10 Responses to “Holding dollars, profits taken on bonds”

1. Graphite
   May 31st, 2009 at 10:53 pm

   

   Even people who should know better are starting to post nonsense about imminent hyperinflation and panics out of the dollar. The past few trading sessions Bloomberg has been plastered with articles about the threats to T-bonds and the dollar’s reserve currency status. Both the news and sentiment flows suggest a near-term bottom for the dollar is approaching rapidly.

2. Graphite
   June 1st, 2009 at 12:24 pm

   

   LOL, Nassim Taleb of “Black Swan” fame is starting a hedge fund to speculate on the imminent central banker mass-suicide-by-hyperinflation:

   http://climateerinvest.blogspot.com/2009/06/taleb-makes-hyperinflation-bet-and-why.html

3. Mike
   June 1st, 2009 at 12:32 pm

   

   Hmm… so his returns haven’t been so hot, other than a big score on puts last year in some funds, though maybe not even with his own personal dough. Seems like his real score was in growing assets under management.

   BTW, I’m back in with more TLT calls bought at today’s low. Tight stop, in case the sell-off continues.

4. Mike
   June 1st, 2009 at 12:42 pm

   

   Lots of big-name bears are making the inflation bet now. John Paulson and David Einhorn have gone heavily long gold this year.

   It is rare to see someone make two big scores in a row. These guys were winners because they were contrarian at the height of a mania — now they are going with the crowd.

   On Taleb’s fund, this from the WSJ today:

   “The new strategy, designed by Mr. Spitznagel, aims to post big gains if inflation and interest rates take off as they did in the 1970s. Universa will invest in options tied to commodities such as corn, crude oil and copper, as well as options on stocks such as oil drillers and gold miners.

   “We think these things are going to see massive volatility,” Mr. Taleb said in an interview.

   The fund will also bet against Treasury bonds, which tend to weaken in inflationary environments.”

5. Aki_Izayoi
   June 1st, 2009 at 2:59 pm

   

   On Market Folly, it was explained that a majority of Paulson’s gold bet was due to demand that his fund issues a share class denominated in gold.

   I think going short on TIPS (not plain vanilla Treasuries) might have a risk/reward. My reasoning: higher deficits would lead to higher interest rates. The reason that JGB yields were low is because Japan had a trade surplus, a large private savings rate, and corporations were suffering from a balance sheet recession so they didn’t take on credit which would compete with government borrow. Remember that when Treasury bonds were yielding two percent in the 1940s, the US had a high savings rate of above 20%. (here are nice graphs on the savings rate).

   Regarding TIPS, people are recommending them as a reflation trade, and they are not pricing in inflation. Furthermore, while their intent is to protect against increases in the CPI (the common “perception” of inflation,) they do not protect against real interest rate increases from decreased savings and global sovereign deficits.

   Ironically, market participant’s inflationary expectations (right now) are actually a deflationary force since they fuel reflation trades (particularly long oil) and a fear of long-term nominal assets. The former reduces consumer buying power because consumers have to allocate more of their income on a relatively inelastic expensive, while the latter reduces the already weak incentives to buy houses, which would cause the already overvalued home equity to drop faster and force a lower market clearing price to sell houses. Also, higher interest rates coupled with a balance sheet recession would make long-term government securities (relatively) attractive compared to most equity investments. Since consumers lack purchasing power, and are frugal with whatever little purchasing power they have, equity would not generate significant cash flow, and that the debt from the boom phase is a potential risk which should increase discount rates and lower the value of equity. In contrast, a 10 year Treasury at the low nominal rate of 3.5% has low risk (relative to equities) and offers a high real interest rate. (On another note, I see TIPS being used as an inflation hedge, and I do not see how inflation [defined by the CPI] would rise in this environment. [But it doesn't really matter in the short term; long TIPS did extremely well as a reflation trade. Perception matters too.] It seems TIPS are more of a bubble than nominal Treasuries because TIPS do not protect against high real interest rates caused by low savings and huge government deficits as it only offers protection from an increased CPI. In Japan, inflation linked notes underperformed relative to ordinary JGBs.)

   That is my thinking for shorting TIPS and it seems somewhat contrarian. Do you like it the idea?

   Mike, what do you think of deflation and hyperinflation? Do you share my sentiments?

   On another more “philosophical” level, what does deflation mean to you? I am not asking for a definition that deflation is a continued drop in prices or a contraction of money and credit. As I stated before, deflation represents sanity while hyperinflation represents delusion. Deflation is the acknowledgement of failure mixed with feelings of despair. Deflation shows us our broken dreams; dreams that central bankers could “control” inflation by raising or lowering short term rates and that this would facilitate prosperity; dreams that technology would solve much of our problems and create wealth (one could argue that technology DESTROYS wealth because one can value of a job as a yield instrument [like a utility stock] and since technology exerts downward pressure on wages, it reduces the “dividend” on these “stocks” and lowers their present value.) Deflation means giving up these delusions of “prosperity.” Hyperinflation, on the other hand, is the avatar delusion. Hyperinflation is the irrational hope that central bankers can create prosperity with the printing press much like Gideon Gono and the Weimar Republic. Hyperinflation represents desparation and irrationality much like Hitler’s beliefs the wunderwaffen (wonder weapons) would save him from the Allied and Russian forces as they approach his bunker.

   Here is what Peter Thiel has to say:

   http://bigthink.com/peterthiel/peter-thiels-four-theories-on-the-bubble-and-bust-economy (play at 4:20)

   After listening to Peter Thiel, read Kurzweil’s essay The Law of Accelerating Returns (it was written in 2001) provides a nice context about progress although it is very long.

