Gross Domestic Product

Is the coming financial collapse going to be inflationary or deflationary?  Are we headed for rampant inflation or crippling deflation?  This is a subject that is hotly debated by economists all over the country.  Some insist that the wild money printing that the Federal Reserve is doing combined with out of control government spending will eventually result in hyperinflation.  Others point to all of the deflationary factors in our economy and argue that we will experience tremendous deflation when the bubble economy that we are currently living in bursts.  So what is the truth?  Well, for the reasons listed below, we believe that we will see both.

There is a saying that debt can't buy growth. When it comes to the US, that saying is absolutely correct: only lots and lots of debt can "buy growth."

As the chart below shows, since officially leaving the gold standard in 1971, annual GDP growth has outpaced the growth of federal debt on just 11 occasions, and of these half were during the dot com boom of the late 1990s. Obviously this chart would look far worse if instead of just federal debt - which is merely a portion of total we used total credit market debt (which is some three time greater). But for illustrative purposes, merely Federal debt will suffice, because the parabolic "endphase" divergence between the two indexed lines - one showing GDP growth, the other debt growth - says more about the final outcome of this tragic Keynesian experiment than 1000 meandering, meaningless, trolling essays written by Nobel-prize winning economists ever could.

We totally get why many are excited by the recent cyclical improvement in the Japanese economy. However, just because industrial production is turning up on the back of exports and 1Q GDP grew more than expected doesn’t mean Abeconomics is working. Most of the improvement in Japan is probably best described as a standard cyclical improvement in the aftermath of very depressed growth that was also heavily influenced by last year’s downturn in global trade. There are definitely signs that Japan’s economy are improving cyclically. However, as UBS notes, structurally, demographics remain a major headwind to raising aggregate demand. We feel many investors have not yet considered what slower growth for Asia will mean for Japan in the medium term. This will make it more difficult to raise aggregate demand above supply since capacity is sticky and Japan already has excess capacity. So for Abe-believers there will be fuel to support their optimism. However, once you move beyond that and think about what comes afterwards things look more challenging.

A data-based look at the financial context of the past 30 years from the perspective of Gen X.

Most people do not think that Europe engages in Quantitative Easing. They know that the United States engages in it, that Britain engages in it and now that Japan engages in it but they think that Europe has so far refused to be involved. They think this because this is what they have been told. Unfortunately this is inaccurate. The European Quantitative Easing takes place every day just not in the manner utilized by America and others. However, it takes place all the same and it is done in a manner to circumvent the rules of the European Union. This is also why the ECB has such a massive balance sheet. What Europe has done is gotten around their own regulations which forbid the ECB from lending money directly to nations.

Once again: The FOMC minutes had nothing to do with overnight's events, especially since both Ben Bernanke and Bill Dudley made it very clear previously that for any tapering to occur (and which is supposedly bullish according to David Tepper, who may finally be done selling to momentum chasers) if ever, the economy would have to be be stronger (which is of course a paradox because it is the Fed's QE that is making the economy weaker). If anything, the minutes reminded us that there is a mutiny in the FOMC with finally someone having the guts to say on the record that Bernanke is blowing a bubble - something never seen before on the official FOMC record. And after all, the Nikkei opened way up, not down. It was only after the realization of what soaring bond yields mean for, wait for it, stocks (despite central planner promises that it is soaring bond yields that are a good thing - turns out, they aren't) that the sell-off really started. That, and of course copper, and the end of the Chinese Copper Financing Deals arrangement that has been China's illicit cross-asset rehypothecation scheme for years (more shortly). So in a nutshell, here is what has transpired so far, courtesy of Bloomberg.

Yesterday afternoon, following the rout in the US stock market, we made a spurious preview of the true main event: "So selloff in JGBs tonight?" We had no idea how right we would be because the second Japan opened, its bond futures market was halted on a circuit breaker as the 10 Year bond plunged to their lowest level since early 2012, hitting 1% and leading to massive Mark to Market losses for Japanese banks, as we also warned would happen. That was just the beginning, and suddenly the realization crept in that the plunging yen at this point is not only negative for banks, but for the entire stock market, leading to what until that point was a solid up session for the Nikkei to the first rumblings of a ris-off. Shortly thereafter we got the distraction of the Chinese Mfg PMI which dropped into contraction territory for the first time since late 2012, and which set the mood decidedly risk-offish, although the real catalyst may have been a report on copper from Goldman's Roger Yan (which we will cover in depth shortly) and whose implications may be stunning and devastating and may have just popped the Chinese credit bubble (oh, btw, short copper). And then all hell broke loose, with the Nikkei first rising solidly and then something snapping loud and clear, and sending the index crashing a massive 1,143 an intraday swing of 9% high to low, leading to an over 200 pips move lower in the USDJPY, and leading to a global risk off across the world.

Do you need a break from public policy buzzwords? Are you happy to go back to the days when cliffs were discussed occasionally on the National Geographic channel but not analyzed ad nauseum on CNBC? Are you tired of reading about austerity, austerians, anti-austerians and austeresis? You’ve come to the right place. “How long have we been deleveraging?” – I’ll answer “zero years.” As in, what deleveraging? We haven’t even gotten started yet.

"The economy is amazing right now - employment is recovering, innovation is going and housing is reviving.  What's not to love?"  This was a statement we heard in the media to justify the recent rise in the stock market. However, back in the real world, what is clear from the two composite indexes is that the broad economy, and by extension underlying employment, has clearly peaked and has began to weaken.  This is well within the context of historical trends and time frames.  While the mainstream analysts and economists continue to have optimistic views for a resurgence in economic activity by years end the current data trends, both globally and domestically, suggest otherwise.

As the global equity and bond markets grind ever higher, abundant signs exist that we are once again living through an asset bubble – or rather a whole series of bubbles in a variety of markets. This makes this period quite interesting, but also quite dangerous. This can be summarized in one sentence:  How could this be happening again so soon?

A week ago it was the better than expected weather's fault for the big Wal-Mart miss. Today, it is the turn of that other retail bellwether, Target, to blame sunny days. From the release: "Target’s first quarter earnings were below expectations as a result of softer-than-expected sales, particularly in apparel and other seasonal and weather-sensitive categories,” said Gregg Steinhafel, chairman, president, and chief executive officer of Target Corporation. “While we are disappointed in our first quarter performance, we remain confident in our strategy, and we continue to invest in initiatives, including Canada, our digital channels and CityTarget, that will drive Target’s long-term growth."

Curious how to trade those Goldman recommendations, such as today's uberbullish "strategic" call seeing nothing but blue skies all the way through 2015? Here is a quick reminder courtesy of your friendly FX wizard, Goldman's Tom Stolper. "On April 18 we recommended going long EUR/HUF. Our view has been that higher US yields would hurt a number of EM currencies (including the HUF). We also thought that ongoing monetary easing in Hungary would further compress interest rate differentials, leading to a gradual weakening in the currency. Although both macro drivers materialized, the HUF strengthened, contrary to our expectation.... we recommend closing the position with a potential 2.86% loss (including negative carry of about 32bp in total)."

If this plan fails to bring about economic growth in Japan, or worse still fails to bring about growth and unleashes inflation, then it’s GAME OVER for Central Bankers. Their one great claim “we’re not doing enough QE” will have been proven to be total bunk.

Preview of tomorrow's Bernanke testimony and FOMC minutes.

Has China been hiding the real state of its economic data?