Last week’s dialogue concerning deflation and the impending hard times produced quite a pile of interesting mail. The discussion resumes today with several more fascinating letters from Rick’s Picks subscribers and lurkers. My responses are in italics. First up is Dave C., a real estate investor who say the market for homes in Michigan, where he lives, has plummeted:

“I see that you have addressed the credit card crisis. I sent the article about the raising of minimum payments far and wide and didn't get much of a response, to my surprise. I did some further research, based on your response to me, and called a few banks to query them on this change. They said the higher monthly payments had already taken effect and that most borrowers would have received a letter stating that this was so.  Well, I'm glad the general public was able to adjust to these changes so easily!  I agree with your assertion that much higher energy costs for an essential commodity may not shake out very well. 

“I would also note that we are in a severe housing-price collapse here in the mid-Michigan area. I deal quit a bit as a real estate investor, so I keep a close eye on the market hereabouts.  I've been hanging back to see how things will shake out come spring, and I'm not expecting a pretty picture, especially in the residential real estate market.  We may well see a mass migration to warmer areas of the country.  In any case, I am in prayer for the less fortunate folks who may face a severe cash crunch due to much higher energy costs.  The whole scenario, from the devastation of the basic manufacturing plants and jobs to higher energy costs are certainly pointing to a Category 3-or-higher economic hurricane for this area and possibly the entire state. I think that the new bankruptcy laws and credit reforms will also factor into our troubles in a very negative way, also.   I hope you -- pray for us too, Rick, as it appears to me that we need it. Thanks for listening and keep up the good commentary, which I look forward to reading every day.”

Rust Belt ‘First’

Michigan unfortunately was fated to be the first over the falls. The pace of layoffs in the auto industry has quickened ferociously and will soon begin to tear into the economic lives of retired workers who had counted on full health care coverage, among other benefits. This is a far cry from the last recession, when I briefly worked as a recruiter of anesthesiologists in the Midwest. I recall searching futilely for a physician willing to take a $300,000 position in Battle Creek. Since then, health care managers have made in-patient care a dirty word, with the result that many medical specialists, like the auto workers, have been running in place for more than a decade. It is beyond my imagination to foresee how the Rust Belt will extricate itself from the coming hard times.

From C. Erber, there was this urgent note: “You just scared the s**t out of me. When you say,  ‘Bottom line, in a deflationary collapse only hard cash – something few of us possess in any quantity – will provide a safe haven,’ do you mean literally the dollar bills in my wallet? Or do you think cash in the form money market funds backed by T-Bills will survive such a cataclysmic event?”

Cash should continue to function much as it has, but we’ll be forced to get by with much less of it, since, as I wrote here earlier, cash money  will lack the steroid boost that credit has long provided. But if money-market funds do survive, that implies the government will not default on its debt via the mechanism of hyperinflation. The deflationary alternative would be for the U.S. to pay only the interest on its debt.

Finally, we have this letter from Rene S., who thinks deflation will not come until a brutal inflation has run its course:

No Overnight Effect

“You argue for immediate deflation after a crash, as there won't be any dollars left. I believe instead we will continue to see a prolonged period of at least a year of high price inflation after a collapse, before deflation kicks in. My reasons:

1)  “As far as I can tell from the last five years, it took a long time for credit inflation to affect prices. I don't see why sudden credit deflation would have an overnight effect on prices.”

The U.S. economy is a consumption machine fueled by borrowing, and it would take only a modest uptick in the cost of servicing household debt to drastically affect discretionary spending. Consumers have been leaning heavily on their home equity to keep the economy nominally out of recession, but it is a very delicate balance. Upset it even slightly and we will find that fear is a much more powerful motivator than greed.

2)  “Right now, all currencies are losing value in lock-step because the U.S. is exporting its inflation in money supply: For every dollar that is used to buy foreign consumables, a foreign central bank prints corresponding local currency. The difference is that those foreign currencies are supported by trillions in dollar reserves (that they could buy gold with, for example, right now) and savings, whereas the Fed's currency is supported by nothing. When the US debt market implodes, I fully expect foreign central banks to dump their U.S. dollars and Treasurys and swap them into gold, unfreezing and dumping a s**tload of dollars back onto the homeland, resulting in more inflation, and a dollar crash, as now the foreign currencies are backed by real assets (e.g. gold) while the U.S. becomes the only holder of paper-dollar obligations onto itself.”

Seemingly Benign

Actually, by purchasing our bonds, foreign holders of dollars are turning the would-be inflation back on the U.S. But who’s going to complain? Until the whole house of cards comes tumbling down, the arrangement will continue to seem benign to all the players, since it inflates the value of a huge class of financial assets they hold while also expanding the stock of collateral upon which even more loans can be made.

But the bottom line is that the world’s $250 trillion credit edifice rests on a $40 trillion economy. Which is to say, the collateral has been stretched thinner than a gnat’s nose-hair. Moreover,  if Europe, Asia and all of today’s net exporters come out of the crash with hard money, who is going to  buy their wares?  The last thing in the world they’d want in a global recession is to be on a gold standard.      

Monday: More provocative letters from readers.