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Current time:0:00Total duration:13:20

Inflation and deflation 3: Obama stimulus plan

Video transcript

I finished the last video touching on the stimulus plan and whether it's going to be big enough and what its intent was that was a little hand wavy about things like savings in GDP and I thought it would actually be good to get a little bit more particular just so you know that you know that this isn't just you know me making up things so a good place to start is just to think about disposable income and people talk about it without ever giving you a good definition it's important to understand what disposable income is so this box right here is GDP so it's all the goods and services essentially all of the income that we produce the disposable income is essentially the amount that ends up in the hands of people so the US GDP I don't know the exact number is it's on the order of I think it's like fifteen trillion dollars whoops it's on the order of 15 trillion dollars and so some of that money goes to taxes I don't know maybe 30 let's just say four trillion dollars of it let's say three trillion dollars ends up in taxes and these are round numbers but it gives you a sense of the makeup then maybe and about another one trillion is saved by businesses so let's say that I'm Microsoft and I make a billion dollars this year Microsoft makes a lot more than that but I make a billion dollars and I just keep it in a bank account owned by Microsoft I don't give it to my employees I don't dividend it out to the shareholders I just keep that so corporate savings let's say it's another trillion dollars these are roundabout numbers and then everything leftover is essentially disposable income I'm making some simplifications there but everything left over is just full income and the idea is is what is in the hands of households after paying their taxes disposable income that check that you get after your taxes and everything else is taken out of your paycheck that money that is disposable income to you so the interesting thing is where this disposable income has been going over the last many many years so this chart right here actually let me let me go down a little bit so this right here this chart is a plot of the percentage of disposable income saved since 1960 and got this off of the Bloomberg terminal again and just so you get a good reference point let me draw the line for 10% because I kind of view that as a reference point that's 10% personal savings actually you could go back even further than this and you can see from 1960s all the way until the early 80s the go-go 80s people were saving about 10% of their disposable income of what they got on that paycheck after paying taxes they were keeping about 10% of it putting in the bank and of course that would later be used for investment and things like that but then starting in the early 80s right around let's see it's about 1984 see that people started saving less and less money all the way to the extreme circumstance to 2007 where you saved where on average people didn't save money where you know maybe I saved $5 but someone else borrowed $5 so on average we didn't save money actually we went slightly negative and all of this and this is kind of my claim and it can be borne out if you look at other charts in terms of the amount of credit we took on is because we took on credit I guess there's two things you could talk about we took on credit and we started having what I called perceived savings right if I buy a share of IBM a lot of people say oh I saved I saved my money I bought you know I'm invested in the stock market but when I bought a share of IBM unless that dollar I paid for the share goes to IBM to build new factories if it and that's very seldom time most of the time that dollar I gave to Ivy to buy that IBM shares just goes to a guy who sold an IBM share so there's no net investment it's only investment it's only savings when that dollar is actually goes to invest in some way build a new factory or build a new product or something so I think you had more and more people thinking that they were saving when they weren't maybe thinking that they were saving is their home equity and their house grew or as their stock market portfolio went up but there wasn't actual aggregate savings going on and is in fact if anything they were borrowing against those things especially home equity and the average saving rate went down and down and down so now we're here in 2007 and maybe you could say you know 2008 where let's say that this is the capacity because we should probably talk about world capacity because so much of what we consume really does come from overseas but this is kind of the capacity serving the US and let's say going into 2007 this was demand supply and demand was let's say pretty evenly matched right and if we go to that top up here you see that we weren't it like kind of a you know we were at like 80% utilization which isn't crazy so if anything you could say that we had you know demand was maybe right around here but that's a good level you want to be at around 80% utilization that's the rate of which you don't have hyperinflation and you bet you're utilizing things quite well now all of a sudden the credit crisis hits and all of this credit disappears and I'd make the argument that the only thing that enabled us to not save this money is more and more access to cheap credit every time we went through a recession and from the mid 80s onwards the government solution was to make financing easier the Fed would lower interest rates we would pump more and more money into Fannie and Freddie Mac we would lower standards on what it took to get a mortgage we would create incentives for securitization we would look the other way when Bear Stearns is creating collateralized debt obligations or AIG is writing credit default swaps and all of that enabled financing right until we get to this point right here where everything everything everything starts blowing up so you essentially have for savings when people can't borrow anymore the savings rate is going to have to go to 10% because most of this is just from people taking on more credit there were as a group of people who are probably all read always saving at 10% of their disposable income but they had another group of people who are more than offsetting that by taking credit now that the credit crisis hits you're going to see the savings rate and you already see it here with this blip right there the savings rate is going to go back up to 10% of disposable income now if the savings rate goes back to 10% of disposable income that amount of money that 10% of disposable income this gap is 10% of disposable income that cannot be used for consumption right and let's think about how large of amount that is right now u.s. disposable income if I were to draw disposable income this number right here I just looked it up it's around ten point seven trillion dollars let's just say 11 trillion dollar for roundabout so this 10% of disposable income that we're talking about this gap between kind of the normal