When A Great Deflationary Bear Starts Turning Inflationary

Tyler Durden's picture

Over the past four years one of the dominant "deflationists" has been Gluskin Sheff's David Rosenberg. And, for the most part, his corresponding thesis - long bonds - has been a correct and lucrative one, if not so much for any inherent deflation in the system but because of the Fed's actual control of the entire bond curve and Bernanke's monetization of the primary deflationary signal the 10 and certainly the 30 Year bond. The endless purchases of these two security classes, coupled with periodic flights to safety into the bond complex have validated his call. Until now.

In his latest letter the Gluskin Sheff strategist appears to be on the verge of a "tectonic shift" in his outlook and appears on the verge of transitioning to an inflationary view. The catalyst? The same one we have been highlighting for the past year - the central-planning induced breach of one of the most fundamental economic principles in the face of Okun's law, which traditionally has been the basis for the Fed's belief that based on current reads of output and GDP, the amount of slack in the system is still a very recessionary 6%, and that with further relentless monetization this output gap may be closed further resulting in a drop in the unemployment rate to the Open-Ended QE's target of mid-6%. However, as we also pointed out previously, this does not jive with the recent surge in labor costs and drop in productivity, both of which are indicative of far less slack in the system and a far smaller output gap, than the Fed believes is present.

Naturally, the logical conclusion is that with the Fed injecting $85 billion in deferred inflation into the system and with the output gap substantially less than forecast, the reflationary inflection point is certainly closer than many have feared. Certainly closer than a great deflationist such as Rosenberg has feared. From his latest letter:

What if the Fed is operating under a false presumption that the CBO's estimate of the output gap is accurate at 6%? And what if the pace of job creation of the past three months is the new normal and that the average pace of the cycle to date is yesterday's story? Well, that would mean that we get to the 6.5% unemployment rate — assuming that the participation rate continues to behave in the manner it has over the past few months — by early 2014. And unless the Fed changes the goal posts again, that would mark the end to this period of ultra-accommodation — aimed at monetizing debts for borrowers and generating asset inflation for risk-toking investors.


Of course, to be talking about inflation today sounds ridiculous, and until recently, I agreed with that. Maybe it's partly because having been in this business for three decades and seeing the Fed make policy mistake after policy mistake — tightening too far in rate-hiking cycles and invariably overstaying its welcome during the easing phases... So this wedge between real growth and real rates is the liquidity excess that is filtering through into the financial markets, triggering excesses in some cases (like in the credit markets).


Again, this is coming home to roost now with respect to deteriorating productivity trends. At the same time, the latest data on earnings from the payroll reports show an uptick in wage growth. This is happening even with a jobless rate of 7.7% and a U6 rate of 14.4%. One would ordinarily believe that we have tremendous slack in the labour market looking at these figures. But maybe the pool of available skilled labour has already been largely drawn out.


If the output gap is actually closer to 2% or 3%, which is quite conceivable, actually, then we are talking about an equilibrium Taylor-based funds rate of 0% — not the de facto -2% that the Fed is targeting via its unconventional easing experiment — and as such, maybe adding more securities to its balance sheet is providing too much juice to the system and risks building an inflationary process in the future. As Herb Stein famously said, anything that can't last forever by definition won't. At some point something will change, and if history is any indication, it is the cyclical view on inflation and how the Fed responds, or whether it will let itself further behind the curve (of course, when the central bank is influencing the price signals by buying up the entire long end of the yield curve) [ZH: someone gets it].


I am not totally changing my view and l am probably way too early as I am talking for the first time in a long time about inflation. I am only detecting some tectonic shifts. Productivity waning. Wages on the rise. This means rising unit labour costs which in turn have their own correlation with inflation — like an 87% correlation (and 84% with the core CPI rate). As a long-term bond and income bull, I am not about to throw in the towel. But to reiterate, I am no longer in this profession of identifying probabilities, in the same comfort zone as I once was. Stay tuned as my thoughts evolve on this file.

