Essential Credit Crunch Reading
October 13, 2008 1:29 AM   Subscribe

Afraid to read the daily news? Need some broader perspective on The Credit Crunch? There are lots of different ideas by lots of different authors floating about ...

One idea is we simply pay up! In The Trillion Dollar Meltdown, Charles Morris advises that we take the hit in one lump sum. A TRILLION DOLLAR lump sum. And what if that impressive lump sum isn't impressive enough? Morris covers that possibility in The TWO Trillion Dollar Meltdown (someone please stop him before he writes another book!)

Embrace the destruction. William Fleckenstein and Fred Sheean in Greenspan's Bubbles argue that we've been saved from bubbles one too many times. Let nature take it's course!

Simplify the system seems to be a theme several writers have raised. Both George Soros in The New Paradigm for Financial Markets or Richard Bookstaber in A Demon of Our Own Design argue that we should simplify financial instruments, and stop market participants from employing excessive leverage.

While simplification is attractive, in The Subprime Solution Robert Shiller not only outlines the causes of the subprime mess, he argues that this crisis shows us the desire to own a home is a problem calling out for a solution. He suggest the creation of a new class of financial product is needed, something he is calling "continuous-workout mortgages", where payments are dynamically adjusted according to an individuals ability to pay.

Back to basics. In Bad Money, Reckless Finance Kevin Phillips argues that we've let Wall Street and financial services dominate the US economy, and now it's time to revert to our roots, manufacturing. He is busily writing a follow up, Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism which seems to cast a wider net of blame.

A crash is inevitable. In Wealth, War and Wisdom Barton Biggs notes that we see systemic crashes about one a century. Its gonna, no, GOTTA happen!

And in the end, keep in mind that we're all in this together. In The Panic of 1907: Lessons Learned from the Markets Perfect Storm Robert Bruner & Sean Carr looked at one of the lesser known (but still very severe crashes), and showed how "collective action by leaders can arrest the spiral" . Everyone pitched in, pulled together and reduced the impact.

So fight, simplify, surrender, pay up, create new instruments, no matter how you're planning to weather the storm, you'll have plenty of reading to while away the time.
posted by Mutant (33 comments total) 49 users marked this as a favorite
Speaking of different ideas. Postroad is the first Mefite I’ve seen mention the W word.

It took about ten years and a war to end bad times...

That’s always been at the back of my mind when I see posts by the "settle down people, things will get better, just look at the All Ords graph" crowd. But good to see a much respected forum member mention it.
posted by uncanny hengeman at 1:47 AM on October 13, 2008 [2 favorites]

I think the best thing to do about the credit crunch is to make a song about it on YouTube, and get a bit of internet celebrity out of it:

beats the hell out of listening to the today programme.
posted by Kimondo at 2:30 AM on October 13, 2008

Or write a funny article in the paper.
posted by jan murray at 2:55 AM on October 13, 2008 [1 favorite]

Interesting to see the Australian market rally today. There wasn't any particular good news (well, Rudd guaranteed bank deposits) but there wasn't any "OMG the world is ending" bad news either.
I feel that the market is poised between recession/depression - that is, normal bad times, or a broken system.
If it is recession, well, with the amount of money being waved into existence, I suspect we will witness some strong price inflation, and to me it is doubtful that wages will keep up. Equities aren't a great place to be when inflation is high, so there is downward pressure on the market.
If it is a depression, then all bets are off. In 1929-1933 stocks lost 89% of their value. Many that were trading over $100 went to a few cents. So even if you invested $100 now, after all these losses, it might only be worth $20 if history repeated. This is what is scaring the investor class.
Of course, with everyone screaming sell, it might be a great time to buy. I have a small retirement fund. If it ends up a depression then there isn't much chance it will be any good when I need it, so I am thinking of investing...err...gambling, some of that on beaten up equities.
Anyone have any suggestions on what does well in high inflation, low growth time? I am thinking gold miners and sin stocks.
posted by bystander at 2:59 AM on October 13, 2008

Well, I took care of the basics -- house almost paid off, new car financed at 0% earlier this year, one credit card (at 0% APR) left to pay off, with a minimal balance. Now I'm saving money, buying a bit of gold and silver, and spending some money on collectibles, which should retain value over time. An example: I bought a book called 'The Riverkeepers' signed by RFK, with an inscription to Bob Weir -- it was a personal gift to Bob from RFK. Unique and historical stuff generally maintains value no matter what.

