"A Full Blown Deflationary Episode" Coming

Tyler Durden's picture

In his latest missive, Albert Edwards, among other things, touches on two of the most critical drivers in the current economic climate: deflation and Treasury supply. His observations lead him to conclude nothing good about the follow-through for the current bear market, liquidity driven, short squeeze induced equity rally. However, more relevantly than touching merely on what is a unprecedentedly overpriced equity market, Albert will likely spark some newly-heated discussions between inflationists and deflationists (which in this economy where the only fundamental analysis deals with the Fed's balance sheet and Cash Flow statement, which until HR 1207 is instituted, readers have to mostly guess at, is really all that matters).

First, Albert has this very interesting tidbit about GDP, and why the headline indicator is really missing the big picture about the encroaching deflation that has gripped the US economy in all but the acknowledgement by TV talking heads, much to the chagrin of the Fed chairman.

My former colleague Rob Parenteau pointed out something interesting to me the other day. He noted the huge divergence between US economy-wide inflation as measured by the gross domestic product (GDP) deflator and a slight variant of GDP, the deflator for gross domestic purchases (see chart below). The key definitional difference between the two measures is that the latter includes recent savage import deflation (as GDP includes exports and excludes imports). Hence the gross domestic purchases deflator is a better measure of what is going on in the US domestic economy. With import prices down some 19% yoy and even a record 7.3% yoy if one excludes petroleum, no wonder the price of domestic purchases has already fallen into deflation. If anything, domestic purchases inflation leads trends in both GDP and core CPI, so this is significant news.


The media's desire to ignore this metric, which convincingly indicates that deflation is among us, despite the wanton destruction of US Dollars by Chairman Ben, is not surprising: the last thing US consumers need to know is that a dollar today may be worth less than a dollar tomorrow, and thus drive them to save even more, further crippling the Ponzi monster that the US economy has become.

As for the other very relevant topic: why are Treasuries now back to yielding almost record lows, despite trillions of new pieces of paper backed by the declining full faith of the US government, Albert had this observation.

But what about massive supply of government bonds I hear you ask? Won?t that drive yields higher? Well it never did in Japan. But let?s cast our minds back to the early 1990?s US credit crunch (which seems so minor in retrospect!). What happened then is that US commercial banks bought US Treasuries aggressively at the same time as they contracted lending to the private sector (see chart below). This continued well after the end of recession in early 1991.



I note with interest that Swedish Riksbank recently took its target interest rate negative, in an attempt to force banks to remove surplus reserves and resume lending to the private sector. Of course, no such thing will happen as banks are continuing to buy government paper in unlimited quantities - I note here the recent collapse in UK 1 and 2 year yields to new lows. In the US and elsewhere, where commercial bank exposure to government paper is still close to all-time lows, the unwinding of grotesque over-exposure to bubble sectors like real estate (see chart below) will continue to underpin the secular bull market in government bonds.


The last is quite an interesting observation, which brings the confusion full circle: as Rosie notes constantly, his thesis is buy Treasuries on the deflation threat. Yet the real issue may be that banks, stuck with record excess reserves, and even more record holdings of toxic real estate paper, will sooner rather than later, realize that they can not rely on the Fed's backing in perpetuity and gradually start offloading the toxicity that currently passes for bank assets, and move into a safer class, especially as leveragability falls off, and banks once again become banks, instead of glorified, backstopped hedge funds, a prime example of which always is Goldman Sachs.

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RobotTrader's picture

There is a new bull market in buying puts.



Anonymous's picture

finally a bubble i can get on board with

Anonymous's picture

Puts and Calls are the same thing*

*when delta hedged.

Anonymous's picture

** and when: strikes are identical, there is a perfectly flat vol surface, and there is zero bid/ask spread in financing!

RobotTrader's picture

Junker Stock Watch:

Man Overboard!!!


BobPaulson's picture

Yeah, but is this just a great buying opportunity ;)


Go get a margin LOC and buy that one!

ptoemmes's picture

I don't thnk there are enough Mae West's to save them all...but a pic or two might help ease the pain ;-)



Anonymous's picture

Priceless. Thanks.

Gilgamesh's picture

Robot - have KRE on 50DMA watch?  The zombie regionals are bleeding profusely again today.

Gilgamesh's picture

Agreed.  Puts are in place on the names that weren't bought by Paulson & Others last Q.  But today I kinda wish I hadn't taken some profits in the gold miners to purchase those puts...  Gold, of course, broke the 960 upper trading range - and now everyone is jumping on the most leveraged names.

Gilgamesh's picture

Nono; physical is in place.  Gold miners are retirement account money used in conjunction with puts on individual names to hedge in this market.  Sadly, all too aware of what can happen to even the best of the miner stocks in a credit contraction/deflation cycle.

thomasstreet's picture

This would greatly improve capex spending and investment in US industry, but not to worry the stimulus is going to do that.

good articles; good articles 4 slow news day ..http://www..
hat tip: finance news & finance opinions

Gordon_Gekko's picture

Ah!...Mr. Paulson - which reminds me - looks like he is winning - again.

Anonymous's picture

Gold cautionary from Global European Anticipation Bulletin:


Anonymous's picture


walküre's picture

You haven't got the memo that AIG, FNM, FRE, CIT and other junk is now carefully "managed" by the staff at Direxion.

AIG is 4x leverage !!!! LOL 


fireangelmaverick's picture

He got it all right except for two letters.


max2205's picture

Why would I save money that would be worth less in the future?  Buying hard assets is more likely.  just asking

dmjung's picture

"...that a dollar today may be worth less than a dollar tomorrow..."

