Well, the reflation trade has managed to hold on for a few more days and even reached new heights, but the case for a pullback is looking that much better. Precious metals, non-dollar and non-yen currencies, oil and treasury yields have all benefited from what looks like a fairly extreme fear of inflation.
At 3.83%, the 10-year note, and certainly the 5-year at 2.83%, are even approaching levels at which they may be attractive buy-and-hold instruments. In a couple of years, we may look back at this sell-off as a great chance to lock in some respectable yields for a long bout of deflation. These bonds will at the very least vastly outperform the stock market or real estate.
I would be surprised if today’s sell-off in the mid-range of the yield curve doesn’t start to lure people back into longer maturity notes.
Source: Bloomberg.com
Today’s “gap and crap” in the stock market can also be taken as a sign of a top, which would coincide perfectly with a bottom in bonds and turnaround in the dollar. Euro and pound bullishness had been holding at well over 90% by early this week, as had that for precious metals. Silver’s two strong pullbacks from the $16 level were encouraging, as were the nosedives in the euro and pound.
From this juncture, I am still more enthusiastic about the prospects for the dollar, bonds and related commodity shorts than I am about stock market shorts, since the sentiment in the later has not reached the same levels of broad consensus. That said, it would be surprising if we don’t at least stop making new highs for a few weeks, if not fall well under 900 in the S&P.
Still a deflationist, huh?
Why am I so sure that we are stuck in deflation? Simple: the inflation we have experienced for the last 40+ years in the US and most of the world is less related to money printing, digital or otherwise, than credit issuance. This was a great credit bubble, during which families and corporations forgot all the lessons of irresponsible borrowing thanks to compromised central banks that provided cheap money and the promise of bailouts to the bankers who would otherwise be on the hook for extending worse and worse loans.
As credit got cheaper and easier to obtain, people relied more and more on it for everything from houses to cars to clothing purchases and even vacations. With easy credit, prices levitated across the economy until we reached the point where we could just not make debt any easier to get. After 105% loan-to-value, neg-am, teaser rate, no-doc loans, what else could be possibly be done to lure more people to borrow?
Debt is now a burden without a reward
Without the continued expansion of credit, there was no reason for prices to keep going up, but after 2005, without prices going up, there was no reason to borrow. Just like a light switch, in 2006-2007, debt became a burden without a reward, and ever since then the magic of leverage has been working in reverse to the tune of tens of trillions of dollars in lost equity.
Creating a few trillion dollars and simply giving it to banks with (still!) massively upside-down balance sheets does nothing to get the inflation ball rolling again. If the money were dropped from helicopters or spent into circulation by the government hiring tens of millions of people (as in the highly-socialist Weimar Republic, where the government owned factories) or, as is more likely here, in a truly massive war effort like the inflationary WW1 and WW2, we would soon have inflation. But nothing that we have seen so far is remotely capable of spurring inflation until asset prices and incomes have so collapsed that most of the bad debt (tens of trillions) is liquidated through bankruptcy.
Without the bailouts, we would already be most of the way through this recession, as in the short depression in the US after WW1, in which the government did very little except lower taxes. Assets like bank deposits and car factories would be finding their way into responsible hands, where they could be put to productive use. The surviving prudent banks would be lending to the surviving prudent manufacturers and prudent families, who would be acquiring assets from the foolish, who henceforth would be much less foolish. This natural process is exactly how the west achieved such fantastic real growth in incomes, technology and quality of life in the period from the 19th century to WW1.
At the rate we are going, prepare for many years of high unemployment (we’re at 16.4% now) and weak corporate earnings, as the prudent are taxed to prop up the foolish and cynical. This is not a formula for rising prices or a better standard of living. This is a formula for political, moral and economic decline.
This is not the kind of process that societies just can just stop on a dime. Nations can’t be expected to just have epiphanies, throw the bums out and install better governments. The baddies are so in control of the nation’s press, schools and political apparatus that events must run their course, over many generations, unto total collapse. Just ask the French of the 18th century or the Russians and Chinese of the mid-20th. The west has been on this course for nearly 100 years now, since a great civilization was dashed to pieces in the fields and forests of Europe and collectivism gained a foothold.
