Tag Archives: inflation

Marc Faber and Mish Shedlock on inflation vs. deflation

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View on the Yahoo! Tech Ticker by clicking here.

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I’m with Mish in this debate of course, since a credit implosion trumps a money printer, I but have the utmost respect for the adroit Swiss. The two of them have much more in common than either has with most other money managers or commentators.

I totally agree with Faber that the US is not a civilized nation anymore, entirely due to the expansion of the state. I could say the same about the UK, Canada, Australia and most of western Europe. The whole region feels like a big kindergarten where the teacher wears a .380 and a bulletproof vest.

I’m with Hendry

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Taleb thinks hyperinflation is a strong enough possibility to justify way OTM bets on gold (long) and bonds (short). The one bit I agree with is the long gold / short stocks play (though I think gold is likely to fall with stocks, just not as much), and I suspect that deflationist Hendry would concur.

Hendry thinks that deflation is here to stay, that nations will start to default, and that the market will at least start to worry about sovereign defaults by nations like Germany and the US (even if they don’t actually default, he’ll make money in that situation as the price of insurance goes up).


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(The video cuts off when Hendry passes the mic, and I don’t have a link to the rest. If anybody else does, please post it.)  (EDIT: http://2010.therussiaforum.com/news/session-video3/ Minute 24:00 and after. Thanks Charles!)

Hendry makes a point I’ve made myself: the euro is like gold for countries like Greece (they can’t print it) so it will have to default.

Hendry says his porfolio is inspired by Nassim, but basically the opposite. He’s fed up with other people’s opinions. The hedge fund guys are “so uncool.” He doesn’t talk to brokers, and he reads nobody else’s research.

Debt loads are bound to squeeze all of the vitality out of the risk takers in the market.

UK interest rates are at the lowest since the Bank of England was established in 1692. He is betting that the central banks won’t raise rates in the next 4 months and he will make 4x his dough if right.

He thinks the sovereign default scenario today is like the mortage bond situation three years ago.

Now, who is the true contrarian? Is hyperinflation really a black swan right now? Every chat board on the net has been buzzing about it for years. When Taleb said every human being should short treasuries, every human being agreed with him!

Add mortgages to the debt bubble (with junk bonds, munis, sovereign debt…)

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Mortgages are still cheap, if you can get them. The spread over 30-year T-bonds has fallen to record lows, at just 0.2%.

St. Louis Fed

This spread is unsustainable and will be corrected by falling bond yields (rising prices) and/or rising mortgage rates. It is possible that mortgage rates fall still lower, but the spread must widen to deliver a decent risk premium (the same is true for corporate bonds). I actually would not discount the odds of yet lower mortgage rates if Treasuries rally hard, since we are going through deflation (best defined as a contraction of money and credit) and the real yield is a good deal higher than the nominal.

Lookat CPI minus food and energy (it is mainly higher oil and gas prices over the last 12 months that are holding it up):

David Rosenberg calls mortgages a bubble:

Once again, this Houdini recovery has involved a situation where mortgage rates have plunged and yet Treasury bond yields have been rising — 30-year fixed rate mortgages have fallen to 4.93% and are sitting are record-tight spreads over long Treasury bonds (see Chart 6). Historically, the average spread is 150bps and this differential is now 20bps. This is remarkable and our concern is that investors who may be exposed to mortgages are at serious risk because there is a considerable chance that these rates will be moving higher over the intermediate term — notwithstanding continued support from Uncle Sam’s pocketbook.

Investors must be reminded time and again that mortgages are callable, Treasuries are not; and we are now in a situation where net of fees, which average 70bps, anyone buying mortgage paper today is receiving a rate that is less than what the borrower is paying, How nutty is that? Remember — despite all the ridiculous comparisons to the Weimar Republic, the long bond is THE risk-free benchmark interest rate in the U.S. and with State taxes going up, Treasuries are an even further bargain because of their tax status.

Houses are still way too expensive in the US, as indicated by inventories, income multiples and rental yields, but if they fall to historically cheap levels in the coming years while mortgage rates stay low, they could be a fantastic investment. This is especially true if we later go through a period of high inflation, so that real mortgage payments drop (fixed-rate only of course) while rents and incomes rise.

This goes to show the importance of keeping hold of your cash during deflation, because there will be historic opportunities in almost every asset class.

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More here from David Rosenberg (free account required).

PPS – Here’s an update on the long Treasury note, short junk bond play. As you can see, we are still in a very nice spot to put on the trade:

Census employment nonsense

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Bloomberg is reporting that some lame-brain economists are excited about the employment boost of the 2010 census:

Jan. 8 (Bloomberg) — The 2010 census couldn’t have come at a better time for the U.S. economy.

