Confusion reigns: A crisis-driven global rush to dollar liquidity is not deflation

[FRED]

http://www.itulip.com/images/emptyshelves.jpgConfusion reigns: A crisis-driven global rush to dollar liquidity is not deflation

In the crisis stage of a debt deflation, defined by Fisher and Minsky as a reduction in debt financing, credit and money market panic causes banks to stop lending and borrowing from each other, pay off existing loans to shore up their balance sheets, and build reserves against expected future losses. This creates a short term spike in demand for the currency in which the debt is denominated, in the current case dollars. To the uninitiated, this looks like monetary deflation. A strengthening currency and falling interest rates also characterizes monetary deflation. That can in time produce commodity price deflation, so the confusion is understandable. But don't be fooled.

Today the Wall Street Journal explains the recent surge in the dollar in dollar demand:Dollar Surges Amid Hustle For Supplies Overseas (http://online.wsj.com/article/SB122328553341907281.html?mod=todays_us_money_and_ investing)
Oct. 7, 2008 (WSJ)

The dollar is in demand because many foreign banks engaged in short-term borrowing in dollars to fund various activities in recent years. Now, one normal channel for getting those funds or rolling over such debt -- borrowing from U.S.-based banks -- is gummed up, as banks are leery of lending to one another.

At the same time, banks world-wide are also looking to reduce their overall borrowing as part of a race to clean up their balance sheets. Where that borrowing was in dollars, they need dollars in order to repay it.

"There is a pyramid of leverage" in the financial system built up over years, says Mark Astley, CEO of Millennium Global Investments, a U.K. currency manager with $15 billion in assets. "This isn't going to be over in a couple of weeks."

The global demand for dollars pushed the U.S. Federal Reserve to announce a major expansion of its "swap" lines with other central banks, which allow them to provide liquidity in dollars to their local commercial banks. The Fed now has arrangements with nine other central banks, which together provide access to a total of $620 billion.

Still, that hasn't been enough to ease the squeeze. Some of the demand for dollars has spilled over into the currency markets. There, participants can buy dollars outright, or use derivatives known as currency swaps to exchange one currency for another at two different points in time.

Some investors say the appetite for dollars is akin to the demand for the yen. The yen surged against the dollar and the euro Monday; late in New York one dollar bought 101.61 yen, down sharply from 105.14 Friday.

The yen's ability to thrive stems from the fact that in better times, investors borrow in yen to take advantage of Japan's ultralow interest rates. But when volatility rises or investors need to cover losses elsewhere, they undo these maneuvers -- known as carry trades -- and buy back yen, boosting Japan's currency.

Meanwhile, by borrowing so much in dollars, foreign banks may have created "the biggest carry trade of all time," says Hans-Guenter Redeker, a currency strategist at BNP Paribas in London.
What will happen when this temporary dollar carry trade reverses? When?

The dollar will weaken rapidly. When? The de-leveraging of the "pyramid of leverage" will take from two to six months but not likely more than that.

What will happen to all of the money that the Fed is issuing to keep the banks liquefied?

To answer that we need to go back to the original source of the problem: asset price inflation.

Asset price inflation leads to asset bubbles that pop, resulting in asset price deflation. Today asset price deflation is occurring in the residential, commercial, and corporate sectors of the US and European economies. Asset price inflation was financed by credit created in the endogenous credit markets, not by central banks issuing fiat money. Asset price inflations and deflations are separate from commodity price inflations and deflations for this reason. However, when asset price deflation threatens to spill over into the overall economy due to a sudden withdrawal of purchasing power from households and businesses, the Fed steps in to substitute government issued money that the panicking and dysfunctional endogenous credit markets are no longer producing.

http://www.itulip.com/images/moneyflows.gif


The chart above shows money flows through the economy. Consumers borrow new money into existence when they purchase cars, homes, and other items on credit through the banking system, resulting in Mb cash balances for households. Businesses and government also borrow money into existence. On one side of the balance sheet (the lenders') lending money into existence (dotted lines) results in an asset. On the other side of the balance sheet (the borrowers') borrowing (dashed line) creates a liability. Once created, the money flows through the economy. The banks fund the new debt through the Credit market. The Monetary agency (Fed) funds the Credit market and government via short term lending. When the Credit markets seize up, as they have recently, the Fed steps up its short term lending to the credit markets. In a drastic measure, it buys securities directly, acting as "buyer of last resort" in order to keep maintain money creation.

The Fed is responding to the seizing up of credit markets with heroic reflation measures, such as outright purchases of commercial paper today. Once liquidity is restored, the money created for that purpose will remain in the economy, potentially producing massive inflation. The Fed will later attempt to withdraw the money by targeting the price of money, that is, interest rates: the Fed will raise rates rapidly.

Future inflation clues

One way we can validate our expectation that inflation will follow the Fed's mass money creation effort is to watch the oil and gold markets. Both are pricing in a future decline in the value of the dollar, despite obvious future declines in demand for oil and gold that will be caused by the developing global recession. This also occurred during and after the 2001 recession when gold and oil started to rise in spite of disinflation in wages and other prices in the economy as the Fed pumped liquidity into the banks and government spending stimulus accelerated.

Future inflation expectations are reflected in recent increases in oil and gold prices even as the dollar has spiked; dollar and oil/gold prices are long term negatively correlated but can be short term positively correlated. The recent spike in the dollar reflects a short term crisis driven rush to liquidity while rising gold and oil reflect expectations of longer term inflationary impact of excess liquidity and dollar weakness.

Why won't asset price deflation lead to commodity price deflation as occurred in the 1930s?

We believe the Fed will succeed in producing enough liquidity to prevent asset price deflation from spilling over into the commodity prices. Unfortunately, we also expect the effort will further undermine the dollar, producing inflation in goods and services that are sensitive to energy prices.

I see deep discounts and fire sale prices at the local grocery store. Isn't that deflation?

