Are Animal Spirits Deflating?

Tyler Durden's picture

Submitted by Tim Price of The Price Of Everything blog,

The Fed insists on saving us from ‘everyday low prices’ – they call it deflation. I submit that in a world of technological wonder, prices ought to be weakening: it costs less to buy things because it costs less to make them. This benign tendency the Fed resists at every turn. It wants the price level (as it defines it) to rise by two percent a year, plus or minus. In so doing, it creates redundant credit that finds its way into other things. These excess dollars do mischief. On Wall Street we call this mischief a bull market and we’re generally all in favour of it..


The Fed, in substance if not in name, is [still] engaged in a massive experiment in price control. (They don’t call it that.) But they fix the Fed Funds rate, they manipulate the yield curve.. they talk up the stock market. They have their fingers and their thumbs on the scale of finance. To change the metaphor, we all live to a degree in a valuation ‘hall of mirrors’. Who knows what value is when the Fed fixes the determining interest rate at zero? So I said “experiment in price control” but there is no real suspense about how price control turns out. It turns out, invariably, badly.”


- James Grant, recently interviewed on CNBC.

Consider the following table. As we showed here, it shows the recommended positioning of Wall Street’s finest with regard to bond markets and equities. (This exercise may well show that when everyone is thinking the same, nobody is really thinking at all.)

As far as the sell side was concerned, brash individualism and bold contrarianism died some time during 2013. By the start of 2014, all that remained on Wall Street was the hive mind of the Borg – a rather bland consensus that bonds were bad and equities were good. Astonishing that stockbrokers might possibly nurse such bias. So January’s primary trends (bonds rallying, and equities tanking), if sustained, may serve to remind us all that unsolicited sell side research, being to all intents and purposes free, is worth precisely what folk pay for it.

If the last investor is already loaded up to the gills on stocks, where is the greater fool to whom those stocks can then be sold? January may have given us an answer. Pimco’s Bill Gross comes to a similar conclusion in his latest investment outlook, from which the following is taken: “careful.” Bull markets are either caused by or accompanied by credit expansion. With credit growth slowing due in part to lower government deficits, and QE now tapering which will slow velocity, the U.S. and other similarly credit-based economies may find that future growth is not as robust as the IMF and other model-driven forecasters might assume. Perhaps the whisper word of “deflation” at Davos these past few weeks was a reflection of that. If so, high quality bonds will continue to be well bid and risk assets may lose some lustre.

Astonishing, too, that the world’s largest bond manager might possibly nurse such bias in favour of “high quality bonds”. Especially when they’re not (high quality, that is) – there just happen to be oodles of them. But the fact remains that investors seem to have been spooked by the final arrival of Fed tapering, and those in emerging markets doubly so. But since we’re all trapped in what James Grant calls that valuation ‘hall of mirrors’, courtesy of central banks endlessly tinkering with asset prices via the most aggressive monetary stimulus in world history, it’s not remotely easy trying to foresee the outlook for either bonds, or stocks, or anything else. Rather than just abandon the field and sit disgruntled on the sidelines in cash, our response is to seek solace in the most compelling examples of deep value we can find, both in the credit market and in stocks.

Tim Lee of Pi Economics also sees evidence of a growing deflation shock. His chart below shows that a proxy for global broad money growth (a simple weighted average of money growth rates for the US, the Eurozone, the UK and Japan) peaked in 2011 and now appears to be rolling over.


Tim now expects major equity markets to continue to decline as the crisis in the ‘Fragile Five’ economies accelerates. “At some stage the dollar will then begin to appreciate more broadly and Eurozone yield spreads will begin to blow out. Treasury yields will, of course, continue to decline.” If this comes to pass, Wall Street will have managed to get its asset allocation advice for 2014 precisely wrong on both counts. Developed equities will fall, while fixed income (notably US Treasuries) will rally further.

Macro hypothesizing is all very well, but it at least partly assumes that the hypothesizer is benchmarked and in our case, we’re not. We don’t currently have significant exposure to developed world equities since we see much more compelling value (in classic Graham & Dodd terms) in certain pockets of the Asian markets. And we currently have no exposure to US Treasuries because we can access higher real yields with objectively superior credit quality elsewhere. That is, of course, a raging anomaly, but we never said markets were entirely or even necessarily remotely rational.

