The Treasury double short fund TBT has had a great run since New Year’s, when the long bond yielded just 2.5%, the lowest level since the WW2 era. I suspect that a lot of readers were with me on my bond short back then, as most bearish-minded folk had been chomping at the bit to short Treasuries (or had already been short while they ran up from summer 2008).
Now I think it’s time to think about buying this horribly overvalued security again simply because it is so universally hated.
Red sky at night, sailor’s delight
Red sky at morn, sailors be warned.
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Technical musings
In recent trading days we have seen various indicators reach levels that, had they occurred together during another set of social and economic conditions, would have warranted an aggressive bullish stance. As they have arisen during the greatest depression and stock market collapse in any living person’s memory (geezers included), traders should perceive an elevated risk of a swift revival of market panic.
If we are going to start back towards the November lows sometime in the first half of the year, the next few days are as good a time as any. Optimism, or at least the abatement of fear, peaked around the first week of the year. At that time, most bulls and bears alike seemed to be counting on a BIG bounce, and that consensus view was manifested as as the top of a relatively anemic corrective rally.
Stocks then sold off solidly for two weeks, as the volatility index (VIX) ran from 38 to 58, a level that until last fall hadn’t been seen since a brief moment in 1987. Even 38 would have been indicated panic conditions until the world was turned upside down. In this environment, it indicates calm. Here is a six-month view:
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The bond market also indicated relief this month, as a rally for the history books finally broke when the 30-year Treasury bond yielded just 2.5%. Yesterday it yielded 3.41%, another level that until a few weeks ago had not been seen for decades (in this case, six of them). In this crash, 3.41% means complacency and even optimism. 30-year bond yield, 6-month view, courtesy of Yahoo! Finance:
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One more indication that the correction is exhausting itself has been the revival of animal spirits in commodities stocks, a popular ‘risk’ sector. XAU, the Philadelpia Gold and Silver Index, more than doubled from its crash lows. I am guessing that these stocks made their post-crash top yesterday, coinciding with bullion’s three-month high, because both are solidly overbought. This top in risk preference has occurred alongside the last few days’ rebound in the broader stocks indexes. Risk assets are the last to participate in rallies and the hardest hit in crashes.
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Now, with the exception of gold stocks and bullion, none of the above markets are particularly overextended at the moment. Bonds today made either a solid correction of their sell-off (corrective itself), or started a fresh leg up. The broad stock indexes are not overbought, which is the easiest time to identify shorting opportunities, so tread lightly if you are thinking about that route. I have been heavily long-term short for 18 months now, so if I am wrong on these little twists and turns it doesn’t bother me.
I would not be surprised by a loss of several percent in the Dow by next week, but neither am I counting on it. This market has been choppy and full of contradictions since December. Stocks went up with Treasury bonds last month, and this month the dollar has rallied with gold. Go figure. In cases like this, it is best to not have too strong an opinion on the market’s short-term moves. In recent days I have even covered several long-standing short positions as stocks such as Microsoft, Harley Davidson, Burlington Northern, and Union Pacific have pushed to new lows.
Keep in mind that we still could re-enact the November 1929 to April 1930 post-crash rally, in which the Dow rose 48% before the mood turned back down and stocks fell another 80% in two years. See A massive rally is straight out of the 1929 playbook.
Anyone sense a change in the air?
For the bigger picture, all you have to do is glance at a newspaper. From a non-technical perspective, the trend is clear: things are getting worse, much worse. Earnings will continue to surprise to the downside, to an extent that few can imagine. Firings and bankruptcies are just getting rolling. As the illusion of prosperity wilts away, we are going to discover that our productive capacity has been hollowed out by the distortions of the credit bubble and regulations, and that a drastically reduced standard of living awaits. Needless to say, stock prices will be proportionate.
Mish has composed a detailed post on the many ways in which the vociferous Peter Schiff has been dead wrong on just about everything in this crash (the two actually had a little debate in December 2007). Mish’s post is essential reading for anyone who is considering following Schiff’s investment advice. In his own way, the man is usually just as wrong as the Pollyannas that he challenges on bubblevision.
