Rosie On Inflation

Tyler Durden's picture

David Rosenberg discussed inflationary pressures "Breakfast with Dave" recreated in its entirety as it touches on many critical points:

As for the inflation-phobes, gold demand hit a six-year low in 2Q, according to the World Gold Council (-8.6% YoY). What is most interesting is that since late July, the S&P 500 has managed to tack on 20 points even as the 10-year Treasury yield has declined roughly 25bps — both markets cannot possibly be right when it comes to depicting the macroeconomic outlook. Our money is with Mr. Bond. After all, we seem to recall that between mid-June 2007 and early October of that year, the 10-year note yield fell 60bps even as the S&P 500 jumped 70 points as it made a last-gasp move to a new high. And, we know who got that story right.

As we saw yesterday, the market responded to reports that another fiscal package was about to be unveiled — even though the last package has yet to fully percolate. This sounds more like desperation than anything else, but there is no question that greed is once again testing the long-term resolve of the marginal investor. Politics is emotional. Like religion, sports, family, house prices, it is emotionally charged and therefore gets a lot more press and the general public forms a strong opinion. After all, the government is doing things that fewer people are favouring, based on the polls, because it is spending other people’s money — that is what fiscal largesse boils down to. Spending our tax dollars. That's why everyone is so crystal clear about the inflationary impact of an increase in the government balance sheet. Deflationary forces are tougher for the masses to understand.

We have said often that just as society couldn't spell ‘inflation’ in 1937, it has no clue what causes deflation now. That's beginning to change in the aftermath of the housing and credit collapse, but try to explain the deflationary forces contained in debt liquidation or global manufacturing over capacity or a socio-economic trend towards savings, and the notion of ‘deflation’ gets fuzzy for most thinkers (even Warren Buffet). That doesn't change the fact that the deflationary forces are enormous (and current) and the policy-induced reflationary forces are a partial antidote.

To be sure, if the government fails to mop it up once the private sector debt liquidation ends, it does mean that an inflationary mistake lurks down the road. But as we have seen in other post-bubble credit collapse episodes, the initial period of deflation can last for years, during which the fundamental trend in bond yields will likely remain in one direction and that is down, to the surprise and dismay of the litany of bond bears that currently populate the capital market. The fact that a year ago, when the inflation rate was over 5% but core inflation was less than half that pace, the market mantra was that we should be focused on headline only — that the core would follow the headline. There was a plethora of Street research published on the topic; we recall that all too well. Today, the year-over-year headline price trend is running at a 60-year low of -2.0%, and now we are being told by the economics community to focus on “core” (which, by the way, has slowed to 1½%) because this is all an “energy story”.

 

So you see, most strategists and economists and market pundits claim that they are concerned about inflation, but in reality, everyone seems to want to see it. As long as we have a lack of pricing pressure, we will see bond yields trend lower, and as long as that happens, there will be a continued lack of confirmation over the growth rate in the economy that is embedded in equity market valuation. Energy prices may, for a short time, give a kick to the headline CPI numbers but rents are almost four times more important and comprise 30% of the index (and 40% of the core). To repeat — three variables: rents, wages and credit — will ultimately determine the trend in inflation. Down, in other words. If you are not yet convinced of that in the consumer arena deflation remains the primary intermediate-term risk, then go the article on page B8 of the WSJ and see if that changes your mind — discount coupon redemptions are up nearly 20% this year (Club Stores Accepting Coupons: Sam’s Club Joins BJ’s, Costco in Issuing Discount Chits to Members).

We should probably add here that even though the moves by the Fed have provided ample liquidity, they have not stopped the underlying fundamentals from deteriorating — see Corporate Bond Defaults Hit Record on page 19 of the FT. (S&P just reported that 201 companies with $453 billion of debt have defaulted this year, exceeding the entire tally of 126 defaults covering $433bln in ALL of 2008). The 12-month speculative-grade corporate default rate has risen to 8.58%, as of July, from 8.25% in June (the rating agency is forecasting that the default rate will rise to 14.3% by the first quarter of 2010, taking out the prior record of 12.54% set in July 1991).