And this of course is the Fed endgame: there are tens of trillions in excess debt that can only be inflated away (absent an outright default) and the Fed, as is to be expected, demands inflation, and will get inflation one way or another: whether supply-push, demand-pull, or outright currency obliteration. The problem then will be when does the Fed admit and acknowledge that inflation has set in (besides the obvious bubbles in equity, credit and real estate which Bernanke and Company are so unable to notice in real time). How much longer after inflation has set in does the Fed continue injecting tens of billions in liquidity each month, which is the only reason the stock market has levitated as it has? But the biggest question is what happens if and when Bernanke, like Rosenberg, finally sees the light and says no more to the liquidity Kool-Aid... or even if that will ever happen?

Because if Rosenberg is right, and he certainly agrees with us that achieving a 6.5% unemployment rate with labor costs already rising is virtually impossible driven solely by rising risk asset prices in the current regime, a major regime change is just around the corner.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Ahmeexnal's picture

sheeple are sheeple

Abraxas's picture

Nobody could have predicted that inflation, and not deflation, would be a ruin of the West. Nobody, since there's nothing beyond the media.

Cult_of_Reason's picture

Bernanke is a modern John Law (held views that money creation will stimulate the economy, that paper money is preferable to metallic money which should be banned, and that shares are a superior form of money since they pay dividends).

He was responsible for the Mississippi Bubble and a chaotic economic collapse in the early 18th century France.

Pinto Currency's picture

The CB's print $12 trillion and maybe, just maybe, we will have inflation.

I'm not quite certain.  Hmmm.

SURPRISE!  We have hyperinflation.

narnia's picture

The level of uncollateralized worthless credit in the system dwarfs the effects of labor rate changes. When the mark to market iceberg breaks, for whatever reason, they'll be the mother of all margin calls. The Fed will fail at preventing this credit purge.

Pinto Currency's picture


The action in Cyprus and the revelation that the BIS / IMF / EU / Cdn Gov etc., etc. plan to confiscate cash deposits to protect distressed banks may lead to depositors withdrawing enough cash that banks are forced to sell bonds/debt to raise further cash.

This could be the trigger that raises interest rates and sets-off a crisis.

LawsofPhysics's picture

Correct, resource scarcity always trumps these types as innovation takes time and advances much slower than population growth.  The "price" becomes irrelevant when some you need for survival simply isn't available, period.  Oh well time for humanity to re-learn what "wealth" really means again.  Hedge accordingly.

Dr. Kenneth Noisewater's picture

So the smart thing to do would be to borrow as much as you can right now and buy assets, then pay off those loans with inflated BernankeBux.

LawsofPhysics's picture

Only if you are close to the "free money" spicket, otherwise you will still depend on revenues and peoples wages going up in order to collect those benankeBux.  I certainly would not count on that.

tbone654's picture

yes... but what else you got?  still requires some agility to know when to get out...

Ahmeexnal's picture

Watch Bela Tarr's last film ("Turin Horse") if you want to know the endgame.  Listen to what the guy who shows up for booze has to say.

bank guy in Brussels's picture

For those not familiar with European film, here is that scene from 'Turin Horse' ...

A man walks in to buy a bottle of liquor ... says he did not go into town, because the town has been in destroyed

And then goes into a five minute quiet rant ... about how the bad guys win in the world, they own everything ...

And how what you would imagine or hope is the 'opposition' ... in fact gives up and fades away, when they realise that they have no hope, no chance ... because, the man claims, there is no god [this is a pessimistic pro-Nietsche movie]

Cinematically well done, but depressing ... and many of us would disagree, believing that there is a God and heaven, and justice that will come one day ...

But worth a look ... the same kind of gloomy European film tradition as Bergman's great 'The Seventh Seal'

The 'Turin Horse' scene here on YT with English subtitles, and its theme of the

« disappearance of the excellent, the great, the noble ... »


macholatte's picture


I haven't seen the film but let me guess what happens........ nothing.

