Friday, May 29, 2009

Krugman vs. Faber vs. Reality

As I write this the market is flat, two of the world's most recently prominent economists argue deflation versus hyperinflation, and the reality of of a woeful economy persists despite a market that continues to hold ground.

Paul Krugman's weekly op-ed piece this week refuted claims for possible inflationary pressure despite unprecedented money pumping by the government. That money is not being circulated by banks he claims, so it has no impact at the present while prices continue to fall. Yes, home prices and the prices of bankrupt car companies do continue to fall, while oil will achieve it's largest one-month gain in 10 years by the end of today. Gas will hit $2.50/gallon before June, and the price of grains are insidiously rising again. You know, Paul, stuff people actually have to buy to live and work.

Meanwhile, Marc Faber is pushing a "Zimbabwe" like hyperinflation scenario due to our government's printing press with dire ramifications. After a rebound call in the markets, Dr. Doom has returned to his bearish ways.

Why such discrepancy in the interpretation of the same events? First of all, as we've discovered quite clearly over the last 2 years, economists work off of flawed models based on past events. The forecasting ability of these models to predict future events given never-used-before inputs is worthless. Second, deflation as pointed out by Itulip on a daily basis, is commonly referenced in regards to all goods and services in total, such as housing. A decrease in home prices is not deflationary if it's the result of an implosion of home equity losses and foreclosures, at least not for the people going bankrupt or homeless as a result. Meanwhile, paying more for health insurance and gas while wages go down, is inflationary.

Perhaps there's a reason why John Paulson (made billions betting on housing collapse) and David Einhorn (predicted demise of Lehman and Allied Capital, now betting against Moody's) have just bought huge stakes in GLD, our gold ETF. They not only think this rally is garbage, but that when inflation kicks in, they'll have a very nice hedge.

Despite it's lofty rise, the markets couldn't be happy with reality numbers this week. "A record 12 percent of homeowners with a mortgage were behind on their payments in the first quarter, the Mortgage Bankers Association said Thursday." That's 1 in 8 homes. But even more disturbing is those with "good" credit are now hitting a 6% delinquency rate. Despite massive sales of foreclosed homes (45% of all recent used home sales), home sales are not rising rapidly. Add in the Case-Schiller numbers that are somehow still declining in this crater (I thought we'd seen the bottom, right?), and people are just nuts to think this economy is improving. Even the CEO of McDonald's said there is no sign of a bottom, despite the company's ability to undersell Starbucks lattes by $3.

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