I'm also accumulating some survivalist-type stuff, just in case. Trade goods, cigarettes (30 cartons so far), alcohol, a generator, some fuel, lots of canned food and bottled water, shotgun, pistol, hunting rifle, and so on. I hope things don't get so bad that I need that stuff to survive, but if they do, I'll be glad to have it. And if things don't get that bad, well, I'll just feel kinda stupid. And then I'll drink some of the booze. ;)
posted by jamstigator at 3:13 AM on October 13, 2008

bystander -- "Anyone have any suggestions on what does well in high inflation, low growth time? I am thinking gold miners and sin stocks."

Ok, in general, recent experience tells us that low inflation is good for stocks. So just on the surface it would appear that high inflation is bad for stocks. Why is this?

Well, as inflation increases currencies loses their value, their purchasing power.

Stocks are priced according to multiple factors, one of which is earnings per share, or P/E.

P/E ratios factor in, to no small extent, investors expectation not only of future earnings but implicitly the value of those earnings; in other words, there is an implicit estimation of inflation in the share price.

So high inflation leads to uncertainty regarding precisely what those earnings will be able to purchase. High inflation is bad for share prices.

We know from past history that P/E ratios decrease during periods of high inflation. In other words, P/Es, Price to Earnings ratios aren't constant and vary according to the business and credit cycles. During times of low inflation (think recent history), P/E ratios tend to increase, as investors are more confident about the future purchasing power of currency. The opposite is true during periods of high inflation; P/Es decrease.

But inflation doesn't impact all companies the same way; as you've pointed out, sin stocks and selected commodity miners do well. I say selected as it's important that these producers don't sell their production forward, and thus are able to benefit as commodity prices increase.

So in terms of commodities, we can look at a company called Barrick Gold , and in particular the performance of it's share price during the last period of high inflation in the United States, the mid 1980's. Seems to correlate positively, unlike the broader market which actually tanked to some extent.

I've got some data which backs up this view; I've summarised it for the purposes of presentation, let's look at a few graphs.

Here we can see how Blue Chip shares perform during periods of high inflation.

This graph shows how gold bullion does, while this chart illustrates the performance of Barrick Gold, discussed above.

I'll leave it to you folks to draw your own conclusions.

Speaking of high inflation, here is some interesting news just off the wire;
"The ECB, the Bank of England and the Swiss central bank will offer unlimited dollar funds in auctions with maturities of seven days, 28 days and 84 days at a fixed interest rate, the Washington-based Fed said today. The Bank of Japan may introduce ``similar measures.'' "
The bold highlight is mine. Interesting. Wonder what author they've been reading? Heh.
posted by Mutant at 3:40 AM on October 13, 2008 [6 favorites]

new car financed at 0% earlier this year, one credit card (at 0% APR)

Ok, for those of us who lives in countries when you cannot really get true credit for free for any longer time period, can anyone explain how the companies expect to make any money at all on 0% car loans and 0% APR credit cards? Where's the trick? What do the zeros mean?
posted by effbot at 3:48 AM on October 13, 2008

Ok, for those of us who lives in countries when you cannot really get true credit for free for any longer time period, can anyone explain how the companies expect to make any money at all on 0% car loans and 0% APR credit cards? Where's the trick? What do the zeros mean?

0% car loans are subsidized by the manufacturer. 0% APR credit cards are teaser rates that go away after a year or so.
posted by mkb at 3:54 AM on October 13, 2008 [1 favorite]

I think the answer is to be found in a yet-to-be-updated "In Praise of Idleness" the 1932 essay by Bertrand Russell. Now, of course, that doesn't address our current financial situation and doesn't consider 70+ years of technological change, but he picked up on the basic issue early on: "Modern technique has made it possible to diminish enormously the amount of labor required to secure the necessaries of life for everyone." and the solution is to, well, work less. A four-hour workday. Additional "leisure time" could be used as seen fit, sciences and art would continue, as would TV-watching. But the system might not collapse. Oh, advertising would suffer, and maybe we wouldn't have so much shit.

I wonder if I am addressing the issue or not. I think I am. But I am not an economist (though dismal I am). I just wonder if re-adjusting our goals as a culture might benefit us far more in the long run than re-adjusting our lending rates. But is that possible? In the US we'd have to fight our current work-ethic and its hatred and fear or idleness (or at least the poor's idleness) and implications of "socialism" and "communism." So one would get there slowly. There are movements for a thirty-hour workweek. There's a start. So are result-only workplaces.

Step back from the forty-hour workweek and it does seem idiotic, doesn't it? All the promises of technology and we use it to buy more promises of technology rather than using it to more consciously design and build ourselves better lives. Edward Tennner's "Why Things Bite Back" argues that technology escalates the demands placed upon and we respond, working more, working faster, filling up the space the machines have made for us. And if we don't step back and assess, these new rules of competition, new expectations, just drive us further into frantic haste.