The man continues to drink and complain and makes himself comfortable foraging at the bottom of the garbage pit because if there was a God, he'd be the one who was rich and shitting on the other people in the bar and that would be justice, ahem, social justice.


walküre's picture

The man should figure out how he can capitalize from gullible people willing to throw time and money at just about any form of religion professing there is good and bad and eternal justice for the poor and dumb.

If people realized there was absolutely nothing after their lives ended and just accepted that, the world might be looking alot better. What you do here and now matters and what you can accomplish here and now is all there is. If you screw up, you screw up for good and won't get a second chance.

The End.

Kayman's picture

Fractional Reserve banking = proof there is no god, only god wannabees.

DCFusor's picture

L Ron Hubbard did just that - professed at a SciFi writers conference that they were all in the wrong game, since they knew how to make decent sounding alternative realities.  The rest is history - and people fell for it despite this being fairly widely known.

However, that doesn't mean all theology is junk - merely that professed by nearly 100% of all organized religion.  The crowd won't take anything else, I know from experience.  It's not that there is no truth, it's just that no one wants to hear that - they want their fairy tales, and that's the only thing nearly everyone will fall for.

The bible does not say you have to die to get into the kingdom of heaven - that's a distorion created by the practicioners of religion, which has little or nothing to do with faith or truth.  It's here and now, and it's what you do here and now that counts...and that IS in the bible.


DosZap's picture

The bible does not say you have to die to get into the kingdom of heaven - that's a distorion created by the practicioners of (SOME)religion, which has little or nothing to do with faith or truth. It's here and now, and it's what you do here and now that counts...and that IS in the bible.

Yes, the moment you accept Christ(by Faith,and believe,and profess) Rom 10:9-10, Eph:2-8-10, you are in.IN the Kingdom of heaven immediately.

and it's what you do here and now that counts

Partially, there is nothing YOU can do to work your way in, that is what separates Christianity from Religion.(If that is what you meant).Christianity in not a religion,it is a way of life.But after this we are meant to do good deeds,to show our faith is real,(not just Fire Insurance.)

robertocarlos's picture

G-d helps those who help themselves.

DosZap's picture

G-d helps those who help themselves.

Nope, just the other way around.

GoinFawr's picture

Ask not what your god can do for you, but what you can do for your god?

DosZap's picture


Read my post above,YOU,in and of yourself can do NOTHING for GOD.(without Faith it is impossible to please him).

GoinFawr's picture

Read my post DZ, it's all second person.  Little to do with me; as long as you stick to practicing what you preach, anyway.

Ahmeexnal's picture

With the beautiful Alida Valli, who stared in italian version of Ayn Rand's "We the Living".

Filmed during il Duce's iron grip, the filming was heavily monitored. When il Duce proudly showed the film to his teutonic overlords, they went ballistic and ordered him to destroy all copies of the film as they realized it was extremely dangerous (il Duce thought it was only a condemnation of communism, but his overlords understood it applied to all tyrannies).

One copy survived, and made it to our day.


msmith9962's picture

Mr. Ahmeexnal - i'm streaming it on netflix now.  I'm 10 minutes in, your killing me here.  Can you just tell me what the boozer has to say? My american attention span can't handle this  ;-)

Ahmeexnal's picture

Be patient, it will be worth every minute.

fomcy's picture

"Today’s Massive Attempt To Break Gold
April 2, 2013, at 8:32 am
by Jim Sinclair in the category General Editorial |

My Dear Extended Family,

This is a massive attempt to break gold in order to camouflage the weakening Western banking sector. Paid bashers are flooding in to all pro-gold sites and many other pro-gold sites are under attack in other ways.

Gold banks are flogging the paper market seeking to depress the price but without selling too much.

