some thoughts on the state of the world's economic union spliced together:
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.
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Just to add my tuppence-worth to that 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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I would add, except from some things we are already seeing in the USA vis a vis, food, energy (less so lately), healthcare, inflation on its face has been a slow creeping... hardly, and not yet, the wheel barrow full of dollars scenerio when going to order a single big mac at McDonald's. We are also seeing product substitutions, where say polo shirts two years ago at target averaged between full price and sale price at Target 5-8 dollars, we now see them average 9-12 dollars. Many products have been spent out of the system along with their old prices, and are being replaced with "new" versions that come in at higher prices. The rock bottom lawnmower price of years gone by at 99 dollars or less has been morphed into the same mower that now costs 129-149. Call it switching without baiting.
Right now every major bank in the USA is technically bankrupt, even today, if their off balance sheet liabilities were to be properly priced at market. They are not loaning money for a very simple reason. The fed has given all of them (2 trillion dollars at last count) "cheap" money which they in turn re invest in higher money, including t-bills, in a virtuous circle, so that on paper the banks are doing well, storing profits, and presumeably repairing the damage on their balances. That money has not left the virtuous circle. It will leave the circle when the fed or the market raises rates in such a way that it is no longer profitable to play the "false" spread currently allowed by the fed's "generosity." Chances are good, in my mind, that once all those reserves are unleashed, inflation will truely become part of the market language...... just as you saw it with housing prices before the crash. housing prices were absolutely "inflated" by huge flows of unrestricted money. They'd like that to happen again, and hence, why the Treasury department took away the lending caps from fannie, freddie and FHA late in the evening last xmas eve. three organizations we the people now own. FHA has zero down loans, in case you did not know this. Needless to say, those organizations and this fake support of housing prices, is yet another bomb that will explode badly, and to a degree is already exploding badly given the steep rise currently underway in defaults on their loan books.........
but i digress. Japan's banks have been in bankruptcy for ten to 15 years now, all hidden in their off balance sheet accounting, while Japan itself has been spending to "fix" the problem to the tune now of easily 300% of their GDP. That is coming to an end. Their population with the savings that allowed the government to borrow from their domestic savings pool is now shifting into retirement (less savings growth nominally) and spending their savings out net net (shinking the available supply). This means, the Japan government will either have to turn to international markets (just like USA) or start to face the day of reckoning they've put off for all of these years. USA looks just like Japan, except we skipped borrowing from our domestic savings.......because we don't have any domestic savings. all we have is debt upon debt, and more of it with every passing day, and no growth mechanism to pay for it.
when we arrive at the greek situation, no money of any kind will fix it. the austerity measures europe is demanding doesn't allow for any kind of growth for Greece to ever pay off any of their structural debts... you can't make a cow produce more milk by telling it to eat less, at the same time. what everyone is avoiding is the simple fact, that throwing good money to save bad money, is not a solution of any kind. It defeats itself in a deflationary spirial.. and once the EU commits to this rescue they will have officially taken a new course.............................and a very bad course.
Greece should be kicked out of the EU, so that it can default. The bondholders should pay the price for investing in what was a clearly dicey economy.
Same thing should have happend in the USA. The investors from unthinking homebuyers all the way to the top, should have paid... defaults taken... prices marked to market.... so that 18 months later we could be rebuilding the country's economy on a sound footing, including more national debt reduction.
BUT NO.............. WE are greece. Wait until california finally goes into default.. you cannot kick california out of the american economic union. their default will make greece look like a kiddie ride at a midway carnival.
If one wanted to find a single place in the world by which to measure inflation, one need only look at the price of gold not only in u.s. dollars but now in every currency on the planet. From the bottom in 2000 until today, it costs more dollars to buy one ounce of gold each and every year since then. and in true terms, this has also been the case since bretton woods was abolished and nixon took the USA off the gold standard. In one form or another, our country and the world has been inflating ever since. When greenspan began his marathon of inflationary policy starting in 1988, right after the '87 crash when he took office, we have seen a series of bubbles occur, as mal invested super liquidity found its way to final destinations: more recently, the mania stock market of 1998-2003, the housing bubble of 2003-2007. we are now in the process of trying for another bubble, and to say the least, a debt bubble of historical size, never seen in recorded history.
all to avoid deflation. japan's stock market has gone no where for two decades since their bust. match that against their debt ratio to GDP. their efforts have been completely wasted. look at usa. the market is no higher now than it was ten years ago. Gold however, is 5-6 times higher. these are just a few examples how you can watch the process unfold. our efforts have gone no where, and i think we shall soon see again, how this is still true, one way or another.
Now this from Barron's vis a vis Russell's letter: According to the latest Barron's, the price/earnings ratio for the S&P 500 is now 23.88.
I'm looking at a study that is titled, "Key Ratios At Market Highs." I'll list all S&P ratios over 20 by year.
5/29/46 -----P/E ratio 22.4
12/13/61 ---------- 23.0
4/28/71 ---------- 20.4
8/25/87 ---------- 22.9
2/2/94 ---------- 23.6
7/17/98 ---------- 30.0
3/24/00 ---------- 31.7
Then if you look at the quality of the earnings, aside from the fact that most growth since 2008 has taken place "outside" the US economy, and not including a certain element of inflation built into these newly minted numbers we have been receiving this quarter, qualitatively speaking, and historically speaking, how much further can the ratio be stretched? With every major turn, we see the pundits start resorting to future NAV pronostications, and in so doing, the attempt to make current values look cheap. It is beyond hilarious to watch these "valuators" talk about main core companies as is they are the internet stocks of the go go years, forward NAV's and all. I think the market is smelling an intermediate cutting off of the flow of oil that greases its wheels with "cheap" money, i.e. mal investing capital, that has found its way to the dining table. Not to worry, we will not reach the true bottom just yet. More cheap money will surely come to the rescue. |