At least here's a connection. The bizarre financial instruments could not be created without the ability to rapidly abstract, recombine, compute and then communicate that new ostensible value. If there is a dystopia up ahead where robots hunt us down, we'll be lucky to make to there -- we'd have to get through the first one where the pre-singularity machines, blink and hum at us, and the pre-singularity algorithms run on, while work ourselves weary to give them such fine homes and futures.
posted by kingfisher, his musclebound cat at 4:07 AM on October 13, 2008 [7 favorites]

Apologies for multiple comments - I meant to include this in my prior but copy/paste did only part of the job ....

In case anyone is interested, I can share some inflation data from 1914 to 2003 here, along with selected share and commodity (gold) prices. Hope this helps!

Also, the fallout in Iceland is getting worse, with store shelves in danger of being emptied, as the Krona is shunned by the big money centre banks.
"Iceland's foreign currency market has seized up after the three largest banks collapsed and the government abandoned an attempt to peg the exchange rate. Many banks won't trade the krona and suppliers from abroad are demanding payment in advance. The government has asked banks to prioritize foreign currency transactions for essentials such as food, drugs and oil."
Tough times to be sure. While I'm sure in the long run those folks will be ok (we're not gonna let 320,000 people starve for gosh sakes!) a hard rain is gonna fall in the near to intermediate term.
posted by Mutant at 4:08 AM on October 13, 2008 [1 favorite]

This graph shows how gold bullion does, while this chart illustrates the performance of Barrick Gold, discussed above.

The reason Barrick has done so poorly is because they're a hedge fund next to a hole in the ground. If you researched those people, it was obvious they weren't going to go anywhere. They made a ton of money shorting gold on the long downswing through the 80s, in essence pulling their profit forward from later years. High gold prices just don't help them much.

Other gold miners are not doing well at the moment, either, though and haven't been for awhile. I've seen this explained as the costs of energy impacting their operations. As oil went up, their ability to profit from the gold price was limited. If oil and gold stay in anything like their present ratio (10:1ish), the miners are likely to be soldly profitable and very good buys. Most of the stock market is wildly overpriced, even now after the big crash, because earnings are suspect and most stocks don't pay dividends. That doesn't appear true of gold stocks at all. From what I can see, taking a small position could serve you very well indeed. The risk involved in something is related to the price you pay for it, and a little bit of nibbling could be pretty profitable, with relatively limited downside. But nibble, because the market is weird just now, and if you take a big position all at once, you could end up underwater for a long time.

And NEVER buy a stock without truly understanding the business you're buying. That's a key difference between investment and speculation.
posted by Malor at 4:09 AM on October 13, 2008 [1 favorite]

cigarettes (30 cartons so far)

cigs go stale pretty quick. Granted, in the Mad Max world you're preparing for, a stale cig is better than no cig, but I think you should re-think your thesis a bit here.

he argues that this crisis shows us the desire to own a home is a problem calling out for a solution.

there is no "affordability" solution to home ownership, since we are all bidding against each other for a limited (or indeed fixed supply in the most desirable areas) supply. Home prices will always be bid up past the point of affordability, as we so clearly saw demonstrated 2004-2006.

Only by artificial limits like DTI ratios, down payment requirements, etc. can prices be controlled at all.

As a quasi-neo-Georgist, the solution, as I see it, is the land value tax, or "split tax" as it would be implemented. Basically don't tax improvements at all and tax land values up the ass, both to nuke the speculative premium and encourage usage shifting to the most economically efficient use of the land.

Another approach, parodoxically to most people I would expect, is increasing minimum taxation burden -- across the board -- to pay for life's minimal personal financial responsibilities like car insurance, local public transportation, health insurance, lifetime education, and retirement pension.

By mandating these expenses to come out of everyone's paycheck, the amount of purchasing power we can push into the housing market would decline proportionally, for the housing budgeted expense -- for the financially-responsible household at least -- has to come after food, insurance, savings, education, and transportation (to/from work) costs.

Well, that's my theory of how we can combat the "All-Devouring Rent" problem, at least.
posted by troy at 4:18 AM on October 13, 2008

Post-apocalyapse at jamstigator's house!
posted by bardic at 4:20 AM on October 13, 2008 [1 favorite]

Wow in spite of unlimited funds being made available, we're still seeing a HUGE discrepancy between Government and market rates for short term loans.

I've previously called this a "Tale of two yield curves", a situation that is apparently persisting. A few data points are of interest here - first up the "official" or government yield curve:

We've got Fed Funds trading at 0.50%, The 3M T-Bill is trading at 0.21%, and the oh-so-important Ten Year Note is trading at about 3.861%.