The government will hire about 1.2 million temporary workers in the first half of the year to administer the decennial population count, possibly providing a bridge to gains in private employment later in the year.

The surge will probably dwarf any hiring by private employers early in 2010 as companies delay adding staff until they are convinced the economic recovery will be sustained. Money earned by the clipboard-toting workers going door-to-door to verify the government population survey is likely to be spent, giving the economy an extra lift.

“It’s a short-term stimulus program in which the government’s injecting money into the economy through additional paychecks,” said Dean Maki, chief U.S. economist at Barclays Capital Inc. in New York, who projects that 2.5 million more Americans will be working at the end of the year. “This will support consumer income during those months.”

(cont…) The stimulus bill President Barack Obama signed in February and additional funding by Congress provided enough money to hire 1.4 million Americans in total for the census, almost three times as many as in 2000. About 160,000 were already employed last year to do preliminary work.

The Census Bureau anticipates hiring about 181,000 workers from January through March and about 971,000 in the following three months.

First Five Months

The economy may add about 700,000 jobs in May alone, mostly because of the census, Gault said. Even Maki’s more optimistic assessment of the employment outlook means the U.S. may take years to recover the 7.2 million jobs lost since the recession began in December 2007.

“The bulk of these employees are from the low end of the income distribution; they are cash-constrained,” said Neal Soss, chief economist at Credit Suisse in New York who forecasts the economy will add a little more than 1 million jobs this year. “Having a paycheck is allowing them to spend in a way that they wouldn’t otherwise.”

Hiring for the census may also help lower the unemployment rate early this year, economists said, though the influence will be less than in payrolls. For example, some of the people hired may have other part-time jobs, limiting the impact on joblessness.

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This is typical mainstream Keynesian hogwash, which always supports government spending, no matter how useless or counterproductive. The less a corrupt government knows about the people who live under its rule, the better. Aside from that, in hard times wasteful programs like the Census should be completely dispensed with or postponed. For goodness’ sake, I bet a private firm could assemble better data for 1/100th the cost (if they haven’t already done so and sold it at a profit).

Keynesians never consider where the capital comes from for all of this useless employment. Capital can’t be created at will by bureaucrats. It has to be produced through intelligently orchestrated labor and saved by not consuming the fruits of that labor. This is what is stolen by the government when it taxes, prints money or issues debt to “create jobs.” It drains the economy of the savings needed to create real jobs and keeps us from building up the capital we need to grow out of depressions. This is what put the Great in the depression of the 1930s.

(Edit: checking Mish just now, I see that he posted on this same topic today)

Cocoa cooling off?

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I follow all sorts of odd commodity futures, since the more you follow, the more set-ups you can potentially find. Cocoa got my attention a few weeks ago as it made a 30-year high on lower momentum than its previous high, and I took a short position when it stalled out at over $3400 per metric ton. It had a violent sell-off several sessions ago, and has so far failed to rebound, suggesting that animal spirits may be waning. This is a daily chart going back to August:

Source: futures.tradingcharts.com

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You can see in this monthly chart that if this new high does mark the end of the bull market, even a retracement of the last leg would take prices to the $2500 area:

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The 25-year view shows how cocoa futures are part and parcel of the larger commodities complex:

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Like other commodities, cocoa was very expensive in the mid-to-late 1970s, with inflation adjusted prices about triple or even quadruple today’s high prices (i.e., nominal prices ranged as high as $4000 in 1978-1979).

Congratulations to Mish Shedlock, star deflationist and gold bug

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I want to offer a little praise here for Mish Shedlock, an investment advisor for Sitka Pacific and proprietor of the hugely successful blog, globaleconomicanalysis.blogspot.com. I owe Mish a debt of gratitude as one of the writers who helped me understand our credit money system and anticipate the events of the last couple of years. He was a deflationist back when CPI was ticking in at 12% annualized (June/July ’08), and he has made a series of very prescient market calls.

Robert Prechter of course is the original deflationist who has seen this depression coming since the late 1970s (when he was a lone “bearma bull” and anticipated a great bull market followed by a giant crash and long secular bear market — his mistake was that failed to anticipate just how manic and levered-up society would get in the 1990s and 2000s — he called for a bubble, but not the greatest bubble of all time), but Mish’s writing has been on par with Prechter’s and he has lately bested him when it comes to gold.