6. Graphite
   June 2nd, 2009 at 12:48 am

   

   Interesting, even Prudent Bear’s Doug Noland is now speculating on the possibility of a quick global recovery and disappearance of deflationary pressures: http://www.prudentbear.com/index.php/creditbubblebulletinview?art_id=10234

7. Aki_Izayoi
   June 2nd, 2009 at 3:17 am

   

   Remember, hyperinflation is a still realistic possibility. Remember the power of human delusion. Remember that people lie to themselves so they can be better liars to others. Bernanke sincerely believes in Keynesianism/monetarism.

   I thought the case for a deflationary spiral was convincing. I thought the massive overpopulation, overcapacity, and the effects of the proliferaton of “neoliberal” policies would drive the prices for everything down. I do not know for sure if this rally is reflation or more of an anti-dollar bias, but currencies such as GBP and NZD (perhaps it was just tagging along for the ride with AUD), which have horrible fundamentals, rallied too. I thought the commodity rally (particularily on energy) would have deflationary effects.

   For some fundamental news, deflation would be the unequivocal outcome without government intervention. Here is a great graph from Brad Setser.
   http://blogs.cfr.org/setser/2009/05/31/more-government-borrowing-doesnt-necessarily-mean-more-total-borrowing/

   Populist political forces lead to deflation if they were allowed to play out. For example, read Patrick Wolff of Clarium analysis. (Although Clarium got their ass handed to them in the second half of last year, and are treading water this year. Their deflationary trades did not work out well. It is still my favorite hedge fund)

   One another note, I am one of those The Limits to Growth types who rants about controlling overpopulation and reducing consumption (I got banned from a Catholic forum for talking about Paul Ehrlich), and deflation seems to be one way of faciliating this. Unlike Paul Krugman, I could at least see some positive effects of deflation.

8. Aki_Izayoi
   June 2nd, 2009 at 3:18 am

   

   Maybe we would get a replay of 1937 if populist forces take over.

9. Mike
   June 2nd, 2009 at 10:42 am

   

   Graphite — That is interesting about Noland. I seem to remember that the Prudent Bear guys have been dollar bears for a very long time, however, so they may be some longstanding anti-US bias to their stance. Now if Mish or Prechter would turn bearish on the dollar and bullish on emerging markets, that would be something.

   I tend to think that we have seen most of the price move we are going to get in this bounce in global equities, though a lot of commodities have room to run.

   Also, this period can last as long as 8 months, judging by some other dead-cat bounces within big bear markets.

10. Aki_Izayoi
    June 2nd, 2009 at 6:40 pm

    

    I’ll post this link by Paul Krugman.

    Besides the issues with the source, one should consider when that was written. It was written in 1999 during the NASDAQ boom, and no one was fearing a fall in the dollar. The atmosphere was different now.

    But, seriously, there is a story behind this no doubt temporary reversal of fortune. Again according to press reports, Stanley Druckenmiller, who mainly runs Quantum these days, made highly leveraged bets that the U.S. dollar would plunge against foreign currencies. He had reasons: after all, America is running the biggest trade deficit in history. It must have seemed logical that this would force a dollar devaluation. Alas, the logic was wrong, or at least premature. Instead of falling, the dollar rose against both the Japanese yen and the euro. And so it was Quantum that got devalued instead.

    You could say that this is a case of being hoist by one’s own petard. Druckenmiller had made a seemingly strong case that the dollar was overvalued; but as his boss’ books have insisted ad nauseam, markets are not rational and often go in the “wrong” direction. Or was his case that strong? Yes, America is running huge trade deficits; but so what?

    Suppose that you didn’t know about those deficits. (In the 1960s, when Britain was plagued by balance-of-payments problems, a journalist asked the Chancellor of the Exchequer why the nation had fared so much better in the days of Queen Victoria. “Ah,” he replied, “back then, we didn’t have any statistics.”) What you would see is a U.S. economy booming while others sputter; it seems likely that over the next year the Fed will tighten the supply of dollars while its counterparts increase the supplies of euros and yen. In other words, if you ignore the trade statistics, everything suggests that the forces of supply and demand will strengthen rather than weaken the dollar.

    And guess what? Investors are mostly ignoring the trade statistics. The truth is certainly out there, but nobody (except Druckenmiller) seems interested. Back in the 1980s, record trade deficits were front-page news; these days they tend to get a couple of inches on page C-3. We have not quite achieved old-fashioned blissful ignorance, but not thinking about something is almost as good as not knowing about it.

    So are those lonely speculators who think that the trade deficit is, as Druckenmiller put it, an “impending disaster,” completely off base? Not entirely. In the long run, a country, like an individual, must pay its way. America’s trade deficits cannot go on forever; and as economist Herbert Stein has famously pointed out, things that cannot go on forever, don’t. Sooner or later, foreigners will grow weary of holding ever larger quantities of U.S. assets; that is, they will no longer be willing to invest enough to finance both the continuing trade deficit and the growing interest payments on America’s foreign debt. When that happens, the dollar will fall–and the longer that day is postponed, the bigger the fall.

    http://www.pkarchive.org/cranks/SorosLost.html

    http://www.smartmoney.com/breaking-news/?story=20000106070916&print=1

    I worship Soros and Druckenmiller.

    I do not know if there is any point to this (maybe it provides a nice compare and contrast between two environments), but Druckenmiller made a contrarian bet and got wasted. Eventually, he did recoup his losses (by going long on the Euro and short on NASDAQ) by going long on the NASDAQ during the late bubble in the summer and fall of 1999 (knowing that is was a ponzi scheme). Later, he got killed by the tech selloff by mistiming it by holding on to his long positions too long.