Summer school

There are still a lot of people out there who didn’t absorb last year’s course on the credit cycle, particularly the chapter on inflation and deflation. To remedy this gap in your elementary economic education, before buying resource stocks or saying that any market will go to the moon on Fed-powered rockets, you are required to read this refresher by Mish Shedlock. An except is below:

…there are practical as well as real constraints on what the Fed can and will do. Nearly everyone ignores those constraints in their analysis.

Congress in theory and practice can give away money. Indeed, Congress even does that to a certain extent. Extensions to unemployment insurance, increases in food stamps, and cash for clunkers are prime examples.

However, those are a drop in the bucket compared to the total amount of credit that is blowing up. Take a look at the charts in Fiat World Mathematical Model if you need proof.

The key point is it is the difference between Fed printing and the destruction of credit that matters! As long as credit marked to market blows up faster than handouts and monetary printing increase we will be in deflation. Deflation will not last forever, but it can last a lot longer than most think.

Also ponder this missive from the dean of Deflation U, Robert Prechter:

“The Fed’s balance sheet ballooned from $900 billion just five months ago to more than $2 trillion, by buying outright, or swapping the pristine credit of U.S. Treasury debt for the questionable paper held by troubled banks, brokerages and insurance companies. One of the marketplace’s most strongly held beliefs is that the U.S. dollar is on the verge of an imminent collapse and gold is set to soar because of the Fed’s historic and irresponsible balance sheet expansion… We agree about the irresponsible part, but not about the near-term direction of the dollar and gold. Our forecast is being borne out by the dollar, which has soared straight through the Fed’s most aggressive expansion to date. Just as Conquer the Crash forecasted, the Fed is fighting deflation but, as the book says, ‘Deflation will win, at least initially.’ The reason is that there are way more debt dollars than cash dollars, with about $52 trillion currently in total market credit. As this enormous mountain of debt implodes, it is swamping all efforts to inflate. Of course, the Fed has explicitly stated that it will keep trying. Its initial effort was akin to trying to fill Lake Superior with a garden hose. But $2 trillion still won’t do the trick of stemming a contracting pool of $52 trillion. The only real effect is that taxpayers get hosed. Obviously not all of the $52 trillion is compromised debt, but the collateral underlying this mammoth pool of IOUs is decreasing in value, placing downward pricing pressure on the value of related debt, which won’t show up in the Federal Reserve figures for many months. A reduction in the aggregate value of dollar-denominated debt is deflation, which is now occurring. Eventually the value of credit will contract to a point where it can be sustained by new production. At that point, the U.S. dollar may indeed collapse, as gold soars under the weight of the Fed’s bailout machinations. But deflation must run its course first. In our opinion, it has a long way to go…”

Also consider an oldie from yours truly  (Some Basic Points on Inflation and Deflation):

#1 The business cycle is the credit cycle.

#2 Inflation is a net increase in money and credit, not just prices (mainstream opinion) and not just money (common misconception among contrarians).

#3 Deflation is a net decrease in money and credit.

#4 There cannot be both inflation and deflation at once.

#5 The central bank and the government bring about inflation by absolving banks of the responsibility for their actions. 9:1 fractional reserve lending would not be rewarded in a free market devoid of FDIC insurance and a central bank to print the money to pay for it and other bailouts for bankers.

#6 Price increases themselves are not inflation. If you have a fixed expense budget and your grocery and energy bill goes from $500 to $700, you must cut back $200 somewhere else (for instance, many are deciding to forgo eating out).

For points 7-11, click here

Also see, Why Bailouts will Not Stop the Depression

Some thoughts on the bear market.