Here is an excerpt:
Schiff’s Investment Thesis
- US Dollar Will Go To Zero (Hyperinflation).
- Decoupling (The rest of the world would be immune to a US slowdown.
- Buy foreign equities and commodities and hold them with no exit strategy.
12 Ways Schiff Was Wrong in 2008
- Wrong about hyperinflation
- Wrong about the dollar
- Wrong about commodities except for gold
- Wrong about foreign currencies except for the Yen
- Wrong about foreign equities
- Wrong in timing
- Wrong in risk management
- Wrong in buy and hold thesis
- Wrong on decoupling
- Wrong on China
- Wrong on US treasuries
- Wrong on interest rates, both foreign and domestic
That’s a lot of things to be wrong about, especially given all the “Peter Schiff Was Right” videos floating around everywhere. The one thing he was right about was the collapse of US equities and no part of his investment strategy sought to make a gain from that prediction.
I will admit that I was nearly taken in by Schiff’s thesis back in 2006 when I first became bearish on the economy and stock market. I even opened an account for someone with his firm, but the only thing I did with it was short the US market — I took none of his brokers’ advice on favored mining juniors.
I owe Mish and Robert Prechter a huge debt of gratitude for beating some sense into me with solid logic. Readers can easily check my archives to see my pre-crash stances on commodities, gold stocks, Treasuries, the dollar, the Swiss Franc and the Euro and the inflation/deflation debate. I can report that things have turned out very well for those who went against the crowd of contrarians, swallowed their fear of the dollar, and shorted not just US stocks but almost everything else in sight. All the world was a bubble.
On the need to stay nimble
Yes, the deflationists were right and hopefully all made some money or at least avoided terrible losses, but nobody can afford to get cocky. The markets do not trade on fundamentals on anything but the longest time-frames, so the ability to read the prevailing mood and adjust accordingly is a critical part of asset management. So is the willingness to contradict yourself and change your mind.
I see now that this deflation can last even longer than I had suspected, and that there may be even ways to avoid hyperinflation, such as negotiated Treasury debt forgiveness, but there is no need to try to guess about outcomes that are years away when you know how to read the signs as they come and remain humble and liquid enough to change your stance as needed.
By the way, Mish manages client accounts
Mish is an investment advisor representative with Sitka Pacific (not Euro Pacific!), a firm that manages private accounts on a percent of assets fee basis. I am not a client, but I would not hesitate to suggest giving them a call. I am working on setting up my own firm of this type, which offers many advantages over hedge or mutual funds, especially when set up with the protections that Sitka Pacific has included. My own style of trading is somewhat different from any of the strategies Mish uses (for example, I am willing to go net short or to a majority cash position), and of course I am not always in agreement with Mish on every aspect of the markets.
I first touched on this topic last week:
“So that’s what I’m working with. All three asset classes look overbought to me: bonds, gold and the Euro/CHF, and I suspect that their rallies are related and associated in traders’ minds with recent Fed and Treasury actions.”
Today the dollar is rallying strongly against other currencies and gold, which behaves like a volatile currency, and Treasuries are falling sharply. This is a reversal of December’s big moves. The dollar fell as the bond climbed. The two are maintaining a kind of balance — from a foreigner’s perspective, you don’t want to buy Treasuries with high bond prices and a high dollar, since that exposes you to elevated currency risk as well as price risk. As bonds correct their overbought condition, the dollar can rise.
This is just my 2 cents on the last few weeks — bonds and the dollar were strong together in the crash, and they can be again. It was only when bonds ran away in December that the dollar corrected sharply.
Is this the start of the next leg up in the dollar, which could push the Swiss Franc down under 80 cents, the Euro to under $1.15, and gold to near $600? Maybe, but it would be odd to see the dollar exhibit that kind of strength without further deleveraging in ‘risk’ assets like equities, corporate bonds, energy and base metals. So, the question is, should we expect such weakness in equities et al. or should we expect a short-lived dollar rally?
