just in in-tray, a discussion between an american, the austrian and a scot
american: Heinz are you thinking the percentage of bears on t-bonds supports expectations of continued low interest and deflation? I know you are into history. Do you know of historical examples where government controls the money, budget deficits become chronic and the result is deflation? I am worried that my expectations are becoming fixated and I might overlook something. Right now I spend my time worried about when inflation will hit and how hard it will hit. I think choices are limited on how to keep up with inflation so I don't worry about that much. Looking at the budget numbers of the US and other "modern" economies I can see very small chance we could muddle through much like Japan but nothing I would put money on.
I am watching unemployment as a measure of political pressures and expecting to see more examples of creative "printing".
How much fraud or market manipulations take place might not matter much in the big picture unless you end up holding a promise to pay that is defaulted on. I wonder if the t-bonds trade in a truly open market at this point. Just like the metals market I assume regulation of the markets is "light" and you want to avoid leverage so you can wait for the long term trends to come to you. At least some of the time I would classify the piling on to momentum by a very small number of traders in metals as manipulation but it is not my main concern. Inflation when and how much is what I see as the most material thing for the next five years because I am thinking that adjusted for inflation most investments will be a net loss unless you are busy day trading and get it right every time.
I think history can teach us about what to expect in the future so I want to thank you for your posts that used historical examples.
player heinz: i've mentioned a historical example that may be pertinent before (apart from Japan's experience). in the period beginning with the 1929 crash, which resembles the current period insofar as private sector debt had also grown to unsustainable levels and a long period of private sector deleveraging ensued, there were only three years of genuine deflation - i.e. a time period during which the supply of money actually declined (note that the reason that the money supply declined had nothing to do with the Fed's alleged 'unwillingness to print money', which was later deemed to have been its failing by Friedman et al. - on the contrary, between late 1929 and mid 1932, the Fed expanded free bank reserves by over 400%. the reason why the money supply declined anyway were reserves not under the Fed's control, and the absence of FDIC insurance. when a bank went under, it took its remaining deposits with it to money heaven, and so the money supply declined in the wake of thousands of bank failures and plummeting credit demand).
this was followed by not only large rates of montary inflation, but also soaring budget deficits. and yet, the all time low on the 10-year note's yield occurred a full decade after the the genuinely deflationary period ended, in 1942.
i've mentioned the reasoning a few times before as well....the bond market seems more focused on expected future CPI than anything else, whereas the gold market seems to look further ahead, and reacts more directly to increases in money supply and government debt.
it is rarely talked about, but both bonds and gold have performed very well over the past decade. contrary to the 1970's, they have not trended in opposite directions. now, i have little doubt that we are ultimately headed to a conflagration of the debt and the underlying currency system - but the timing is to my mind not so clear cut. i expect several more episodes of deflation scares, followed by inflation scares, until some sort of threshold is reached when the wheels come off the wagon.
in medium term time frames, the Fed acts countercyclically, i.e. it inflates the most precisely when deflation scares become the market's major focus (see both 2001/2 and late 2008/early 2009, which were the heights of monetary pumping, and concurrently the time periods when people were most worried about DEflation), and it inflates less when inflation concerns (or let's rather say, concerns about falling and/or rising prices) become prevalent.
for instance, in mid 2008, Bernanke explained to Congress that he thought that the rising price of crude oil may 'create inflation' - which is of course complete nonsense, but he seems to believe it. so he didn't , at the time, want to 'overdo it' with rate cuts and money printing, so as to keep 'inflation exectations' in check. there is in reality never a time under the fiat money system when the Fed does NOT inflate. there are only times when it inflates more, and times when it inflates less.
so i can for instance prove right away, that from 1980 - 2010, there was not a single micro-second of monetary deflation. and yet, there was no bear market in bonds, on the contrary. in short, whether one should be bullish or bearish on t-notes and bonds does not necessarily depend on there actually being 'deflation'.
however, i bet that when the stock market declines next time, bonds will rally, and possibly rally big. the argument that foreign demand is receding is imo not so important given that domestic demand seems quite capable of replacing it thus far.
meanwhile, from a technical point of view, the fact is:
1.the secular up trend line in bonds seems in no way endangered. 2. everybody hates them. the Rydex inverse bond fund has reached a new all time high in cash flows and assets. speculators hold a record net short position in t-note futures. the Barron's poll has 1% bulls left.
my experience with such situations is: a market that is in a long term uptrend that has not been violated and is hated by everybody is highly unlikely to go down in the near to medium term. it is more likely to go up.
there may at some point come a hyper-inflation period like the one you described earlier - but i don't think it's imminent. it will take some time before faith in the monetary authority is truly lost.
walker: Just to add my tuppence-worth to Heinz’s more-than-full explanation of why inflation is not inevitable despite central banking proclivities. There is a bizarre separation of economic activity in people’s minds: commentators and mainstream economists seem to think that there are three sectors of the economy that have to add up to balance, the external sector, the private sector and the public sector. This is, like Bernanke’s view of the oil price as potentially inflationary, complete nonsense. The private sector and the public sector are the same thing. Who finances all public sector spending? Which government has money of its own? Some will argue that the government can print money and thus ‘monetise’ debt via inflation but the problem boils down to Ricardian-equivalence.
The private sector is heavily indebted and want to reduce its debt burden (repay debt or, in other words, contract credit). This is deflationary. The public sector – in its infinite stupidity – is trying to offset the private sector in building debt and therefore ‘keeping activity up’ (even if it is false/artificial activity, which it is). But the private sector knows that every instance of public sector debt accrual is a future tax liability (just another name for debt servicing except you can’t default). In order to stabilise the private sector’s overall debt burden it has to redouble its efforts to pay down privet debt in order to offset government’s futile attempts to p*ss into the wind. That is why credit contractions take years to complete rather than months.
And if the government embarks on a debt monetisation strategy the private sector’s response is even worse. It redoubles its efforts to pay down debt and it begins to expect higher interest rates in the future so DECREASES its willingness to spend on capital (I am thinking of the private sector that really matters here, entrepreneurs and companies). This happens because the anticipated future growth under a higher future interest rate scenario is low (by the way, the growth trajectory gets even worse if inflation does take off because then no-one can work out what the real return on capital is with depreciation destroying profitability at all turns).
No matter what these guys do they will reduce private sector growth and spending into the future the more they persist with this ‘stimulus’ strategy. This is being clearly shown in the credit and money supply numbers at the moment, both in the US and Europe. And as oil and other commodity prices keep rising just expect domestic demand in the US and Europe to keep falling and, along with it, the prices of all goods and services produced locally.
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