This post started as an email that got way too long. I added some charts and put it up here:

The rally has not surprised me (on March 31 I expressed the opinion that we would hit 900 or higher by summer:

…more likely in my mind is a protracted rally extending to 900 or higher by summer, then rolling over to meet a date with 400 next winter. Look at last year’s rallies from March to May and July to August for an idea of what this might look like, though on a larger percentage and time scale because we are correcting a larger sell-off. The case for such a move is bolstered when you hear major investment banks’ strategists calling this a dead cat bounce. Too many people are still afraid to call a bottom, and they need to be suckered into long positions before this is over (along the same lines, too many traders are embracing the dead cat bounce and need to be shaken out before it can get back to leading the buy-and-holders to slaughter).

That said, I was leaning closer towards 900 than 1050:

I am highly skeptical, though respectful, of calls for a the mother of all bear market rallies. Robert Prechter and some other Elliott Wavers, as well as Tim Knight ( seem to be anticipating a 6-month or longer rally to as high as 1050. I simply don’t see why that is necessary in this environment. This is a depression, and the last one was accompanied by bear market that, after the first 6 months, maintained the momentum of a cruising supertanker. Rallies of 20 percent and 2 months were about all you got from April 1930 to July 1932 as the Dow dropped from about 295 to 41. That deflation-driven event was a much more orderly bear market than the jagged trajectory of the dot-com crash, which occured while the credit bubble continued to expand. Interestingly, the 1966-1982 secular bear (a brutal 75% loss in real terms) also traced out such a series of steep plunges and rallies as the bubble kept inflating thanks to a compliant Fed and the abandonment of the last trace of the gold standard. Employment was down, but animal spirits were still running high with the computing boom, the advent of securitization, and new innovations in consumer credit.

Though I saw this rally coming a mile away, I have traded it very poorly. First, I put too much emphasis on picking the absolute bottom for a buy-in.  Back in Feb and March I got out of most of my shorts by the time we were under 700, and I entered a bunch of limit orders to put over 1/2 of my net worth in SPY on the long side. Unfortunately, those orders started at 620, and we bottomed at 666. So I missed the bounce, and not only that, starting in April I began to short the junk stocks that were flying the highest and have been the real driver of this market. That was way too soon, and they kept on going, to the surprise of many a long-short fund as well. The outperformance of junk was a surprise, but the overall bounce has not been. When you have mood as compressed as it was back in March and you reach an exhaustion point after 18 months of a strong bear trend, you get a big reversal, which can then generate the extremes of optimism needed to set up the next plunge.

I’ve been buying long-term puts on the S&P and Nasdaq again since late March (way too soon, considering that I expected the rally to continue). I bought a bunch more yesterday, by the way. I view it as extremely unlikely that this market doesn’t decline to the point where solid value offers support — that would be a sub-10 PE and dividend yield of over 5% on dividends that have to fall by 50% or more from here to around $12 for the S&P. That would be the 240 level, but it should take at least a couple more years to get there (or below), if not four or five.

What has always worried me as a short in this market is not a 5-8 month rally, but a 12-18 month affair  like some of those that Japan has experienced in its long bear market since 1989:

Source: Yahoo! finance

That said, Japan’s financial sector was deflating while exports were improving, families had savings and the rest of the world was growing. Today’s situation is much, much more severe of course, and we can only find a parallel in the Great Depression for so many of the economic trends we are seeing. The longest bounce in that bear market was 5 months, and it was of similar magnitude (48% from Nov. ’29 to April ’30; we’re up 47% in the 4.5 months since March 6).

This is the Dow from 1928 to 1931:

Source: Yahoo! finance

And here’s how that bounce looked from 1933:

Source: Yahoo! finance

The S&P500 is now the most overvalued in history by PE (infinite as of this quarter’s running 12 month total, or a dot-com-esque 32 times current annualized earnings levels, about $7.50 per quarter). The dividend yield is about 2.5%, but dividends are nearly as high as earnings right now, which is completely unsustainable (they should be less than half of earnings). On a sustainable basis, the yield is 1.0 – 1.25%.