The strongest indicator we’ve had in the markets of late is that Treasuries were overbought by late December. This is not to say that we won’t see 2.5% yields on the 30-year again, but simply that this run was overdone. If Treasuries continue to fall, that would typically coincide with more animal spirits in the sectors that got clobbered this fall, in which case the dollar may find its rally short-lived at best, since dollar weakness was such a part of the bullish atmosphere from ’04 to early ’08.
The “short Treasuries” crowd is very much of the inflationist bent, so I would not be surprised to see oil and base metals surge with a continued sell-off in bonds, but then gold and gold stocks have already been overbought (I bought GDX and GLD puts last week), so we have a major divergence among the so-called hard assets.
This is not an easy market to read, as is characteristic of Elliott wave 4. It is best to just stand aside until things are more clear.
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PS — Just sold my TBT for a quick 8%, as well as those January DIA puts that I bought at Friday’s close. The Treasury short is a crowded trade, which I don’t like, and the strenuously overbought condition is now releaved. Bonds could fall a lot more here, but with a short ETF, any chop in the trading can eat up your returns.
The markets are experiencing a bit of a thaw today, with the memory of panic several weeks behind us now. The VIX has just broken decisively below 40 for the first time since September. Treasury yields have broken out just a tad from their extreme lows. Oil has jumped back to the mid-40s, copper has relieved its oversold condition, the GDX gold stock ETF has more than doubled, and the Dow has crept back to near 9000 again.
The question now remains, how will fear return? In several more weeks or months after the mood turns from relief to greed (and fear of missing out), or in the very near future?
My mind is not made up, but any breakaway rally is way overdue. With every week since the November 21 lows, we have been relieving the oversold condition as a function of time rather than price. That is not to say that the Dow couldn’t creep all the way to 10,000 by March, but the longer we hover here, the less necessary such a rally becomes.
What would be interesting in a January plunge is for the bond market to sell off with the stock market for the first time in recent events. But if the inverse correlation still holds, the overbought condition in Treasuries could find relief in a “happy days are not quite here again but will be soon” rally in stocks. Today’s action is what such an environment would look like, but with a great deal more animal spirits — $65 oil might even materialize (before new lows of course).
At any event, with the VIX below 38 I picked up a few more cheap puts on GDX today. Gold stocks have had a great run, and the same people are buying them today as were holding them in the crash, and for the same reasons. That is a bad sign.
My favorite short though is still the death-defying Home Depot. Also keep an eye on WalMart. People need cheap stuff, but they don’t need as much of it as they have been buying in recent years. At 16.5, the PE on that behemoth is still out of line, as is Costco’s at 18.5.
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PS — Note that in this kind of analysis, I don’t pay much attention to news pieces or economic releases. That is not the way to trade. For instance, we have horrible manufacturing data out today, and all data is worse than 6 weeks ago, but the mood is hopeful and stocks are up, so how can you make money trading on the news?
I look at the mood of the market itself and try to figure out what it is feeling and what themes it is trading on: greed, panic, relief, inflation, deflation, dollar bad, dollar good, etc. I try to figure out the mood by what different asset prices are doing, and wait for entry and exit points when trends look exhaused. To know the larger trend is key, in this case deflation and depression, but the market’s take on the situation is always changing. You wait for Mr. Market to be very wrong about a situation or just too enthusiastic, as in the case of the overextended bond rally this month — in deflation, bonds are good, but overbought is overbought.
December’s themes have been ‘quantitative easing,’ the ‘bond bubble,’ and the resumption of the dollar crisis. It seems as though reaching the $9 trillion bailout figure and ZIRP (Zero Interest Rate Policy) triggered some more recognition of Bernanke’s plan to destroy the currency. This helped to spur a rally in Euros, Swiss Francs and gold, all of which were oversold thanks to the general unwinding of the inflation/anti-dollar trade this fall.