Cutting prices to burn off inventory is indeed deflationary. But deflation refers to the condition of a self-reinforcing process of declining demand, rising unemployment, falling wages, and falling output. This happens in countries that are net creditors and have a positive trade balance, such as Japan in the 1990s and the US in the 1930s. That cannot happen in the US because the US is a net debtor that achieves low goods price inflation via imports of goods from low wage producers. Elsewhere in the economy where trade with low wage countries does not contain inflation, such as insurance and tuition costs, inflation is high. The US finances its trade deficit via the sale of financial assets. As US demand for imports falls in recession, demand for US financial assets is also declining for a combination of reasons, including loss of confidence in US markets. As a result, the US will experience a combination of rising prices and falling demand and output.

Consider the example of your local grocery store and its fire sale. Across the entire retail food sector you will see sales as the recession deepens. The question is, what is the new equilibrium price between the price your grocer pays for new goods and how much he can charge for them?

Clearly he cannot stay in business for long if the input costs for his goods remain higher than the price he can charge his customers. Input costs must fall as well to match the new lower end user sales prices that are meeting demand in the slower economy or he will not be able to restock the next cycle of inventory and sell it at a profit.

http://www.itulip.com/images/foodppi2000-2008.gif

Unfortunately, with oil still 400% above 2001 prices due to the weak dollar, producer prices are still high and rising. If your grocer does not have a lot of cash on hand to wait out a decline in input prices, he will have to go out of business because he cannot sell every unit of inventory at a loss for long. If the dollar remains weak, as we expect it to, input prices will not fall much if at all; many grocers will have to go out of business; with less competition for customers the survivors will have sufficient pricing power to charge the prices they need to charge to stay in business.

What happens if half of the grocers in your area wind up going out of business? As floor space per capita shrinks by 50%, stores that survive get to charge what they need to sell at a profit over input costs. A new, higher equilibrium price for food at a smaller number of grocery stores will result as the number of grocery stores in your area declines. Those prices may be higher than they charge today. As a result your grocer's customers' buying behavior will change. Customers will buy less and they will substitute lower quality products.

That's how it is in countries where the standard of living has declined because the nation had lost purchasing power. If you were in Mexico during their bond, currency crisis and inflation that is what you saw. Or in Russia in the early 1990s, but more extreme. Or Argentina in 2001 but very extreme. A similar process happened in the US in the 1970s.

Politicians will claim we are suffering from temporary "stagflation" but a more honest phrase is "now we are poor." The only cure is to improve the pricing power of the US, and the only way to do that is to restructure the economy to produce, save, and invest instead of trade inflated assets, borrow and consume. It will be a long road.

What's the status of the Debt Deflation Bear Market that EJ warned subscribers about on Dec. 27, 2007 when the DOW was at 13,365?

As of today, the DJIA is quickly catching up with the performance of the Nikkei in the first year of Japan's post bubble debt deflation in 1990. As the US markets continue to price in the US debt deflation, the DJIA is now off 30% from the time of that call versus 40% at this point in the first year debt deflation process for the Nikkei.

http://www.itulip.com/images/debtdeflationbear100708.gif
iTulip Select announced and started to track the Debt Deflation Bear Marked Dec. 27, 2008
in an article Time, at last, to short the market (http://itulip.com/forums/showthread.php?t=2774) ($ubscription).
Since then the DJIA has declined 30%.

I didn't listen to you guys and stayed in the stock market. Am I screwed? Should I sell? I also didn't listen to you in 2001 when you said gold was going to go up or at all of the other times when others were calling gold a "bubble" in 2004, 2005, 2006... Is it too late to buy?

These are the most frequent questions we get. We generally advise against selling into a panicky market, but these are unusual times. A very large domino is still to fall: credit default swaps.

Four trillion in OTC credit default swap gross market replacement value (the notional value is just silly) of credit debt default insurance that can never be paid has been taken out against trillions in mortgage and corporate debt that can never be repaid. The CDS are thousands of hand written contracts sans clearing house, settlement based on novation, the weakest form of contract settlement. A huge disaster waiting to happen. It's been waiting to happen for at least nine years:
Derivatives markets guarantee a winner for every loser, but they will over time concentrate the losses in vulnerable sectors. Nature obeys Mayer’s Third Law, which holds that risk-shifting instruments will tend to shift risks onto those less able to bear them, because them as got want to keep and hedge while them as ain’t got want to get and speculate. The logic behind margin requirements in stock markets and capital requirements in banking also holds in the derivatives markets. Permitting highly leveraged institutions to hold private parties behind closed doors is the political version of selling volatility: the predictable likely gains will one day be overwhelmed by an equally predictable disastrous loss. - Martin Mayer, Somebody Please Turn on the Lights (http://www.derivativesstrategy.com/magazine/archive/1999/1199fea5.asp), Derivatives Strategy, 1999
Buying gold on the short term dollar bounce is probably a sound move, if you buy into our general thesis that a new global currency regime is needed that does not have the dollar at its center; a smaller role for the dollar in the global economy is not dollar positive.



iTulip Select (http://www.itulip.com/forums/showthread.php?t=1032): The Investment Thesis for the Next Cycle™
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[grapejelly]

excellent article, thank you, even I can understand this, and that's scary: :eek:

Why should the dollar remain weak? Compared to other currencies it should not be particularly weak, should it?

[jtabeb]

Excellent FRED, thanks.

[don]

We believe the Fed will succeed in producing enough liquidity to prevent asset price inflation from spilling over into the commodity prices. Unfortunately, we also expect the effort will further undermine the dollar, producing inflation in goods and services that are sensitive to energy prices.

Fred, shouldn't that be deflation?

Great stuff, very accessible.

[babbittd]

Two to six months. So we're moving towards the endgame. I am vastly more prepared thanks to EJ, Fred(s?) and the entire Itulip community. A huge thank you to everyone. Don't know about you all, but I've been stressing out for the past month and hadn't slept. Thanks to Dr. Sarno I finally did last night and am re-charged, ready again to tackle the consequences of what is about to go down.

[mercerbear]

Great piece. I'm in a situation where my mom took her financial advisor's advice over mine last winter when I told her it was time to liquidate the mutual funds in her IRA. Now she's down huge and wants to know what she should do next. Ordinarily, I would balk at suggesting she sell into so much weakness but I can see this thing getting so much worse that I told her she should get into cash right now. I feel much better knowing that you agree.