Here is the S&P PE ratio (TTM data through 12.31.08) going back to 1936. (the dates read right to left, since I can’t figure out how to reverse them in Excel). Data through 6.30.09 would be off the chart:

Real (U-6) unemployment is approaching 17% and climbing, and that is if you exclude the likely 6 million illegal immigrants who are out of work now (who used to take home $100 per day as construction cleanup boys or dishwashers). Throw them in, as we would have in the 1930s, and you get a solidly depressionary 20%.

Credit is still being withdrawn everywhere you look, whether in home equity, credit cards or small business loans. There has been a bounce in the corporate bond market, but that is due to the same technical forces that are driving the stock market, and the big bankruptcies are just beginning. Only the very weakest have gone under so far, like the car companies.

So with this backdrop, I don’t expect this summer’s good feelings to last into the holidays. The markets should start to roll over again soon, since the big-money value investors needed for a sustained advance can find no reason to buy in, and the little guy has been burned too many times to chase this market very far. Volume is very thin, and an unusually large fraction of trading is taking place between automated programs.

When the data to back up the green shoots theory fails to show up after another few weeks or months, and even official unemployment is solidly into the double digits and climbing, while another huge wave of mortgage resets hits the middle class, there will be no hope at all left to support this market, and it will slide to levels not seen since George Bush Sr. was in office.

It will then still not be a safe long-term buy. For that, considering all of the obstacles that the government has created to profit-making, we need to get back to Reagan-era levels, somewhere under the bottom of the 1987 crash.


Source: Google finance

Real credit vs. fake credit.

The essence of why bailouts will only deepen our problems is that real credit cannot be created out of thin air. This counterfeit operation is what caused the bubble to begin with, and by trying to put out a fire with gasoline, Bernanke, Congress and Obama are going to burn down the whole city.

Frank Shostak, the Chief Economist at M.F. Global, knows a thing or two about economics, which is not something you can say about many of today’s economists. The Mises Institute website publishes this essay of his on credit, which illustrates the critical identity between savings and investment, and the proper role of banks in an honest system.

Central-bank policy makers have said that the key for economic growth is a smooth flow of credit. For them (in particular, for Bernanke) it is credit that provides the foundation for economic growth and raises individuals’ living standards. From this perspective, it makes a lot of sense for the central bank to make sure that credit flows again.

Following the teachings of Friedman and Keynes, it is an almost-unanimous view among experts that if lenders are unwilling to lend, then it is the duty of the government and the central bank to keep the flow of lending going. …

It is true that credit is the key for economic growth. However, one must make a distinction between good credit and bad credit. It is good credit that makes real economic growth possible and thus improves people’s lives and well-being. False credit, however, is an agent of economic destruction and leads to economic impoverishment.

Good Credit versus Bad Credit

There are two kinds of credit: that which would be offered in a market economy with sound money and banking (good credit); and that which is made possible only through a system of central banking, artificially low interest rates, and fractional reserves (bad credit).

Banks cannot expand good credit as such. All that they can do in reality is to facilitate the transfer of a given pool of savings from savers (lenders) to borrowers. To understand why, we must first understand how good credit comes to be and the function it serves.

Consider the case of a baker who bakes ten loaves of bread. Out of his stock of real wealth (ten loaves of bread), the baker consumes two loaves and saves eight. He lends his eight remaining loaves to the shoemaker in return for a pair of shoes in one week’s time. Note that credit here is the transfer of “real stuff,” i.e., eight saved loaves of bread from the baker to the shoemaker in exchange for a future pair of shoes.

Also, observe that the amount of real savings determines the amount of available credit. If the baker had saved only four loaves of bread, the amount of credit would have only been four loaves instead of eight.

Note that the saved loaves of bread provide support to the shoemaker, i.e., they sustain him while he is busy making shoes. This means that credit, by sustaining the shoemaker, gives rise to the production of shoes and therefore to the formation of more real wealth. This is a path to real economic growth.

