Deflation

[clowboy]

I was first thinking this in regards to the sharemarket but it would become quite complicted what with shorting of stocks and so forth so I will use property to simplify the example. I still think the same would hold true to shares though despite shorting and other wonderful techniques.

In a rising market prices go up becuase people are willing to pay more for them. The price paid for the asset is real money and comes from somewhere despite that more often than not being a loan.

Using only one house to keep it simple I assume that someone has bought a $100 ,000 property (cheap I know) and a year later they decide to sell it.

The market has stalled and the highest offer that they recieve is $90,000.
Assuming that there is no other factors influencing the transaction (selling/buying costs/ rent/tax/mortage etc) for simplicities sake.

The owner of the house sells it for the $90,000 releaseing a $10,000 loss.

My question is this......where has the $10,000 gone?

In the event of a recession/depression vast sums of money are lost? Where does this money go?

Using sydney property as an example, if at it's peak all property in sydney was worth $10 billion and it has since devalued by 10% to $9 billion, where has that $1 billion gone?

Any thoughts and/or explanations would be appreciated.

 

[Smurf1976]

To my understanding it simply disappears back to where it came from - literally thin air. Using the property example, let's assume that a net 10% of all property owners wished to sell. That is, the number of sellers exceeding the number of buyers by an amount equal to 10% of all houses physically in existance. The bottom line is that in practice they could not sell and the keenest sellers would drop prices to chase the available buyers. A classic house price crash situation. It's happened before and IMO will at some point happen again since nothing fundamentally has changed to prevent it.

All those properties collectively worth, say, $10 billion are then unsellable at any reasonable price. The physical wealth is still there, the houses still exist, but the financial wealth is gone. In real estate terms this is known as "negative equity". It's when your mortgage debt is higher than the property is worth in today's market. Your debts are bigger than your assets. If that happens in business then it's called "bankruptcy". The term "negative equity" is, however, more socially acceptable (though not necessarily to those with the debts once they realise what the consequences are).

Fiat currencies (eg Australian Dollars) are literally borrowed into existence. The money is backed not by gold, silver or some other "hard" asset but by debt. The debt in turn is partially backed by other assets including those themselves backed by debt, confidence and other "soft" things. Some of that debt is of course backed by physical assets such as property, but then property prices are a matter of opinon which changes in both directions and are themselves backed largely by debt and the ability to obtain it. The backing of the money can thus literally disappear in a financial sense and, in the case of debt used to fund TV's, holidays etc does exactly that almost from day one. Such debt is backed by the assumption of future earnings only which in many cases are themselves dependent on the debt cycle continuing. So overall it's backed by basically nothing apart from confidence that the system will continue. Hence why central banks pay so much attention to inflation expectations since this is effectively a measure of confidence in the money itself.

So it's entirely possible to my understanding for very large amounts of financial wealth to literally disappear simply because of a change in opinion. In recent times the opinion of Sydney house prices has already been reduced by about 10% and with a steep slide in January 2006 (source Commonwealth Bank) it seems that more is to come. A similar story is unfolding with sliding house prices in parts of the UK and US. Many other parts of Australia look (on a chart) exactly like Sydney but with a time lag.

Property prices went up with money from thin air and they're going back down again the same way. No surprise here since houses are still being built at a cost not much higher than before the boom. Hence supply will rise until such time as either building costs rise to match selling prices (that would take a massive rise in building costs) or selling prices fall so that building "on spec" ceases to be profitable. A normal house price cycle only this time the general low rate of wage inflation means that rather than the falls being only "real" with prices flat in nominal terms, outright nominal price falls are occurring. This is happening without large interest rate rises, high unemployment or a recession and IMO the real estate market is in for one almighty shock if any of those things occurs in the next few years.

As for actual deflation, my guess is that the central banks will keep printing (literally creating money out of thin air) and that money will end up going somewhere (anyone like to play the central banks' "spot the next bubble" game?) such that the total money supply continues to increase. US stocks were done and then popped (Nasdaq especially although the Dow is still below it's highs of six years ago) and now real estate has been pushed to the limit of affordability. Likewise it could be argued that bonds are pretty highly valued by historic measures. So the money will go somewhere else. My guess is commodities and/or wages (general inflation) with the former being the more likely based on recent trends and the political motivation of governments. Either way the currencies continue to lose purchasing power slowly in general and rapidly when measured against whatever the inflating asset of the day is. Until the bubble pops.