[Chris]

would someone mind explaining to an economics bumpkin how credit is created in the endogenous credit markets? What is the mechanism? How does that created credit then shrink in the debt deflation part of this cycle? Or doesn't it shrink?

Thanks.

[sunskyfan]

Nice work as usual :).

[xela]

This is the stuff I struggle most with understanding properly.. so thanks for the timely article.
OTC-CDS seem the bankers way to make sure the ship sinks if they are left behind, but isn't that these days not also true for most businesses (bonds, credit+interest deals), thus the financial system toast, trust going to be lost and thus currencies done as well?

[*T*]

A very large domino is still to fall: credit default swaps.

If Tim Geithner gets his CDS clearing house pronto, do you think this problem will be solved?

[ASH]

would someone mind explaining to an economics bumpkin how credit is created in the endogenous credit markets? What is the mechanism? How does that created credit then shrink in the debt deflation part of this cycle? Or doesn't it shrink?

Thanks.

I believe this refers to fractional reserve banking.

The Federal Reserve initially creates some money by buying US bonds and paying for the bonds by creating reserve deposits for the seller's bank.

"Endogenous credit creation" happens when the bank loans money to consumers and other businesses based upon this reserve deposit. They can issue credit on the initial deposit created by the Federal Reserve up to the reserve fraction limit. This amplifies the money created by the Federal Reserve... e.g. 10 times.

When the credit created by the bank is "spent" it often gets deposited at a different bank, which can then use the money as a new deposit against which even more loans can be issued, up to the reserve fraction limit.

And so on, and so on.

Thus, vastly more credit is issued than the underlying deposit created by the Federal Reserve.

BTW: Bart has a much more complete writeup on his website, in his FAQ (http://www.nowandfutures.com/faq.html), that addresses credit contraction in a debt deflation. My simplistic take on credit contraction in a debt deflation is that credit gets wiped out when banks fail, and credit contracts when banks allow loans to be paid off without issuing new loans (something they might do to prevent failure). Oh yeah -- and if the bank has a lot of debt-based assets like mortgage-backed securities on its books, whose loss of value affects the bank's capital position (i.e. its basis for issuing credit) -- then that will also force it to pull its horns in. To the extent that they are a basis for deposits, outright default on debt-based instruments sucks credit out of the system.

[dbarberic]

Hmmm.... I'm still holding my gold (PM & mining companies), energy, and natural resources stocks, and a hard currency fund. I've never had luck trying to time EJ's calls over the years, so I stuck with a buy and hold strategy after several failed attempts at market timing based on EJ's commentaries. Gold is my only saving grace at this time, but based on the above forecast, I think it will make the right long term call to hold on to the other plays that should benefit from rising inflation. At this point, those stocks are down so much, I might as well not sell. At least most of them are dividend paying.

It is gut-wrenching though. Ugh.

[gphillips]

Not to put too fine a point on it Fred, or be overly demanding, but is that 2 to 6 month call from today or from when the dollar started its rise back at the end of July? :)

[grapejelly]

Hmmm.... I'm still holding my gold (PM & mining companies), energy, and natural resources stocks, and a hard currency fund. I've never had luck trying to time EJ's calls over the years, so I stuck with a buy and hold strategy after several failed attempts at market timing based on EJ's commentaries. Gold is my only saving grace at this time, but based on the above forecast, I think it will make the right long term call to hold on to the other plays that should benefit from rising inflation. At this point, those stocks are down so much, I might as well not sell. At least most of them are dividend paying.

It is gut-wrenching though. Ugh.

I'm with you on that one. 55% drawdowns...otoh, the bullion has held up and I am confident that this panic will pass and that virulent inflation will take hold...and a flight into tangibles. I knew that we'd have extraordinariy volatility but this took even me by surprise becuase knowing something is one thing, but having it become real is another :eek:

[metalman]

Hmmm.... I'm still holding my gold (PM & mining companies), energy, and natural resources stocks, and a hard currency fund. I've never had luck trying to time EJ's calls over the years, so I stuck with a buy and hold strategy after several failed attempts at market timing based on EJ's commentaries.

huh? ej says 'sell dot com crap' in march 2000 go to cash, 'buy gold' 2001, 'sell real estate' 2005, 'dump stocks' dec 2007.

how the hell have you lost money? oh, i see...

M & mining companies), energy, and natural resources stocks

ej has said over and over since day 1: don't buy mining stocks. you must have mixed up itulip with some other site's advice. get out of the stock market dec. 2007. that's THE WHOLE STOCK MARKET not excepting some sweet corner of it where the stocks of mining companies where the genius mining co. ceos live. :D

Gold is my only saving grace at this time, but based on the above forecast, I think it will make the right long term call to hold on to the other plays that should benefit from rising inflation. At this point, those stocks are down so much, I might as well not sell. At least most of them are dividend paying.

physical gold is the only advice from here you appear to have listened to, near as i can tell. :eek:

It is gut-wrenching though. Ugh.

no shit. these are the times that try men's souls... more trials coming.

[Starving Steve]

Anything about twenty-five TRILLION dollars in asset DE-flation in world equities this year that anyone doesn't understand? Then add to that, the DE-flation in real-estate, in commodities, in bankruptcies, in wages, in corporate earnings, in general income streams: What is so hard to understand?

But deflation is a picnic, even a deflation worse than the 1930s--- as this worldwide deflation in 2008 appears to be.... Only if world currencies are competitively DE-valued outright by order of their central banks, would this deflation turn into a Latin American style hyper-inflation. And then we all would starve.

[sadsack]

But deflation is a picnic, even a deflation worse than the 1930s--- as this worldwide deflation in 2008 appears to be.... Only if world currencies are competitively DE-valued outright by order of their central banks, would this deflation turn into a Latin American style hyper-inflation. And then we all would starve.

"Now evil, idle son - sell the land! It is the end of a family - when they begin to sell the land. Out of the land we came and into it we must go - if you will hold your land you can live - no one can rob you of land - if you sell the land, it is the end."