We always thought that markets (in both the debt and equity spheres) were overly complacent about the risks associated with Fed tapering. Last year, for example, the Fed printed and bought $500 billion-worth of US Treasuries – and the Treasury market still went down. The idea that the Treasury market would shrug off the determined departure of its biggest buyer in 2014 always seemed nonsensical. Now, however, there is increasing reason to fear deflationary forces at work throughout most of the developed markets other than Japan, so the price dynamic for Treasuries has changed markedly.

Similarly for developed world equities, where the gyrations of January indicate – to us – a market that is coming to the slow realisation that it has already stepped over the cliff edge. Unfortunately many investors, with central banks having slashed deposit rates to de minimis levels, have gone ‘all-in’ with regard to risk assets in the desperate pursuit of yield. Be careful what you wish for. It is quite clear that central banks will do literally anything within their power to attempt to avert deflation – to ensure that “it cannot happen here”. That does not mean they will succeed – but they may end up destroying fiat currencies in the process (one of the reasons we have consistently held gold).

Tim Lee believes it is “quite obvious” what the Fed will ultimately do:

They will expand their balance sheet dramatically further by doing QE in outright risk assets – junk debt, equities, etc. They will swap money for risk assets, not money for safe assets.


The problem is that this would be a very big step; a further violation of the ‘rules’ of central banking. And we have a new Fed chairman, who has only just taken office. It is likely that things will have to get very bad before that very big step can be taken.

Six years into this crisis, and in the words of Lily Tomlin, things are going to get a lot worse before they get worse. From our perspective as asset managers, it comes down to a simple mantra: continually question precisely what you own, and why you own it.

Comment viewing options

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

Monetary Base has stopped it’s year long $100 B/mo growth and as of Dec added only $30B, Jan added just over $10 B/mo…likely to rollover and go negative in Jan???  Big change in trajectory since November…prior to taper $10B (now $20B/mo taper)??? 

here are the last five months…after growing by about $100B/mo all ’13..Novembers growth was $31B, Dec $13B…and likely going negative in next month…

2014-01: 3,749.462 Billions of Dollars

2013-12: 3,736.789

2013-11: 3,705.077

2013-10: 3,610.306

2013-09: 3,508.808

Liquidity pool sprang a leak or is it being drained on purpose???

Flakmeister's picture

Maybe some of that debt is making its way to money heaven....

LetThemEatRand's picture

"money heaven"

I think you just nailed Jamie Dimon's password to his personal accounts.  Cufflinks is also a good guess.

max2205's picture

When the fed buys my house at's game over

Ham-bone's picture

Little wonder the EM's are freaking out. Fed's announced $10/B and then $20/B mo reduction of QE resulted in about $250B of $ flow / liquidity reduction over last 3 months EM's had come to depend on over the course of '13...

Reverse repo's fast at work???  Not sure they're rdaining the swamp...but definitely cutting off the flow of new water, and with thiss level of leverage, a tipping point may be all that's neccessary?  We'll now next month if they really are truly starting to drain the liquidity!?!

Real question is WHY???

LawsofPhysics's picture

Reverse repos exceeding 110 billion, yes, someone else big is going down, but who, and why? Does it really matter one bit if the BRICs go play in their own sandbox...

Interesting times.

One thing is for sure, fraud is the status quo, and all ya'll know what that means.

X_mloclaM's picture


balanced expansion, ya need to match printing pace with deficit pace

as Fed Ts can't be pledged onward, to the degree Ts are making it back into the market from the SOMA consistently, it's only removing participants from the (non-Fed) repurchase market who won't need to pledge like collateral onward, reducing demand and the relative premium for liquid assets over non-marketable assets (reserves)

RR important in otherways, however, as it allows short-rates to be kept positive by decree, even while the Fed prints at varying paces all the while increasing liabilities relative to good assets (price would fall)

- negative short rates'd means shadow banking collapse, 1970's MMMF law essentially imploded, asset reflation failure

- cycling printing pace is good practice for sentiment training, bank prop positioning, and the take-a-breath ratcheting effect prolongs debt expansions rather than a brisk run up of debt/credit vs. real economic activity (cough China)

- to the extent reserves are 'drained', whether net of printing or not, it must be remembered it's voluntary market participants who are essentially depositing at the Fed rather than commercial banks, so the liability is just shifting from commercial banks to the central bank, if anything, freeing up regulatory leverage ratio for lending (one can't lend against the deposits held at the Fed that comprise the payments for the SOMA portfolio)

so this introduction of the new tool is very pro inflationary, very QE1ish, QE2ish, as those programs came to a dead-halt, this transition timed with (any?coming)Chinese error correction, Japanese tax hike, and relative US fiscal safety (gunna spend a lot soon)


ht Peter Stella, Tyler Durden

VD's picture

the game: Apoplithorismosphobia ---> rob 99% (more at 89%)...

