The Great In/De-flation Debate

Presently there is an increasingly raucous debate brewing between those who believe there will be long-run inflation, and those who see an extended period of deflation.  I have elaborated my position here and elsewhere, which is basically that we're currently at the head-end of a deflationary period which risks collapsing into a broader deflation cycle.  The actions of the Federal Reserve in concert with other world central banks strongly suggests that monetary policy leaders also fear deflationary forces.

This subject is particularly interesting being that it has generated the most email I've received on any topic since I wrote about the Second Life virtual world economy.  Following are a few examples...

The first is a typical article of many that are appearing with increasing frequency on seekingalpha.com.  It is entitled First Comes Deflation, Then Comes Inflation.  It starts out reasonably enough, but upon reading it quickly becomes apparent that the author has an ideological bias.  And, that is ultimately the problem with so many of these economic debates:  ideology.  Many are tied to an outcome for deeply ideological reasons -- for some, those border on matters of religious faith.  Others have specific financial outcomes riding on a particular outcome, so the end up wrapping themselves in whatever dogma supports their desired ends.

But there is a theme emerging.  Many who point to the prolonged, exaggerated inflation scenario don't really understand the theories upon which they are basing their arguments.  Put bluntly, they are wrong.  They repeatedly point to the Fed (and now others) "printing money" as sufficient reason to cause inflation.  That argument is a monetarist one.  Unfortunately, the quantity theory of money also incorporates a strong demand-side function, expressed as velocity.  When that demand outpaces the supply, then there is deflation regardless of how much money is "printed up".

A well reasoned author and frequent commenter on seekingalpha responded to the above linked article.  I believe he hits the nail squarely on the head, and he also expresses my frustration with the inflation-is-coming-I-tells-yas-so-buy-gold-now crowd:

Ideologues can't admit they are wrong and let go of their slander-script.

The error lies in thinking only the supply of money determines its value. Name any other commodity whose value depends only on its supply, and not on demand for it as well.

For the millionth time, demand for money is not a constant. It is money illusion in spades to think that it is.

Money is not wealth, it is not the "real" form of wealth with others being fake, nor is it a scam itself, with only "real" assets having value. Money is merely one asset among others, with a small and relatively stable *transactions* demand and a huge and quite unstable *safety* or investment demand.

When the investment demand for money changes dramatically, the objective exchange value of money changes too, if the quantity of money does not immediately change in exact proportion to that shift in demand. Even if the quantity of money is increased dramatically, its value can still rise, if the demand is increasing even more.

Why is the demand for money rising? Because real interest rates are rising, and doing so dramatically. This is making long dated claims fall in value compared to short dated claims. Risk premia are also rising dramatically, making safe claims rise in value compared to uncertain claims. Money is rising in value dramatically, compared to every kind of commodity that bubbles were blown in, making *nominal* claims more valuable than *real denominated* ones. (Being paid in dollars a year from now is worth *more* than being paid in steel a year from now, for example).

All of this is an entirely predictable consequence of too many people believing simultaneously that real assets would be worth infinity and dollars worth nothing, and every one of them being hopelessly wrong.

Who was going to pay them all if they were right? Were central banks ever going to print enough money to justify all the bubbles you-lot blew? No, it was pure slander on your part, and chutzpa.

From March of 2005 to March of 2008, the Federal Reserve did not allow the M1 narrow spendable money supply that it directly controls, to move one inch.

That broke all of your bubbles. Real estate first.

In case nobody has noticed, the whole trade that blew up and caused the credit crisis, was exactly this insane belief that any real asset - like a house - would always be worth infinitely more than any amount of nominal debt used to carry it. Sorry, no, untrue. Bid prices high enough and the debt is worth more than the real asset.

What will it take before you-lot get this slanderous inflationary brainstorm out of your system? How about grinding you to atoms for a decade? Whatever it takes.

Bonds at the current huge spreads are going to pay. None of your bubbles are.

Your unwillingness to simply lend on nominal claims to investment grade credits, will choke off all fuel for any of your bubbles forever, and they will not go anywhere. Not until bond owners are first *paid*.

Savings capital will be paid in full for its services ,and in real terms. Every attempt to avoid that will blow up in your face. Nobody is going to ride in and reinflate your cockamamie schemes. Not until you disgorge all of it and pay bondholders back every dime stolen from them, twice.

It isn't complicated. You just don't like it. Tough toenails, you are wrong.

I don't agree with this commenter exactly in that I obviously think there is a greater risk of deflation than he does.  But he elaborates well the problem with the self-described "inflationists".  They don't seem to realize that for their outcome to be realized they are demanding another, new bubble.  Bear in mind that many of these folks came out of the real-estate-bubble[head] camp.  They argued, along side folks like me, that a mega-real-estate-bubble had inflated and was becoming dangerously close to popping.  They railed against Greenspan and Bernanke for creating the bubble.  They welcomed its popping as a beginning to a return to sanity.

But that's where they got off the rationality train and boarded another bubble-cheerleader express.  Most of them are in the gold & precious metals camp, as the seekingalpha author is.  Others like Peter Schiff embraced a worthless dollar theory and started cheering for the euro to replace the dollar as the world's reserve currency, and to buy all things European and euro denominated.  Yet others are holding out for $500 oil.  And then there are all those who simply want real estate to re-inflate.

Suffices to say, I've yet to meet one in this camp who recognizes the ironic hypocrisy of their position.  They are wishing for a bubble to replace the bubble.

...

I received another, more reasoned email from a reader who firmly believes that we are more likely to inflate further, then default, and finally deflate.  This reader also believes that stagflation is unlikely-to-impossible.  I, however, believe we have actually just emerged from a stagflation which lasted from 18-24 months, maybe longer.  A lot of that depends upon how gamed the government stats really are -- and I think all of us can agree that the government stats are at the least "lacking".

The main issue I have with the overall conclusion that the US will default is that it is not necessary.  The same can be accomplished without a default, which is arguably what occured in the 1930s.  In essence, the rest of the world has much more to lose in the case of a US default than we do.  We derive roughly 4/5 of our economic activity from internally generated GDP.  That means we keep 80% of our standard of living after a default, give or take, with oil being the only real problem for a while.  Europe, on the other hand, loses from half to 3/4 of theirs.  Japan loses 80% of theirs.  And so on.

Also, after a default there would not be deflation.  There would be little left to deflate.  The US stopped deflating by the late 1930s, but didn't start really re-inflating until the 1960s.  And that brings me back full-circle:  monetary theory.