-- Pearl S. Buck, The Good Earth<!--INFOLINKS_OFF--><!--INFOLINKS_ON-->

[raja]

ej has said over and over since day 1: don't buy mining stocks. you must have mixed up itulip with some other site's advice. get out of the stock market dec. 2007. that's THE WHOLE STOCK MARKET not excepting some sweet corner of it where the stocks of mining companies where the genius mining co. ceos live. :D

Does that include GLD, SLV, CEF and GTU?

[BrianL]

I bought into VGENX just before discovering itulip last month. That was a mistake. I'm still holding it - clinging to the idea that long term energy will go up long term. This is looking more and more depressing.

(Not as bad as the large cap fund I have in my 401k - thats now down 45% for the year. At least I only had ~6k there)

[metalman]

I bought into VGENX just before discovering itulip last month. That was a mistake. I'm still holding it - clinging to the idea that long term energy will go up long term. This is looking more and more depressing.

(Not as bad as the large cap fund I have in my 401k - thats now down 45% for the year. At least I only had ~6k there)

what??? he says..."go to cash, buy alt energy AFTER THE CRASH"

listening skills, people...

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[jtabeb]

Does that include GLD, SLV, CEF and GTU?

To quote Mike Myers from SNL "If it ain't PHYSICAL, IT'S CRAP!!!!!!!!!!!!!!!!!"

[ASH]

I bought into VGENX just before discovering itulip last month. That was a mistake. I'm still holding it - clinging to the idea that long term energy will go up long term. This is looking more and more depressing.

(Not as bad as the large cap fund I have in my 401k - thats now down 45% for the year. At least I only had ~6k there)

That's rough. Don't mind metalman's razzing, he's an... enthusiastic... proponent of most things iTulip (or, specifically, official iTulip sourced from Eric Janszen, as opposed to member commentary -- which covers a wide range of viewpoints).

If you just discovered iTulip last month, there's not a lot you could have done. Even if you read the right posts, a month isn't long enough to decide to commit your life's savings to the macro theories of a website. Any duly diligent investor would require quite some time to weigh the arguments, pass them through the "smell" test (assuming you have an accurate nose for who is trustworthy and who is full of rat droppings and sawdust), and perhaps to verify that events were proceeding according to prediction. By that time -- BAM!

I'm no great trader, but for what it's worth, I believe that the energy sector represented by VGENX stands a better chance of recovery, and sooner, than sectors more closely tied to credit and discretionary consumption. I am personally about 20% cash and 80% precious metals. Energy is one of the first things I will buy back into, once I see the foundations of a recovery.

I would not discount the possibility that the markets will fall much further, nor that the dollar will implode (both predicted by iTulip). You may want to familiarize yourself with the arguments for these scenarios, appraise their likelihood, and hedge accordingly -- even if it means realizing large losses.

[metalman]

That's rough. Don't mind metalman's razzing, he's an... enthusiastic... proponent of most things iTulip (or, specifically, official iTulip sourced from Eric Janszen, as opposed to member commentary -- which covers a wide range of viewpoints).

If you just discovered iTulip last month, there's not a lot you could have done. Even if you read the right posts, a month isn't long enough to decide to commit your life's savings to the macro theories of a website. Any duly diligent investor would require quite some time to weigh the arguments, pass them through the "smell" test (assuming you have an accurate nose for who is trustworthy and who is full of rat droppings and sawdust), and perhaps to verify that events were proceeding according to prediction. By that time -- BAM!

I'm no great trader, but for what it's worth, I believe that the energy sector represented by VGENX stands a better chance of recovery, and sooner, than sectors more closely tied to credit and discretionary consumption. I am personally about 20% cash and 80% precious metals. Energy is one of the first things I will buy back into, once I see the foundations of a recovery.

I would not discount the possibility that the markets will fall much further, nor that the dollar will implode (both predicted by iTulip). You may want to familiarize yourself with the arguments for these scenarios, appraise their likelihood, and hedge accordingly -- even if it means realizing large losses.

you are one smart and diplomatic SOB! glad to have you here. my humility deficiency is well known. i'm not good enough to be humble.

[ASH]

Does that include GLD, SLV, CEF and GTU?

Insert rehash of superiority of CEF and GTU to GLD and SLV, the limitations of all paper PM in the event of a systemic crash or government confiscation, and the cases for and against the likelihood of said systemic crash and/or goverment confiscation. I think you were a participant in some of those conversations, so may I assume your point is that metalman's sweeping statement is a bit broad... if you have faith in paper PM?

[ASH]

you are one smart and diplomatic SOB! glad to have you here. my humility deficiency is well known. i'm not good enough to be humble.

Ah, we acolytes spread the Good Word in our own ways. Since BrianL is new to the forum, he may not yet know and love your style. Honestly, I'm likely as enthusiastic about iTulip as you... but I don't want to drive those who arrived late to iTulip away with undue triumphalism, because there is a good possibility that if they stick around, they might still benefit.

Rather, those who were out of the stock markets, and thus far insulated from the widespread losses (or even profitted therefrom) should reserve our taunting for family members, co-workers, and in-laws who said we were nuts. That's sure to improve our popularity! :D

[metalman]

Ah, we acolytes spread the Good Word in our own ways. Since BrianL is new to the forum, he may not yet know and love your style. Honestly, I'm likely as enthusiastic about iTulip as you... but I don't want to drive those who arrived late to iTulip away with undue triumphalism, because there is a good possibility that if they stick around, they might still benefit.

Rather, those who were out of the stock markets, and thus far insulated from the widespread losses (or even profitted therefrom) should reserve our taunting for family members, co-workers, and in-laws who said we were nuts. That's sure to improve our popularity! :D

was going to ask a question about how to handle the family, friends, and neighbors, who didn't listen... but that's a new thread.

[phirang]

was going to ask a question about how to handle the family, friends, and neighbors, who didn't listen... but that's a new thread.

What's the point in panicking? The money IS THERE: it just hasn't been spent yet!

Jeez... the Fed and Treasury will unclog this mess, but on their terms, eh?

