Will Trump’s Coronavirus stimulus cause prices to go down?
Lacy Hunt Ph.D. is an internationally recognized trader in U.S. treasuries. He understands how the Federal Reserve creates and distributes money. He works at Hoisington Investment Management Company (HIMCo) and produces a newsletter read by commodities traders and large investors around the world. We discuss how the economy works in real terms. I learned more in this one hour, than my graduate level economics courses. See the full interview here.
VC: You had mentioned with deflation that you imagine that prices will actually go down and when I’m sitting here as somebody with money in a savings account it would appear to me that the price of things going down would be really good, now how can my money can go further?
LH: If you have fewer net holder financial assets, you’ll be better off, the debtor will be worse off. Let me just give you a couple of parameters with what I’m talking about — if you look at the three worst post-war recessions in the world since 1945 from the peak of inflation in or before the recession to the trough after the recession, the best measure of inflation dropped an average of about four hundred and thirty basis points. In other words — if it were seven and went to three something like that, okay so that’s the average but this time we’re starting when the inflation rate is one point seven, we don’t have a high inflation rate but a very low inflation rate and moreover one of the wild cards in the inflationary story is what happens to the most critical of the raw materials which is energy. If you look at these three terrible previous recessions the oil price was actually unchanged. It went up in two of them and went down in one and the oil plays to its own tune. It’s based on supply and demand characteristics and so forth but what we’re looking at right now is a record-setting percentage decline in oil prices which is the largest of the commodity prices. It’s not a determinate of inflation but it adds to inflation so the risk is that we’re going to go from a 1.7 percent rate of inflation down to minus 2. It’s a mild deflation it’s not serious like it was with the Great Depression but the risk is that it’s going to be persistent. It’s going to hang in there and there are a couple reasons for that — number one, we have these deleterious effects as well as a debt that we’re taking that are mandated by the circumstances we have no choice other than to try to help people through the matter.
Moreover, once we get our pent-up demand recovery and economic activity right after the corona virus is contained, we’re going to have unprecedented amounts of what economists call “the output gap”, which is the amount of redundant resources we have in labor and capital.
Because of this huge output gap and the fact that we’re going to struggle it out, it’s going to take us six to nine years to shrink this output gap and get it back to where it was in 2019.
VC: Now when you say the output gap, do you mean that because we’re going to have such high unemployment, we’re going to have people that aren’t working and then you’re going to have capital assets that aren’t being used or machinery that you’re not actually putting to use so even if you had people that wanted to buy it, you don’t have enough to be able to get that?
LH: The two main components of the output gap where labor and capital resources they just won’t be needed and so when you say there is a lot of excess for resources then the whole of the owners of those resources are forced to sell their services and their product at lower prices which creates a marginal squeeze.
It puts downward pressure on the inflation rate and so the significant risk here is that when we go to deflation, the output gap suggests it will be staying with us and we will see something that most people are not familiar with — wages will actually fall — they won’t have to fall dramatically but they will be persistently downward.
That’s what firm managers who know nothing about measuring deflation are going to have to grapple with and the employees don’t know what about having wages is good and so it’s going to create a very challenging situation so in deflation, you don’t want to be a debtor because let’s say you borrow a dollar today and we have a two percent deflation rate a year from now — you’re going to have to pay back in purchasing power dollars that are worth the dollar in two cents and the other aspect of deflation is that although the Treasury rates come down, the corporate rates go up and the private borrowing rates go up because in deflation, it will raise the risk premium that the non-governmental borrowers will be able to repay and so you’re going to have an ironical situation. The government yields come down but the other yields don’t really and so it will be a difficult.
Let’s keep the conversation going,
Vance
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