See, the reason we didn't inflate after the Great Depression and WWII for decades even though they drastically increased the money supply was because we were growing.  That's really the key.  Growth.  If an economy is growing, then it needs more money or it deflates by definition.  If an economy experiences increased demand for money, then it needs more money, or that money becomes more and more valuable and deflates prices.  It actually has nothing to do with the gold standard, etc.  It has to do with the theory of money, which is really unrelated to which form of fiat money is.  Keep in mind that a gold-standard system is still a fractional-reserve banking system, and the money is still fiat.  It's just a different sort of fiat.  The only non-fiat money system is one without any money at all, which seldom exists in societies with more than a few thousand people. 

...

I know this was one of my longer articles, but I hope this prompts some reasonable debate.  I, for one, believe it's very important to move past the ideological and self-serving conclusions such as typified by the seekingalpha article's author.  We are headed towards rough times, and it is in all our interests to cut the bull and deal with this thing for what it is.

--Randy

Comments

[randolfe]

The Physics of Money. Another great article just posted today on seekingalpha that outlines exactly what I was talking about re: the velocity of money.

Simply, demand for money is causing velocity to slow to the lowest levels since ... well ... the Great Depression. That's why Ben is trying to print, print, print. But all the printing can't change the demand side.

[Brand]

Randy, perhaps you could elaborate on what you feel is driving the demand side of the money equation? I understand that there is presently a flight to U.S. Treasuries as "ultimate quality", and also that dollars are needed to pay off various huge debts. Can it really be that rising interest rates are pushing that hard on the demand side, especially when the Fed is trying desperately to keep them down? Is this why the gap between LIBOR and the Fed rate kept widening in the last couple of months?

[TunaFish]

AH HA!!

I knew that, eventually, i would find something pointing to the Fed as the cause of all this mess.

" They railed against Greenspan and Bernanke for creating the bubble. They welcomed its popping as a beginning to a return to sanity."

"From March of 2005 to March of 2008, the Federal Reserve did not allow the M1 narrow spendable money supply that it directly controls, to move one inch.

That broke all of your bubbles. Real estate first."

also
Randy,
If you have some time, I would like your take on the following as a possible real solution.
MonetaryReformAct

[randolfe_]

Section 15 would cause a world war within 18-24 months, perhaps less. The US cannot unilaterally withdraw from the Bank of International Settlements, the IMF and the World Bank. That is insanity.

All of those institutions could use reform, which may be consistent over time with the goals of that act. But to withdraw unilaterally would be to guarantee the starvation of tens of millions of people in the developing world, not to mention almost certain collapse into genocidal civil wars making those of the 90s look like a campy horror movie in comparison.

Overall, I'd say it's largely a protectionist, isolationistic move. Hardly fair given that the US is the one who globalized the hell out of the world for us to then be the one who takes his ball and goes home, does it?

[randolfe]

Brand, demand for money is being driven by deleveraging, flight to safety, and capital shifting international capital flows. Every time the euro weakens their demand for dollars increases.

Today the 30 year treasury swaps turned negative. That is directly related to the Lehman CDS unwinding, which the media is trying to spin as no big deal. But it is a big deal. A huge deal. It's causing a loss of confidence in the Treasury complex, and thereby dramatically increasing demand on the money supply (thereby decreasing the velocity of money...making money very sticky).

People are betting that either (a) the US will default, or much more likely (b) the US won't default but will enact capital controls preventing defaults but tying up money.

FT article

[TunaFish]

"Overall, I'd say it's largely a protectionist, isolationistic move. Hardly fair given that the US is the one who globalized the hell out of the world for us to then be the one who takes his ball and goes home, does it?"

Thats a good point. We dont want to be the "Eric Cartman" of the world.

I have a problem with the mandated 3-5% inflation. I think 0 - 5% would be better in case of a population decline or no growth period. Evan placing an fixed upper limit could be problematic...we dont want magic numbers. It would probably be better left to some well though out algorithm.

In any event, this act will probably never see the light of day.

[Toronto realtor]

Very interesting article. I think the world has never seen such a financial chaos (maybe in 16th century, when flowing gold from the New World showed the surprised Europeans there is something like inflation). Some people are announcing the end of capitalism. I believe this can be serious blow to central banking system. If want free market and the invisible hand working, we can't have administratively set interest rate and randomly printed papers called money...

Julie

[EBGuy]

That's why Ben is trying to print, print, print. But all the printing can't change the demand side.
I'm assuming you're using the term "print" tongue-in-cheek. All of the Fed's (and for that matter, the Treasury's) activities up to this point have been sterilized -- although some might argue that the Fed is taking in bum collateral (which I suppose leads to debasement). Ultimately, as you say, the banks are the ones who put the "fraction" in fractional reserve banking, and if they aren't lending...
I think most of us have such a hard time getting our head around the issues as we've never lived through a time when "cash was king". I believe you noted a reverse effect when pointing out many Great Depression era savers couldn't re-adjust their actions once monetary inflation started kicking in. FWIW, our fiat money exists because the government demands it for payment of taxes. In a deflationary death spiral, people begin putting more trust in alternative stores of value, and I think that's why interest in gold spikes.

[FuzzyMath]

Randy,

I didn't really get this comment in your article...

"When that demand outpaces the supply, then there is deflation regardless of how much money is "printed up""

Isn't the printing increasing the supply? And at some point this printing of money will outpace the demand for money?

I believe the velocity of money point is a good one. In that as long as velocity goes down, it requires more and more money supply to maintain price levels. And right now, the velocity is certainly slowing.

The fed is trying to compensate for the slowing of velocity by printing money. If for some reason velocity were to increase again, money would need to be destroyed or we would run the risk of a high inflation environment.

The real question would be... what would be a catalyst for an increase of velocity given the current set of factors? I can't think of any reason to spend more money right now myself.

[randolfe]

FuzzyMath,

Some others pointed out that the Fed's "printing money" isn't really increasing money supply in the manner that I think most people imagine. EBGuy put it good: last I checked Bernanke hasn't landed his helicopter outside my house giving me a barrel of cash.

There are a couple of things to remember:

1. If all the "printed up money" never ends up increasing nominal salaries and wages then even if it ends up as easy credit, it doesn't increase the money supply to consumers. All the easy credit does -- most of which is revolving credit and short-dated term credit -- is push out the equilibrium point by a couple years. It just buys time, not inflation.

2. Because of fractional reserve banking ever tick down in velocity destroys far more demand than supply can be printed. And velocity is slowing for two reasons itself. First because of slowing transactional demand. But much more so because of increased demand for cash as an investment class in its own right.

If you want to think of it like this, consider that a new bubble is emerging: money. People are flooding value they wish to store into money, which is destroying velocity and making money sticky.