It is so obvious that this is a gold bank organized strategy to keep gold under $1600. Old lows will hold and the reversal will be at a spiritual level.

My strategy is to simply to do nothing."

macholatte's picture


I have a theory....... based upon no quanttative evidence, but yet a hunch.

Here it is......

During the past year or so, whenever PMs have dropped for no logical reason, a financial crisis surfaced shortly thereafter. Later, when "calm" is restored, the PM's spike up.  So maybe another EU coutry is going to crash soon.


Ahmeexnal's picture

The small strip of Slovenian coast is about to witness lots of naval calamities.

robertocarlos's picture

I thought the giant S stood for Spain and here it is Slovenia. And I also would have hoarded the Euro notes stamped G. A little bit of knowledge is a bad thing.

Debugas's picture

my guess is Italian Monte Paschi is going belly up

AGuy's picture

"Paid bashers are flooding in to all pro-gold sites and many other pro-gold sites are under attack in other ways."

Hope they win! I would love another discounted buying opportunity. Also hope they do the same for the other heavy metal commodity that contains lead and brass.

As I see it, we have two gov't departments buying Heavy Metals. We have Central Banks stocking up on PMs, and we have gov't departments like the DHS buying up all the lead and brass available. Too bad hoarding regulations don't apply to gov'ts.




CheapBastard's picture

We are in a pre-hyperinflationary stagflationary depression right now depending on where you are located on the totem pole. Bankers are still at the top with little to no pain....public sector not too bad, and privately employed, middle class sector getting royally reamed with little to no KY lube and the ss retiree group devastated by ZIRP's 0% COLA and soaring food prices.


jerry_theking_lawler's picture

was told at my local deli today that my normal chef salad was increasing 20% in price....due to increase in input costs (ingredients that make it up).....

yep, no inflation to see here, move along.

Buck Johnson's picture

I know, only the economists who have written about what we did would cause inflation aka hyperinflation.  It will kill our economy and also our govt..

MayIMommaDogFace2theBananaPatch's picture

sheeple are sheeple

didn't take you for a Depeche Mode fan...

JustObserving's picture

When A Great Deflationary Bear Starts Turning Inflationary

make sure that you hammer gold and silver - Bernanke's red book.


Ying-Yang's picture

"But maybe the pool of available skilled labour has already been largely drawn out"

He makes a good case for this. By the time you see it, it's too late.

Political_Savage's picture

Does he only consider the skilled labor of the domestic pool, meaning Americans? Because I wonder about the impact of skilled immigrant labor... which companies are apparently maxing out Visa-wise. America still draws the best and brightest (open to argument in regards to China) from around the world.



are we there yet's picture

Yen-yang... Going out to lunch on todays workday in Houston, I saw lots of unemployable looking youth on cell phones walking aimlesly as far as I could tell. Healthy,young, hoodie 20ish somethings that I whould be unable to inspire or lead as employees for any kind of work I can think of.... so maby you are right 'the pool of available skilled labour has already been largely drawn out'

Snoopy the Economist's picture

I wonder what most of us looked like to the then 40-50 year olds when we were in our 20s. I know I was in college and then working in my 20s - but hey you were walking around at lunch just like them. I wonder what they thought of you.

mkkby's picture

Except we've never had a whole generation of young people coming out of school with no opportunities -- except taking on a crippling amount of student debt just to delay the inevitable lower middle class existence. 

They know their future is bleak, so they make do with welfare and living with their parents or multiple room mates.

walküre's picture

Everyone is suddenly "employable" when their lives depend on it. Turn the wifi off, cut the phone lines and see what's cooking under da hoodie.

pitz's picture

Maybe they're like that because the employers that actually pay a living wage generally won't give the 'time of day' to younger people.  May as well have fun, instead of giving your labour away for free.

Danielius's picture

hey whatever happened to the "BITCHEZ"  or however he spelled it- guy.  ?   I was thinking that was part of the deal here.  wtf?  Been missing that!