The long bond is severely overbought at near 2.5% (though it can come back after a correction, this being a strong deflation). It is essentially all risk and no reward. Buyers at this price assume huge interest rate risks, but the fall in the dollar this month eliminated a fair chunk of currency risk in US bonds. If bonds sell off, as they should simply because the market is so bullish, I expect the dollar to regain much of its lost ground, thereby maintaining a kind of balance.
I have had some mild trepidation in seeing the Swiss Franc come back to 95 cents from 81 last month (I figured 90 would be all), but a quick check of Yahoo’s currency page reveals that the market still treats this venerable script much the same as the EU’s shaky upstart (3-month chart. CHF in blue, EUR in red):
Source: Yahoo! Finance. Click for sharper view.
The Franc of course is a far superior currency and lately strong against the Euro, but there has been no phase change since last summer, when I first got bullish on the dollar and realized that despite fundamentals, the Franc was due for a fall. The Euro is just as fundamentally junky as the dollar, since the ECB will surely come to ZIRP as well, and the Eurozone is under tremendous political strain. Plus, most people still think it is better than the dollar, and all things being equal it is usually preferable to be contrary.
Now let’s layer gold on here (GLD in green):
Source: Yahoo! Finance. Click for sharper view.
So gold still trades like a currency, albeit a volatile one.
Now let’s layer on the long bond (TLT as proxy):
Source: Yahoo! Finance. Click for sharper view.
So that’s what I’m working with. All three asset classes look overbought to me: bonds, gold and the Euro/CHF, and I suspect that their rallies are related and associated in traders’ minds with recent Fed and Treasury actions.
Could a sell-off here coincide with a surprise resumption of the equity crash, now that the widely-expected (even here) bear market rally (something akin to the 45 percent move from Nov ’29 to April ’30) has yet to materialize with any real strength?
October and November unwound a lot of old bull market positions, but not all of them. The equity culture is still alive, and since it’s never the thing you fear that gets you, perhaps despite Mr. B and the Bailouts, the dollar is not done with its comeback.
Here’s a two-year view of my proxy for the US 30-year Treasury bond, TLT:
Source: Yahoo! Finance. Click to enlarge.
It seems as though the mother of all Treasury rallies has run out of steam for now. I’m stepping in to play a possible correction, with a target exit range of 100-105 on TLT, corresponding to about 3.5 – 4.0% yields.
I also expect the dollar to regain lost ground at the same time, and for the Euro and Swiss franc to retrace the gains of the last three weeks.
Gold should also fall in such a scenario, as it’s price in Euros and Francs has barely changed since departing the 750 dollar level.
Whether or not to short the long bond has been the most consistent question posed by friends. I have advised against it until now, having called for sub-3% yields as early as last August. I still think this topping process needs at least another year to play out, but when nearly everyone is on one side of a trade, it is time to take the other. Simple as that.
Shorts have been burned all the way from 5.5%, and most have now given up in frustration. The news that the Fed will start buying is the perfect cherry of bullish fundamental news to complement a market top. What more could you ask? With every schmuck of a money-losing manager finally talking up bonds on Bloomberg, who else is yet to come on board?
I’m an options guy, but another way to play, besides futures, is to simply buy TBT, an ultrashort ETF.
Why do I think that yields will stay this low for over a year? Because this is the top of a 28-year bull market, and we’ve only been under 3% for a few weeks. At the last Treasury top, the 1940s, yields held under 3% for nearly a decade, even as inflation hit 10%. Market prices don’t have to make sense, in any sense other than as a reflection of mass psychology.
Disclaimer: Don’t trade like me. Don’t trade at all. It’s too dangerous out there, and this is very risky stuff, especially shorting in anticipation of a countertrend move.
When I started this blog in early August, I was living near the equator in a city overlooking the Pacific, having packed up and shipped out of New York just after Bear Stearns blew up. 18 weeks ago, the Dow was solidly over 11,000, the 30-year bond was 4.6%, gold was $900, oil was $120 and the latest CPI figures were showing double-digit annualized inflation. I was holding a huge array of LEAPS and ETFs that put me massively short equities (including mining and energy), net short gold, and long Treasuries.