By the way, we are sure that for a market grasping on to any good news it can get, there is bound to be a buzz over the article on page 11 of the FT — U.S. Office Prices Raise Hopes. But turn to the Lex column on page 10 of the FT and you will see that there is less to the story than meets the eye (commercial real estate values are down 36% from the peak, which makes this downturn even worse than what we saw in the residential market!).

And lastly, this amusing anecdote from Rosenberg:

From our lens, there is always a catalyst or a spark for the next economic expansion and bull market. In 2003, it was leverage and a housing boom. What is it today? Cash for clunkers? Digitized medical technology? Chinese consumption? Government incursion into the economy and capital market? Perhaps we should also recognize that heading into the post-recession environment of 1991, there was a tailwind from sub $20/bbl oil; and heading into the 2003 rebound, we had sub $30/bbl oil; so it may pay to ask the question as to how $70+ oil is going to play in the recovery, unless we are talking about recoveries in Saudi Arabia, Qatar and the UAE?

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Mos's picture

Where does a sinking dollar play into the inflation/deflation argument?  It seems to me that we have obvious debt/credit and asset destruction which is deflationary but at the same time have rising prices for food/energy and many other necessities.  Certainly my electric bill and gas expense is not deflating.

Sqworl's picture

Mos: who rules the world???  either way they make money.

mgarrett84's picture

Mos,  We still have strong underlying demand for dollars for deleveraging and wealth destruction.  We do have huge capacity in the system and are pretty efficient.  The inflationary forces will be imported.  We will continue to have internal deflation and exgternal inflation.  

Assetman's picture

This is a very good answer to a very good question.

I'm going to put this another way... a declining USD doesn't have much of an inflationary on goods and services produced inside this country.   What we are feeling, though, is massive deflation on internal pricing (supply/demand) dynamics such as housing .

The declining USD, though, has real inflationary effects on global goods and services (i.e. global commodities).  One primary reason why oil stays elevated around $70 per barrel and natural gas is hitting new lows below $3 per mcf is that the former is traded globally and is crossing demand from stronger currencies (think China).  The latter (like housing) is primarily a domestic supply/demand dynamic.

The bottom line with all this that both internal deflation (lower asset values, lower wages, declining credit) and happen at the same time as higher external inflation (higher oil prices, dollar devlauation) are occurring. 

As long as we continue the printing presses, importing inflation from the rest of world is bound to occur.  And as long as we continue to delay pressing the reset button on toxic assets, we will continue to suffer from internal deflation... which is, right now, overwhelming.

The result?  A much lower standard of living for Americans, as we are on the wrong side of both equations-- and it is expected to remain that way for awhile.  Most ironically, it's been a policy wholeheartely endorsed by Washington... just like it was endorsed by policymakers in Tokyo over a decade ago (the excpetion is that Tokyo didn't have to seek Foreign capital to fund toxic waste removal... it was handled by an over saving public).

The sad part of all this is... the current policy of burning the buck and delaying the ineivtable (asset writedowns, etc) may be the best policy to avoid total catastrophe in the financial markets.

SWRichmond's picture

Thank you for a very succinct explanation.  It fits with my belief that the thing that MUST deflate is American lifestyles; a situation wherein everything we own becomes worth less, and everything we need becomes more expensive, makes perfect sense.

 

cougar_w's picture

The nail, hit on the head. You can say good-bye to perpetual positive growth in GDP, and economic growth writ large. Shortly after you say good-bye to those, say so-long to to the stock market as a speculator's haven, embrace 18% standing joblessness, and be glad you have a producing garden in the backyard where the pool used to be. I'm not saying this is bad. It is good. It needs to happen, and it *will* happen. The destruction is baked into the cake. But we seldom talk about that and need to.

Because it begs the question: What comes next? We can approach that issue now while we have some time yet, or later when we are too busy with other things, but one morning we are going to wake and know beyond any doubt that what comes next... has finally come.

cougar

Anonymous's picture

We will see deflation on everything inside and outside the country that is not manipulated by the pigmen. Oil is manipulated by Goldman and Morgan Stanley. You sound like Bernanke. Dollars are traded on a world wide market and their value are not dictated by borders.