Meanwhile, in the market driven "real world" we see 3M Dollar LIBOR is trading at 4.75% and the The Ten Year Swap rate is 4.46%.

The site that I source overnight dollar LIBOR from is down, but I'm off to University shortly and I've got a Bloomberg terminal in my office. I want to look up some Credit Default Swaps spreads as well, so I'll report back.

Here's one that making the rounds on trading desks this AM; "Stephen Jen, currency chief at Morgan Stanley, says bank crises are bloody for currencies, but nationalizations of the banking system (which is what we have here, in disguised form) typically mark the bottom." A little out of date, written maybe three weeks ago and we've now progressed to open nationalisation, but curious nonetheless.

The one thing we haven't seen reported yet are the widespread hedge fund collapses that I'm aware are taking place. Lots of these folks were sitting on the wrong side of a CDS (e.g., Lehman) and now they've gotta pay up. But that's NOT the only reason; anyone who was leveraged long in this market and didn't move fast enough got reamed, big time and right out of business. But those two groups are the minority.

What is now happening on a large scale are slow speed collapses, as investors pull money at of funds, any way possible and at any cost. This is really interesting.

Finally (no really, I've got to get to Uni - but this is such interesting stuff!) - the recent volatility.

Well, I've previously posted about a trading strategy called Volatility Arbitrage; a way for market participants to actually monetise and trade volatility.

I've seen some interesting dead tree research this AM about more proprietary trading desks moving into this asset class. Hopefully this will start to dampen the extreme swings we've seen to date.
posted by Mutant at 4:36 AM on October 13, 2008 [2 favorites]

0% APR credit cards are teaser rates that go away after a year or so.

Sorry for being somewhat off-topic, but can you use the full credit at 0% for the full period, or do you have to pay off the dept regularly? (say every month or so). Are there any extra fees outside the APR figure? What credit limits are we talking about?
posted by effbot at 4:39 AM on October 13, 2008

Speaking of different ideas. Postroad is the first Mefite I’ve seen mention the W word. "It took about ten years and a war to end bad times..."

Maybe no one else has suggested it because we're already IN a war, which actually seems to be making things worse?
posted by EmpressCallipygos at 4:40 AM on October 13, 2008

kingfisher, his musclebound cat, interesting links those you are posting. But I would argue that rather than reducing the time we spend working (the rationale being that we no longer have to), we might think of starting to reduce productivity.

The reason is that we still need to occupy ourselves, to fill our time. My experience tells me that many people, if left to themselves, will literally become sick (depressed), for lacking a goal to their 'leisure activities'. There is, after all, no point in life other than to live and multiply, at least on the basic level, so the best motivation for any activity is survival.

So I'd say, reduce machine-work, go back to more manual tasks and let more people do jobs which were rationalized out of proportion.

After all, this 'crisis' is just a set-back of the virtual values (i.e. stocks, year-end figures) which were rising for ages although nobody in their sane mind can expect anything in a fundamentally limited world to rise forever. In other words, I'd be hard pressed to see how the current crisis affects, for instance, staple production - as far as I am concerned, that is a safe bet.
posted by Laotic at 4:46 AM on October 13, 2008

Interesting takes on the long term effects of this downturn/recession/end of the world/whatever you want to call it, kingfisher, his musclebound cat and Laotic. However, I think there's an issue with both approaches (i.e. scaling back of work hours or productivity.

Both approaches are not ones that could happen within market economies. Scaling back of working hours ala Bertrand Russell can't work because without central co-ordination or enforcement, it undermines the ability of a company to compete. Consider - from single freelancers right up to big megacorps, if they are not reducing the hours they work in concert with everyone else in the market, they become hampered in that they have to work extra hard in the hours available to them or choose more profitable work in order to remain competitive. Everyone else can get the jump on them simply by having more availability for clients/uptime on assembly lines/whatever. If you put in artificial constraints like France's 35 hour workweek, it's the same problem except it's other countries you're competing against.

Personally, I think ROWE as noted above is a step in the right direction, but in blurring the lines between work and homelife it could potentially be destructive, especially when it's not really ROWE at all, it's just always-on-check-your-email-at-midnight type working. And it goes out of the window when you're outside 'knowledge worker' territory - you can't duck out to go fishing and manage a shop by BlackBerry.

It's a fascinating subject for me (personally and professionally) and I really do wonder what the workplace and the workforce will look like in ten, twenty and thirty years time. I'm currently scheduled to retire around 2050, and given the job I do now didn't exist even ten years ago, and the way I do my job is something I'm largely inventing from scratch as I go along, I have literally no idea what work and the economy that goes along with it might look like.

