Thoughts On the Continuing Crisis The Elements of Deflation A Presentation by John Mauldin, Author of Bull’s Eye Investing And the Editor of Thoughts from the Frontline

Is the Glass Half Full…

Or is it Half Empty and Leaking?

US Headline CPI Inflation

The Elements ofDeflation

9 Million Part Time Workers

Total “U6” Unemployment Including Part-Time Workers is 16.8%!!!

33% Unemployed for 6 Months

Jobs Losses are Far Below Average This is NOT a Typical Recession

A Few Data Points on Unemployment If you include “discouraged workers” with U6 then unemployment is 21.1%, and therefore more than 13% total unemployed If you include “discouraged workers” with U6 then unemployment is 21.1%, and therefore more than 13% total unemployed Since 1999,, even as the population grew by 33 million, the private sector has lost 235,000 jobs (BLS data) because of job losses in the current recession. Since 1999,, even as the population grew by 33 million, the private sector has lost 235,000 jobs (BLS data) because of job losses in the current recession. Wages are falling and Hours Worked is at an all time low 33 hours Wages are falling and Hours Worked is at an all time low 33 hours 18 million NEW jobs will be needed in five years to get us back to employment levels last seen in million NEW jobs will be needed in five years to get us back to employment levels last seen in 2007

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

Mortgage Equity Withdrawal Fueled the Economy

The Impossible Happens The US Consumer Stops Borrowing

The Psyche of the American Consumer Has Been Permanently Seared with the Pain of Falling Home Prices and Stock Prices ************** Faced with Retirement Issues, And the Need for Increased Savings, Consumer Spending is Going to be Challenged for Years

Savings Actually Explode Upward During this Great Recession!!!

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

Mortgages It’s Not Just a Sub-Prime Problem

Housing Sales are Flat

Housing Prices are at Best Flat

Banks Have Yet To Deal With Bad Loans

Most likely recovery is a “W” with a long tail due to slow growth and rising mortgage rates. Fall 2005

Housing Data Points Over 1/3 or Mortgages are Now Underwater Over 1/3 or Mortgages are Now Underwater It will be 2011 Before We Move Through the Excess Housing Inventory It will be 2011 Before We Move Through the Excess Housing Inventory Foreclosures are Adding More Homes to the Inventory of Unsold Homes Foreclosures are Adding More Homes to the Inventory of Unsold Homes There May Be as Many as 500,000 Homes in the Shadow REO Inventory There May Be as Many as 500,000 Homes in the Shadow REO Inventory

The Effect of the Stimulus Without the Stimulus, GDP would have been a -6% in the Second Quarter! Without the Stimulus, GDP would have been a -6% in the Second Quarter! Without the Stimulus, GDP Would Be Flat to Negative this Quarter Without the Stimulus, GDP Would Be Flat to Negative this QuarterQuestion: What Happens When the Stimulus Goes Away? Especially to States and Municipalities?

Government Receipts Are Down

Be Careful What You Wish For

Volume of Word Trade Collapses 20%

And Thus Capacity Utilization Falls off the Cliff

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

M2 is Flat or Falling Since the End of February

What is Money??? M-1, M-2, gold? – Misleading Measure Money is CASH + Credit Money is CASH + Credit Cash is $2 Trillion Cash is $2 Trillion Backed by Credit of $50 Trillion Backed by Credit of $50 Trillion

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

Deleveraging brings Deflation DNA Changes in the FED Governors….they become genetically opposed to deflation

The FED is at a Major Crossroads Allow inflation like 1970s or Withdraw liquidity and slow recovery

The Great Experiment KeynesVS von Mises VSFisherVSFriedman

Re-Inflation? It may take up to $2 Trillion in new printing press money to re- inflate in new printing press money to re- inflate It will work, but what then?

Like John Paul Jones, Bernanke will soon say: “Sir, I have not yet begun to print!”

How did we get it Sooo Wrong? How did we get it Sooo Wrong? We taught two generations of managers theories which were patently absurd We let rating agencies become too important We believed the trend.

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

You Get Deflation and You Get Deflation and Nothing But Bad Choices