Anonymous's picture

Impressive insight. Thank you.

I have one question.

If the China bubble finally bursts, as Andy Xie and others predict, what will then happen?

Will we get both external and internal deflation? What will happen to treasuries if China does not buy them anymore because of their own burst bubble?

Thank you and thank zerohedge.

aus_punter's picture

i think what you are getting at is stagflation ?

Anonymous's picture

Your electric bill is regulated, so it is not a good proxy for inflation. As for gasoline, unless I'm wrong you're going to see /CL take a massive hit. Usage continues to fall and I don't see anything on the fundamental horizon to turn it down. The pigmen can rally it for awhile, but it will eventually come back to fundamental reality. BTW, what do you think of food prices? They're falling through the floor where I live.

texpat's picture

Here in Texas, lowest available rates for residential are dropping about 15% or so. Sadly, it still takes 30 days to switch contracts to the cheaper provider, so we've missed the best savings on the most expensive part of the year, but hey, headed in the right direction.

paydirt's picture
paydirt (not verified) texpat Aug 20, 2009 5:44 PM

Indeed. When are option grants, vesting, and exercise counted in this ratio? good articles; good articles 4 slow news day ..http://www..
hat tip: finance news & finance opinions

cougar_w's picture

[gasoline] Here in California (silicon valley) people are trapped in long commutes with virtually no access to mass transit. The price is hovering around $3.10/gal for 4 months now, right now is heading back up; the oil oligarches have found their sweet spot. The ones still buying gas will continue to buy it at $3.25, then $3.50, and up past $4 because THEY HAVE NO RECOURSE. The price will go up just slow enough to avoid a very public backlash and congress-critter posturing, and everyone (inlcuding the motorists) will go forward as if this is just how it is.

The economy cannot recover with gas over $3/gal. The household balance sheet here in CA will simply not support discretionary spending with that much money going out as a utility. Not unless the banks open the credit spigot, at which point things take off again for maybe 4 months.

The vise is closing. The squeeze is on. The last discretionary dollar was spent last year, the game now is to get the last utility dollar. Then the game is over. Consumers (nay, we are citizens) will be tapped, exhausted, frustrated and afraid. They are nearly there already. They will park their cars, get in line at the food bank, and wait it out.

What will be the tax income to the state -- and the national economic picture -- when that tsunami hits?

cougar

citizen38's picture

One more time boys & girls you need to read Mish's explanation of inflation and deflation:

The logical outcome of the above discussion is that a proper definition of inflation or deflation must be built on the foundation of a sound definition of money supply that distinguishes between money itself and credit. The definition should also ensure that the horse and the cart are in their proper places.

With the above in mind:

  1. Inflation is best described as a net expansion of money supply and credit.
  2. Deflation is logically the opposite, a net contraction of money supply and credit.
  3. Government mandated solutions to problems best left to the free market is the root cause of money supply expansion.
  4. With no enforcement mechanism such as a gold standard to keep things honest, and with no desire to raise taxes, governments simply approve programs with no way to fund them. The FED has been all too willing to play along by printing the money needed for those government programs. To make matters worse, the fractional reserve lending policies of the FED allows an even greater expansion of credit on top of the money printed. Eventually those actions result in a crack-up-boom and debasement of currency.
  5. Changes in "Purchasing power" required to buy a basket of goods and services can not be accurately measured because of the need to continuously add new products to the basket, because the measurement of quality improvements on existing products is too subjective, and because it is impossible to pick a representative and properly weighted basket of goods, services, and assets in the first place. Furthermore, such measurements are highly prone to governmental manipulation at private citizen expense. Endless bickering over the CPI numbers every month should be proof enough of these allegations.
  6. Measurement of equity price fluctuations poses a particularly difficult problem for those bound and determined to put the cart before the horse as well as those that think such assets belong in any sort of basket.
  7. Price targeting by the FED is doomed to failure because a representative basket of goods and services can not be created, because prices can not properly be measured, and because price targeting puts the cart before the horse.
  8. Expansion of money supply (typically to accommodate unfunded government spending) and expansion of credit (via GSEs, fractional reserve lending, and other unsecured debt issuance) are two of the biggest problems. Targeting the outcome (prices) can not possibly be the solution.
  9. Ludwig von Mises describes the endgame brought on by reckless expansion of credit: "There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved."
  10. The FED should have been listening to Mises all along. Instead they have put their faith in "productivity miracles", "new paradigms", and their own hubris. Those actions have accomplished nothing other than delay the eventual day of reckoning.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