There is another aspect that is very important to consider: destruction of money. Money is being destroyed at a frantic pace today. Again, due to fractional reserve banking, it is being destroyed faster than it is being printed. A couple weeks ago I was writing about how some of the "stable" big money center banks were levered 40:1 and now must come down to 8:1 or 5:1. Well, who knew that there were European banks levered 150:1 and even 200:1 in a few cases? And all that in dollar-denominated assets. As they delever, there's less and less money in the system. It was this notional money they were lending, at a multiplier of their fractional reserve requirements.

[FuzzyMath]

I guess it really comes down to the numbers. Which, I'm sure you are right, there is far more money destroyed through deleveraging than can be printed. In fact it's probably a decent multiplier of the total money supply. Anyone have numbers to back this up?

Randy, you're making a pretty convincing argument. Do you think there are any other alternative outcomes to another Depression or Japan part II?

[DebtsNMesses]

I see this a bit differently as you know. The Great Depression, along with the hyperinflations of recent years, such as Israel, Russia, Argentina, etc., are a collapse of currency. The similarities are there, in that the monetary system no longer shows the currency 'value' of items and a barter system is created.

The difference is the monetary supply. In hyperinflation, the money supply increases. To continue the same inflation rate, say 20%, or 1.2 trillion with one trillion being the base, the next cycle we must print 1.44 trillion just to maintain the inflation. This continues until the currency is in complete collapse. Since the individual people in a country have a difficult time keeping up with such inflation, essential goods increase in price, causing the others fall. Although they don't fall in 'price' per se, they fall in comparison to the essential goods. In a Depression, the money supply decreases, yet the essential goods are still considered expensive.

The problem that has me most concerned is the United States ability to produce our own goods. We no longer do that. Our oil, food, and almost all our products are to some degree reliant on outside sources. Simply put, we have lost the ability to fend for ourselves and have made the world our 'slaves' to do our bidding. (no, I'm not saying real slaves, but they are our workers)

This inability to function w/o the rest of the world in turn forces our govt to create inflation, so that other countries will continue to do business with us. Otherwise saying, if we want to do business with them, we MUST pay them, whether we have the money or not.

Regarding the current oil prices, please remove them from consideration for now. The govt released a large quantity of reserves (the excuse being Gustav, but most would think it's for the election).

Whether we inflate or deflate, the collapse of the currency and the start of a barter system I believe is inevitable. I just can't see that our govt is not making every move possible to 'spend our way out of debt', which every economist knows is impossible.

Btw Randy, I completely agree with you that we have just been through a Stagflation of sorts. In my own theory of Stagflation, it's a high inflation, but not a 'super-high' and out of control inflation. Still we agree. On the other hand, according to every bit of literature I've read, the way to get out of Stagflation without furthering inflation is to raise the fed rate and lower the govt spending. Bernanke did not increase the fed rate, nor did the govt lower spending. In fact, they did the opposite, which would again promote inflation.

[Brand]

I disagree that the United States no longer produces its own goods. It is very true that we import heavily for specific items, and that some industries like electronics have drifted partly overseas. But even in the globalized economy, this country still has an enormous manufacturing base. In addition, we are still the breadbasket of the world. If imports and exports stopped tomorrow, we would have almost everything we needed (except luxuries), and most of our trading partners would be completely screwed.

[Brand]

Randy, I think I've finally understood most of deleveraging and deflation, but I did have a last question on the topic. In advance, please correct any errors on my part.

You routinely state that the banks must deleverage, and that effectively moves the fractional reserve system in reverse. Banks want to move from 30:1 down to 10:1, for example. However, the banks can't just call in loans and receive the cash back. So it seems that they are more likely to manipulate the reserve side of the equation for existing loans by simply raising the reserves against them.

If I understand correctly, the economy perceives this as deflation, because suddenly a lot of Fed-issued money becomes "dead money" sitting as reserves at the major banks. This is to the banks interest, because the Fed even pays them interest on the collateral they put up for the loans. And when the banks get paid back on short term loans, those repayments are used to increase reserves. Many new loans are not issued, and those that are will be at a 10:1 rate.

In as many words, banks are effectively deleveraging, but the true mechanism is simply raising reserves against existing loans with cash borrowed from the Fed, and keeping higher reserves against new loans (or not issuing new loans at all).

The economy perceives this as deflation because once the banks reach their new target reserve levels, they are not interested in issuing large amounts of new debt into the economy (the Fed is pushing on a rope here), and the banks are sucking up cash from repayments without lending it back out.

If this is all correct, then at some future point, couldn't the banks decide that it's a safe environment again, lower their reserve requirements to lever up, and release all that "dead money" back into the system? It seems like once all the CDS garbage is cleared up and counterparty risk approaches healthy levels again, that we will have a reflexive moment of sharp inflation, sort of like a dam opening up its spill gates.

[DebtsNMesses]

Brand, we cannot even move a product, even if we make it 100% in the usa, with 100% usa materials, without oil. Therefore, there is not one thing we make that is not reliant upon imports in one way or another. If you examine the big companies we are bailing out, you will find that much of their merchandise comes from outside the usa. As far as being the bread capital, have you driven the country lately? Corn for fuel is planted in almost every field it can be. Second, is soy, which is a preservative, not food. With corn prices through the roof, even the farmers are concerned about food supplies. The last samilila scare was from food from Mexico... tomatoes I believe? Can you imagine paying off your farm loan with just filling it with corn? Yes, the profits are great, but it leaves us vulnerable. Even if we plant wheat, it is subsidized, so that way the farmer doesn't take a pay cut from doing the 'lesser' paying crop. That means the govt will give the money paid for corn for a farmer to plant wheat. What exactly do you think that will do to food prices?

Just food for thought! lol

[TunaFish]

Well we produce 12% of the worlds rice and are the #3 wheat producer so i think we are OK. As far as using oil goes, we have the technology to get off the stuff for transportation, but lack the "will" to do it.

http://en.wikipedia.org/wiki/Wheat#Health_concerns

http://en.wikipedia.org/wiki/Rice#United_States

[randolfe]

The US is actually *overproductive* in terms of agricultural output. Joseph Stiglitz won the Nobel largely for his work at the World Bank and criticism of the IMF on these points. In actuality, the WTO agreements are heavily focused on controlling US ag export pricing so that we don't destroy the entire rest of the world's ag industries.

We are over 3x as productive as Europe in ag. Only Canada compares, and even they are well behind. Most of US ag productivity comes from technology, automation, and scale operation management.

As for energy, the US isn't as "100% reliant" on foreign oil as the pop media spouts. Firstly, the US only depends on just under 20% foreign energy in total. True, most of that foreign sourced energy is in transport, and is oil. But, of that foreign oil, over half is from Canada and other reliable trade partner sources (who are subordinate to the dollar).

