johnnymk

http://www.investorsinsight.com/media/p/2686.aspx

You must register to download the PDF file, which contains a lot more information, including how the stimulus package will have a negligible effect and what will be the outcome of the Fed using the printing press in attempting to bring back inflation:

It would be a strange, strange world indeed if inflation could get any real traction in such an environment, and it didn’t. But now we have a structural problem in that deflation has the potential to get some very real traction going forward. Why? Because not just in the US, but all over the world, we built too much of almost everything. Too many houses, too many manufacturing plants, too many retail stores – and just too much stuff.

In the US, capacity utilization is falling rapidly. Typically, if we produce “stuff” (cars, food, lumber, etc.) in the range of 80% of potential capacity, that is considered to be a good
economy. Capacity utilization has been dropping for some time and is down below 75% for all industries, but in many industries is close to 70%. And the clear trend when looking at ISM manufacturing statistics is that it has a lot further to fall.

That means industries have no pricing power, as they can make a lot more “stuff” than they can sell. And when demand due to the recession drops as well, prices fall as producers try to stay in business.

As a very visible example, global output capacity for automobiles is 92 million cars, but sales will probably be around 60 million. Output in the US will be around 12 million, but right now sales are only about ten million. The average American household has 2.2 cars. Evidently, consumers are reducing the number of cars they own, buying used cars,
and making their current vehicles last an average of 6 months longer – all in just the last year.

Many auto plants, both in the US and abroad, are simply going to have to be closed.

“Super-efficient Toyota expects its first operating loss in 70 years in the fiscal year ending March 31. Weak sales in China will probably force many of her 80 automakers to merge. Russian sales dropped 15% in November and 25% in Brazil from a year earlier.”

Just as there are too many auto dealers and too much auto manufacturing capacity, there are too many stores for a country whose consumers are in retreat. Consumer spending could easily drop 7% as the saving rate heads back up to 5% (or even more). It
is estimated that over 70,000 retail stores will go out of business in the next six months.

That would be in line with the 140,000 that closed doors last year. The economy and its businesses have to adjust to a new level of spending that will be the first serious consumer recession in 26 years.

Unemployment could rise to 9-10% or more this year and on into 2010. That means we could easily see another 3 million lost jobs over the next year. That is going to put a lot of negative pressure on consumer spending. It also means that wages are not likely to rise, and we have already hard evidence of wages falling in many industries as companies try to find ways to remain solvent.

And that 9% will be the headline number. If you add people who have part-time jobs but would like a full-time job, and what are called marginally attached workers, the current rate is already 13.5%.

Average hours worked dropped to the lowest level since they began collecting data in 1964, as did hourly income. Given the increasing difficulty for consumers to borrow money and with income dropping, plus increased savings on the part of consumers, it is difficult to see how pricing power is going to come back any time soon.

This problem is multiplied throughout the developed world. The developing world, which sells products and goods to the US and European consumers, is starting to feel the pinch. Chinese and other Asian exports are dropping (more on that in future letters,
but the data is ugly).

Overcapacity, rising unemployment, imploding leverage, lack of borrowing and/or lending, a serious retreat by consumers, and increased savings are all the conditions needed to bring about deflation.

InfiniteNothing

Deflation sucks. Here's some thoughts on why:

Why buy something today when it will be cheaper tomorrow. Consumer spending decreases even further which makes more companies go out of business as they aren't needed any more. Also, it might make walking away from a loan more attractive as the loan amount in real dollars becomes more painful. Also, why take a risk with your dollars and invest in a small business when you could just sit on them and have them grow for you

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As for our common defense, we reject as false the choice between our safety and our ideals.

VTGreg

I think a period of contraction is inevitable. The economy and consumer spending have been propped up by borrowing for so long that we just can't leverage ourselves anymore. We have fabricated much of our wealth.

I'm not really sure how you can have a contraction period without deflation. A question for those that know the markets far better than I do: Is it even possible to have contraction without deflation of some sort?

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It only ends once... Anything that happens before that is just progress.

Courage is not the absence of fear but rather the judgment that something else is more important than fear.