 

Anonymous's picture

Agreed.

Rosie, like many others, leaves the world outside of the US out of his deflation/inflation equation. Other countries, with maybe the exception of the UK and China, are not printing money like mad, and if the dollar goes south, see what happens to inflation with fuel prices at $10 per gallon.

Anonymous's picture

It is inflation of things we need and deflation of things we already have. This is the best way the Fed can cause "max-pain" for the sheeple.

cougar_w's picture

Nice observation, I like it. Let me suggest however that this is less about pain. Rather it is the most efficient way to transfer the greatest amount of wealth from the lowest economic tiers to the highest without raising an alarm.

Once that wealth transfer is complete, raising an alarm won't matter.

This is exactly how you play the end-game. Set the framing, establish the rules to suit you, drive the ignorant into the dark night with nothing, destroy anyone with half a brain, build walls and set yourself behind them and venture out once the fires and lamentations have subsided. The survivors will embrace you as a savior.

It is worth noting that history is written by those behind the walls. In the end they will have done the best they could, and the rest will have been... regrettable.

cougar

ng2amarinefunk's picture
ng2amarinefunk (not verified) cougar_w Aug 20, 2009 11:29 PM

yes, THAT has been how 'history' HAD moved along -

i believe, however, that Hegelian/Lenin 'history' CONCEIVED as progress, MOVEMENT stories to be told by the fireside... this 'definition' of history, as a blundering mistake, and cycles of Life that repeat, and re-incarnate til the Karma is good,

in other words History as a Story For-tolded, up landing higher and higher in PROGRESS - its a rather, essentially STATIC story, not much more, really than the recital of Homer - indeed there is  even, a bit of male chavinistic 'victory' 'conquest' in the story, called 'History'

THATs over, not human nature, completely,

but the usual program entry, the usual basic Operating System instilled from childhood, and, even the hardware - DNA stuff has come for an upgrade -

a NEW history of PROCESS and REALITY, say, of ability to make up the story as we go along, the ability to instantaneously respond in new ways as needed, as enhancement of the very concept of 'a life lived fully'

curiously Hitler had THIS in mind with his folk people, with Jungs Archetypal studies, to live a life fuller, with more meaning, without the knee jerk Great Simplications, and quick fixes, include the needle administered 'fixes'

ng2amarinefunk's picture
ng2amarinefunk (not verified) Aug 20, 2009 11:13 PM

very very clever and cute, too

Groty's picture

Hog farmers are rapidly liquidating their herds because they can't recover their costs of production at current prices, and that's with corn down from about $8 a bushel a year ago to barely $3 today.

mgarrett84's picture

Sorry, a lil off topic.  But Goldman putting GOOG on Conviction Buy list,  Thats what tops are made of right?   

 

Anonymous's picture

No thats what $100mm trading days are made of. Those playing the pin GOOG game just got run over by the GS freight train.

deadhead's picture

close, but GS must first upgrade BAC from the Conviction Buy list to the "supercalifragilisticexpialodocious" Conviction Buy.

