Thoughts On the Continuing Crisis

The Elements of Deflation

A Presentation byJohn Mauldin,

Author of Bull’s Eye Investing And the Editor of Thoughts from the Frontline

www.2000wave.com, www.johnmauldin.com

Is the Glass Half Full…Is the Glass Half Full…

Or is it Half Empty and Or is it Half Empty and Leaking?Leaking?

US Headline CPI Inflation US Headline CPI Inflation

The Elements The Elements

of of DeflationDeflation

9 Million Part Time Workers9 Million Part Time Workers

Total “U6” Unemployment Total “U6” Unemployment Including Part-Time Workers is Including Part-Time Workers is

16.8%!!!16.8%!!!

33% Unemployed for 6 33% Unemployed for 6 MonthsMonths

Jobs Losses are Far Below Jobs Losses are Far Below AverageAverage

This is NOT a Typical Recession This is NOT a Typical Recession

A Few Data Points on A Few Data Points on Unemployment Unemployment

If you include “discouraged workers” with U6 then If you include “discouraged workers” with U6 then unemployment is 21.1%, and therefore more than unemployment is 21.1%, and therefore more than 13% total unemployed13% total unemployed

Since 1999,, even as the population grew by 33 Since 1999,, even as the population grew by 33 million, the private sector has lost 235,000 jobs million, the private sector has lost 235,000 jobs (BLS data) because of job losses in the current (BLS data) because of job losses in the current recession.recession.

Wages are falling and Hours Worked is at an all Wages are falling and Hours Worked is at an all time low 33 hourstime low 33 hours

18 million NEW jobs will be needed in five years 18 million NEW jobs will be needed in five years to get us back to employment levels last seen in to get us back to employment levels last seen in 20072007

History Tells Us Without Wage History Tells Us Without Wage Pressure There is Little Chance Pressure There is Little Chance

of Inflation of Inflation

Mortgage Equity Withdrawal Mortgage Equity Withdrawal Fueled the EconomyFueled the Economy

The Impossible HappensThe Impossible HappensThe US Consumer Stops The US Consumer Stops

BorrowingBorrowing

The Psyche of the American The Psyche of the American Consumer Has Been Permanently Consumer Has Been Permanently

Seared with the Pain of Falling Seared with the Pain of Falling Home Prices and Stock PricesHome Prices and Stock Prices

****************************Faced with Retirement Issues, And Faced with Retirement Issues, And the Need for Increased Savings, the Need for Increased Savings,

Consumer Spending is Going to be Consumer Spending is Going to be

Challenged for Years Challenged for Years

Savings Actually Explode Savings Actually Explode Upward During this Great Upward During this Great

Recession!!!Recession!!!

As Does The Savings Rate! As Does The Savings Rate! File Under Be Careful What You File Under Be Careful What You

Wish For!Wish For!

MortgagesMortgagesIt’s Not Just a Sub-Prime It’s Not Just a Sub-Prime

ProblemProblem

Housing Sales are FlatHousing Sales are Flat

Housing Prices are at Best Housing Prices are at Best FlatFlat

Banks Have Yet To Banks Have Yet To Deal With Bad LoansDeal With Bad Loans

Most likely recovery is a “W” with a long Most likely recovery is a “W” with a long tail due to slow growth and rising tail due to slow growth and rising

mortgage ratesmortgage rates. . Fall2005

Housing Data Points Housing Data Points

Over 1/3 or Mortgages are Now Over 1/3 or Mortgages are Now UnderwaterUnderwater

It will be 2011 Before We Move It will be 2011 Before We Move Through the Excess Housing InventoryThrough the Excess Housing Inventory

Foreclosures are Adding More Homes Foreclosures are Adding More Homes to the Inventory of Unsold Homesto the Inventory of Unsold Homes

There May Be as Many as 500,000 There May Be as Many as 500,000 Homes in the Shadow REO InventoryHomes in the Shadow REO Inventory

The Effect of the StimulusThe Effect of the Stimulus

Without the Stimulus, GDP would Without the Stimulus, GDP would have been a -6% in the Second have been a -6% in the Second Quarter!Quarter!

Without the Stimulus, GDP Would Be Without the Stimulus, GDP Would Be Flat to Negative this QuarterFlat to Negative this Quarter

Question: Question: What Happens When What Happens When

the Stimulus Goes Away? Especially to the Stimulus Goes Away? Especially to States and Municipalities?States and Municipalities?

Government Receipts Are Government Receipts Are DownDown

Be Careful What You Wish Be Careful What You Wish ForFor

Volume of Word Trade Volume of Word Trade Collapses 20%Collapses 20%

And Thus Capacity Utilization And Thus Capacity Utilization Falls off the CliffFalls off the Cliff

The Velocity of Money is The Velocity of Money is SlowingSlowingY=MVY=MV

(Where Y is Nominal GDP, M is Money Supply and V is Velocity(Where Y is Nominal GDP, M is Money Supply and V is Velocity and Y is Sometimes seen as Price times Quantity) and Y is Sometimes seen as Price times Quantity)

M2 is Flat or Falling M2 is Flat or Falling Since the End of FebruarySince the End of February

What is Money???

M-1, M-2, gold? – Misleading M-1, M-2, gold? – Misleading MeasureMeasure

Money is CASH + CreditMoney is CASH + Credit Cash is $2 TrillionCash is $2 Trillion Backed by Credit of $50 TrillionBacked by Credit of $50 Trillion

Destruction of Assets in the Destruction of Assets in the Great DeleveragingGreat Deleveraging

Deleveraging brings Deflation

DNA Changes in the FED DNA Changes in the FED Governors….they become Governors….they become genetically opposed to genetically opposed to deflationdeflation

The FED is at a Major Crossroads

Allow inflation like 1970s or Allow inflation like 1970s or

Withdraw liquidity and slow Withdraw liquidity and slow recoveryrecovery

The Great Experiment

Keynes Keynes

VSVS

von Misesvon Mises

VSVS

FisherFisher

VSVS

FriedmanFriedman

Re-Inflation?It may take up to $2 TrillionIt may take up to $2 Trillion

in new printing press money to in new printing press money to re-inflatere-inflate

It will work, but what then?It will work, but what then?

Like John Paul Jones, Bernanke will soon Like John Paul Jones, Bernanke will soon say:say:

““Sir, I have not yet Sir, I have not yet begun to print!”begun to print!”

How did we get it Sooo Wrong?

We taught two generations We taught two generations of managers theories which of managers theories which were patently absurdwere patently absurd

We let rating agencies We let rating agencies become too importantbecome too important

We believed the trend.We believed the trend.

The Elements of DeflationThe Elements of Deflation

If you add:If you add:

Rising Unemployment and Wealth Rising Unemployment and Wealth Destruction and Reduced Borrowing and Destruction and Reduced Borrowing and Lending and Decreased Final Demand and Lending and Decreased Final Demand and Increased Savings and High Capacity Increased Savings and High Capacity Utilization and Massive Deleveraging and Utilization and Massive Deleveraging and $2 trillion in Bank losses and a Very Weak $2 trillion in Bank losses and a Very Weak Housing Market and Slowing Velocity of Housing Market and Slowing Velocity of Money Money

You Get Deflation You Get Deflation

and and

Nothing But Bad Nothing But Bad ChoicesChoices