environment and what people what the environment that was enabled from super easy credit that's 10% of disposal income 10% of 11 trillion is 1.1 trillion dollars per year of demand that will go away that's per year so all of a sudden you're going to have a gap where this was the demand before and now the demand is going to drop to here and all of this 1.1 trillion of demand is going to disappear because the credit isn't because credit is now not available and then you do get a situation where you might hit a low capacity utilization and unfortunately the capacity utilization numbers don't go back to the Great Depression and we could probably get a sense of at what point does a deflationary spiral really get triggered but because at one point one trillion dollars in demand disappears you're going to see this orange line just drop lower and lower in terms of capacity utilization and that's going to drive prices down and what Obama and the Fed and everyone else is trying to do is to try to make up this gap now everyone else can't borrow money companies can't borrow money homeowners can't borrow money but the government can borrow money because people are willing to finance it or at the bare minimum the feds willing to finance the government and so the gut the government wants to come in and take up the slack with this demand and spend the money themselves with the stimulus now we just talked about what's the magnitude of this demand shock it's 1.1 trillion dollars per year right 1.1 trillion while the stimulus plan is you know on the order of a trillion dollars and that trillion dollars isn't per year although I have a vague feeling that we will see more of them coming down the pipeline this trillion this stimulus plan that just passed this is expected to be Pat spent over the next few years so in terms of demand created over the next few years it's going to be I don't know several hundred billion per year so it's going to be anywhere near or large enough to make up for this demand shock to make up for that demand shock so we're still going to have low capacity utilization so so the people who argue that you know this these stimulus plans are going to create a hyperinflation I disagree with that at least in the near term because in the near term it's nowhere near large enough to really soak up all of the extra capacity we have in the system and if anything it's going to soak up different capacity so the stimulus plan it might create inflationary light conditions in certain markets within where the stimulus plan is really focused but other areas where you used to have demand but the stimulus plan doesn't touch like $50 spatulas from William Sonoma or granite countertops that area is going to continue to see deflation and I would say net net since the stimulus is actually so small even though we're talking about trillion dollars relative to the amount of demand destruction destroyed per year we'll probably still have deflation and for anyone who's paying close attention to it and I am because you know I I care about these things the best thing to keep a lookout for to know when to kind of start running to gold maybe or being super worried about inflation is if you see this utilization number creep back up into the 80% range and you know at least over the last 40 years that's been the best leading indicator to say when are we when are we going to have inflation and for all those gold bugs out there who are you know who who insist that all of the hyperinflation or the potential hyperinflation is caused by our not being on the gold standard I just want to point out that you can very easily have you know we went off of Bretton Woods and completely went to a fiat currency in 73 that's right around let's see 69 it's right around here but our worst inflation bouts were actually while we were on the gold standard and that's because we had very high capacity ization this is the war period what happens during a war you run your factories all out you run your farms all out to feed the troops of factories instead of building cars build planes and everyone was working wages go up everything goes up and you have inflation right and a lot of people say that oh you know the war was was the solution of the Great Depression and it is true and that it got us out of that deflationary that negative deflation airy stuff viral that I talked about in that last video and it did it by creating an unbelievable amount of inflation and then after the war you could argue you know what allowed I don't have GDP here but the GDP US GDP really did do well in the post-war period and it wasn't the war say although the war kind of did take us out of the deflationary spiral it was it was so you know after the war you had all of this capacity after World War two she had all this capacity that was used being used up by the war then all of a sudden the war ends and you're like what we don't have to build planes anymore we don't have to feed the troops anymore and now we have all these unemployed troops who come back home what are we going to do with them right you would say maybe capacity utilization would come back down there but what a lot of people don't talk about is the rest of the industrial world's capacity was blown to smithereens the at that point in time the u.s. was a smaller part of GDP and the other major players were Germany Western Europe and Japan and all of these guys in the u.s. we didn't have any factories bombed all of the wall the entire war took place in these areas and whenever people go on bombing raids the ideal thing that they want to bomb is factories so what you had in the post-war period is you had all of these countries had their capacity blown to smithereens the u.s. was essentially the only person left with any capacity and so all the demand from the rest of the world picked up the slack in the u.s. capacity and that's why even though there was a demand shock in the US after that you had demand from what you also had a supply shock from the war where you had all of this capacity that was blown to smithereens in this situation that we are now we have a major demand shock right financing just disappears and the savings rates going to skyrocket because people can't borrow anymore but there's no counteracting supply shock right supply of of really you know factories making widgets and all the rest is staying the same so the Obama administration they're trying to create a stimulus to stop some of this up but it's not going to be enough and my only fear is with all of the printing money and all that goes is once we go to a situation once we do get back to the 80% capacity utilization once we do go back here how quickly they can unwind all of this printing press money and all of the stimulus plan because that's going to be the key because if we do get to 80% capacity utilization or we start pushing up there and we continue to run the printing press because that's what essentially governments incentive is to do because they always feel better when we're flush with money then and only then you might see a hyperinflation scenario but I don't see that at least the next few years