The Limerick King's picture



Are animal spirits deflating?

The Keynesian boobs are debating

They see that demand

Is not what they planned

These morons we should be castrating

NOTaREALmerican's picture

I'm thinkin' a nice war with some evil-doers will git them aminal spirits flowin' again.  

Why,  I bet a nice war - with a typically fearless Merican leader - telling da troops to go shopping to defeat the evil-doers will work (again).  

pachanguero's picture

Just BTFD don't you get it?  the Fed is on our side!  What could go wrong? <S>

Ignatius's picture

"Animal Spirits" is code and cover for the fact that normal economic growth is normative ('S' curve) while debt growth is exponential (parabolic).

If ZH hates Keynes, why use his fucking language?

Cacete de Ouro's picture

This is a case for ....Ace Ventura - when nature calls

LawsofPhysics's picture

Animal spirits?  In today's politically correct fascist "my kid's a winner because I am in the club and can buy his future" world?



Say it with me, you know you want to...

Roll the motherfucking guillotines already, we let the weak paper-pushing fucks take over...

Nothing changes otherwise.

Moe Hamhead's picture

Why does that table look like an airline seating chart?


Manipuflation's picture

Mrs M said I had to read something and she worked hard to translate it.  It is usually me telling her she needs to read something and not the other way around.  Mrs M wouldn't translate it if it was not worth it.  I do not know where else to post this but if you really want to know what Russians think it is all right here.  Mrs M asked if I would edit it but I said "I am not touching that one".  The point was made.  I hope you enjoy. 

Professional athletes - lazy freeloaders. These people don't produce anything, neither cultural, nor intellectual or physical product. Nor even services. Even fucking hipster, smuggling trendy Converse sneakers in his luggage from US to Moscow, creates a service - supplying a customer with desirable, hard to obtain in Russia product, delivering those sneakers to your door. All while athletes do nothing. They are just training. Year after year. Month after month. Million after million (of taxpayers money). Then they compete and suddenly it turns out that these people, who can't even smuggle sneakers, are pride and embodiment of our country. We all should be proud of them because nothing makes you more proud as a genetically modified pumped with pharma mutant-freeloader, who went downhill on his sled and was one second faster than the mutant from neighboring country. No, do not misunderstand me, amateur sport is great. Mostly because amateurs compete in, you are correct, amateur sport. Those are the people that have other things they do in their life except going downhill on the sled. Went downhill on the sled, then fixed nuclear reactor, or composed an opera, no questions asked. That is great and that is right. However, when the whole life consists of running on your skates (to prove what? to whom? why?), that person is insane and needs a treatment. Even more, we all need to be treated because that person wastes our taxpayer money to run all day on his skates. No, if you are a billionaire, you can afford to run on skates the whole day, or walk on your hands upside down, that's your right to spend your money in a way you see fit. Those freeloaders compete using our taxpayer money. I can understand hockey, it's a huge, self sustaining, even profitable business. Just like a reality show, your goal is not to win, but to create a great show, with fights and drama. Or take figure skating, a great opportunity to look at 15 year old's toned thighs and mumble about "amazing technique, great performance, great butt". These sports I can understand, serious guys are beating each other with hockey sticks, fresh meat in spandex twirls this way and that way, people are going to watch it and pay money for watching. BUT A MOGUL? Do you know what a mogul is? They competed in it yesterday and someone even got medals. They have their own heroes, foes, schools, state financing of course. Or take skeleton. What Russian is not proud of our great skeletonists, that fought hard to win a medal competing with... whatever, somebody. Or lost. Who cares? 90% of Olympic sports are not interesting to a viewer. It's not a show, it's a fan club, party of genetic freaks, paid for from the federal budget. Nordic combined. Can anyone tell me what that is? When you have to wrestle one ski from the athlete and then the other? Or two people are pursuing you to steal your skis? Nah, whatever, we live in a free country and these "mogulers" and "skeletoners" can do whatever they want. Question is - why they do it using federal budget and why we should be proud of them? Like, you are just an ordinary engineer, working on a new power station project, but look at real hero, Akhmed Cocksucker, who moguls and skeletones better than anybody else, and changed the world! Not. That's a real hero, not you, not glamorous airplane turbine engineer. Yes. during times of USSR the stand off with USA in sports was a muted war, pretend war, lite-version of WWIII, that held attention of the world because of other super empire stuff. Those times are long gone, nobody can imagine a real war with USA (and Olympics as a form of that war). That colossal suspense is over but the herds of mogulists, skeletonists, bobsleists etc are still here. Here's what I want to tell you, 90% of professional athletes are freeloaders and welfare receivers. Only here it is possible to receive welfare and on top of that medals and honors. The rest 10% turn into reality show stars, puppets created for sparkling into the camera with their swarovski studded butts and boobs. I'm not saying it's a crime (after all they are not stealing, killing, although they could - look at the hockey players, ready to go gang). You just have to understand that any regular Russian who produces something is ten times more hero than all of those professional athletes combined. The sad reality of our world is that no one shows, say, work in nuclear physics lab ("OMG, they are so close to discovery, so close, look at their equipment and technique!"), they show us badly veiled striptease and fake fights of billionaires on ice, and make us think it's an object for pride and admiration. Grow, Russians, aspire, and someday you too will twirl your sparkly butt into the camera for the whole world to see! That is disgusting.