So I don't see general deflation, a contraction in the money supply, as being a problem whilst there is still something that can be inflated but IMO the property bubble isn't in for the "soft landing" that many expect. Sydney prices down 10% and the falls are ongoing on increasing volume whilst even the media, which helped fuel the boom in the first place, is starting to turn bearish with TV property programs now being more about "how much to drop the price to find a buyer" than "how to double the price with a "reno"". Meanwhile repossessions in NSW are hitting record levels and rising. NSW tends to lead the rest of the country...

Now, where's that next bubble I ought to be investing in? Or is it wages after all? Tassie bus drivers are going on strike tomorrow wanting a 33% rise over 3 years and I've heard of a few others getting big (over 20%) rises lately too. So the next one might be wages after all. That could moderate the property situation somewhat although it would also lead to general (CPI) inflation and upwards pressure on interest rates so it's somewhat complex...

 

[rederob]

In the event of a recession/depression vast sums of money are lost? Where does this money go?
Any thoughts and/or explanations would be appreciated.

It went where it came from - the banks - via a fractional reserve system.
You actually answered you question with your question.
Let's review it:
When the person bought the home for $100k did they get out bank notes and count each dollar handed to to the seller?
Doubt it.
The bank probably approved a loan of $100k and transacted that amount electronically to the sellers account. Better still if both parties used the same bank.
When did you ever see truck loads of money being deposited into any particular bank?
When the house sold again, same deal.
If there ever were to be a run on the banks, get there very early because the reality is, they won't be able to give back in currency what people have as holdings via lifelong deposits etc.
Ever wonder why the price of gold has being going up recently?

 

[clowboy]

Yea,


It is a worry.

The value of an asset detirmined by opinion.

The problem really hits home when the banks are owed all this money and have security worth didly sqat.

Thanx for the replies guys, very profesional response smurf.

 

[Aussiejeff]

With WORLD DEFLATION (barring a few pockets of Mega-Inflation) well underway, it's time to resurrect this thread methinks.

Interesting to see it has been almost 3 years since the last post!

Speaking of "the last post", that is what may well be being played at the next crisis meeting of the G-Whizz20.....

Oh dear, that Big Balloon called Planet Earth appears to have been pricked well and truly. It is deflating at an alarming rate

 

[Nick Radge]

Jeff,
This is an interesting indicator listing all the commodity prices. I have only ever seen it completely red across the board once before (about a month ago) but last night was a close one. Certainly looks deflationary.

I see Gold remains the safe haven...not. Just another asset going down the toilet like the rest of them.




Here is the link if anyone wants to watch it in the future:

http://www.marketwatch.com/tools/marketsummary/futures/contracts.asp

 

[Aussiejeff]

Here is the link if anyone wants to watch it in the future:

http://www.marketwatch.com/tools/marketsummary/futures/contracts.asp

Does it come in any other color other than red?

I prefer green

 

[Bronte]

LOL Great link that one Nick...
Thank you

 

[Indie]

Lean hogs at 65.63, mmmm gotta get me some lean hogs.

 

[wayneL]

Jeff,
This is an interesting indicator listing all the commodity prices. I have only ever seen it completely red across the board once before (about a month ago) but last night was a close one. Certainly looks deflationary.

I see Gold remains the safe haven...not. Just another asset going down the toilet like the rest of them.



Here is the link if anyone wants to watch it in the future:

http://www.marketwatch.com/tools/marketsummary/futures/contracts.asp

It wasn't that long ago that folks were looking for grain ETFs so they could "invest" in wheat.... IIRC Chicago wheat was a $12 a bushel at the time.

A classic sell signal.

Indie,

A contract is 40,000 lbs worth. I'll go you haves... unless of course you have a reeeeeeeally really big freezer.