Whatever happens, this Big Change we are living through will doubtless have a profound effect on many aspects of our working lives.
posted by Happy Dave at 6:11 AM on October 13, 2008 [2 favorites]

I think simplifying market instruments and putting in tighter limits on leverage might be a good thing in the long run but I do have some concerns that in the short term the credit contraction necessary to reduce leverage rates is going to force banks to close a lot of lines of credit to not just large corporations but also small business owners.

One problem with doing this is that it might force a large number of struggling businesses to go ahead and fail. While in a pure free market sense this is good because failing companies will in theory be replaced by stronger new companies in the short term a lot of people will be out of work. Of course with a lot of people out of work, aggregate incomes are lower and demand decreases putting further pressure on additional firms.

It seems the ideal scenario is one where we can shift from being so dependent on Financial, Insurance, Real Estate (FIRE) for so much of our economic growth. Perhaps that can be done through reining in over-leveraged firms, perhaps it can be accomplished by revitalizing our export/manufacturing sector, perhaps it can be done through increasing productivity through a renewed focus on education and training. There are a ton of possible scenarios but I don't really see a national dialogue about what sort of long-term economic policies should be undertaken on a governmental level.

Of course the free-market purists will simply assert that free markets are self-correcting but isn't there a saying that everyone becomes a Keynesian in a downturn?
posted by vuron at 6:22 AM on October 13, 2008 [1 favorite]

So I'd say, reduce machine-work, go back to more manual tasks and let more people do jobs which were rationalized out of proportion.

You'd need to reduce competition to get away with this. Someone tried it a while back, ended messily after problems with oil, grain and a psycho-competitive space-racing superpower attached to Alaska getting edgy.
posted by bonaldi at 6:53 AM on October 13, 2008

Well forcing companies to abandon labor saving machines will just encourage those firms to locate offshore which will simply undermine the economy further.

I guess you could even make the case that enforcing a shorter work-week will simply reduce the relative productivity of US workers making outsourcing to nations with lower labor costs more attractive.

To combat this effect you could engage in protectionism vis-a-vis imports but that would simply increase the costs of consumer goods significantly moving a greater percentage of them into luxury items.

The world economy seems far too integrated at this point in time to try to return to a period of self-sufficient nation state (if that period ever really existed). Unless we as a society are willing to trade our focus on material rewards (pay, consumer goods and services) and focus more on relative intangibles such as increased leisure time, improved quality of life, environmental sustainability, etc. While I do think there are some improvements being made on that regard I'm not sure there is anywhere near the broad societal support necessary for the types of sacrifices that would be required. Indeed it seems that with limited exceptions the majority of the people pushing a quality of life scenario also enjoy many of the consumer goods that our capitalist society affords us.
posted by vuron at 7:11 AM on October 13, 2008

one more PoV, Barry Ritholtz' "how to cure what ails us"
posted by infini at 7:54 AM on October 13, 2008

Market crash foto tips
posted by hortense at 10:21 AM on October 13, 2008 [1 favorite]

Laotic, I think you're right about the need to fill time, and that would probably need to be part of the equation. I would continue to work, but on specific projects that interest me. Most of my friends are this way, and I could see leisure time for them and many others being productive and probably generative of some hugely beneficial, enlightening, or at least amusing creations.

Others are not so auto-teleological, so what then? Would we need (and here comes the irony) public works? Where labor might not be so divorced from meaning because you would be working for your community and family. It becomes perhaps more of a co-op model. Then again, there's always TV and the internet.

Another good discussion of the value of idleness, by the way, is Quitting the Paint Factory. Mark Slouka, as I recall, argues that idleness is important to thinking and therefore for political good. Not sure, though, what the Palin masses would do with too much time on their hands, but I'm guessing thinking would be way down the list.
posted by kingfisher, his musclebound cat at 12:19 PM on October 13, 2008 [2 favorites]

Happy Dave, I agree completely. Market forces make scaling back the work week (ostensibly) impossible. After all, it's not email that makes us jump and respond immediately in a work setting, it's email + expectations and knowing that someone else just might meet those expectations. So the speeding up of work is a result of technology and competition, so it doesn't seem likely that one can slow down while that competition exists.

On the other hand, Ford created a five-day workweek for his employees by changing the methods of production. And it wasn't an accident. In a race to work people harder, he focused on working smarter. The moving assembly line was part of it, but so were the Taylorist time-motion studies of individual workers. People ended up being treated like automatons and there were some weird rituals about being "Americanized", but benefits like education and health care came out of it. It also led eventually to legislation in 1938 for the forty-hour (I wish) workweek.