There would be a very real challenge if we abruptly lost the other half. But we could, and would work through it. With short-term measures like conservation and rationing, and long term solutions like conversion to natural-gas fuels followed by new energy technology, I have no doubt whatsoever that such an event would end up propelling the US into an even more dominant position in the world.

And that is ultimately why the world won't want that to happen. They'd just end up creating an even more hyperpowerful US.

As for manufacturing (non ag), there are a lot of misconceptions about US output. The US is the only non-Asian country to have its share of global value-weighted output rise of the past 20 years. Germany and all of Europe fell. Remove commodities and everyone fell but the US, China, S Korea, Vietnam, Mauritius, etc.

The reason is we produce extremely high-value, complex goods that literally no one else in the world can produce economically. Something like 40% of the guts of every Airbus, for example, are US components. The Europeans would produce those themselves. And they actually _can_ make them. But not economically. They aren't productive enough. We are. But, all that high-end manufacturing doesn't employ many people. It is capital intensive, highly automated, and requires only highly-educated technicians, engineers and managers. Virtually no labor.

The only area we're exposed in is heavy-scale, low-tech manufacturing like bulk steel. But then, no one produces that economically worldwide anymore but South Korea. But everyone else _can_. The UK, Germany, Japan, Russia, the US all have the ability to produce steel. We haven't forgotten how. We just don't because the Koreans do it cheaper. But the converse is not true. The South Koreans cannot produce high-end, exotic alloys right now (economically), even if they want to. (Only the US and Japan can).

I referenced all this in a thread I wrote on Patrick.net about 2 years ago ("Why I'm not a Doomster", Google to find it). The data on how strong the US actually is should slap some reality back into some of us. Don't believe the pop-media. The US is not dying on a vine anytime soon.

[randolfe]

Brand,

The other aspect of the deleveraging that is working to force deflation is that many of those debts are defaulting. So that money never even recycles through the banking system at all. The banks are writing down, and off, many of those debts.

That money is gone. Destroyed. It is real wealth destruction at work. In fact, it is the failure side of the equation why I disagree with those who argue that bubbles are somehow a good thing, in that they allow all kinds of new experiments that result in some great innovations. I believe those innovations come from challenge and need, not from excess and surplus. The problem with the pro bubble arguments is that bubble-popping events are rapid deflations which destroy more wealth than just "washing away the trash".

That's the fear I believe the policy makers have right now. This deflationary episode risks dragging down some otherwise solvent, responsible, stable firms, industries, and people.

I'll use myself as an example. I have a significant amount of wealth tied up in absolute government-sovereign debt right now that is impaired. So that wealth is now illiquid. It is cash-equivalent, but I won't realize those losses knowing they are only temporarily impaired. The US will not default on sovereign debt, and it still yields, but the problem is the economy has stranded that cash for the indefinite future. So a portion of cash I might otherwise use for downpayment on a home, for example, now has a velocity of zero until such time as the Treasury complex returns to some order.

That's what the Fed is trying to unravel. I don't think they care a hoot about reinflating prices of discretionary goods. They care about unfreezing the money markets and addressing the bond spreads.

[randolfe]

One more thought. I've heard here, read on seekingalpha, and recently read a thread on Patrick.net that Patrick wrote that all imply people are trying to effectively "short the US". I think Patrick openly asked about how he could go about shorting US treasuries.

Of course, shorting treasuries can be a valid trade, but that's not the context in which Patrick or others are thinking when you read their reasoning. They want to bet against the Fed (and Treasury to a lessor degree). All I can say about that is this:

It is ill advised to bet against the interests of the US Federal Reserve (or the ECB or the BoJ). These institutions have the ability to remain irrational far longer than you have the ability to remain solvent. For what it's worth, take it from my experience. I have spotted at least two major Fed "irrational" situations, in which I tried to take the other side of the bet. Both times I never realized the benefit due to the length of time the Fed was able to hold their position.

So the way I see it is that you have a choice to make positioning wise: position for inflation or for deflation. Here's the rub, you cannot reposition from inflation stance to deflation stance, but you can from deflation to inflation stance. That is, if you're a firm, you can horde your cash and pull in costs preparing for deflation and loss of pricing power. If you're wrong, and the situation changes abruptly, you can lever that cash and exploit the inflation. But if you lever and exploit for inflation, you can't suddenly wave a wand and bring that cash back if deflation turns out to take hold.

The same goes for individuals. Cash is king. You can always borrow against it later if they start giving you free money notes.

[Brand]

Randy, I think your sovereign debt example is exactly what I'm driving at. Effectively the liquidity crunch has made that dead money, but it hasn't destroyed that money.

The defaults destroyed the money from the perspective of the banks, but it went somewhere (to homebuilders, stocks, etc.). Much of that money is also dead--sitting in assets like unsold new homes. But the new money from the Fed to the Chosen Nine is just pooling up there. At some point they will perceive that the situation is finally close to resolution, and when they do, can't they just release that money via new loan originations and create a huge outflow of cash (and thus inflation)? I mean, the Fed and Treasury can only reel in chunks of that cash as the notes come due... they can't mop it all up in a month. And they will return the collateral, which hopefully at that point will be more liquid and thus have a less impaired value (i.e. an accurate reflection of its true risk-discounted market worth).

[Brand]

By the way, I wholeheartedly agree with your comment about cash being king. It's all about the flexibility premium.

I get the same argument from people when they find out that I've rented month-to-month for five years. The premium per year was about 8% to do that. But tech was unstable for a long time, so the premium was worth it to me (my company had constant layoffs from 2001-2005). Many people kept telling me, "You need to commit, think about how much money you've already lost." Most people are incapable of comprehending that backwards-looking data cannot be accurately projected into the future. They focus on that small amount of "lost" money. But what if I had faced a layoff with 11 months left on a lease? That "lost" money is a small premium to avoid a much larger risk.

In other words, I found myself willing to pay a small premium for flexibility and more predictable cash flow. It's the same with buying a house--if you can't predict stable cashflow going forward, there is no reason to lock yourself into an illiquid asset. Gold & commodities are in the same boat right now--if major inflation and/or a brutal recession struck, it is far better to have available cash than to have a potentially illiquid asset of improved value. They don't take fragments of gold, land or crude oil at the supermarket.

I've been 80% in cash for five years, which finally allowed me to make significant S&P 500 buys at Dow 8500-9500. I don't make short term plays (I've never held a stock for less than four years), and eventually all educated patience pays off. If we do start having bad inflation, then I can easily shift into a neutral position or even get aggressive. But I expect that if we're having serious inflation, that we are also having a recession, which makes it very likely that I'll need some available cash to make it through.