Money and Credit

The introduction of money does not alter the essence of what credit is. Instead of lending his eight loaves of bread to the shoemaker, the baker can now exchange his saved eight loaves of bread for eight dollars and then lend those dollars to the shoemaker. With eight dollars, the shoemaker can secure either eight loaves of bread (or other goods) to support him while he is engaged in the making of shoes. The baker is supplying the shoemaker with the facility to access the pool of real savings, which among other things includes eight loaves of bread that the baker has produced. Note that without real savings, the lending of money is an exercise in futility. …

The existence of banks does not alter the essence of credit. Instead of the baker lending his money directly to the shoemaker, the baker lends his money to the bank, which in turn lends it to the shoemaker. …

Despite the apparent complexity that the banking system introduces, the act of credit remains the transfer of saved real stuff from lender to borrower. Without the increase in the pool of real savings, banks cannot create more credit. At the heart of the expansion of good credit by the banking system is an expansion of real savings.

Now, when the baker lends his eight dollars, we must remember that he has exchanged for these dollars eight saved loaves of bread. In other words, he has exchanged something for eight dollars. So when a bank lends those eight dollars to the shoemaker, the bank lends fully “backed-up” dollars so to speak.

False Credit Is an Agent of Economic Destruction

Trouble emerges however if, instead of lending fully backed-up money, a bank engages in fractional-reserve banking, the issuing of empty money, backed up by nothing.

When unbacked money is created, it masquerades as genuine money that is supposedly supported by real stuff. In reality, however, nothing has been saved. So when such money is issued, it cannot help the shoemaker, since the pieces of empty paper cannot support him in producing shoes — what he needs instead is bread. But, since the printed money masquerades as proper money, it can be used to “steal” bread from some other activities and thereby weaken those activities.

This is what the diversion of real wealth by means of money “out of thin air” is all about. If the extra eight loaves of bread aren’t produced and saved, it is not possible to have more shoes without hurting some other activities — activities that are much higher on the priority lists of consumers as far as life and well-being are concerned. This in turn also means that unbacked credit cannot be an agent of economic growth.

Rather than facilitating the transfer of savings across the economy to wealth-generating activities, when banks issue unbacked credit they are in fact setting in motion a weakening of the process of wealth formation. It has to be realized that banks cannot relentlessly pursue unbacked lending without the existence of the central bank, which, by means of monetary pumping, makes sure that the expansion of unbacked credit doesn’t cause banks to bankrupt each other.

We can thus conclude that, as long as the increase in lending is fully backed up by real savings, it must be regarded as good news, since it promotes the formation of real wealth. False credit, which is generated “out of thin air,” is bad news: credit which is unbacked by real savings is an agent of economic destruction.

Fed and Treasury Actions Only Make Things Worse

Neither the Fed nor the Treasury is a wealth generator: they cannot generate real savings. This in turn means that all the pumping that the Fed has been doing recently cannot increase lending unless the pool of real savings is expanding. On the contrary, the more money the Fed and other central banks are pushing, the more they are diluting the pool of real savings. …

If the pool of real savings is still growing, then doing nothing (and allowing the interest rate to reflect reality) will allow the recession to be short lived and economic recovery to emerge as fast as possible. (At a higher interest rate, various bubble activities will go belly up. As a result, more real savings will become available to wealth generators. This in turn will work towards the lowering of interest rates.)

We suggest that decades of reckless monetary policies by the Fed have severely depleted the pool of real savings. More of these same loose policies cannot make the current situation better. On the contrary, such policies only further delay the economic recovery.

By impoverishing wealth generators, the current policies of the government and the Fed run the risk of converting a short recession into a prolonged and severe slump.

If Princeton and the rest weren’t run by fools and knaves, this is the kind of thing they would be teaching, not Bernanke’s brand of institutionalized theft.

I recommend reading Shostak’s whole essay. Click around the Mises site while you’re there. It is a wonderful resource for real economics, the kind that can make you money. The Rothhbard and Mises files would be good places to start.

Bailouts will cost jobs and cause good businesses to go bankrupt.