ShankyS's picture

LOL - you both stole my thunder. It is my belief that the buys are usually after the fact and adding a conviction buy is the death blow. I'm with you DH, will they introduce a stealth mega buy so they can take it any higher? We all know at this time the next move has to be down on their recs. I don't see goog making another C note from here.

ng2amarinefunk's picture
ng2amarinefunk (not verified) mgarrett84 Aug 20, 2009 11:35 PM

what one man can do, another can copy, eventually the front runner always takes the Hits first - Microsoft of course being different, let the 'Hits' be first taken by small, other companies, and THEN implemented their Microsoft business plan, based on the 'other mans' hard work - of course Google MIGHT just already have been flat for some time, already 'fully priced' 

I'd say that WHEN "goldman" puts some company on its conviction list SELL SELL and then borrow some stock and 'short sell'

HEHEHE's picture

There's three problems with the inflationista's arguments:  1) The huge amount of dollar denominated debt that needs to be destroyed; 2)The US money printing is occurring while most countries are doing the same to the relative impact is reduced; and 3)The unlikelihood of the dollar losing it's reserve currency status as long as the US has the strongest military.

As Rosie points out you are looking at years of deflation no matter what the US government does.  Ask Japan.  Their stock market continues to make all time lows.

Bearish News's picture

Unless the dollar starts to unwind, or even collapses.

Then Eric Janzen's Argentina 2001 scenario takes place, as I understand it.

lookma's picture

Janszen also thinks that even if we don't have a Ka-Poom theory event (which I don't think he is calling for in the USA), that the dollar is still depreciating.  Ka-Poom (prime example is 2001 Argentina) is more fiat relative to other fiat.  But they can all go down together.

http://www.itulip.com/forums/showthread.php?t=10874&page=2

http://www.fourthcurrency.com/

Anonymous's picture

Not sure if you saw it yet, but EJ just put out a great piece on how he sees the mechanics of inflation playing out in the U.S. Seems to be that he expects supply to be destroyed in the near-term.

http://itulip.com/forums/showthread.php?p=116417#post116417

Marley's picture

Doesn't deflation come before inflation?

lookma's picture

"2)The US money printing is occurring while most countries are doing the same to the relative impact is reduced "

There is no inflation because everyone is inflating, brilliant!

============

Some would argue that there are more meaningful comparisons than fiat to fiat, like for example fiat to precious metals, like gold.  Some think gold is a currency.

 

Marley's picture

A race to the bottom.

Anonymous's picture

comments on ML fund mgr survey Tyler?

Cash balances plunge to 3.5%, lowest since July’07;

• Highest equity allocation (34% from 7%) since Oct’07;

• Bond allocation (-28% from -12%) lowest since April’07.

• Tech (28%) is the most favored sector everywhere;

• 75% believe the world economy will strengthen in the coming 12 months (highest reading since November 2003 and up from 63% in July).

• 70% of the panel respondents expect global corporate profits to rise in the coming year, up from 51% last month.

• Confidence about corporate health is at its highest since January 2004

Anonymous's picture

That last point on next catalysts is an excellent one. The tsunami of liquidity that ZH rightly focuses on is going to create higher asset prices in some area. It always does. It may well be energy commodites, although tell that to a nat gas producer and they may disagree. At least so far.

Financial stocks seems to the near term answer, as long only managers pull out the recovery playbook and buy those assets.

Anonymous's picture

comments on ML fund mgr survey Tyler?

Cash balances plunge to 3.5%, lowest since July’07;

• Highest equity allocation (34% from 7%) since Oct’07;

• Bond allocation (-28% from -12%) lowest since April’07.

• Tech (28%) is the most favored sector everywhere;

• 75% believe the world economy will strengthen in the coming 12 months (highest reading since November 2003 and up from 63% in July).

• 70% of the panel respondents expect global corporate profits to rise in the coming year, up from 51% last month.

• Confidence about corporate health is at its highest since January 2004

Anonymous's picture

is this true?

"Today on #WBBR's 'Taking Stock' - Tyler Durden - Zero Hedge LLC, Yves Lamoureux - Blackmont Capital, John McDonnell - Patron 3PM ET"

http://www.zerohedge.com/comment/reply/17219#comment-form

Anonymous's picture

sorry here's the correct link

http://twitter.com/Bloomberg_Radio

mdtrader's picture

Rosie rocks. I think yesterday's move has more to do with option expiry. They want the S&P to go out around 1000 on Friday, I think.