I was then constantly emailing friends and family with my latest reasons to get out of stocks, miners included, and to buy into Treasury MMFs and index puts. For the previous nine months I had been endlessly explaining the logic of deflation and its implications, having been dissuaded of Schiff-esque conclusions by the likes of Mish and Prechter, and I wanted to go on the record more publicly with my calls. Besides bragging rights, I wanted the pressure to dig deeper and get the details right.
I called for a depression worse than the 1930s. I said that the Dow was on its way to below 3500 (under 9500 by Christmas, I suspected), that commodities would tank, that gold would fall well under $700, that there would be huge bailouts for the crooks who blew the bubble (though I never thought we’d see anything like $9 trillion by the end of ’08), that Obama would win and back a “new New Deal” and that the long bond would yield less than 3% anyway.
Let it be known…
I believe that the only market call that I got wrong was my early preference for the Swiss Franc over the dollar, but I switched out of that on the first real signs of dollar strength. Please call me out if you know of any others. I also sold my Proshares inverse ETFs very early in the crash (over the week or two following the late September shorting ban), and of course they did not proceed to fail from a swaps default, but given the lack of disclosure regarding counterparties and collateral, that was the right call, especially for a portfolio stuffed to the gills with puts anyway.
Living history.
And so this is Christmas, and where are we now? Well, I’ve ditched the volatility of Latin America for frosty and gorgeous Zurich, and the world is falling apart more or less on schedule.
I haven’t traded much since November, other than to close some more shorts on dips. I’m not a short-term trader. Starting in mid-2007, I recognized a rare opportunity to catch a tidal wave, and positioned myself for the big move. I wound down my business by early ’08. I got out of all long positions. I put most of my eggs in one basket, and I watched that basket!
By August I was glued to the computer, tracking dozens of data streams. At times this fall I was sleeping 4 hours a day, waking up at 3AM to watch the crash wash around the globe and plan out the day’s orders for several different accounts. Naturally, this blog was a big part of that routine, as it helped me to organize my thoughts. It was also fun to see all of the traffic come in, 600 visitors a day at times.
Man, the action was fantastic, wasn’t it? What thrills! The weekend that Lehman was thrown to the dogs; the desperation and collapse of Wachovia; the ETF scare when AIG folded (swaps mayhem!); the 4% TED spread; even worries that the Options Clearing Corporation might default. This was uncharted territory. Nobody knew exactly how fragile the system was — clearly, it had been built by schmucks who hadn’t read history and wouldn’t give a damn anyway, and we didn’t know how much stress each component could take.
So for now “the system” still stands, though I have a few more gray hairs.
Politics is (really) theater.
Team Obama is of course the same Team America that has been running this show for time immemorial, the face change being a tried and true steam release for public discontent. But this time around, with the internet allowing any inquiring mind to look behind the curtain, it is still astounding to me how even intelligent people are relieved to see a ‘change’ in the White House, even as well known made men line up for posts at Treasury and such.
The Who knew this game:
We’ll be fighting in the streets
With our children at our feet
And the morals that they worship will be gone
And the men who spurred us on
Sit in judgement of all wrong
They decide and the shotgun sings the song
I’ll tip my hat to the new constitution
Take a bow for the new revolution
Smile and grin at the change all around me
Pick up my guitar and play
Just like yesterday
Then I’ll get on my knees and pray
We don’t get fooled again
The change, it had to come
We knew it all along
We were liberated from the foe, that’s all
And the world looks just the same
And history ain’t changed
‘Cause the banners, they all flown in the last war
I’ll tip my hat to the new constitution
Take a bow for the new revolution
Smile and grin at the change all around me
Pick up my guitar and play
Just like yesterday
Then I’ll get on my knees and pray
We don’t get fooled again
No, no!