PhilofOz's picture

Gotta keep the masses amused and distracted somehow.

boogerbently's picture

You're tougher to read than Vonnegut.

Manipuflation's picture

I did not write it.  I just thought some ZHers might like it.  I know it is hard to read but is not for me to alter it at all but I do appreciate the Slaughterhouse 5 reference though.  Those Russians are not so different than us are they?

Cacete de Ouro's picture

Can someone explain how a Nigerian taxi driver can say with a straight face that he knows where he's going?

logicalman's picture

Depends where he is.

If he's in Nigeria, he's likely to do better than I would.

Ewtman's picture

animal spirits aren't the only thing deflating. In fact, not much isn't apparently


LawsofPhysics's picture

That's a whole lot of mental masterbation on that link.  Name one society or currency that has collapsed or died because it's purchasing power became too strong.

Wake us when the human population starts "deflating".  That's all that matters now, history is very clear on this.

socalbeach's picture

Some never seem to give up on the deflationary idea, no matter what. From the article,

"Tim Lee of Pi Economics also sees evidence of a growing deflation shock..."

and yet the accompanying graph shows weighted money supply increasing at 3+%/year. But since the rate of increase is decreasing (deflating), that's the new definition of deflation I guess.

X_mloclaM's picture

no matter 2007?

it's just that 'money supply' is typically M2 charts, and nowadays means M2+private credit creation, where it is the later that's deflating

not 'disinflating', which should also signify deflating net supply, but as you point out even that's wrongly used nowadays


repurchase agreements average less, one portion specifically is in mortgage backed securities, these aren't used to the same degree (as last month, or last year) in loans as collateral

Less reuse of the same collateral for multiple inter-institutional loans (onward pledging)

EZ loans (and thus deposits) are shrinking as bad assets are realized (correct me if I'm wrong, but that's net deflation in EZ, despite any M measure configuration)



Ewtman's picture

I don't remember reading anything about the currency collapsing. What I read said the currency would actually get stronger as the global economy deflated. Historically, collapsing currencies hyper-inflate... wiemar, argentina, zimbabwe, etc. Explain your point?

DOGGONE's picture

The simple truth is
"The Public Be Suckered (that's you)", at

Ewtman's picture

True that. More downside in housing to come per same Case/Shiller data extrapolated


Westcoastliberal's picture

I expected this article to be "Are animal spirits deflating....or is it from Fukushima".  You guys know we're experiencing a die-off, don't you.

Wait What's picture

God damn Bernanke, the AEA, and the Federal Reserve!!

I'll start singing their praises when they exit their 'extraordinary, unprecedented monetary policies.' why? cuz it's never going to happen! until then, the 'animal spirits' assholes are celebrating a touchdown at the 10 yard line. never mind the idiocy of subordinating the metric system. get with it, you fucks!!

rant of the day... i feel better now.

TheRideNeverEnds's picture

Tim now expects major equity markets to continue to decline 


So by decline he means they will continue to go up 1-2% per day right? 

moneybots's picture

Tim now expects major equity markets to continue to decline 


"So by decline he means they will continue to go up 1-2% per day right?"


No market goes straight down.



kurt's picture

I want my money back.

moneybots's picture

"We always thought that markets (in both the debt and equity spheres) were overly complacent about the risks associated with Fed tapering."


Put the horse before the cart.  The market was compacent about the risks associated with QE.  Bursting the bubble is not what creates the problem, creating the bubble is what creates the problem.  You can't burst a bubble that doesn't exist.