Sqworl's picture

Because its programmed to do just that!

Anonymous's picture

Rosie was wrong on last who knows how many SP points and will stay wrong. By the time he becomes bullish - time to sell

McLuvin's picture

I'm sure he's pretty dug in at this point and will not turn bullish.  He will ultimately be right I believe, but he will not endorse this liquidity bull market.  His logic is very sound but he does miss the key drivers of this type of run-up.  Meanwhile, he and others provide enough fodder for bears that will keep this market from getting overly bought for too long, which ironically is bullish.

Sqworl's picture

Japan has been on Hamster wheel for the last 20 years!

paydirt's picture
paydirt (not verified) Aug 20, 2009 10:31 AM

I mean, something so mundane as inventory replenishment must have already occurred

Miles Kendig's picture

We have been seeing just that play out with the just in time story in the Baltic Dry, port activity, & tons/rail mile.

HEHEHE's picture

I for the life of me still don't see how another "stimulus" would, could, should alternate or divert our trip down the toilet.

paydirt's picture
paydirt (not verified) HEHEHE Aug 20, 2009 5:44 PM

Indeed. When are option grants, vesting, and exercise counted in this ratio? good articles; good articles 4 slow news day ..http://www..
hat tip: finance news & finance opinions

VLee's picture

It may not change the outcome, but more stimulus $=more ammo for me.

PragmaticIdealist's picture

Rosie has it all right except for the "monetary policy as an antedote" argument.

Printing money does not fix problems and it does not stabilize the stock market or bond prices. It distorts the markets by killing savings and routing money to risk markets, and by halting credit destruction which should probably be occurring anyway.

If the financial markets rebound due to money printing even without inflationary forces, it's by diluting the dollar and redistributing purchasing power to financial markets players. Players who, upon blowing their money on their previous gambles, have fresh capital to start afresh.

SWRichmond's picture

I'd be very interested to know if Rosenberg totally discounts the notion of U.S. sovereign default, and if so, why. 

"if the government fails to mop it up once the private sector debt liquidation ends, it does mean that an inflationary mistake lurks down the road. But as we have seen in other post-bubble credit collapse episodes, the initial period of deflation can last for years, during which the fundamental trend in bond yields will likely remain in one direction and that is down, to the surprise and dismay of the litany of bond bears that currently populate the capital market."

Is this just another "post-bubble credit collapse"?  Estimated losses dwarf those of GD One in inflation-adjusted terms.  The Fed and Treasury have responded with loans, backstops and gifts equivalent to U.S. GDP.  Seems more like an historic, global catastrophe to me.  Inflation is NOT a concern to me, it is currency collapse that occupies my thoughts.

"We have said often that just as society couldn't spell ‘inflation’ in 1937, it has no clue what causes deflation now. That's beginning to change in the aftermath of the housing and credit collapse, but try to explain the deflationary forces contained in debt liquidation or global manufacturing over capacity or a socio-economic trend towards savings, and the notion of ‘deflation’ gets fuzzy for most thinkers (even Warren Buffet). That doesn't change the fact that the deflationary forces are enormous (and current) and the policy-induced reflationary forces are a partial antidote."

I understand and appreciate quite well the deflationary forces that are in play now.  In fact, they form the basis of my argument: that the deflationary forces are so severe that, left unchecked, they will cause sovereign default.  Therefore, reinflate or die.  And yet, the act of trying to reinflate has required Treasury and the Fed to write so many deficit checks that our lenders are balking, and publicly.  The Fed has already resorted to SPV's.  The taxpayers are revolting (pun intended).  ZH has clearly documented the failure of these measures to reignite real economic activity.  Tax revenues continue to fall while demands for free money continue to rise. 

Maybe Rosenberg sees a bottom; is he expecting Japan?

John Self's picture

The challenge for the Fed is to convince us that it's ready and willing to spend ad hyperinflatium, while actually spending considerably less.  I'm not sure that's possible at all, and even if it were, I'm not sure we have the right people in place to accomplish it.