[Andreuccio]

you are one smart and diplomatic SOB! glad to have you here. my humility deficiency is well known. i'm not good enough to be humble.

Disagree strongly, dude. You're more than good enough.

Strongly agree on your other three points, though. :D

[GRG55]

I bought into VGENX just before discovering itulip last month. That was a mistake. I'm still holding it - clinging to the idea that long term energy will go up long term. This is looking more and more depressing.

(Not as bad as the large cap fund I have in my 401k - thats now down 45% for the year. At least I only had ~6k there)

Timing of that not so good for you, but hopefully its early in your investing career, and like all of us over our own lives you can chalk it up as part of the "tuition cost". Also note EJ's comments regards the energy input source of the inflation to come.

[BrianL]

Thanks for the kind words all. I'm young; I have plenty of time to absorb the hit.

I've been reading the the site passionately since arriving. ASH's post nailed my disposition - I'm slow to commit to changes. That said, I just opened a bullionvault account a few days ago and an on the edge of a purchase there. As I ignored PMs entirely before arriving here, I'm still working through the most practical ways to invest in it. I know I should probably buy and hold some gold directly, but that isn't a move I'm quite ready for. Odd psycological barrier there for some reason.

I'll probably be 1/4 bonds, 1/4 gold, 1/4 energy, 1/4 cash shortly. I'll probably hold the remains of the large cap (it was heavy in Wells Fargo and JPMorgan - perhaps long term they'll emerge as winners). It isn't totally in line with the thesis, but better than where I am now.

[dbarberic]

To quote Mike Myers from SNL "If it ain't PHYSICAL, IT'S CRAP!!!!!!!!!!!!!!!!!"
CEF has been widely discussed here and of the choices listed above, it is much more solid than ETFs based on paper.

[dbarberic]

I think my problem is that EJ tends to write more in a theoretical or hypothesis basis and I find the recommendations somewhat obscure and indirect. Over the years I have found difficulty translating his writing into tactical trading actions with specifics to my portfolio. I need something more direct, such as someone hitting me over the head telling me “sell now” or “buy now” and telling me “sell this” and “buy this”. I guess Metalman is much better at this skill than I am.

[sadsack]

Does that include GLD, SLV, CEF and GTU?

CEF has been widely discussed here and of the choices listed above, it is much more solid than ETFs based on paper.

As I ignored PMs entirely before arriving here, I'm still working through the most practical ways to invest in it. I know I should probably buy and hold some gold directly, but that isn't a move I'm quite ready for. Odd psycological barrier there for some reason.

In my own situation, as a renter, it is impractical in the extreme for me to store PM. I've split my PM allocation between Bullionvault and CEF.

Note that CEF, as a closed end fund, often trades at a premium to NAV. For those who are opposed to paying exorbitant spreads over spot for physical PM, I don't know if CEF is much better in this respect. In tight markets, the premium can go ballistic. In the last few weeks, I've seen the premium gyrate anywhere from 4% to 27% :eek:. One iTuliper has been making nice profits by trading on these wild swings.

As far as I know, neither CEF nor Bullionvault lease their gold. In my mind, it is insane to buy into a PM vehicle, the underlying assets of which can be lent out without your knowledge, let alone your permission. Isn't security the very reason why you're considering PM's in the first place?

If you don't have the option of secure personal storage, then Bullionvault, CEF, and GTU (there may be others, but I've done the most due diligence on these) are the least unsavory alternatives.

Are they perfect? No. Then again, unlike jtabeb, I don't have guns, safes, and ammo, let alone his military training, and so for me the risks of remote storage are less than the more considerable risks of self-storage.

[we_are_toast]

I'm one of those who are relatively new to itulip (3months) and am holding a pretty good chunk of PM stocks. My head is spinning from trying to read the dizzying quantity of great information here. I've learned the evils of my PM stock ways and am planning on selling into strength as I think we'll get a short rally in stocks, like today. But just when I was ready to roll into GLD I start reading threads like this. So now it's off to investigate the alternatives listed here. I think I might just roll the PM stocks into aspirins and antacids. :(

[robinmky]

"The dollar will weaken rapidly. When? The de-leveraging of the "pyramid of leverage" will take from two to six months but not likely more than that."

Could Fred / someone explain this statement? Why rapidly? How was two to six months arrived at?

[ocelotl]

There are already the first signs of de-leverage. In order to stem losses due to the unwinding of carry trade, down here in tropical shores, there is this kind of action:

Brazil, Mexico Pump Dollars Into Market to Stem Currency Routs (http://www.bloomberg.com/apps/news?pid=20601086&sid=aPec45ArCFrw&refer=latin_america)

[GRG55]

I think my problem is that EJ tends to write more in a theoretical or hypothesis basis and I find the recommendations somewhat obscure and indirect. Over the years I have found difficulty translating his writing into tactical trading actions with specifics to my portfolio. I need something more direct, such as someone hitting me over the head telling me “sell now” or “buy now” and telling me “sell this” and “buy this”. I guess Metalman is much better at this skill than I am.

Three thoughts:

EJ almost goes out of his way to ensure we all know that he doesn't do any tactical trading. And he's written at least one piece I can recall where he argued that most of the rest of us shouldn't either. IIRC, bart and Santafe rebutted that based on the results from their own apparently intensive and disciplined trading methods, but once again I seem to recall that both noted that what they do is not for everyone. Having said that, iTulip's major strategic trading calls have been few, but pretty clear [e.g. start of bear market call in Dec 2007]. We don't need to make a lot of frequent changes in our portfolios to do quite well over time, as iTulip's track record demonstrates.
metalman seems to follow EJ's approach with more discipline than most others around here, so if you are looking for a lot of "buy now", "sell this" from him, that'll be fun to watch...:D
I sympathize with what you wrote as iTulip and all the subscribers put out a lot of good stuff, and often I also find it difficult trying to reconcile what's being said with what's actually happening with what's my current investment situation.

[aa]

A very large domino is still to fall: credit default swaps.