I’ll move myself and my family aside
If we happen to be left half alive
I’ll get all my papers and smile at the sky
For I know that the hypnotized never lie
Do ya?
YAAAAAH!
There’s nothing in the street
Looks any different to me
And the slogans are replaced, by-the-bye
And the parting on the left
Is now the parting on the right
And the beards have all grown longer overnight
I’ll tip my hat to the new constitution
Take a bow for the new revolution
Smile and grin at the change all around me
Pick up my guitar and play
Just like yesterday
Then I’ll get on my knees and pray
We don’t get fooled again
Don’t get fooled again
No, no!
YAAAAAAAAAAH!
Meet the new boss
Same as the old boss
Travel, sleep, extracurriculars.
I apologize again to those of you who miss the active posting. Everything is fine. I’ve just been away from the markets (relatively speaking) since November, since I’ve been on a lot of airplanes and have lately been taking some time out to attend a German course.
Besides, I never really intended for this to be a news blog. I don’t have much new to say on each bailout measure or report of economic distress, since they are all just color at this point. They shouldn’t surprise anyone now, nor should they change anyone’s expectations. This is a depression and the government is only making it worse. It will last for years, and the US will become much less free in the meantime. At some point in the next few years, the Treasury market will buckle. Things will get very interesting when the government has to default on its promises. In the process, the global paper money system may change dramatically, from a fracturing of the EMU to unprecedented inflation in the US. We don’t know how or when these things will happen, but we do know that holders of all kinds of government paper will get stiffed, so we just have to keep buying gold at a measured pace — less now, more later, much more under $600.
So here are some new predictions for the next 24 months:
Unemployment as reported will hit 12%. Real unemployment (U6 — see shadowstats) will be 25%, as in the ’30s.
GDP will fall at least 15% from peak 2007-2008 levels. GDP is a bogus stat (why are consumption and government expenditures included?), but I’ll defer to convention.
The Dow will have breached 3000, with a few 20% rallies along the way, a couple of which lasting a few months.
Home prices will continue to drop, and Case-Schiller will register a 40% decline from peak by the end of 2010.
Trading notes
As far as trading goes, nothing is very compelling to me at the moment. I’m still holding a large, though much smaller, basket of 2010 puts on the S&P and various and sundry industrials, retailers, REITs and miners. I’m still holding real money of course, though I still have some hedges on it via GLD, and I have put the bulk of my shorting profits in T-bills, where they will sit until I am compelled to go more heavily short by a more heartfelt equities rally or heavier into the heavy metal at the right price.
Agriculture, as I have mentioned, is interesting. Grains never go out of style, depression or not, and prices are not in bubble territory anymore. Except for the last couple of years, farming has not been very profitable for decades, so the sector could be in need of investment. Also, a less free global market and greater political tensions (both a consequence of government responses to depressions) could mean shortages.
Energy is also getting tempting. Crude production peaked in the first half of 2005 — we will never again get as much out of the ground as we did then. The stuff is really, really, cheap. It was also cheap at $147, but I still shorted Suncor. $25 is not out of the question, but really, waiting for the bottom of the bottom is a fool’s game. I’ll be looking for ways to scale into oil and uranium slowly over the next couple of years.
No final bottoms.
I don’t think we have seen bottoms in anything yet: neither grains, nor metals, energies, foreign currencies, corporate bonds, munis nor equities (other than those at zero already). We have only seen the first move, but this move tipped the market’s hand.
All the same, I don’t like to be in the way of such a compressed market. Make no mistake — a rally and general improvement in mood could last a year! At all points in this bear market, consider what would happen to your portfolio if prices were higher 12 months out. Being right but early is being wrong if you lose so much that you compromise your ability to trade within the limits of prudence. Look for the layups and buy yourself as much time as possible. If you are going to short, find far-out LEAPS and buy them cheaply. Be a miser. The profits (and losses) are all in the buy.
