Sunday, December 14, 2008

Deflation in scrap prices and Treasuries




There's a lag effect that will affect municipalities. Just check out Milwaukee, WI the beer capital of the United States. Who would recycle more aluminum than them?

Although values of scrap metal, paper and aluminum cans have rapidly crashed to record lows, City of Milwaukee and Waukesha County budgets should not be hurt by the late-year downturn.

The same likely will not hold true for area residents who recycle scrap metal and aluminum cans to earn a little extra cash.

From a June high of 85 cents a pound, aluminum can recyclers are now fortunate to get 37 cents a pounds, said Tony Teich, owner of Mill Valley Recycling of Milwaukee.

"It's a downturn market," Teich said. "When the markets collapsed in October, mills weren't even buying recycled products. Right now, the monetary gain is not there. We're seeing less scrap come in due to depressed prices."

Rick Meyers, the Milwaukee Department of Public Works recycling specialist, said the city collects recyclables from about 190,000 households and receives about $1.3 million a year by selling the materials.

Prices for recyclables were so high throughout the summer and into October that the profits from sales then should offset the losses incurred from the recent downturn, officials said. Many municipalities, including Milwaukee and Waukesha, rely on large cash contributions from usually profitable municipal recycling programs to help balance their budgets.

Milwaukee already is ahead of last year with $1.39 million in revenue from recycling, Meyers said.

If the economic downturn and resulting depressed scrap prices continue deep into next year, officials fear municipal budgets will suffer and scrap could become unsellable.

http://www.jsonline.com/news/milwaukee/36116429.html

It first hits the resource economies. Seven weeks ago, Sims Group in Australia, the world's largest recycler warned that falling scrap prices would hit their bottom line.
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=augnSIq_v0Gs

Now municipalities are recognizing that sources of revenue will no longer be there. It's just not property and other taxes that are going away. How about the write-off for capital gains?

At least the world's Central Bankers finally have recognized deflation. It was a bit more than six years ago when Bernanke gave his Deflation: Making Sure "It" Doesn't Happen Here speech.
Bernanke's thesis in 2002 was that our banking system was too healthy for that to happen, making it a de minimus threat:

A particularly important protective factor in the current environment is the strength of our financial system: Despite the adverse shocks of the past year, our banking system remains healthy and well-regulated, and firm and household balance sheets are for the most part in good shape.

Now we see the flight to cash. And household and bank balance sheets are not healthy. What did Bernanke have to say about that in 2002?

Deflation of sufficient magnitude may result in the nominal interest rate declining to zero or very close to zero. Once the nominal interest rate is at zero, no further downward adjustment in the rate can occur, since lenders generally will not accept a negative nominal interest rate when it is possible instead to hold cash. At this point, the nominal interest rate is said to have hit the "zero bound."

After that the strategy is to print money.

By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

But currently every country around the world is attempting to debase their currency. So the Fed must expand the range of assets that they will purchase. So through the AAA idea out of the window. Which is just when Bernanke suggested.

To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system--for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities.

And why does the Treasury and Fed always change their policies? Let's look to Bernanke again.

One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it.

One of his plans was to limit the yield on two year Treasury debt.

A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years).

That rate is already 1%. So what is next? If that didn't work the next step was to purchase GSE paper.

Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association).

They have already announced that. They are already luring Japanese buyers into our debt with synthetic securities tied to our 10 year paper. Bernanke's solution in his 2002 speech was the following:

Prior to that agreement, which freed the Fed from its responsibility to fix yields on government debt, the Fed maintained a ceiling of 2-1/2 percent on long-term Treasury bonds for nearly a decade.

So the ten year rate is at 2.5% already. What's next?

Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral.

They already have those alphabet soup programs. So what's next? Buy foreign government debt!

Because the economy is a complex and interconnected system, Fed purchases of the liabilities of foreign governments have the potential to affect a number of financial markets, including the market for foreign exchange.

He doesn't have to do that. The currency market is already making those adjustments! I suppose Treasury then could buy distressed assets. But wasn't that what the TARP was for?

Of course, in lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.

But for this to work, the Federal Reserve needed to act pre-emptively.

Fortunately, for the foreseeable future, the chances of a serious deflation in the United States appear remote indeed, in large part because of our economy's underlying strengths but also because of the determination of the Federal Reserve and other U.S. policymakers to act preemptively against deflationary pressures.

Did Bernanke act pre-emptively? Let's use his own words in the New Yorker magazine in the article entitled Anatomy of a Meltdown.

The front page says it all. Bernanke said he was "mistaken early on in saying that the subprime crisis would be contained."

So much for pre-emptive. But rest assured, we are in good hands because Tim Geithner, is our new Treasury Secretary. The one, who said Lehman was a "strong institution."

Seperated at birth from Tate Donovan, (next to the car) who, in the movie played Nancy Drew's dad! (I stayed home and watched movies with my six year old sick daughter yesterday. And yes, I watched Nancy Drew. That movie had better acting than our Government officials!)

Let's hope that he recognizes the obvious.

This is real life, not reel life!

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