Four trillion in OTC credit default swap gross market replacement value (the notional value is just silly) of credit debt default insurance that can never be paid has been taken out against trillions in mortgage and corporate debt that can never be repaid. The CDS are thousands of hand written contracts sans clearing house, settlement based on novation, the weakest form of contract settlement. A huge disaster waiting to happen. It's been waiting to happen for at least nine years

What's the feasibility of the government passing a law that credit default swaps are now illegal and all existing ones are null and void ?

Problem gone.

[ASH]

What's the feasibility of the government passing a law that credit default swaps are now illegal and all existing ones are null and void ?

Problem gone.

So, uh... you avoid the danger of trillions of dollars worth of financial instruments vaporizing by -- vaporizing them?

[xela]

What's the feasibility of the government passing a law that credit default swaps are now illegal and all existing ones are null and void ?

Problem gone.

Would equal throwing contract law over the board, no? Those are over the counter contracts stipulated between two parties as far as I understand it.

[we_are_toast]

So, uh... you avoid the danger of trillions of dollars worth of financial instruments vaporizing by -- vaporizing them?

Yes! Most of the cds's are simply bets. The bets off!
If you have a legitimate bond that the cds was written against, present it and it will be covered, but all cds's that were written against someone else's security, forget it! Taxpayers shouldn't be covering bets.

[bam]

now wait a minute....
What the Fed and Treasury are trying to do is coordinate an orderly destruction of debt. By being the lender of last resort, companies can borrow money so that they don't go bankrupt overnight. For instance, the writing is on the wall for junk rated firms that couldn't get successful auctions these last 2 weeks. The trick is to help them liquidate over a longer period of time so that it's not massively disruptive to the economy (it's just hugely disruptive). If that is allowed to happen, the US will reduce the amount of treasury issues needed for debt destruction over time. Sure there's a cost, and more treasury auctions will be needed for a new deal, unemployment, etc, etc.
But it seems to me that net/net this is still deflationary. No?

[$#*]

now wait a minute....
What the Fed and Treasury are trying to do is coordinate an orderly destruction of debt. By being the lender of last resort, companies can borrow money so that they don't go bankrupt overnight. For instance, the writing is on the wall for junk rated firms that couldn't get successful auctions these last 2 weeks. The trick is to help them liquidate over a longer period of time so that it's not massively disruptive to the economy (it's just hugely disruptive). If that is allowed to happen, the US will reduce the amount of treasury issues needed for debt destruction over time. Sure there's a cost, and more treasury auctions will be needed for a new deal, unemployment, etc, etc.
But it seems to me that net/net this is still deflationary. No?
I believe you are correct. Plus a controlled inflationary shock (25-35 % devaluation of the dollar) will wreak havoc in the economies of all currency manipulators ( across the spectrum from China to OPEC), bring up the value of US houses ( in devalued dollar terms) stop the subprime mess and Maiden Lane can make a truck load of money for JPM .

[LargoWinch]

Ok the US bonar looks like it is toast while you guys are replacing that pretty debt clock and all.

...but what if all CBs in the world have their own private parties and decide to support the value of the dollar? We get global inflation, but the US dollar stays.

[phirang]

Ok the US bonar looks like it is toast while you guys are replacing that pretty debt clock and all.

...but what if all CBs in the world have their own private parties and decide to support the value of the dollar? We get global inflation, but the US dollar stays.

The "G20" HAS to bailout the US banking system. This stuff about letting the US fail is crap. What IS changing are the terms of the bailout.

All the politicans and various factions are using the misery of their own people to compel someone else to fold first... first, BRICOPEC was on the ropes, now the US and Europe are... I fully expect a happy, inflationary medium with much more nominal "state" ownership acting on behalf of foreign dollar-reserved stakeholders(whoops, is that Bob Zoellick?).

The terms will be hashed out over the weekend w/the IMF orchestrating the meeting.

This weekend is the key determinant for how we move forward.

[metalman]

Three thoughts:

EJ almost goes out of his way to ensure we all know that he doesn't do any tactical trading. And he's written at least one piece I can recall where he argued that most of the rest of us shouldn't either. IIRC, bart and Santafe rebutted that based on the results from their own apparently intensive and disciplined trading methods, but once again I seem to recall that both noted that what they do is not for everyone. Having said that, iTulip's major strategic trading calls have been few, but pretty clear [e.g. start of bear market call in Dec 2007]. We don't need to make a lot of frequent changes in our portfolios to do quite well over time, as iTulip's track record demonstrates.
metalman seems to follow EJ's approach with more discipline than most others around here, so if you are looking for a lot of "buy now", "sell this" from him, that'll be fun to watch...:D
I sympathize with what you wrote as iTulip and all the subscribers put out a lot of good stuff, and often I also find it difficult trying to reconcile what's being said with what's actually happening with what's my current investment situation.



a weekly if not monthly summary of positions on assets would be nice.

[ocelotl]

The "G20" HAS to bailout the US banking system. This stuff about letting the US fail is crap. What IS changing are the terms of the bailout.

All the politicans and various factions are using the misery of their own people to compel someone else to fold first... first, BRICOPEC was on the ropes, now the US and Europe are... I fully expect a happy, inflationary medium with much more nominal "state" ownership acting on behalf of foreign dollar-reserved stakeholders(whoops, is that Bob Zoellick?).

The terms will be hashed out over the weekend w/the IMF orchestrating the meeting.

This weekend is the key determinant for how we move forward.

I protest on us next 13 (BRIMCOPEC) increasing our position as net creditors of USA, it means it will take us down on the fall. We do need to improve first our infrastructure and our social support network instead of dumping resources in this money pit...

Balance of economy and power has to shift. It is not worthy enough to keep supporting a free ride for any other country. Enough is enough...

[LargoWinch]

Timing of that not so good for you, but hopefully its early in your investing career, and like all of us over our own lives you can chalk it up as part of the "tuition cost". Also note EJ's comments regards the energy input source of the inflation to come.

GRG55; not that I want to put you on the spot or anything, but I haven't seen you posting your current allocation anywhere. Unless I missed it?

[GRG55]

GRG55; not that I want to put you on the spot or anything, but I haven't seen you posting your current allocation anywhere. Unless I missed it?

I have never posted it.