Bottom line: Bailouts will waste our savings and remaining credit, and exacerbate the flight of capital and talent from the US.


I was extremely surprised on Monday when the House rejected the first version of the Crime of ’08, but I remain certain that an essentially identical bill will become law. When it does, maybe as early as the end of this week, any ensuing rally (and there is no guarantee that a rally will occur) will last a few weeks at most and lead to a very powerful decline as the reality of the depression sinks in this winter. (Obama’s inauguration should be another huge disappointment, just more false hope to be sold.)

The bailout will cost the economy jobs because it is a transfer of savings from intelligent, prudent hands that are likely to deploy it productively to those that create nothing but distortions in the marketplace. The financial scamsters have balance sheets in such horrible shape that it could take up to $5 trillion to recapitalize them, so it is a certainty that this $700 billion is just a first installment to keep the lights on, but not enough to enable them to start taking risks again.

You can lead an investor to credit, but you can’t make him borrow.

On the demand side of the credit equation, the citizenry is fed up with debt. People are saddled with enough of it already, and with their homes and investments falling in price, they feel compelled to save, not borrow. Anyone willing to take a consumer loan right now is the most reckless sort of borrower and should learn to live on earnings alone. Smart car shoppers pay cash, and smart house shoppers are biding their time. It is a bad policy to finance consumption anyway, including home purchases. What’s wrong with renting and saving up?

Many companies have a need for short-term funding, but this is just to put out fires, not to invest in productive capacity. Interest rates on those loans should be high in order to justify the risk of supporting businesses that might be dependent on a bubble economy and therefore deserve to fail. The short-term commercial money market got way out of hand in recent years and contributed to a lot of wasteful expansion, so it is healthy for it to contract.

Today’s ISM numbers are just a taste of what is to come. The industrial sector will need to scale down massively because it expanded too much during the boom. Responsible executives are in no mood to borrow and build. It won’t do any good to offer them even extremely low interest rates because if they invest right now it will be hard for them to generate a positive return.

Companies will start to invest again when the contraction runs its course, when assets and labor are attractively priced and executives perceive a resuscitation in demand. There is nothing the government can do to speed along this process but get out of the way and let the reorganization take place.

Beanie Baby economy.

Think of the economy as a large corporate conglomerate with lines of business in a dozen sectors from Beanie Babies to soybean milling. The company has a line of credit at its disposal, in case it wants to take advantage of opportunities.

The Beanie Baby line was generating great profits until two years ago, but last year kids moved on to Hello Kitty, and the company has had to take some big write-downs on unsold inventory. During the mania, the head of the Beanie Baby division was the highest paid employee outside the executive suite, and the adjustment has been very hard on him. He won’t accept that Beanie Babies were just a fad, but insists that the continuity of this line of business is absolutely critical to the future of the company, and he is clamoring for more funding to make up for the losses on inventory and keep the factory running.

Of course, any CEO worth his stock options knows not to throw good money after bad, and a good executive would probably liquidate the whole Beanie Baby operation and maybe find another use for those employees.

What we have here, though, is a former Beanie Baby division head as CEO, and a board of directors that itself got caught up in the craze and won’t let go of the hope that it can be resuscitated through a capital infusion and a good ad campaign. They decide to drain the company’s accounts and draw down its line of credit so that their favorite employees can keep their jobs and the factory can restock on Beanie Baby materials.

Month after month, the company makes the division’s hefty payroll, and even issues bonds to keep going, but despite their best efforts at advertising, the public just won’t buy more Beanie Babies, even at huge discounts. They have been burned by Beanie Babies and aren’t about to get caught up in that nonsense again.

Thank you for your contribution.

The soybean division, on the other hand, is generating solid profits on account of increased demand for protein in Asia, and they make a presentation requesting funding for a line of tofu. The expected returns look great, and equipment can be bought very cheaply because of the recession. The CEO explains that he is sorry, but the company’s cash and credit have tapped out to keep the essential Beanie Baby division going. All of the soybean profits are to be channeled there as well, and he appreciates the contribution.