Of course, my greatest asset is that I have almost zero required outlays and 95% flexibility. Which increasingly seems like a brilliant move, and not just a relaxing lifestyle choice. :)

[randolfe]

Brand,

What you're describing is basically the value of holding a real option. I really think real option valuation is an incredibly powerful way to look at real-world decisions. We made similar decisions to your, though somewhat different for our situation. We've been renting since selling in 2005. Rather than a month-to-month, we entered into a somewhat complicated lease that involved a very large cash forward of pre-paid months in return for an ongoing exit-option. That has served us well for going on the 4th year now, but it has cost us between 8%-10% premium over straight rent on a yearly lease. But, we have the ability to exit within any 3 month rolling period should we need to, whether that is because we buy a house or because we elect to leave Marin. The value of that option to us is very high; I roughly modeled it is worth close to $100K given our rent levels and the guestimates about risks.

I think it's very difficult for most folks to think in terms of opportunity costs, let alone real-options valuation of decisions which affect those costs. So, they look at people like you and I as if we're "leaving money on the table" or "being noncommittal". Over on Zillow I can't tell you how many times the knee-jerk reaction of real estate types was something like "well, you just need to grow up and get serious about your future".

Frustrating. But, those people are sweating bullets right now and I'm so not concerned about our future that my lack of concern is concerning.

[randolfe]

Your rationale of my sovereign debt example leaves a couple of points open. Think of it like this when considering wealth destruction and deflation. And consider not just me, but say ten million mes all doing facing the same decisions:

a) Some of us are ultimately forced to realize the losses on our impaired assets, so that wealth is then lost. Then we have less cash to cycle through the economy causing deflationary pressure. Those assets can be sovereign debt, real estate, etc.

b) Some hold that impaired debt until it becomes less impaired in the future. That cash has a velocity of zero for cash-equivalent assets (like bills and notes) and is dead equity in the case of real estate. That robs the economy of capital which would otherwise feed into the growth equation. So the Fed tries to plug the gap with liquidity which, as you point out, doesn't become growth capital either, but just reserves against that dead equity and stuck assets.

c) At some point in the future the impaired assets are reconverted into cash. But now that cash is cycled at a reduced leverage, so the capital growth curve is dramatically flattened, causing a cycle where ever more cash is required for ever less capital growth.

Now what can the Fed do? They can loosen reserve requirements. But those are too loose already, and the Fed realizes that and instead is trying to raise reserve requirements (indirectly) by pouring cash into the banks balance sheets. The Fed can penalize cash and try to force lending, but they can't affect real interest rates. And those are skyrocketing, exacerbated by risk premiums.

How about if this all does end up causing too much liquidity and inflation? How could the Fed mop it up? They have far more tools than just the open market operations and official rate: they can just raise reserve requirements. They Fed holds the power to halt inflation in its tracks regardless of how much money they "print". If they raised reserve requirements to 100%, for an extreme example, then all the credit-liquidity would go away.

I just can't get worried about doomsday inflation scenarios. The other aspect of broad price inflation is it implies massive growth. Massive. Inflation doesn't happen during recessions except for the short bouts of historical stagflation, in which it is arguable how high inflation was -- ie., it wasn't broad. Some things inflated, others stagnated or deflated. Recessions are inherently deflationary. So for rampant inflation to take hold something has to grow. Something. That something can't be a store of value, either, like gold. It has to be some sort of asset class that explodes in price.

Food? Not likely. I reference the arguments above about how the US overproduces and is overproductive in ag. Energy? Perhaps, but energy is a tricky asset class. Every time prices go up alternatives become more viable. If oil rises enough, for example, then oil shale becomes economical. I think that's $250/barrel, if I remember. And that's today's prices. And the US + Canada hold most of the world's oil shale and that's an amount greater than all the proven reserves in the middle east. Discretionary consumer goods? Perhaps, if the Fed starts giving consumers Fedit cards that work at Fed ATM machines. Durables? Again, not unless everyone starts buying everything on even more credit.

I guess I see the credit cycle has come to an end. It must shrink. Shrinkage of the credit pool available to consumers causes deflation without exception. I don't care how much money the Fed prints. Unless that translates into higher salaries and/or higher consumer credit lending then prices go down and the economy shrinks.

[randolfe]

One other point. Someone pointed out that hyperinflation and deflation are both cases of collapse of currency. I don't believe that is true. Hyperinflation involves the collapse of currency, but it is not because of the collapse of currency. The causality is the other direction. Hyperinflation is caused by servicing foreign held debts at a rate higher than the growth of the real economy, to a point where faith is lost in the ability of the country to make good on its sovereign debt. The result is ever decreasing demand for that sovereign debt making the currency effectively worthless.

Deflation, on the other hand, does not imply any collapse of currency. In some deflationary depressions it has collapsed, none in the US unless you consider the Confederate notes during the Civil War. Currency did not collapse in the 1930s. Quite the contrary. It became so heavily demanded and in such short supply that you could literally spend it about any place on the planet outside of the Soviet Union and Japan. US dollars were even spendable in post-Weimar (post Inflationszeit) Germany, under the leadership of he whose name will go unsaid.

[Brand]

Randy, excellent point about comparing lease structures to real options. I do agree, most people are incapable of factoring in opportunity cost. Truthfully, I think that's as much psychology as anything else. People don't like to consider the paths they might have taken, except in silly circumstances ("If I'd put my net worth into Apple stock in the late 90's, I'd be a multimillionaire by now."). They certainly don't like to think about the paths they might take in the future, at least not once they've made up their minds. People are very uncomfortable with doubt, even though it's obvious that we all have to face it.

For the same reason, I think pressure to buy homes is generated by a self-reinforcing cultural trend. I constantly get told that since I'm over 30, I should definitely own a house. You have no idea how many older people (40+) ask me about this every single time they see me. It seems to be a cultural right of passage--if you own a house, you're more grown up by the American yard stick. At least, the J6P yard stick. Some people buy houses just to undergo the right of passage (they argue to the contrary, but if you listen to them talk long enough, a lot of them basically admit this). If you have the means and you're not buying a house, then you're indirectly snubbing their rite of passage, and when people feel that their traditions are snubbed they get indignant. It reminds me greatly of hearing fraternity Greeks talk about college... they wonder how any non-Greeks made it through or had any fun. Some people staked their entire identity around that rite of passage, although thankfully there are plenty of normal Greeks to balance them out. But the balanced folks are never the most vocal.