I come to this site for a macro outlook. I am not a trader.

[metalman]

I have never posted it.

I come to this site for a macro outlook. I am not a trader.

high five from a fellow 'don't trade' ituliper.

http://www.desmondandthetutus.co.za/HighFive/images/index_02.jpg

[LargoWinch]

I'm one of those who are relatively new to itulip (3months) and am holding a pretty good chunk of PM stocks. My head is spinning from trying to read the dizzying quantity of great information here. I've learned the evils of my PM stock ways and am planning on selling into strength as I think we'll get a short rally in stocks, like today. But just when I was ready to roll into GLD I start reading threads like this. So now it's off to investigate the alternatives listed here. I think I might just roll the PM stocks into aspirins and antacids. :(

shhhh don't say or write "PM stocks" if Metalman or whatever that old pic of his is around...that is just silly.

[Lukester]

Whaddaya mean yer not a trader? What the heck kind of answer is that? Everybody's got to be a trader!

I have never posted it. I come to this site for a macro outlook. I am not a trader.

[LargoWinch]

I protest on us next 13 (BRIMCOPEC) increasing our position as net creditors of USA, it means it will take us down on the fall. We do need to improve first our infrastructure and our social support network instead of dumping resources in this money pit...

Balance of economy and power has to shift. It is not worthy enough to keep supporting a free ride for any other country. Enough is enough...

Ocelotl, where have you been?

Anyway, my view regarding infrastructure, is "P3" format.

That is ppperfect for the FIRE eco. and could put this mess on the shelve for awhile.

[babbittd]

Once liquidity is restored, the money created for that purpose will remain in the economy, potentially producing massive inflation. The Fed will later attempt to withdraw the money by targeting the price of money, that is, interest rates: the Fed will raise rates rapidly.

At least one of the Congressman on the House Fin. Svcs. Committee asked Ben Bernanke about the possibility of inflation this morning.

What does Bernanke mean when he says (in disagreement with the paragraph above) that "the money created for that purpose" is being sterilized and therefore won't lead to inflation?

[LargoWinch]

I have never posted it.

I come to this site for a macro outlook. I am not a trader.

Jim where are you :( ? GRG55 and Metal are ganging up on me and are shying away from your very insightful post!

...anyway, I think that a very bright guy once said that "buy and hold" is the most speculative/risky strategy to follow. How is that for convincing?

For my part, I see investing a bit like chess; the stronger the players you play, the better you get.

http://3quarksdaily.blogs.com/3quarksdaily/images/chess.jpg

[Jim Nickerson]

Jim where are you :( ? GRG55 and Metal are ganging up on me and are shying away from your very insightful post!

...anyway, I think that a very bright guy once said that "buy and hold" is the most speculative/risky strategy to follow. How is that for convincing?

For my part, I see investing a bit like chess; the stronger the players you play, the better you get.

http://3quarksdaily.blogs.com/3quarksdaily/images/chess.jpg

I'm wounded. Do what you think is best and live with the outcome, that way there's never any question of who's to blame.

One thing, maybe one thing, is clear to me after reading here a couple of years. Everyone has their own needs, fears, goals, peculiarities and probably no two of us are alike. Figure out as well as you can what you need to do, do it, learn from it, live with it, and don't go around looking for someone to bless your actions or thinking. Winch, this is not directed any particular aspect of what I perceive you to be, i.e. nothing negative about your thought or actions.

[bart]

At least one of the Congressman on the House Fin. Svcs. Committee asked Ben Bernanke about the possibility of inflation this morning.

What does Bernanke mean when he says (in disagreement with the paragraph above) that "the money created for that purpose" is being sterilized and therefore won't lead to inflation?

The simple answer is that he was being quite disingenuous in my opinion.

[metalman]

The simple answer is that he was being quite disingenuous in my opinion.

where's my deflation!

http://www.kitco.com/images/live/gold.gif

Mortgage rates spike - leap size tops '87

Rates saw the biggest weekly jump since 1987 - analysts predict 30-year fixed mortgage rates will climb higher, and pin the hike on government rescue efforts.

er, shouldn't the gov't rescue send the rates down?

[Rajiv]

Nystrom's article - Money is Also Destroyed (http://www.financialsense.com/fsu/editorials/nystrom/2007/0720.html) may shed some light here

July 20, 2007


If money can be created from thin air, the opposite is also true: it can be destroyed as well. Usually it is the Federal Reserve System that does the creating, but the destruction comes by other means. Bear Stearns’ hedge fund investors have found this out the hard way. Two of its funds recently went belly up, taking 100% of investors’ capital with them. One of the funds, the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage fund, reported $638 million of investor capital in the first quarter. Today nothing remains.

How can money so quickly and effectively be destroyed? To understand this, we have to understand how the money was created in the first place. According to news reports, the underlying securities in the hedge fund in question were subprime mortgages.

Mr. Jones Takes out a Sub Prime Loan

Let’s say it’s 2003, and Mr. Jones, who has less than stellar credit wants to buy a house. He goes to the bank to get a mortgage. The conventional wisdom is that the bank loans him money so he can buy the house. In reality, Mr. Jones is actually borrowing the money from himself, -- or rather against his own future earnings. The bank simply facilitates the real estate transaction between him and the house seller. It does this by writing a note that says ‘we’ve loaned Mr. Jones X dollars and he’s promised to pay us the money back over 30 years. We are holding his house as collateral until the money is paid back.’ This note is called the mortgage, and it becomes the bank’s asset. Under Federal Reserve rules, it can use this asset to create the money to pay the seller of the house.

In reality, the bank has no money, and the mortgage has value only because of Mr. Jones’s promise to pay back the money. As long as Mr. Jones’s promise is good, the mortgage will retain its value and the bank can sell it to another investor – for example a hedge fund.

The Hedge Fund Buys Mr. Jones’s Mortgage

The hedge fund bought thousands of mortgages like Mr. Jones’s, with the hope of collecting a steady stream of income as borrowers paid off their mortgages. That sounded like a good idea, and a solid bet. People traditionally are very good about paying their mortgages back. No one, after all, wants to lose their home. In fact, it sounded like great idea – so great in fact, that Bear Stearns took the $638 million of its investors money, borrowed $10 billion more, (yes, that is a b) and put it all into subprime mortgages.

