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"A Full Blown Deflationary Episode" Coming
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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I wish to God that this sorry-a** excuse-of-an-economy never f**king recovers - EVER. Gold will keep on going higher until it becomes money again and becomes the foundation of a new economy - a new Golden Era, if you will.
Be careful what you wish for. Learn Chinese and muscle up if you wish that to happen. If you've got time to post here such dribble with a groovy handle and avatar im going to assume youre not exactly immune to the social disruptions this would cause. Being long a few nuggets or few option contracts isnt going to make your life much easier. Nose. face .cutting .spite.
"Being long a few nuggets or few option contracts..."
Well, that's rude...you presume to know how many contracts or "nuggets" I am long.
Greece PM is calling for an early election due to "crisis".
Dominoes are falling.
Greece, Spain, Ireland possibly the UK about to be insolvent.
The Euro is under much more pressure than the USD.
At least America has the FED which is corrupt like the dirtiest stinking oligarch in Russia.
Would you park your wealth with ISO certified bureaucrats that resemble the Weimar Republic politically and economically or with gangsters and crooks that have been successful in trading, hording and increasing wealth at the expense of others over several hundred years?
I would stay out of both.
In Germany there is still memory of the weimar inflation. Turning on the printing press in Euroland will be difficult.
That must be why folks are just as happy with Euro from Italy, Spain & Germany.
I'm unfortunately not short the market right now, expecting the noise to rise later this year, but is anyone else concerned that we're getting a rush to quality in the markets? It's not as if this little slide has been worth playing, but someone is buying Treasuries and gold for a reason. Perhaps this is the event many of us have been waiting for.
Check out LQD:JNK (or HYG) action today. Hello, confirmation. Worth a Bloom screencap?
http://finance.yahoo.com/echarts?s=LQD#chart5:symbol=lqd;range=1d;compare=jnk;indicator=volume;charttype=candlestick;crosshair=on;ohlcvalues=0;logscale=off;source=undefined
Wow! Big move - thanks
Pulling Gs on the PM rocket ride.
Crikey!!! (as Crocodile Dundee would say)
Let the games begin. It's time for kids (Prechterites) to leave the room and let the adults play...it's gonna get nasty in this motherf****r.
BTW, I bet most Prechterites don't even know that Bobby has either been in cash or short since BEFORE the 1987 crash.
The argument for deflation as stated here seems incomplete at best. Supply-nice; but what about demand? Right now nobody seems to have excess savings to put into bonds. Market-driven demand is so low that central banks buy bonds, called “Quantitative Easing” otherwise known as inflating the money supply.
The trade might work; Heli-Ben stated that he wanted mortgage rates to be low. That means high bond prices due to central bank buying. A deflationary thread helps to mask this monetization of debt. This works until a flight out of the dollar happens.
I agree with what you've written in regards to US attempts to debase the currency. But what happens if the rest of the world is doing the same? Fiat currencies are a relative valuation game, not an absolute valuation game unless you compare them to gold or oil. I see currencies as being in a race to the bottom, but they're also racing against deflation because global income doesn't appear to be strong enough to support global debt. Maybe we should looking for countries that generate enough income to support their debt and handle an upward revaluation in their country such that debt servicing wouldn't be adversely impacted. From my vantage point, no such country exists.
One is left with the impression that the fiat currency game is just a prelude to the soveriegn default gambit. Everyone has their finger on the trigger, just waiting for (a) an iron-clad excuse to default, or (b) some other sovereign to default first so they can shoulder the blame in the history books (if anyone is interested enough later to write any.)
The Chinese will be blown out of the water by sovereign defaults, is my understanding. Their attitude might be that if you want to default on their investment, that's fine with them, just be prepared to hand over part of your territorial integrity in exchange.
They can have Alaska, for starts. And I bet the US military will click their tongues in annoyance if China goes after Korea and Japan, but do little else.
cougar
Cougar,
Why would we let them have anything in exchange for defaulting on our debt? We have a bigger military, which means their unsecured debt is really just that. I don't recall us getting South America in the 80's.
Think of a guy like Soros with holdings there. They could go all "Cuba" on his butt. A whole lotta nationalization going on. They have already threatened default. They sound like they are threatening, but they may be as screwed as we are and actually need to default cause they can't pay because of their losses in our derrivatives market.
These things cut both ways though. We could just tell the Chineese to "come over and get it" if they think it is theirs.
Could get ugly.
"Fiat currencies are a relative valuation game,"
Excellent post. As I have said many times, measuring one fiat currency against another is like measuring the world's tallest midget.
There IS a global race to devalue. Witness the Canucks, who are absolutely freaking out about the strength of the loonie.
And so the dollar is right back where it was at this time yesterday.
What's the point boys?
The point is that it has fallen against what matters most - Gold. DXY is a flawed and misleading indicator.
So the ONLY long-term inflation trade is stocks, right?
Look at 1980. You had significant inflation the next 20-years and yet LOWER gold and commodity prices, and mediocre real-estate results.
Its hilarious to talk about gold in crisis (Argentina, Weimar) bc of 2 things: 1) guns >> gold and 2)you cannot do this trade in size. An institution with $10B (much less $1T) both cannot put significant assets in gold and it is not transportable (one cannot even guarantee ownership/storage). Its a true suckers trade.