I see that we're still circling the velocity of money concept. I superficially understand your points, but isn't velocity of money ultimately comprised of static and elastic components? Deleveraging and realizing losses are static. Dead money in illiquid assets is static. However, it seems to me that the lending component is dependent on confidence. At some point once deflation has bottomed out, won't confidence take that into account? It seems that many bear markets end with a sudden sharp climb of commodities and stocks into a bull market. If there is a large pool of money that the banks could access but refuse, coupled with a confidence barrier, and that barrier suddenly breaks down thanks to a brighter outlook, then can't the available supply suddenly rocket upwards?

I liken it to a parallel plate capacitor. Right now the dielectric constant (1/confidence) is high, blocking the charge built up on both plates. But if confidence suddenly climbed, that would quickly allow an arc, and with all the pent up electrostatic pressure the current would create a major spike.

[randolfe]

It's always hazardous to draw comparisons to the Great Depression. But, after the GD stocks did rocket. Commodity prices became essentially invaluable (due to the war), and continued to hold value after. Yet, inflation didn't hit until the 1960s.

The key was growth.

After a prolonged deflationary period any ensuing money supply increases are eaten up by real growth. There is a multiplier there too. Because real growth requires capital growth, a lot of money supply is needed just to hold prices relatively constant.

The real questions here I see are (1) how deep will the deflation be; (2) how long will the deflation last. Deflationary periods can be brief as in recessions. 18 months or so is a long one. Or they can last a decade.

If this turns out to be a cycle that deflates for even a couple of years, then we can expect a lot of the money supply growth to be consumed by growth out the other end.

--

By the way, try being a head-end Xer who's crested 40, owned houses since he was in his late 20s, has kids, the means to buy, and still elects to rent. So many people are so uncomfortable with the situation that they won't even talk about it. It seldom comes up in polite company even among people who know us. When it does, they write it off as my wife and I both being "finance types" who "think they know better than everyone else".

And, if we're right (which we are), they'll dismiss our having been right as being finance types who were uniquely able to see what was happening. Of course, that's all bull and anyone with half a brain and honest critical thinking skills knows what's going down, but that's not how psychology works.

[Brand]

If growth is the key, then I am curious what will drive U.S. growth in the coming years. Can it really be exports? There is certainly a bias towards shipping new manufacturing jobs overseas, so we will need a product that plays to both our technological prowess. Friedman and others have been pounding the table for a "green economy" led by the U.S., but of course he is also the king of oversimplification. Short of that, I don't see any particular boom areas on the horizon... at least, not those unrelated to Boomer aging, and they will eventually die off in a few decades.

As you pointed out, many expensive U.S. exports require little actual labor, which is in contrast to previous generations. Could we have a GDP recovery without an employment boom? Perhaps Boomer retirement could help employment numbers, but we've still got a very strong dollar relative to the Asian economies (particularly since their stock markets are crumbling as we speak). Even with most of our consumption directed internally, the system seems ready for contraction, not expansion. How do you transfer all the labor from sectors like homebuilding into non-manufacturing sectors?

[Brand]

btw, you're over 40 with kids and you don't own a house? You guys must just be hippies or something. If you don't buy a house soon, they're just going to stop making them, and then what will you do!

Heh, I was fortunately able to restrain myself right before going off on another rant about converting all the local farms into developments. I think the earlier Ag discussion pointed me in that direction.

Oh, and I almost forgot, you owe me $45,000,000,000 and Heidi Klum. That's the second time this year Tressel the Vessel struck an iceberg.

[EBGuy]

I suppose its worthwhile to post this, Deflation: Making Sure "It" Doesn't Happen Here, as part of the discussion. I had never read it before, but I believe it is the classic "Helicopter Ben" text that folks on the Internets often quote. Here's a few highlights:
A particularly important protective factor in the current environment is the strength of our financial system: Despite the adverse shocks of the past year [2001], our banking system remains healthy and well-regulated, and firm and household balance sheets are for the most part in good shape.
...
If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.
...
Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral.
...
If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.

[randolfe]

I definitely agree that the policy goal of the Fed is to prevent deflation at all costs. I think they are ultimately all Keynesians in the grand "use it or lose it" sense. Since they realize that the US is effectively immune to classic hyperinflation for the foreseeable future, they believe that printing their way out of deflation is reasonable.

That implies some unpleasant side effects. Terrible inflation in petrodollar countries. Drastic shrinkage of total global trade. A breakdown of the Asian currencies as they try ever more in vain to keep pegged to the dollar for trade reasons.

Playing out the macro simulation is unpleasant. Most of the pain will be felt outside of the US. Places like India may well suffer outright crisis as an entire middle class built almost solely upon currency-derived wage arbitrage with he US breaks down. In China, it's a roll of the dice. They have enormous productive capacity and lots of momentum, so there will be some other outlet if not shipping billions of tons of cheap injection mold plastic crap to American Wal-marts. Probably into military expansionism. Isn't that always where these episodes head?

The other big problem is that liquidity != capital. The Fed can print and print and print, none of that means automatic market liquidity, growth of credit, or productive capital growth.

I just heard that the Fed is seriously considering cutting rates to 0%. So at that point we're in a ZIRP scenario (zero interest rate policy). The big unknown about ZIRP is if it will work.

The problem with ZIRP is that the US dollar has effectively been taken over by the rest of the world. While everyone was declaring the death of the dollar few noticed that the entire world was accumulating so many that it rivaled their home currency reserves. So now they have much more real interest rate power than ever before. If the Fed cuts rates to 0%, but real rates climb to say 12%, then what's the outcome? The Fed can start buying private assets all they want, but that will just drive the real rate up ever further.

It's just this sort of deflationary cycle I really fear. I can almost read the history 50 years from now already: "Federal Reserve Chairman Ben Bernanke, a great student of the Great Depression 1.0 of the 1930s, believed lowering nominal interest rates and printing money would stave off a second catastrophic deflationary cycle. Inadvertently, however, it was the policy of ever more loose money supply which necessitated ever increasing government interventions which then caused the dollar as a world reserve currency to become ever more highly demanded. This deflationary cycle proved to be even harder to break than the simpler version faced by policy makers 80 years earlier".

[Brand]

So how is that massive swing in dollar strength going to affect commodities like concrete, steel and base metals? Can China really keep industrializing at this pace, or is their construction boom finally over?

I fail to see the point in currency pegging if the U.S. refuses to buy services from other countries. A few companies use outsourcing as their primary personnel strategy, but most use it as a method of creating cheap, flexible labor for speculative projects or non-core functions. Once the bad times set in, those contracts will be cut within months. Even if China turned its production force to other areas (hopefully not military), it still has to amortize all the equipment purchased with the intention of supplying the U.S. with an endless stream of cheap plastic crap. If their domestic market would pay for that stuff, they would have already been addressing that need. They will have massive unused capacity, and if they have truly become capitalistic, then that will produce massive downwards price pressure as everyone fights over a shrinking revenue stream.