I entered an order to buy GDX (a gold stock ETF) calls on Monday, but didn’t hit the buy button, since no matter the technicals, I’m never very comfortable going against my understanding of the forces at play, even just for a short-term trade. Turns out those contracts would be up by a factor of three by today. I’ll just wait out the rally and go short again if things get out of hand, as in $32 for GDX. I have a hard time believing that the bear market in commodities is finished after only 4-7 months, when the economy is crashing through the floor and credit remains extremely tight.
Here’s a visual of the bloodbath and bounce in gold stocks (three-month chart from bigcharts.com):
Click for sharper view.
I’m in no hurry to go long anything at all, since the unwinding of the credit bubble will take years. I don’t think that we have seen any bottoms, not in gold, oil, copper, wheat or any kind of equities or bonds.
The risk is all to the downside. The looming risk of currency failure is the lone caveat, so it behooves everyone to have some physical gold — more if you are a renter with no other hard assets, less if you are an oilman or farmer or own significant real estate, within the range of 5-20% of assets for now. I intend to bump up my own allocation to near 50% or even much higher over the next couple of years, hopefully at very favorable prices.
This intention is predicated on the expectation that the US and other governments will before long saturate the markets for their treasuries and follow up by saturating the markets for their fiat monies. This will create all manner of chaos and depress real asset prices yet further, even from the very low nominal prices that I expect in the interim.
The assets to buy in the nominal and continuing real deflation will be those that generate income, since anything spinning off cash two years from now will have proved its mettle. Those companies and properties will be the most likely to hold their value in currency mayhem, and could generate fantastic capital gains in the recovery as earnings and multiples expand from highly depressed levels.
That said, all of this will take longer than even I think. Buffett, sell-out that he has become, was once a great investor, and he has remarked that sitting in T-bills is one of the hardest things to do.
Here are a couple of charts that illustrate the significance of what the Fed has undertaken lately. First, look at the change in its balance sheet this year from about $870 billion, almost all in Treasuries, to $1.5 trillion, with fewer Treasuries, more repos and swaps, and an alphabet soup of new credit facilities:
Source: Federal Reserve Bank of Atlanta’s Macroblog (yes, a Fed branch has a blog).
For the inflation/deflation issue, what matters at the moment is that all that new credit (not much new currency, only about $30 billion more in actual notes) is just sitting in banks. Unlike in the Greenspan years, nobody worthy of credit wants to borrow the new funds, since they can’t generate positive returns on investments, and the banks aren’t lending to people with bad credit anymore.
How do we know it is not being lent out? The Fed is actually pretty transparent as far as nefarious government sponsored entities go, and provides a lot of useful data through the FRED website. Here is the sum of loans and investments at US commercial banks:
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As you can see, lending has gone flat after an enormous expansion. And this is just the past 5 years — check out the longer view for a graph that would have knocked Mises’ Austrian socks off:
When you hear “credit bubble”, think of the above.
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Workers of America, Unite! (to fight the evil of lower prices)
Inflation, in the end, will have to come from massive government spending programs. The Greater Depression will have a scaled up New Deal. Keynesianism is still all the rage, and when the bailouts have had time to fail, expect Obama to start handing out trillions to government contractors through various new Orwellian-sounding departments and administrations.
For the dollar, the Treasury market will be the canary in the coal mine. It is rallying now from safe-haven buying, as it should, and it could even go a lot higher, but when it turns, grab your gold and run. Nothing is so damaging to an economy as government work programs and the kind of inflation that they create. This is what happened in the Wiemar Republic. The government was the main employer, and it paid workers (and foreign creditors) with freshly printed cash.
In the US, I imagine that the public finance system will continue to operate as it always has: 1) Taxes, income from which will continue to drop in the depression; 2) Bond sales, but there is a limit to the world’s appetite for notes from a bankrupt creditor; 3) Federal Reserve money creation for the purchase of bonds that the public does not want. This last part is how fresh cash gets into circulation, and how the government indirectly funds itself through printing. When public demand for Treasuries dries up, you can bet the government’s demand for funds will be greater than ever, so then we will see what Bernanke can really do with a printing press.