Mr. Jones Defaults

As it turned out, Mr. Jones, and many more like him were unable to keep their promises to pay the money back. Maybe Mr. Jones lost his job in this terrible economy; maybe he got sick and couldn’t work; maybe he didn’t understand that his mortgage payment was going to jump to something he couldn’t afford; maybe he thought he could sell the house for more money, and never expected to hold on to it this long; maybe he just wasn’t a good credit risk to begin with.

Whatever the reason, Mr. Jones and millions like him had to break their promises about paying back the loans. In the end they’ll just give their keys back to the bank and say, “Thanks, but no thanks. I can’t afford it.”

The banks in turn will say, “Don’t give us the keys. We sold your mortgage a long time ago. We don’t even know who owns your mortgage now, and frankly we don’t care.”

Until now, his debt was an asset of the fund, and was being used as collateral against loans ten times its value. But the moment that Mr. Jones gave up on the idea of home ownership, the value of his mortgage simply disappeared. The paper asset, which derived its value from Mr. Jones’s promise, was destroyed. This had a cascading effect, since Mr. Jones’s mortgage was being used as collateral to borrow money to buy even more subprime mortgages, many of which were also defaulting. Assets purchased on borrowed money were now worthless. Only the debts remained, and suddenly there was more debt than the original amount that investors had put into the fund. These original funds would be needed repay the debts incurred by the fund. Nothing is left to return to investors. This is the process by which money is destroyed.

What about the houses, you ask? Yes, they have some value, but not nearly as much as when they were first purchased. Again, it was not the houses that had the value, it was Mr. Jones promise to pay a steady stream of high interest income over 30 years that was valuable to investors.

.
.
.
.

[Jay]

Would someone mind explaining how sterilization works for me?

[bart]

where's my deflation!

Back ordered again?
It's waiting until after Halloween?



Mortgage rates spike - leap size tops '87

Rates saw the biggest weekly jump since 1987 - analysts predict 30-year fixed mortgage rates will climb higher, and pin the hike on government rescue efforts.

er, shouldn't the gov't rescue send the rates down?

That's one universe over, in the Land of Oz. ;)

[Rajiv]

The Hank/Ben bailout is trying to slow the rate of destruction of money by replacing some of the Banks' lost capital -- Finster's FDI (http://users.zoominternet.net/~fwuthering/FFF/FinsterDollarIndex) is the clear evidence of money destruction -- if this slowdown works, it is hoped that the economy will not spiral into a self reinforcing deflation -- but only result a very painful recession.

In a nutshell, it is thought that more money will be destroyed than is pumped in by the Government

The Jury is still out on whether it is going to work see again Finster's FDI (http://users.zoominternet.net/~fwuthering/FFF/FinsterDollarIndex) and the discussion (4, 3, 2, 1 ... Deflation!)

[Jay]

The Hank/Ben bailout is trying to slow the rate of destruction of money by replacing some of the Banks' lost capital -- Finster's FDI (http://users.zoominternet.net/~fwuthering/FFF/FinsterDollarIndex) is the clear evidence of money destruction -- if this slowdown works, it is hoped that the economy will not spiral into a self reinforcing deflation -- but only result a very painful recession.

In a nutshell, it is thought that more money will be destroyed than is pumped in by the Government

The Jury is still out on whether it is going to work see again Finster's FDI (http://users.zoominternet.net/~fwuthering/FFF/FinsterDollarIndex) and the discussion (http://4, 3, 2, 1 ... Deflation!)
So sterilization is the destruction of money in one area of the economy while it is created in another, or by another more charged name... a massive wealth transfer, from the ecomomically uneducated to the rich?

[phirang]

So sterilization is the destruction of money in one area of the economy while it is created in another, or by another more charged name... a massive wealth transfer, from the ecomomically uneducated to the rich?

No, no, it's an investment.:)

401k's, mutual funds... all of this is part of it. but it gets worse in this case: they're attacking GLOBAL savings now.

100 years ago, you did this through war. now, we do it exploiting the weakness of human nature: no bravery nor sacrifice required. Quite Taoist, really... the Tai Chi of theft.

Master Thief Rothschild would be impressed by this coup.

[Rajiv]

A massive wealth transfer, from the ecomomically uneducated to the rich?

That is the raison d'etre of the whole Financial System -- and it has been for a long long time

[Rajiv]

a massive wealth transfer, from the ecomomically uneducated to the rich?

Ellen Brown had a good article on this topic --
THE COLLAPSE OF A 300 YEAR PONZI SCHEME:
THE REAL DEBATE IS CRONY SOCIALISM OR FINANCIAL SOVEREIGNTY (http://www.webofdebt.com/articles/modest_proposal.php)

Her other article - IT’S THE DERIVATIVES, STUPID!
WHY FANNIE, FREDDIE AND AIG ALL HAD TO BE BAILED OUT (http://www.webofdebt.com/articles/its_the_derivatives.php) is worth aread as well

[grapejelly]

Ellen Brown had a good article on this topic --
THE COLLAPSE OF A 300 YEAR PONZI SCHEME:
THE REAL DEBATE IS CRONY SOCIALISM OR FINANCIAL SOVEREIGNTY (http://www.webofdebt.com/articles/modest_proposal.php)



This one has seeds of truth in it and then the usual claptrap about "credit" or "money" should be created by the government, a national resource. :rolleyes:

Plllllleeeassse...

[Rajiv]

Before you throw her ideas out of the door -- constitutionally, issuing money was the sole perogative of the government until not too long ago -- something to think about.

Article 1, Section 8 of the Constitution enumerates the powers of the government. It reads in part:

The Congress shall have Power . . .

* To borrow Money on the credit of the United States;

* To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes;

* To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;

* To provide for the Punishment of counterfeiting the Securities and current Coin of the United States;

There is an extremely good library on monetary topics (http://www.complementarycurrency.org/materials.php) at appropriate-economics.org -- It is well worth exploring