It's akwardly worded, but he's describing deflation where tomorrow's dollar is worth more than today's or as he said today's is worth less than tomorrow.

dnarby's picture

That threw me too.  Better would have been:

"The last thing US consumers need to know is that a dollar tomorrow may be worth more than a dollar today, and thus drive them to save even more."

Always good form to phrase in the positive, makes it easier to grok.

Project Mayhem's picture

Two words:  Exter's Pyramid


Capital ultimately moves *down* the pyramid during systemic crisis.  Thanks to FOFOA for the image.


chunkylover42's picture

I think the food pyramid would be more appropriate here.

PAPA ROACH's picture

If the shit truly hits the fan, even gold will be fairly useless. You can't eat it, sleep on it, grow anything on it, drink it, wear it or even wipe your ass with it.

A better store of wealth would be raw land/acreage. And you get to use it for enjoyment to boot!

PAPA ROACH's picture

can you elaborate a little further? I know the general story, but in reference to gold vs. acreage.

Anonymous's picture

When people get hungry your farm is a soft target for murder/takeover/government expropriation. You can't take land with you. Gold fits in your pocket.

That's what they found out in Argentina.

SWRichmond's picture

That is the short version and is correct.  Gold also fits quite well in the Bank of Gaea.

Anonymous's picture

Better yet, ask Zimbabweans!

Anonymous's picture

History tends to disagree with that analysis, which is why most governments reserve the right to deprive their people of owning gold. Ultimately, a transportable and non-perishable form of wealth (i.e. money) is needed to carry on business/bartering. When the fiat paper (including bonds and equities that are based upon it) becomes only so much Charmin tissue, one can be fairly certain the de facto transportable wealth will be precious metals once again.

dnarby's picture

Catching comes before hanging.

lookma's picture

"You can't eat it, sleep on it, grow anything on it, drink it, wear it or even wipe your ass with it."

Buy you can trade it for stuff you need. 

Will you be able to do the same with currently commensurate pieces of paper, or electronic media representative of that currently commensurate amount of paper?

Charley's picture

"Buy you can trade it for stuff you need."

If the dollar collapses against gold, there will be no prices for anything, I think. Gold is presently about 1/100 to 1/80 of its true value.

scepticus's picture

"Gold is presently about 1/100 to 1/80 of its true value."

I disagree. Historically (i.e. for millenia) gold has been worth about 300 loaves an ounce and has always crashed back to earth when it has exceeded about 3 times that level. If the dollar goes kaput that doesn't at all justify an order of magnitude increase in the gold/bread ratio, because in that scenario bread will be more popular than gold.

Indeed in zim the purchasing power of gold and US dollars fell significantly  wrt bread (bread going for $5 a loaf), simply because the bread supply declined so momentously.






Rusty_Shackleford's picture

Why don't you ask these people if they can "eat" their gold?







How much is land worth when there is no rule of law and no resources to farm it?  Zimbabwe was once known as the "Breadbasket of Africa".

Anonymous's picture

No resources to farm it?? If they can dig for gold they can plant crops.

Dr. Kenneth Noisewater's picture

I'm thinking ammo > gold when TS really HTF...

dnarby's picture

You don't own land.

You lease it from the state.

Think that's wrong?  Try not paying your property taxes.

MsCreant's picture

PM, Look at the jump in Gold just now! I'm getting a gold nosebleed. Ahhhh!

Project Mayhem's picture

Yeah!  It's interesting because the dollar has barely moved.  I wonder what it looks like in Euros or Yen...   I hope it stays there haha.

Gordon_Gekko's picture


Green Sharts's picture

Capital ultimately moves down the pyramid in precisely that order during systemic crisis?  It must be great to be smart enough to have the world figured out with such precision.

Anonymous's picture

That didnt hold true last Oct or this past Feb-March. Not saying anything about the future, nor any opinion of this chart....just an unbiased comment

long-shorty's picture

it's interesting that it didn't hold true. if you'll recall, however, most of us knew about the subprime crisis _before_ the S&P 500 actually rolled over hard. it's like most people thought "it's known so it's priced in." and then finally it rolled over as it should have, and everybody freaked out.

everybody knows we are expanding the monetary base, which unlike lending or derivates, creates PERMANENT, rather than temporary, money, and therefore, essentially permanent inflation, and yet gold hasn't really done all that much so far. to this point, it has just recovered from the forced selling it saw in the crisis.

everybody knows where we are here, but I still think the "freak out" in gold (much higher prices) is still to come.

for what it's worth, the four local managers I'm aware of in my city who had positive returns in the last 12 months are all, independently from their own research, long gold here. either it's a very crowded trade, or a very smart money play. only time will tell.


Anonymous's picture

After all those dollar collapse posts and Marc Faber missives I started to prepare for hyperinflation and $50000 gold.

What to do now? What to do....

Please advice us....

Anonymous's picture

You are on the right track. Inflation is all around us, but Precthologists will never admit it. Cooked CPI numbers won't buy you bread and milk from the store.

long-shorty's picture

find a thoughtful IA who can construct a portfolio that will reasonably withstand either an inflationary scenario, or in a deflationary scenario.

you are going to have to look hard. it won't be a guy who works for a national brand, and it won't be a guy who believes in a 100% index fund portfolio. if someone lost more than 15% in 2008, you know right away that you should probably disregard their advice.

Pizza Delivery Man's picture

No large funds are levering up to buy stock.

Maybe at the EOD we might see a ramp up in equities.

Almost 0 dollar movement so nothing spectacular should be expected....going to sleep, this day is gona be boring.

Anonymous's picture

"...the last thing US consumers need to know is that a dollar today may be worth more than a dollar tomorrow.."

Shouldn't that be reversed?

US moving from cars to bicycles, China moving from bicycles to cars. Oh, the symetery.