I believe Mish has only been following the markets intently since the early 2000s, when he lost his job as a programmer. He used his free time and the internet to educate himself on economics and markets, and thanks to an intelligence uncluttered by a formal economics education or Wall Street voodoo, came to understand that we were experiencing a credit bubble — a business overexpansion and misallocation of resources due to easy access to debt. Debt was cheap because under our fiat money central banking system, bankers had created a cartel for themselves and a safety net. They had a license to blow enormously profitable bubbles and a get out of jail free card in the Federal Reserve, which of course is their own creation. Politicians love this system because it allows them to grow the government at a pace far in excess of the economy, since the Fed can just print money to buy T-bonds.

With his excellent understanding of debt, Mish came up with what I consider to be the best definition of inflation and deflation: inflation is an expansion of money and credit, where credit is marked to market; deflation is a contraction thereof. Rather than looking only at various money measures (M1, monetary base, M2, etc), Mish’s definition is most useful in our system since credit acts like money and dwarfs actual cash.

As Professor Steve Keen has shown, credit expansion precedes monetary expansion. In a fractional reserve world were credit can be created out of thin air with practically no restraints on reserve ratios, commercial banks and other “shadow banking” institutions are in the driver’s seat, not central banking committees. Even as the Fed’s balance sheet (like those of other central banks) has grown from $850 billion in early 2008 to nearly $2.5 trillion today, this increase in cash has been dwarfed by the contraction in private credit (which started out at $50 trillion for the US and is surely much smaller today). This is why cash has been king on Main Street, the recent stock and commodity rally notwithstanding.

Back to the story of the bubble, so long as debt got cheaper and easier, people could afford to take on more, which they did because it allowed them to keep up with their neighbors and feel good about themselves. Also, when credit is expanding, levering up is a fast way to get rich — asset prices soar, since you don’t actually need cash to buy things. A bubble mentality forms: when the only reason to buy a class of asset is because you can sell it to someone else for more (there is no reasonable prospect of sustainable cash-flow), you have a bubble. The bubble bursts when marginal buyers fail to show up and relieve the last round of speculators at a profit, since everyone is already stuffed to the gills with debt and debt-financed assets. When there is nobody left to buy and prices stall, that class of asset becomes a burden (taxes, maintenance, interest), and a crash is imminent. That was 2006 (a clear warning then was the inversion in the yield curve, as demand for credit started to abate and savvy Treasury traders bid up long-dated bonds in anticipation of a drop in short-term rates).

Anyway we all know the story now, but thanks to Mish and others of the Austrian school of economics (Ron Paul, Peter Schiff, Prechter, Marc Faber, Jim Rogers), a large segment of the internet-using public was forewarned. I single out Mish here for praise because he has arguably the best record of anyone for calling the shots since 2007.  Of course he was bearish on stocks going into the crash, but as a deflationist he was also bearish on commodities and foreign stocks and currencies, as was Prechter. Like Prechter, Mish called for a turn in the stock market early in 2009, though Prechter has been more prescient in anticipating its duration and magnitude. Mish was bullish on long-term Treasuries in 2008, when Prechter’s EWI was not, and I was glad to be on his side there.

Where Mish has really stood out has been in his understanding of gold. He has always said that gold is money, and he correctly anticipated its strength during deflation. I understand that this may have come from reading or reading about Professor Roy Jastram’s “The Golden Constant,” a study of 400 years of gold’s purchasing power during periods of inflation and deflation under both gold standards and fiat regimes. Jastram’s conclusion is that gold decreases in real value during inflations and increases in value during deflations — in effect, it acts like money. Now, Prechter has always said that gold is money, and he has always recommended holding gold and silver for the depression, since it is likely that the fiat system breaks down in the advanced stages, but he has failed to anticipate that the precious metals bull market would power through these first years of deflation (though he did anticipate the latest manic phase this fall after gold broke upwards in September).

Now solidly over $1200 per ounce, to my eye the gold market looks like a full-blown mania. DSI bullishness has been over 90% for a month now, and has been over 70% for much of the last six months. There have been no significant corrections. Every commercial break on cable TV seems to have an ad from one bullion dealer or another, and former Nixon plumber G. Gordon Liddy is touting it. That said, even if this parabolic rise is followed by a crash of $300 or $500, gold will likely still be leagues ahead of every other asset class since 2007 or 2000 (if gold hits $700, I bet the S&P will be 700 and oil will be $35 again). It truly is acting like money, high-powered, robust money, and it should continue to increase in relative terms even faster if credit strains worsen, as I think they will in 2010 and 2011. And as the US and other governments proceed in the following years to destroy their currencies through continued war and Keynesianism/Socialism, it will truly be a life-saver.

In addition to his excellent market analysis, Mish deserves our thanks for his consistent efforts to fight the bailouts and other thievery and stupidity in Congress. He has also no-doubt played a strong role in advancing Ron Paul’s bill to mandate an audit of the Federal Reserve and to defend it from those who would water it down.

