of bank revenue -- consumer credit and state taxes -- are plunging as more people opt to pay DOWN their debt. Also, a compelling chart of leveraged buyouts since 1995 shows a third catalyst for the credit binge -- private equity -- on the decline.
All that is just the beginning. Bob Prechter’s 13 pages of commentary, riveting charts, and unparalleled insight that make it impossible to ignore the deflationary shift underway in the financial landscape. For that reason, we have compiled the most "the most important investment report you'll read in 2010."
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Continuing—and Looming—Deflationary Forces
The Fed and the government quite effectively advertise their efforts to inflate the supply of money and credit. But deflationary forces, to most eyes, are invisible. I thought I would point some of them out.
1. Banks Are about 95 Percent Invested in Mortgages
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Figure 4, courtesy of Bianco Research, shows that U.S. banks used to be fairly conservative, holding 40 percent of their assets in Treasury securities. This large investment in federal government debt, the basis of our “monetary” “system”, served as a stop-gap against deflation. In 1950, even if mortgages had been wiped out by a factor of 80 percent, banks still would have been 50% solvent and 40% liquid. Today, banks hold federal agency securities (backed mostly by mortgages), mortgage-backed securities (meaning complicated packages of mortgages), plain old mortgages that they financed themselves, and a few business loan contracts. If these mortgages become wiped out by a factor of 80 percent, which in turn would cause many of the business loans to go into default, the banks will be only about 22% solvent and 1% liquid. I believe the coming wipeout will be bigger than that, but let’s be conservative for now. The point is that, unlike Treasuries, IOUs with homes as collateral can fall in dollar value, and such IOUs are pretty much the only paper backing U.S. bank deposits. The potential for deflation here is tremendous.
2. More Mortgages Are Going Under
It has been well publicized recently that commercial real estate has been plunging in value as business tenants walk away from their leases, leaving properties empty. Zisler Capital Partners reports, “Returns were negative for the past five quarters, the longest streak since 1992. Property prices have fallen by 30 percent to 50 percent from their peaks. Much of the debt is likely worth about 50 percent of par, or less.” (Bloomberg, 11/11) Needless to say, the fact that commercial mortgages are plunging in value is stressing banks even further, which in turn restricts their lending. This trend is deflationary.
3. People Are Walking away from Their Homes and Mortgages
Great numbers of people are ceasing to pay their mortgages, even if they have the money to pay them. When people walk away from their mortgages, they are reneging on a promise to pay the interest on the loan. … Refusal to pay interest is deflationary. When banks can’t collect fully on their loan principal, as is the case by law in the above-named states, it is deflationary. Even in states where banks can go after other assets held by borrowers, default is still deflationary if the borrowers are broke. The reason is that, in all these cases, the value of the loan contract falls to the marketable value of the collateral, and a contraction in the value of debt is deflation.
Some people who walk away from their mortgages purposely damage the homes when they leave. New businesses have sprung up to take on the job of cleaning up the houses that former occupants trashed as they left. Angry defaulters are stripping coils out of stoves, pulling electrical wiring out of walls, ripping fixtures out of bathrooms, yanking seats off of toilets, punching holes in walls and leaving rotting food in the fridge. (AP, 8/9) Such actions, and the threat of more such actions, lower the value of the collateral behind mortgage debts, thereby lowering the value of mortgages, which is deflationary.
4. Bank Lending Standards Have Stayed Restrictive
As people default on mortgages, banks are tightening lending standards. Figure 7 shows that banks loosened credit standards from late 2003 through the summer of 2007. By the end of that time, you could borrow money if you were breathing and could operate a ball-point pen. Banks have been tightening credit standards ever since. The rate of tightening peaked in October 2008, but the graph shows that over the past year various banks have either left their new, tighter standards in place or continued to tighten their standards further. Across the board, it is harder to get a loan, and it’s staying that way. Lending restrictions reduce the credit supply. This condition is deflationary.
5. Banks Are Cashing Out of the Credit-Card Business
Articles have revealed that banks are doing everything they can to get credit-card debtors to pay off their cards. They are raising penalties and rates, lowering ceilings and otherwise bugging their clients to pay up, one way or another: Transfer your debt to another bank’s card; default; pay us off; we don’t care which. And it’s working. Through September, consumers have paid down credit card balances for 12 months in a row. Figure 8 shows the new trend. The credit-card business was another formerly humming engine of credit that is sputtering. You might call the new program “cash from clunkers,” and it is deflationary.
For more information from Robert Prechter, download a FREE 10-page issue of The Elliott Wave Theorist. It challenges current recovery hype with hard facts, independent analysis, and insightful charts. You'll find out why the worst is NOT over and what you can do to safeguard your financial future.
This article was syndicated by Elliott Wave International. EWI is the world's largest market forecasting firm. Its staff of full-time analysts lead by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.
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