So perhaps a smart entity in a competitive market could create a better, shorter workweek. And that could be a huge recruiting advantage.
posted by kingfisher, his musclebound cat at 12:31 PM on October 13, 2008

Happy Dave, kingfisher, his musclebound cat, you are mentioning valid points, but I think considering the issue from the confines of the free market dogma blurs the options. There ARE ways of reducing per capita productivity without upsetting the whole society, or rather, of finding equilibrium between the number of able persons and the quantity of work anyone is willing to pay for.

First, distances will get bigger as fuel becomes less cheap. This resolves one issue - local production will then by definition become cheaper.

Second, I've just come from a meeting of the 'conservatives' of Europe. Now, even they say a free market without state regulation and interventions does not work so well. (You don't even want to know what the socialists are saying, what with nationalizing the banks etc.) So state regulation is not a filthy subject anymore. It can go a long way - customs duties on imports, selective taxes to promote certain modes of production, you name it.

Third, while some things take care of themselves (price of energy and mobility), there is still plenty of room for 'soft' regulation of the society. I'm thinking a new education paradigm, developing an ethos of self-employment and self-reliance, or something, that worked marvels before - a state sponsored campaign to promote gardening, scale modelling or arts as pastimes to fill people's time.

Why all this? Apparently, human societies often tend to converge to the lowest common denominator, as testified by the recent discussion here in the blue about the viability of unmoderated discussion boards (there is none) or books like Philip Ball's Critical Mass (herd-like characteristics of financial markets, driven by the stupidest and the bravest - often combined in one). So some nudging in the 'right direction' appears necessary.
posted by Laotic at 1:24 PM on October 13, 2008

So some nudging in the 'right direction' appears necessary.

Free markets, like evolution, are path-dependent, so sometimes government intervention -- just like the intervention of the Intelligent Designer -- are necessary to get things moving in the right direction again.

j/k kidding about the ID stuff, but the parallel holds since we don't have a million years and parallel trials to wait for the market to sort itself out.
posted by troy at 3:59 PM on October 13, 2008

Here we can see how Blue Chip shares perform during periods of high inflation.

I'll leave it to you folks to draw your own conclusions.

I can draw no useful conclusions (or any conclusions at all, to be honest) from that chart. Anyone else care to make a stab at it?
posted by stavrosthewonderchicken at 3:08 AM on October 14, 2008