If there is going to be massive inflation, then one should be borrowing $$$$. This always works. We should be levering to buy every asset, bc those debts will be very easy to repay. Just ask Argentines, Zimbabwaeans, or Weimar Germans... the best thing to be in hyper-inflation is a DEBTOR! If there is hyper-inflation then my Social Security check (indexed to CPI) will go up 100% per year... so I can easily afford to be 20x or even 100x levered to my income. Right?
There is so many things wrong with this argument, I don't even know where to begin.
agreed. I know so many people with 40-60% LTV who are rushing to pay off the rest of their 5% fixed mortgage now. That is insane! a nice healthy amount of debt is a great diversification tool against inflation.
What of this idea that all the gold investments, other than product in an easily accessible hidey hole, will, in a true crisis, reach a price that will eventually render them "worthless" in any practical sense of the word. The idea that those who actually offer the assett will at some point of demand and pricing take it and go home. The mines closed by their owners. The stock pilers hang the "gone fishing" sign. The depositories of the etf's closed to the little people. I just wonder if transactions for gold and silver that may be "signed, sealed, and delivered" electronically will be of much comfort in a true storm.
Marinus Willett
Bingo. Extending that, the entire economic promise based on contract law, good faith, and 30 day billing will be toast.
Gold I can live without. Contract law, not so much.
cougar
So would this be deflationary?
"With unemployment as high as 9.4% and job prospects scarce, job seekers are willing to accept as little as half of what they were making before, if it means finding a job.
In a recent survey, 65% of out-of-work respondents reported willingness to accept wages up to 30% lower than their previous compensation. And, 3% and 4%, respectively, said they would accept up to 40% and 50% of prior wages, according to the 2009 Annual Career Fair Survey released by Next Steps Career Solutions."
http://money.cnn.com/2009/08/28/news/economy/paycuts/index.htm?postversi...
No. History shows that you don't need wage inflation to have price inflation. Even if you get nominal wage inflation n real terms incomes never keep up with prices. That's how everyone ends up a millionaire, and a pauper (see Zimbabwe, Weimar, etc. etc.)
a proud weimerican
Unless Pres. Obama signs an executive order mandating that every American gets $10,000 as a 0% interest loan, there won't be price inflation.
People in Weimar or Zimbabwe showing bundles of worthless cash to buy a loaf of bread. The money got printed and swamped into circulation.
At $8/hr jobs this is impossible to achieve.
Dear Anon in Seattle:
I share your concerns, granted for the sake of arguement lets say housing takes 3-4 years to bottom while treasuries gain in value. Once a true bottom has been realized, rates start to go up as treasuries are sold as banks start lending again. My Father passed away at the age of 90 a couple of years ago, as a result I inherited the following mind-you he was an adult in the depression and served 3 years in WWII with no college education:
1). Enough land to grow on but not too much keep overhead down. Home is less than 2500 sqft.
2). P.M.'s and Firearms-a boatload of them with a few other goodies that still have jap blood on them.
3). Tools that were built back in the day, dozens of each that are needless to say of much higher quality than anything built today (i.e. how do you think my Dad built this house, deck, garage, etc...?).
4). Food supplies but not too much garden supplies fresh goodies that fill the non-carbs void.
goodluck!
Just a point on the first chart of the options Put/Call Ratio. Either there was a data print errror or the market has changed significantly from AM to PM.. See chart
http://stockcharts.com/h-sc/ui?s=$CPCI&p=D&b=5&g=0&id=p89693636685
Buy bricks and bust them down to 8 balls. A fortune to be made when the craziness I have read today on this site actually happens.
Store in a cool dry place.
Man this is a heavy news day and, it is only September 2.
Just showed the deflator on Bloomberg. First time negative since 1950!
On another note- can people stop junking the comments with off-topic, minor moves in stocks??
"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"
OMG. Buying newly issued gov. paper is the ONLY way banks can reduce reserves.
Do you have a link or document for the Albert Edwards article? Thanks in advance.
Keep one thing firmly in mind - a negative GDP deflator allows governments to turn negative nominal GDP into positive real GDP. I'm not saying this is necessarily happening, but the Japanese did this for years and it made their economy look stronger than it really was.
Physical Gold. Not the same as ETF gold and gold stocks.
Gold price was down in the 90s partly because of new mining techniques brought into the production side of things, on a large scale, am I right?
Instant currency devaluation. All fixed interest loans are proportionally reduced and made more serviceable, while wages and all further production adjust upward to similar terms in purchasing power. Loans take an immediate discount and defaults are reduced.
Downside, of course, is that debtors are rewarded while the creditors, savers, and cash hoarders are neatly ruined, or nearly so.
Gold, being money, though not formally recognized by a peg to currency adjusts or overadjusts, making holders whole or increasing their wealth.
Thus, if devaluation is the next step, which I think it must be, cash will be neutered. Commodities, especially precious metals, will be king and may be exchanged for fiat paper to make immediate exchange. But beware paper promises when all about you are reneger, liars, skulking debt shirkers, and indolent gamblers.
The field is ripe for harvesting the host of unwary $ holders.
"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"
no no no
inflation causes panicked buying of goods as the dollars they save become worth increasingly less. this blog is descending rapidly.
"I note with interest that Swedish Riksbank recently took its target interest rate negative, in an atte"
No, it didn't. It set the rate for DEPOSITS at the riksbank to a negative rate. The relevant rate, the REPO, which is on money they lend to the swedish banks is still at 0.25
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