The ambitious managers in the soybean division get fed up with this ridiculous and nepotistic company, and decide that their talents would be better rewarded in Hong Kong. Investors eventually make the same decision regarding their capital, and the company’s bonds and shares plunge. The exectutives now see which way the wind is blowing and start embezzling funds, and eventually the heap of the company ends up in bankruptcy court.

Bond sell-off just a correction. Bailouts will not stop deflation.

Bottom line: Paulson brings a bazooka to an H-bomb fight.

Bond update first:

As usual of late, today’s action in Treasuries was the exact opposite of the stock market: a massive sell-off.  High bond prices reflect fear, which hit a new high earlier this week. Today’s action was not just a short-squeeze. It was collective relief, a pause for our nerves. We will need them for what is yet to come. Here are the bonds (Bloomberg):

Click image for sharper view.

Does he even know how that thing works?

Like all of the bailouts, the planned socialization of (admittedly bad) mortgage debt puts another chain around Lady Liberty’s neck for the short-term of benefit of a few bankers. But hey, what’s another trillion or so when taxpayers are already on the hook for $100 trillion?

Here’s Paulson on the program’s ostensible goals:

The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy. This troubled asset relief program must be properly designed and sufficiently large to have maximum impact, while including features that protect the taxpayer to the maximum extent possible. The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars. I am convinced that this bold approach will cost American families far less than the alternative – a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion.

*Opposite rule of government action

According the rule of opposites (the most reliable indicator for predicting the outcome of government actions), we now know that the program will threaten the economy, not protect the taxpayer, cost far more than the alternative, and impede economic expansion.

The Sum of All Debts

And yes, these kinds of programs are highly inflationary, but they still pale in comparison to the size of the debt and equity that is imploding. The Fed’s balance sheet is 900 billion and growing, the deficit next year will certainly be over $1 trillion, and GDP, which used to ostensibly be $13.8 trillion, is shrinking fast. These figures put upward bounds on the payload of government’s bazooka.

To put this in perspective, Paulson’s gang is squaring up against the following:

  • Private debt is roughly $50 billion (Federal Reserve: sum of domestic non-financial and domestic financial).
  • The total capitalization of the US stock markets is roughly $15 trillion.
  • Total residential real estate has been estimated at over $23 trillion.

The amounts by which the latter figures are contracting exceeds the government’s reflation efforts by some multiple. Deflation will continue — accelerating in the near term — and not abate until so much wealth has gone to money heaven that government’s expenditures finally surpass its rate of implosion. Despite the bailouts, and what will surely be a new New Deal and probably an expanded war in Asia, that point of equilibrium will arrive years from now. In the meantime, cash is king once more.

Risk hangover

One more point on the banks: they may be relieved of their bad debt and provided with fresh reserves, but the inflation machine will remain impaired because individuals and corporations have just learned a very hard lesson about debt and will be averse to borrowing for many, many years to come. Borrowing like we have seen in recent decades requires an appetite for risk, but the stuff now makes people nauseous.

*Rule of opposites as applied to government action: Every action that government takes results in the opposite of its stated intention. (credit to Mish for identifying this law of nature)

  • Affordable housing programs make housing unaffordable.
  • Deposit insurance makes the banks unsafe.
  • The SEC creates risks for investors but does not protect them.
  • Free trade agreements are thick books of rules restricting trade.
  • Social welfare programs create poverty and poor health.
  • The Ministry of Peace (er, I mean Department of Defense) conducts offensive wars.
  • Homeland Security makes Americans feel insecure at home and relaxed abroad.
  • FEMA inhibits recovery from emergencies.
  • The FDA keeps Americans hooked on drugs, many of them dangerous, and inhibits accurate labeling on food.

The list goes on ad infinitum.

PPS — For a full rundown of why these bailouts won’t stop deflation, read chapter 13 of Robert Prechter’s Conquer the Crash. He predicted this exact scenario years ago.