Stavros: I am no economist, but sadly I've already lived long enough to play one on TV.
In general, the sharemarket does poorly in high inflation environments. It costs a lot to borrow money, your costs go up faster than you can raise prices, and the lag between when you do business and when you report it to the stock exchange makes your results smaller (as the $$$ are worth less over time).
Some asset classes are excepted. Traditionally, the best place to stick your money in high inflationary times was the US bond class that accounts for inflation (can't remember what they are called off the top of my head - its not something easy to invest in for mug punters outside the USA).
The other class that rules for inflation and safety is gold, as in ingots of. The drawback, of course, is it is totally defensive - no earnings, and it fact costs to keep it (insurance, storage etc.) so normally it is an investment that is very safe but returns less than a bank account.
If the situation gets to a point where banks are offering less than inflation on savings ( now in the USA) it makes sense, so you will see the price of gold is currently high historically. Better to get no real return but make no losses.
Otherwise, probably gold miners, which are an easy investment in the US, CA, SA and AU. If things are nasty they can go down a bit, as they become less profitable due to raising costs, but they produce the gold, so are naturally hedged to some extent.
Traditionalists (Mutant, I'm looking at you) say the most dangerous thing to believe is "its all different this time", in other words, when you are in a bubble you can believe earnings can stay inflated for some new reason (the e-economy, for a recent-ish example) or that on a downside not to invest in the old reliables because they have lost their inherent position (like many national banks did in the late nineties when they dropped their gold holdings, believing fiat currencies had enough inherent stability to hold value based on national economies alone).
Personally, I am conflicted, as I think one of the foundations of the global economy is changing, that is, the end of cheap oil, but predicting how to play such a monumental shift is difficult to do.
For example, the run up in oil prices earlier this year is largely now laid at the feet of speculators. My own guess, is it was an artifact of booming economies hitting the natural production limit. Because the global economy has cooled, we don't know for certain who was right (although I will concede the rapid drop in oil probably indicates there was lots of speculation - for me though, the question is whether it was on the back of a real and ongoing supply constraint).
So...what conclusions to draw? I know you are in Korea, so I guess you have at least a passing familiarity of the economic issues Japan has had for the last 18 years. They were/are fundamentally down to deflation - a reduction in the money available for investing/driving the economy to growth. There is a real risk that this might become the issue for the whole world due to the banks current reluctance to loan money, and it is this risk that has spurred the global central banks to throw (that seems to mild a word - hurl, dowse, drown?) money at the banks to push them to lend.
If you think this is actually the likely shakeout, there is nothing better to do than hoard cash. You can then deploy it to buy cheaper assets when you think things are back on a more even keel. In other words, in deflation, stock prices, cars, houses, food etc. will be cheaper in the future, so having cash in hand (or in the bank if you are comfortable with the guarantees) is by far the smartest move. This is Malor's long held position (although he goes one step further and says that governments can't be trusted and will devalue paper currency - so hold gold).
What seems to be generally the more mainstream position now (and I'd ask Mutant to weigh in if he thinks I am wrong, as he has impeccable ears for what the street is saying) is that the central banks have said the problems of inflation are more tractable than the problems of deflation, so they are fighting deflation with everything they have, damn the inflation. Of course, they hope that inflation will remain under control, being moderated by slower economic growth due to a recession, but they will count themselves winners if they get that rather than a depression.
The evidence for this is the amount of liquidity pumped into the banking system. This is the electronic equivalent of running the printing presses round the clock. Imagine if you had your own money machine - all of a sudden you wouldn't care if a Ferrari was $100,000 or $500,000, you would just go on a spending spree, and everyone you bought from would raise their prices if they were smart. The risk with central banks doing the same is that you will borrow at 0%APR or otherwisely low rates and buy more than you can really afford. Indeed, I don't think anyone argues this is what happened in the US around 2001-2003 when interest rates were so low.
Malor's valid argument is that such unrestrained good times, the cliche is the pucnh bowl was not taken away in time, will ultimately end up in Zimbabwe/Wiemar Germany style hyperinflation. Obviously, this would also be a devastating problem.
So this is the road the US Fed and the ECB etc. are toe-ing. Too much one way and we all starve, too much the other and we all starve.
Importantly, you should also consider who is the decision maker. I throw up my hands at the folk that think this is about Obama or the New World Order - this is a huge deal to Europe, Oceania, Asia and South America, and frankly, we care little for the US 2nd amendment. BUT the conspiracy guys are not wrong to look at the decision makers. In this case it is Henry Paulson - ex-Goldman Sachs, Ben Bernanke and Mervyn King are both academics - these guys are establishment. Given the choice where the financial system, with its known, if unwelcome inflation rules, or a threatening new ground of deflation looms, they will do everything they can to take inflation. And in the last few days they announced *unlimited* liquidity to the markets. This is basically asking to make you a loan, who cares about collateral. It is hard to describe how astonishingly inflationary this is in normal times - it is a measure of how seriously these guys view the situation that they are offering it.
So, what conclusions to draw? If you think the central banks will fail - and there is, to my mind, astonishingly, big, BIG, money betting against them, you should plan on widespread deflation, lack of confidence in money (fiat currency) and within a year or two, probably government in general - basically guns and ammo as your investment of choice, with a sock full of gold coins and very high unemployment, poverty etc.
If you bet with the central banks (never fight the Fed is a traditionalist maxim) then the best case is business as usual with rising inflation, rising employment and general bad times - worst case hyper inflation.
If in two years time you are bitching that employment is at 7% and a gallon of gas is $6, remember that we stared over this abyss back now and thank the central bank guys.
posted by bystander at 3:07 AM on October 15, 2008

stavrosthewonderchicken -- "I can draw no useful conclusions (or any conclusions at all, to be honest) from that chart. Anyone else care to make a stab at it?"

My apologies stavros for that presentation. The data and charts were for a different purpose, especially so the presentation. When the question arose I had the data and tossed it up to (hopefully) resolve the query. While the underlying data is complete the chart failed at this purpose (although it was fine for the original purpose, but that's neither here nor there).

In any case, I've augmented the original data, and prepared two additional presentations that hopefully will clarify beyond what bystander has already eloquently (and correctly) explained. I should add at this point that I'm not an economist either, rather an econometrician by education and practice. I only mention this as I'm aware there are some real economists here on MeFi - none participating publicly in this thread so far although we have been emailing - who hopefully weigh in and perhaps not totally correct me on some of the finer points. So I'll try to keep my observations to market driven dynamics, which I'm very comfortable discussing.

To this end, I've created a newspreadsheet that which can be downloaded here. All comments from this point on shall reference this spreadsheet and not the one I mentioned yesterday, although they are largely identical; the second spreadsheet has been enriched with some additional time series, and consists of four worksheets of interest as follows:
  • Desc Stats - Descriptive Statistics of the time series under analysis
  • Correlations - We calculated the degree of correlation of various time series in this worksheet
  • Inflation vs. Indices - The data underlying each time series which is used for the following analysis
  • Gold - A special bonus in the form of annual gold prices; while I do have higher frequency historical data for gold, but I can't legally distribute it but thought annual data would be better than nothing if someone else wants to mess about with this data
All this information was sourced from Data Stream and Bloomberg. I corroborated some data points from each series against another database and while the information is presumed to be correct, it is, of course, presented solely for educational purposes.

