Wednesday, February 01, 2006


wow, three in one day after so long away. Ah well, off we go.

Way back in the earlier posts I discussed planning for disaster - that is, I believed we're coming to some economic (among other things) hard times. Practical paranoia was the series, and looking I've discovered much has disappeared. That's both good and bad. Good because I said some dumb stuff earlier. Bad because I said some good stuff earlier, and this is supposed to stick around - that's a big reason I'm writing in blogs. Obviously, I'll need to do this again somewhere else. Anyway, wrenching back to the topic at hand...

My prognostications turn out to be decent - not great, but pretty good. (conservative if anything). I'm going to do it again - practical paranoia part six, sorta.

See, in PP5 I couldn't decide if our economic problems were going to be inflationary or deflationary. I think I've got a better handle, but will ramble to see if some other things make sense to me.

I anticipate the US to experience a set of economic doldrums, probably recessionary, within six months. Actually, I expect people looking back to say they began sometime in the next three months (if you can set aside the mixed tenses), but everyone will KNOW it's going on within six months. The process will be deflationary.

Some caveats. I don't know how severe or how long. It'll last at least three months, but could go on for a couple of years if people in positions to influence it act in the most stupid fashion possible. It could only deflate the value of our currency by half a percent. Again worst case it could deflate by half. My guess for the two is about six months duration with an effect in the vicinity of 2-3 percent, with the wild card being just what happens when credit clamps down.

OK, a bit of why. First (again) a "what is deflation". I find the easiest way to keep it straight is to remember who of a creditor/borrower relationship comes out advantaged if it's unexpected.

I borrow 100 dollars from the lender, and to keep it simple I owe him 100 dollars in one year. If it's inflationary, I win. That means that while I pay the 100 dollars, it won't buy as much as it does now. OTOH if it's deflationary the lender wins. That 100 dollars will buy MORE than it would a while ago.

Let's not get sidetracked - both inflation and deflation hit people close to the edge with their borrowing. Inflation hits them because there's a window in which they're paying new prices with old wages. In other words if they can ride out the early part they're fine, but that ride's going to be interesting. Deflation hits on the other side. For a while the borrower is doing better because he's still got old dollars and they're buying MORE short-term goods. Unfortunately (just as with the inflationary side) wages shift to be in line with value. Suddenly there's less cash coming in, and while it's buying as MUCH as it was for short-term goods (groceries and monthly goods) the long-term stuff's still on old values.

So, what should I be doing since I expect a deflationary cycle? Well, I need to decide if the house I bought LESS THAN SIX MONTHS AGO is worth the effective increase in payments. I'm pretty well ok right now - I can stand it if it only adjusts a percent or two. But if the deflation looks like it's going to move my monthly house bill to, say, 50% of takehome, then it's time to reconsider.

By the way, that's going to be chicken and egg with this cycle. I know that a lot of real estate is going to apparently deflate. Heck, it's already started with the Centrex ads (100,000 off a 500,000 house? riiiiight.) Some is just overvalued, but still... if people find they're paying a loan for $500,000 when the house is now valued at $400,000, they're not going to feel good about it. And as the house prices decline they're likely to trigger other deflations which will in turn deflate the house prices till... Yes, it's not perpetual, but for a while it'll feel that way.

I think the problem is that there's an excess of money right now. Deflation is what happens when the money supply tightens. Historically that's a fed control job. But the fed can't control a virtual money - credit. With looser lending restrictions the defacto money supply has gone nuts - with the caveat that eventually it has to be realized. As the realization fails to occur and people start to go bankrupt instead... there's the collapse.

I still think it won't exceed 5% - and actually will be less. I have two loans right now - the house, and a car that's half paid off. Assuming everything balances for a while I THINK I can withstand a 10% drop. More than that and I look at following others into bankruptcy. There's the negatives, now to the opportunities.

Opportunity one is a window mentioned already. For a while prices will deflate but wages will stay at the higher level. During that period the opportunity exists to leverage that margin. There are two basic methods. First, loan it out. Remember that basically the lender wins in deflationary windows. The risk is that the borrower defaults. Still, lending is a GOOD thing in that window. High grade bonds is the safest. Short term bank counterloans is another option. This needs thought.

The second thing is to buy something that will defacto appreciate in value, but which won't break me to hold or to sell. Classically this is gold, though I admit to having trouble seeing how it gets me past a deflation. See, if I buy $1000 of gold at ~500 per ounce today, and in six months everything has balanced, then it SEEMS to me that my two ounces will have the same nominal purchase power -- be worth $800. hmmm, nope. still don't see it.

OK, so practical paranoia says:
In the window where I'm still getting pre-drop wages but what I'm buying is dropping (I'm getting better prices on food and clothing and such) I take the slack and put it into bonds - how risky depends on my tolerance, but I'd be well advised to keep confidence the borrower WILL be able to pay on expiration. Anyway, after the drop I sell the bonds -- or if I can last it I keep them till things start turning around so I can maximize my practical profit.

Enough for now.


Anonymous Prince Hydrajak said...

Its going to be worse than anything you likely imagined.

Oil up the gun, make sure you have land you can defend from the roving hordes, and I hope you know how to grow your own food using hand labor.

However, I don't think its going to me total Mad Max. Sterling Energy will save civilization, it will just look a LOT different. Electricity will exist, Oil will be a rare substance. (200-300 a barrell? At least...)

Anyway dude... Anytime you want to pack up the family and move to Colorado with me, you are welcome on my comound.... unfortunately it does not exist yet. I'm still stuck in Detroit, but the wife and I are looking.

Hi Kirk!

2/28/2006 2:09 PM  

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