Real interest rates are positive

Strong Incentive to Save

Mish knocks it out of the park with this one. Not only are inflation-adjusted rates positive, they are actually above average on a historical basis, and with stocks and other risky assets tanking (see charts below), there is a very strong incentive to save money in Treasuries.

Home prices are crashing and those prices are not adequately reflected in the CPI. Instead, the single largest component of the CPI is “Owners Equivalent Rent“. OER is a process in which the BEA estimates what it would cost if owners were to rent the homes they own from themselves. I do not believe this to be a valid construct of prices.

By ignoring housing prices, the CPI massively understated inflation for years. The CPI is massively overstating inflation now.

In normal times with rents in sync with home prices, it did not matter much if one used OER or actual home prices. It’s a remarkably different story now. We have just seen the biggest housing bubble in the history of the world. At the peak of insanity, home prices were 3 standard deviations above rental prices and 3 standard deviation above wage growth.

Now, the important factor is that home prices are crashing, with quite a big drop still needed to get back to historic norms. With that in mind, housing can be expected to be weak for quite some times.

The treasury market seems to have figured all this out quite nicely. Pundits screaming “treasury bubble” clearly have not.

Case-Shiller vs. Owners Equivalent Rent

Case-Shiller shows that home prices have declined 15.4% over the past year. Currently, OER is the largest component of the CPI at nearly 24%.

A CS-adjustment (substituting Case-Shiller for OER in the CPI) would knock 3.7% off the CPI (15.4 * .24).

We must also take into account the reported OER was +2.6 vs. a year ago. It’s affect on the CPI is (2.6 * .24) or .624 of the reported 5.6%. Rounding to the nearest tenth, another .6 needs to be subtracted from the adjusted CPI. (5.6 – 3.7 – .6 = 1.3)

This would make the CS-CPI +1.3% instead of the reported 5.6%

Prices are a Trailing Indicator of Credit Expansion (aka Inflation).

As Mish always explains, CPI looks in the rear view mirror, not out the windshield, so let’s look back for a minute. What has driven up the price of housing, education, clothes, food, entertainment and travel? The quick answer is credit, easy credit extended by an inherently corrupt banking system. Bankers had been bailed out so many times that they finally lost all sense of decency and respect for lending standards. That easy credit made people feel rich, in no small part because it inflated investment assets, so people weren’t worried about higher grocery prices.

Now that credit is unavailable and investments are crashing, suddenly $4 bread feels a little excessive. If credit is the fuel for price increases, and investment assets lead the way, then the outlook for lower consumer prices is very good. Let’s gaze out the windshield and see how good:

We know what the mortgage market looks like, but here’s total bank credit (roughly $9.5 trillion):

Source: St. Louis Fed

Ok, other than the sharpness with which credit stopped expanding last year, this doesn’t look like much yet, but credit has gone flat after the greatest rise in history. And actually, the reason why bank credit is flat and not down since mid-2007 is that companies have been frantically drawing down existing credit lines and stuffing the cash in the money market (why M3 soared), since they know they’re going to need it and rightly suspect that those lines will soon be withdrawn.

Credit is Withdrawn, Asset Prices Fall

Real estate is ultra-sensitive to credit, so it was the first sector to turn, back in 2006:

Source: Standard & Poors

Stocks of course turned last year, and now commodities have turned:

Source: Bloomberg

That includes the grains…

(All grain charts from the Chicago Board of Trade)

…and the metals. We all know gold and silver are down, but here’s a peek at the base metal index from Kitco. Party’s over:

Treasury Rally is No Conundrum

So, where’s an investor to hide? My advise is to invest in the future: stop investing.

That’s what Treasury buyers are doing. Treasuries are set to continue their bull market, and I bet they will make a rally for the history books in the next 12 months. Here’s the 30-year:

Source: Chicago Board of Trade


Don’t trash cash. It’s the new, new thing.