For The Dow and S&P 500 indices, I've divided all observations by 10 just to make the presentation nicer; these are named Dow (1/10) and S&P (1/10) respectively. I've also constrained the time series as to reinforce the topic under discussion - the performance of the stock market during periods of (relatively) high inflation. Specifically, I've selected the time period January 1st 1972 through and including January 1st 1987.

Referencing worksheet Desc Stats, which presents some overall statistics describing the various time series, we can see that inflation during this period ranged from a low of 1.1% observed in December of 1986 to a high of 14.86 observed in March of 1980. For the period in question, inflation on January 1st 1972 was 3.27%.

Another worksheet of interest is Correlations, which contain the correlation coefficient for each series in question (i.e. Inflation, S&P 500 or The Dow).

The key idea to keep in mind when looking at correlations, is that they lie in the bounded range -1 to +1, indicating perfect negative or perfect positive correlation respectively.

In other words, a largely positive correlation indicates that the two series tend to move together in the same direction, while a largely negative correlation means the opposite; as one series rises the other falls.

When looking at the calculated correlation between The Dow and Inflation, we see the coefficient is -0.67, meaning as one series rises the other falls (and vice versa). As correlation lies in the range -1 to +1, this is a very strong relationship. Similarly, when looking at correlation between the S&P 500 and Inflation, we see the coefficient is -0.10. We can conclude that while the overall stock market is negatively impacted by inflation, the very broad S&P 500 (an average consisting of the market capitalization of 500 shares) is less impacted, presumably due to this index having exposure to firms that benefit high inflation e.g., miners, etc as bystander pointed out. The actual metrics follow:
	 Inflation	DOW(1/10)
 Inflation	1	
DOW(1/10) -0.675823164 1 Inflation S&P500(1/10) Inflation 1
S&P500(1/10) -0.102565285 1
As pictures communicate this information much, much better than words, this graph illustrates the performance of The Dow during the period in question, and this graph the S&P 500.

The graphs pretty clearly show that as inflation increases the two indices decrease, and vice versa. There are, of course, lags but the overall pattern is pretty obvious. Part of the reason we chose to work with monthly share price data for this analysis is that noise in the system may and in fact does cause the markets to move against the trend for short periods of time. If someone reworks this analysis with daily data the patterns wouldn't be so apparent.

Hope this helps!

Wow bystander totally excellent comments, kicks off lots of interesting discussions.

"Personally, I am conflicted, as I think one of the foundations of the global economy is changing, that is, the end of cheap oil, but predicting how to play such a monumental shift is difficult to do."

Well, there is clearly a change going on, but I think although the shift in commodity pricing is important what's more intriguing is the nascent battle between the regulators / Central Banks who are doling out the dosh, and the banks who need / want this money.

Not clear who's gonna win here. I think no small amount of rework has to be carried out, that financial innovation has clearly outpaced regulatory developments. This has been true for perhaps a decade, maybe a little longer, but in recent years the gap has significantly widened. Now that tangible losses are being borne by the taxpayers perhaps the political muscle will be realised to push through the changes that many in industry wanted for so long.

"If you think the central banks will fail - and there is, to my mind, astonishingly, big, BIG, money betting against them,..."

I agree some big money has lined up against the Central Banks; the thing that concerns me is when this has happened in the past the Central Banks always lose (i.e., Soros knocking Pound Sterling out the ERM, there are lots of other examples).

I'm wondering if we're gonna start to see some crackdowns not only on the big funds but also the various instruments & leverage they employ. That, to me would make a lot more sense than shutting the markets for any period of time.

Speaking of markets closing - and reopening - Iceland closed their stock market for three days, and it promptly dropped 71% in one day upon reopening. This coup de grace follows a stomach wrenching, but relatively gentle decline of 30% realised across nine days in the beginning of this month.

Sorts puts those US & European plunges in perspective, eh?
posted by Mutant at 10:29 AM on October 15, 2008

Thanks, bystander.
posted by stavrosthewonderchicken at 4:22 PM on October 15, 2008

Ta for the long term equities/inflation data Mutant. I was surprised to see the strongest correlation was falling inflation/rising equities, and the opposite scenario is substantially less marked.
Short popularist article from CNN on deflation. Basically saying the risk is there, but the central banks would rather fight inflation.
posted by bystander at 4:57 AM on October 18, 2008

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