 

[wayneL]

FYI

http://www.telegraph.co.uk/finance/...all-further-than-during-Great-Depression.html

Metal prices fall further than during Great Depression
The price of key industrial metals has fallen further over the last four months than occurred during the worst years of Great Depression between 1929 and 1933, according to research by Barclays Capital.

Kevin Norrish, the bank's commodities strategist, said the average fall in the price of copper, lead, and zinc has been roughly 60pc since the peak in July this year. All three metals were traded on the London Metal Exchange in the inter-war years so it is possible to make a comparison.

Prices for the three metals fell 40pc from their highs in 1929 before touching bottom in 1933, with the bulk of the fall in 1930 as the slump spread worldwide. "Lead and zinc have already lost more than they did in the 1930s," he said.

Copper was hit hardest during the Depression, despite the electrification drive in the US and the Soviet Union, falling 70pc at one stage before creeping back in the mid-1930s. The reason was an 85pc fall in US construction, then the biggest user of the metal.

Barclays Capital said the broader equity markets are already discounting the sorts of "savage declines" in corporate profits that were last seen in the Slump. It said (trailing) price to earnings ratios are actually lower now than they were the early 1930s, with moves in credit spreads that suggest investors are anticipating depression-era levels of economic contraction.

 

[numbercruncher]

Better get all those industries a Gov bailout , they obviously need it ...

 

[Aussiejeff]

Better get all those industries a Gov bailout , they obviously need it ...

Pfffft! BRING IT ON I SAY!!!

Big deal. Smart US investors backed by the US Treasury have caused a HUGE rally on the DOW in response to the worst economic news in a zillion years.

Cop that bears.

Bulls are feeling feisty again....

*pop*

Oh, am I having a wet dream????

 

[wayneL]

A quick whip around the new sources shows the authorities with their fingers stuck in their ears singing LA LALA LA LA, whenever the big D is mentionted.

Meanwhile, contrary to these overt denials, they are literally warming up the printing presses... and I mean physical printing presses for a direct paper cash injection.

Houston, we do indeed have a problem.

 

[noirua]

A quick whip around the new sources shows the authorities with their fingers stuck in their ears singing LA LALA LA LA, whenever the big D is mentionted.

Meanwhile, contrary to these overt denials, they are literally warming up the printing presses... and I mean physical printing presses for a direct paper cash injection.

Houston, we do indeed have a problem.

An ice cold wind is blowing from America across Europe and Aussie Interest rates should be 1% as demand for commodities crashes.
China are set to sell coking coal at the same price as power station coal.
In these circumstances Australia needs a parity exchange rate with the greenback.

 

[shaunQ]

Interest rates in the UK are now 2%. I saw a report that it hasn't gone below 2% since 1694 or something... which I find amazing. To think that it is quite possible to go lower than almost 100 years before Captain Cook came to Australia.

 

[noirua]

Interest rates in the UK are now 2%. I saw a report that it hasn't gone below 2% since 1694 or something... which I find amazing. To think that it is quite possible to go lower than almost 100 years before Captain Cook came to Australia.

They're suggesting zero in the States shortly as rumours gather that Ford or General Motors could file for bankruptcy. UK will probably hit 1% in January.
Some thoughts that negative interest rates could hit some types of inflation bonds.

 

[IFocus]

An ice cold wind is blowing from America across Europe and Aussie Interest rates should be 1% as demand for commodities crashes.
China are set to sell coking coal at the same price as power station coal.
In these circumstances Australia needs a parity exchange rate with the greenback.

Noirua I don't understand what you mean highlighted in red I though a lower AUD was the go

cheers

 

[noirua]

Noirua I don't understand what you mean highlighted in red I though a lower AUD was the go

cheers

Sorry Ifocus, I mean't AU$2.00 to the US$1.00. Nearly hit parity back in May and I mixed myself up. There I was thinking I'm perfect, drat

 

[chops_a_must]

Lean hogs at 65.63, mmmm gotta get me some lean hogs.

At least with Orange Juice, I've been personally averaging in on Harvey Fresh for the better part of 6 years now.