Why there’s no inflation – real estate prices still going down

Yes, we know, many, if not most, of our friends think we already have inflation, or will soon. They invoke the specter of wheelbarrows full of greenbacks – a symbol of hyperinflation in Germany before WW II.

It may happen. But it isn’t here in the U.S. yet. How do we know? Signs and wonders abound.

The housing market is still declining. A MarketWatch survey found that “falling market values pose a greater threat to homeowners than fire and natural disasters.”

Now that may sound like bad news to people with underwater home loans (loan balance higher than current value of house), but it’s good news for people looking for homes they can afford to buy.

Meanwhile, Bloomberg reports: SNB Is Ready to Act on [Swiss] Franc If Gains Risk Deflation.

The following long, edited excerpt from today’s Sovereign Man Chief Investment Strategist Tim Staermose describes why and how we are in a world-wide deflationary period:

[In] the modern banking system, banks use depositors’ funds to make loans or buy securities. Regulators require them to hold a certain amount of capital against these “assets,” and the amount is known as the “Capital Adequacy Ratio.” The idea is to ensure that the bank will still have money on hand if its asset portfolio goes bad.

[T]things are fairly predictable in the day-to-day course of banking business. Money is lent out, paid back, deposited, and withdrawn. To guard against fluctuations in activity and imbalances that arise in the normal course of business, the bank keeps a certain amount of liquid cash (and near-cash instruments) on hand as a buffer.

When sudden volatility strikes, the amount of liquidity banks wish to hold goes up … sometimes dramatically. [W]e’re in a heavy period of volatility right now. Banks are all scrambling to get more cash in order to have larger buffers against system shocks.

What does this mean?

[L]longer-term factors are at play beneath the surface, which reinforce this trend.

Capital adequacy ratios are complex calculations, but the basic idea is that the riskier the loan made, or security purchased, the more capital a bank should set aside against it. [But] the bureaucrats at the Bank for International Settlements (BIS), which sets global capital adequacy standards for the banking industry, deemed ALL bonds issued by ANY Eurozone governments to be “risk free.”

The government bonds of Ireland, Portugal, Spain, Italy, not to mention Greece, have ALL fallen dramatically in value. Greece has already agreed to an official write down. [B]anks around the world, most notably the German, French, and Italian banks, are going to see huge holes appear in their balance sheets FOR WHICH THEY WERE NOT REQUIRED TO SET ASIDE ANY CAPITAL.

These losses are very real, and they will have to be paid for out of banks’ capital. To maintain their mandated capital adequacy ratios (risk-weighted assets/capital), the banks need to do one of two things.
1. Raise fresh capital (increase the size of the denominator).
2. Shrink their at-risk assets (reduce the size of the numerator).

Right now, most banks either cannot raise fresh capital, or do not want to do so at current depressed share prices (it dilutes the holdings of the bankers themselves). That means option 1 above is largely off the table.

So, they are all going to try to shrink their assets instead. That means they are calling in loans, selling securities, dumping collateral that they’ve seized, and so on. All of this is draining liquidity from the financial system and setting off a huge scramble for cash.

It won’t work. Since the banks are all trying to unload assets at the same time, the price for those assets will plunge, which in turn means they will have to take losses. And losses are hits against capital. Which puts them back to square one. It’s a vicious circle.”

So, there you have a few of the many signs that inflation isn’t happening. Just because the Fed “prints money” doesn’t mean the general level of prices will go up as long as counter-fources are still at work.


About InvestingforOne

I've been investing in various assets by myself using a discount broker for many years. Over that time, I've developed some theories that others might find useful. Plus, there is more to investing than money. Time, talent, work, friends, family all go into developing a good and satisfactory strategy.
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