Default, Deflation and Other Financial Curse Words

By Bill Bonner

03/18/10 Mumbai, India – In the US, producer prices fell in February, more than expected. Core inflation was barely positive. That is not just a US trend. In Europe, price increases have fallen to the lowest level in 11 years. Japan is experiencing the biggest price drops in many years.

This sounds like a D-word to us…disinflation, almost deflation.

One report tells us that greater than 5% of Fannie Mae mortgages are 90 days in arrears – or more. Another report says it’s 10%.

This too sounds like a D-word. Default.

But wait…

“Fed signals optimism over US economy,” is the lead headline in today’s Financial Times.

The markets responded, pushing the Dow up 47 points to a new high for this bounce…though still midway between its all-time high and its low of March 2009.

Oil rose a dollar too. So did gold. The euro edged up too…

Reading more closely, we don’t see much reason for the Fed’s optimism. And apparently, neither does the Fed. It is leaving its monetary stimulus program in place for an “extended period.” It says inflation is likely to remain subdued “for some time.”

The Great Correction (our term) destroyed nearly 8.4 million jobs (the FT’s count) and wiped out $14 trillion in household wealth. And now Americans are struggling to find firm footing in an economy with fewer job openings, less credit available, and an uncertain growth outlook.

What’s going on? There’s a word for it. Another D-word…several of them. There’s Depression. Deflation. And De-leveraging, for example.

Our old friend Porter Stansberry writes to tell us that we’re wrong about household de-leveraging. The drop in credit we reported yesterday was caused by defaults…not by voluntary reductions in debt, he says.

He’s right. Most of the decline in household credit, so far, comes from defaults. And maybe it is just wishful thinking on our part… hoping that Americans would willingly and eagerly improve their balance sheets. The savings rate is up…but it’s not yet clear whether this marks the beginning of a major trend or not.

But whatever the cause – be it voluntary de-leveraging or involuntary de-leveraging – we think there’s more of it ahead.

Here’s a statistic: 21% of Iraq and Afghanistan veterans are jobless. They’re mostly men. And mostly unprepared for the modern job market. After all, who wants to hire someone who knows how to drive a tank or patrol a gas station?

Ultimately, an economy gets rich by making and acquiring things people want.

Ah…we look back nostalgically at the Bubble Epoch. It was so easy to make fun of people back then. They thought they could get rich by buying things they couldn’t afford with money they didn’t have. Now, we’re in a new era… of sorts. Now, it’s the public sector that has lost its head. The feds think they can make the economy work better by buying things nobody really wants with money nobody really has.

Who really wants to guard a gas station in Baghdad? Nobody we know. Who’s got the money to fund the fed’s $1.8 trillion deficit? Nobody.

And think of the poor fellow who draws that sorry duty in Iraq. When he comes back to the US, what does he have on his résumé? He’s good at guarding a gas station against terrorists? Not many job offers for that skill set.

So, one in five of these fellows is unemployed. And the feds try to do something about it by spending more money they don’t have on more things nobody really wants.

Bill Bonner
for The Daily Reckoning