[GK]

Note that while past deflationary periods were painful, today in the 21st century, not all deflation is bad.

There is a new, good type of deflation : the Moore's Law deflation. Your purchasing power increases by 58% a year, when purchasing semiconductors, storage, or bandwidth. There are products where your purchasing power increases every few months, simply by waiting (PCs, LCD TVs, cell phones, iPods, networking products, software, cellphones, game consoles, etc.)

While this is still a small part of the global economy (about 1%), it is at least large enough to be a factor, unlike before the 21st century.

[Brand]

LOL. Did anyone see the White House press release this morning? Bush is telling the banks to start lending, or else! I guess he didn't get the memo about pushing a rope...

[randolfe]

Now is a very interesting time. Deficits are already out of control, so the basic Keynesian approach might not work: deficit spending to prime growth. The yen carry trade unwinding so fast that Japan is basically being begged by the US and Europe to intervene and weaken their currency. Japan, with only 0.5% left, doesn't have a lot of room to weaken it. Add to that the ECB and Fed now cutting their rates, and we're brewing the perfect storm.

The real unanswered question is what happens when you push on a string with a bulldozer? We're about to find out.

[randolfe]

Natural product price deflation is something I hit on in the last thread. It's far more powerful than just 1% of the economy. It dramatically increases the US purchasing power of many items which are effectively out of reach to most of the world, even if they have nominally stronger currencies. At the core, it makes Americans feel wealthier because they have ever increasing consumer purchasing power.

Like general inflation, most people don't perceive product deflation at all, or if they do, they mistake it for the opposite effect. In actuality, you can purchase almost more of everything discretionary, durable, or luxury in terms of dollar per value today than you could 10 years ago, 25 years ago, 100 years ago...

The obvious are computers, home electronics, etc. The "Moores Law" group of products. But it also applies to large durables like dishwashers. Today a dishwasher is quieter, safer, more energy efficient, better at cleaning the dishes than one manufactured 30 years ago. For some odd, nostalgic reason, people think the opposite is the case. But, in general, newer products represent higher total value than older products, and they are being purchased with greatly inflated dollars, so they are much cheaper in real terms than products 30 years ago.

Automobiles are an extreme case. I can use my own anecdotal experience. My 2008 Nissan cost less in actual price tag than my 1992 Saturn. And it's a dramatically safer, more efficient, more reliable vehicle.

I think this effect is core to the whole J6P phenomenon. J6P feels wealthier all the time because his purchasing power keeps rising even as his debt load rises, and his income stagnates and future earnings prospects weaken. So J6P gets fooled by tax plans which actually don't speak to him at all, because he imagines himself much wealthier than he really is. He's not wealthy. He's just enjoys a strong purchasing power. Those are not the same thing.

[GK]

Randolfe,

I said 1% because out of a $50T global economy, Semis are $250B and storage is $200B, so a total of $450B = 0.9%

But biotech, software, and a few other product categories also qualify (but are hard to quantify).

Another way to look at it is that since 2000, the US economy has shrank in size, if measured in Euros, Oil, or Gold.

But almost all the world's economies have grown greatly if measured in GB of RAM, TB of Storage, MIPS of Processing Power, etc. The question is, are these product revenues big enough for this metric to have any value?

That is why this recession may not become as directly painful as the 70s (except for the most over-leveraged home-owners), since Moore's-Law time purchasing power jumps will continue unabated. It may be only 1-2% of a consumer's budget, but it is rising.

[Brand]

Technology isn't deflating directly in correlation to bits, so there is little point to measuring the world that way. Technology represents a particular capability. As processors accelerate and storage increases, we simply direct that new power to additional capability. Eventually a specific set of capabilities becomes the technological baseline, and society will come to require that baseline for full participation.

In the early 1990's, a desktop computer was the tech baseline.

In the late 1990's, a basic cellphone and an Internet-connected desktop computer were the tech baseline.

In the early 2000's, you needed a cellphone with text messaging and a camera, an iPod to carry your music, and a laptop to enjoy high-speed Internet connectivity emerging everywhere.

In the late 2000's, you might eventually need a cellphone with full bi-directional video capability, coupled to a a server-based store of all your personal data, accessed via a single integrated device that can service all of your other needs (GPS, texting, music, telephony, e-mail, web access).

Now, you could just stick with the late 1990's level of technology. After all, not everyone today is up to the advanced "late 2000's" level described above. But in another five years, anyone who isn't to the "early 2000's" level won't be equipped for many typical business and social interactions of the early 2010's.

My point is simply that the bits/speed/accessibility might climb expoentially, but that only means deflation if the capability level doesn't rise. I find it more relevant to compare what a typical technology set cost a consumer as a median income percentage. There is also utility value--you can get a 2x bigger LCD screen for the same price as 5 years ago, but is that really 2x better?

[randolfe]

Brand,

It isn't irrelevant at all. It represents productivity, not capability. There is a reason the US worker is, by an enormous margin, the most productive in the world. We employ orders of magnitude more capital-intensive technologies per unit of labor than anywhere else.

Productivity matters. In the Solow equations, which I strongly believe are correct, the only source of real growth over the long term is productivity, which itself reduces to technology advancements. All other sources of growth net out: population growth and deprecation replacement are offset by capital growth (which is why growth in the Soviet Union was false growth, unsustainable over the term).

All real growth in the US is the direct product of technology advancements.

[randolfe]

I also have to admit, the Nissan I speak of is our "daily utility" car. I have a very weak spot for German automobiles, and I would be forever lost if the new world economy somehow displaced the finest makers of automotive machinery that ever existed. I try to keep my real love to under 10,000 mi/year, and I beat up the Japanese car for daily routine.

[Brand]

Randy, I think superior education and quality healthcare also play a strong role in worker productivity.

Terminology aside, I think if you divided per capita spending to achieve a technology baseline by the median income, that number would remain fairly constant over the years. The "deflation" in price per bit or price per MIPS is equally offset by a demand for ever-increasing capability.

[randolfe]

Education and health care do matter. But consider this. Health care is significantly tied to technology. Technology isn't just chips and bits. It's everything propelled by science, including treatments, procedures, drugs, and even overall approach. The same goes for management technique, organizational policy, etc. which apply to business at large. Those things improve with technology over time.