Mish’s success goes to show the power of a geek with broadband connection. Since the formal education system and old news media have become propaganda outfits for the political and corporate parasite classes, if there is any hope for capitalism and a free and prosperous future, it lies with independent nerds.

The “other side” of the deflation trade

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Graphite here. I remain an ardent deflationist and continue to see strong risks of a continued collapse in asset values in world real estate and equity markets. That said, one key practice in speculation, no matter how strong one’s conviction in a particular trade, is to understand the other side of that trade and how the market could move against your position.

This can sometimes present a challenge for deflationists because so much of the opposing camp is composed of die-hard Panglossian buy-and-holders betting on a V-shaped recovery, rounded out with a few gold bugs who present little or no argument other than that the Bernanke Fed will embark on a suicidal campaign of massive money printing.

Although Marc Faber has issued calls for hyperinflation before, the discussion in the video below represents a much more measured discussion of a serious alternative to the near-term bearish case for stocks and the economy:

“My sense is that — here I’m talking about the economy — that the economy, near term, can recover, and maybe the recovery will be somewhat lengthier than expected a crack-up boom, because the first stimulus package in the U.S. probably will be followed by a second one, and money printing will lead to even more money printing next year. So it can last, say, 12 to 18 months, and then we will get another set of problems ….”

Faber goes on to recommend buying financial stocks, on the expectation that the banks will continue to get free money from the government and parlay that largess into significant profits. His long-term view remains as bearish as ever, but he presents an important alternative perspective on how soon the economic calamity will arrive and what form it will take.

That said, I think Faber is wrong that the market will continue to enthusiastically take up the Fed’s offers of liquidity and use them to fuel speculation for very much longer. No one is laboring under the delusion that the garbage stocks like AIG, FNM, and FRE which have led this last leg upward are worth anything more than zero — and while from a contrarian perspective that could indicate that there is room remaining for investors to develop an even more desperate belief in a new bull market, I think it is much more likely a manifestation of the new trend toward skepticism which will come to permeate the entire market as the bear runs its course.

Whatever your perspective, it’s always fun to see Marc Faber’s characteristic chuckle at the suggestion that our wise overseers will competently steer us through the crisis.

That great economist, Ben S. Bernanke

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For your amusement, here’s Bernanke a couple of years ago doing his best to downplay our problems:

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To the dismay of many a fair-minded observer, Bernanke the Fool has been nominated for another term as Fed chairman. My comment is, so long as there is a Fed, who cares who runs it? The chairman, like the US President, is nothing but a figurehead. He provides lip service for policies that exclusively benefit the cartel of big banks.  Thus it has been since the Morgan, Schiff, Warburg and Rockefeller syndicates conspired in 1913 to draft the Federal Reserve Act and ram it through Congress two days before Christmas.

I’m a little bit surprised that Bernanke was nominated again, since there is such low public opinion towards him and his employer. I thought that he might be thrown to the dogs to satisfy the public’s urge for ‘change,’ but I guess the logic is that by keeping him on they can better preserve the fiction that the Fed saved the world. He is also very lucky that the nomination schedule coincided with the likely peak in Wave 2 sentiment (2nd waves are characterized by the near consensus that the old trend is back to stay, in this case, the Great American Bull Market).

Along the same line, I’m also surprised that the campaign to audit the Fed hasn’t found more support from the White House, since it would be the perfect PR opportunity for them to pretend that they were independent of the bankers. I half expect to see the audit happen, with the results decided in advance of course, something akin to past Congressional “investigations.” Maybe they will have to do something like this once mood sours again with the next wave of foreclosures, bank failures and panic selling in the markets.

The real campaign should be to end the Fed, not audit it. We already know what it does, and they are actually surprisingly transparent for such a sinister institution. It’s all right there on their website.

Summer school

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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

Ron Paul sums up the crisis in 3 minutes

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(thanks again to zerohedge for finding this video)

I remember when I first discovered a speech by Ron Paul back in boom-time 2005, and was shocked that a Congressman was so eloquently warning of the dangers of fractional reserve lending, the Federal Reserve system, and welfare/warfare deficit spending. It was the first time that I could fully respect a standing politician.

Dr. Paul is still the nation’s strongest voice for an honest monetary and banking system, and he delivered a zinger in front of Bernanke and Frank yesterday. If, like me, you haven’t heard him speak in a while, have a listen and you’ll remember why his campaign was so exciting for so many of us.

Money quote: “I would suggest that the problems we have faced so far are nothing compared to what it will be like when the world not only rejects our debt, but our dollar as well. That’s when we’ll witness political turmoil that will be to no one’s benefit.”

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Now wouldn’t it be great to have Peter Schiff to cause the same trouble in the Senate?