Education is tricky. Of course it is important. And it's certainly correlated with all kinds of good things. But the evidence isn't really there that education is causal to productivity. Simply, there have been significant periods of history where education remained stagnant, or even eroded, yet worker productivity dramatically increased due to technology.

I personally believe that education is a factor which is changing as the economy shifts away from labor and towards knowledge. So it will be more closely related to productivity going forward.

There's another, more essential aspect to education, however. It is one of the key components of emergence. Education along with the other ingredients found in the US are what make us innovative. But not any kind of education passes. That's the problem. Standardized education which overemphasizes on rote knowledge seems to diminish productivity, for example. That leads to a whole other discussion on how we've mismanaged education policy in the US over the past decades...

[GK]

Yes. Productivity is the only source of real growth. Technology is a large part of productivity (others being education levels, infrastructure, rule of law, etc.)

Technology is lowering the price of many types of healthcare, even if that means the cost reductions are outside of the US. More and more people are going to India or Thailand for a $10,000 heart procedure that would cost $120,000 in the US. Insurance companies are encouraging this.

Healthcare spending still rises despite technology, as previously fatal conditions can now be staved off with very expensive solutions. So we are currently in a phase of spending tons of money to extend the life of a patient by 6 months. I don't see this trend ending. I think each successive year of life expectancy gain will cost exponentially more money.

The cost of education is deflating, but this takes the form of more education being outside of school/college (where the costs are rising). Accessing Wikipedia from home is far more efficient than going to the library for half a day, as one had to do before 2000, to research a subject.

However, the value of most university degrees is dropping, since they have dumbed down the curriculum and removed rigor for the sake of emotion. The Bachelor's degree is a very pooor bang-for-the-buck even relative to 10 years ago. Even top-10 MBA salaries have been flat for 8 years, while MBA tuition costs have risen 60% in this time.

So 22-year-olds today are 'sharper' than their counterparts a generation ago, but this is because they have learned so much outside of the University, which has actually declined in bang-for-the-buck.

[busybee]

I found this article about the unlikelihood of a coming deflation on Morgan Stanley's website. What do you guys think about their reasons?

http://www.morganstanley.com/views/gef/index.html

[GK]

There is no risk of deflation, as per some major economists.

[EBGuy]

Deflation is threatening because of all the money that died and went to heaven. I am a bit skeptical of the MS article as it does not even attempt to address or quantify this issue.

[randolfe]

Where is the price growth? How do prices grow to the lofty inflation (or even hyperinflation) levels some are predicting without income growth? Where is there a single shred of evidence that incomes are growing anywhere but in the top 5% of the distribution?

Anybody?

If you haven't been watching the US savings rate went from negative to +7% *instantaneously*. If you adjust US savings rate to put it on par with how they compute that metric in Europe & most of Asia (ie, adjust the way we treat housing to be the same as they do) then we now have one of the top savings rates in the world.

Every dollar saved instead of spent or invested deflates prices further.

And now we find the banks with all this free taxpayer money are *NOT* lending it out as consumer credit, or even as housing mortgage debt. What are they doing besides buying other banks?? Well, they're using those lovely FDIC guarantees we raised recently to offer CD rates now well above what one can earn in money markets. The effect? More and more enticement to save and starving already desperate commercial financing markets.

My question is this for those so sanguine about deflation: what is going to restart consumer spending? How does the Fed affect that? Are they going to start issuing Federal Reserve credit cards to all those tapped out consumers with $70K per of debt hanging over their heads? Are they going to "buy" all the consumer debt and let us all just start over from scratch?

The equation is simple on the consumer side. There are two variables that matter now: prices & incomes. To argue inflation you're arguing incomes will go up. A lot. A huge amount. That's because, even if incomes rise just a little, prices _must_ come down in order for consumers to work off their debt overhang.

[randolfe]

GK

However, the value of most university degrees is dropping, since they have dumbed down the curriculum and removed rigor for the sake of emotion. The Bachelor's degree is a very pooor bang-for-the-buck even relative to 10 years ago. Even top-10 MBA salaries have been flat for 8 years, while MBA tuition costs have risen 60% in this time.

I agree with some of that. But you need to quantify it to make it convincing. For example, your statement about top-10 MBA salaries is categorically false. You can look for yourself in any of the respectable surveys, like the FT business education rankings. It's hardly controversial to say that top-schools, especially top b-schools, have seen dramatic salary increases over the last 10 years. Where do you think all this income disparity at the top is coming from? If you thumb back through the FT surveys to the late 90s you'll see many schools now boasting over $200K annual salaries for 1-3 year out grads was just over half that 10 years ago.

On the broader point about education: I agree that education standards need to be improved. However, I draw the line at the current wave of populist, anti-intellectual, anti-education discourse I hear from many on the extreme right & extreme left. Simply, education matters. It matters a great deal. There are a great many things that require rigorous education to undertake with any degree of success. I, for one, don't want some self-taught, "college doesn't matter", pseudo-doctor operating on my aneurysm anymore than I want some self-taught, Microsoft Flight Simulator pilot trying to land the 767 I'm flying on.

[GK]

randolfe,

Forget the FT rankings, which are poorly vetted. Go to the websites of top B-schools themselves, and track the placement reports.

You will find that at your own Columbia, as well as at Michigan, Kellogg, Wharton, Chicago, Stanford, etc. The starting salaries are the same as in 2000. Granted, that may have been an artificial peak at the time, but 2000 is the same as 2008, for starting salaries. This is true for MC, IB, and corporate marketing jobs. I think you know that entry-level MBA Investment banking compensation for 1st and 2nd year associates is no higher than in 2000 (even before the recent Wall-Street blow-up).

Despite the fact that MBA tuition has risen about 6% a year for 8 years straight.

Check the actual placement reports on teh B-school websites. These are simply the facts.

[GK]

In fact, your own link to the FT ranking shows the same entry-level salaries, for a particular school, in 2002 vs. 2008.

Harvard has had no rise in that period, nor have any of the others.

[randolfe]

Looks to me like salaries rose rapidly from 1995 - 2007 as per Columbia's own employment reports. Most of those gains came in investment banking, consulting, and corporate finance.

In fact, these numbers are more outlandish than the FT numbers. I don't know where the FT is "poorly vetted" comes from. Again, where's your support for that statement?

In fact, the FT numbers are lower because they track salaries 1-3 years out from graduation which gives more normalized salary results. Many new grads will receive an artificial pop after graduating (depending upon timing) only to find out later that their salary doesn't scale.

FT data aren't "entry level" salaries either. MBA's aren't entry level when they graduate as nearly all have between 5-8 years of experience when entering their graduate studies .. and that delay is rising currently. So newly graduating MBAs generally represent 28-35 year old workers who are hardly "entry level".