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"The risk, if not the probability, is that deflation lies ahead." 7/10/2010

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  • "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

    7/10/2010 If interested in deflation, see the attached pdf from Van Hoisington and Lacy Hunt, which is just available this morning. These guys are bond bulls even now and as such continue to focus on the potential effects of deflation as the outcome of the debt debacle in the US (world?). Anyone interested in reading previous quarterly opinions from these two guys can do so at http://hoisingtonmgt.com/hoisington_..._overview.html

    Interesting to me is iTulip has no Forum section for deflation/inflation discussion and generally has spat upon any articles/opinions that deflation is a pertinent ongoing consideration, so I put this post into the section someone in iTulip hierarchy might choose as its appropriate categorization.

    Personally, I am a big fan for deflation continuing to be a problem.

    Originally posted by Hoisington and Hunt
    Long term Treasury bond and zero coupon
    bonds will perform well in this environment.
    Collapsing inflationary expectations (or should we
    say rising deflationary expectations) will drive the
    bond yields lower; perhaps even into the range of prior
    historical lows. In this environment, holdings of long
    Treasury paper will serve not only as a safe haven but
    an asset whose value will appreciate significantly.
    Attached Files
    Jim 69 y/o

    "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

    Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

    Good judgement comes from experience; experience comes from bad judgement. Unknown.

  • #2
    Re: "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

    Originally posted by Jim Nickerson View Post
    7/10/2010 If interested in deflation, see the attached pdf from Van Hoisington and Lacy Hunt, which is just available this morning. These guys are bond bulls even now and as such continue to focus on the potential effects of deflation as the outcome of the debt debacle in the US (world?). Anyone interested in reading previous quarterly opinions from these two guys can do so at http://hoisingtonmgt.com/hoisington_..._overview.html

    Interesting to me is iTulip has no Forum section for deflation/inflation discussion and generally has spat upon any articles/opinions that deflation is a pertinent ongoing consideration, so I put this post into the section someone in iTulip hierarchy might choose as its appropriate categorization.

    Personally, I am a big fan for deflation continuing to be a problem.
    There are several things done by iTulip that I've raised an eyebrow at. The insistence that any deflationary episode is over. The holding of treasury bonds *well* beyond what I'd consider a safe period for the return involved.

    ...and yet, so far it's all gone that way and has worked. I know EJ has tried to explain why he's doing some of these things multiple times -- I'm not sure whether I'm just too thick or the explanation is not persuasive enough to make me willing to follow completely (I *do* know that EJ's "here today, gone for three weeks" has made me more wary on anything other than big picture thoughts, which is admittedly where the strength lies)

    We'll all see soon enough. For now, I'm trying to cover as many bases as possible and make sure all my eggs are *not* in one basket.

    Comment


    • #3
      Re: "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

      I find it interesting what Hoisington and Hunt have been writing in their quarterly notes regarding the attractiveness of US Treasury Bond.

      Below is from their quarterly letter in July 2009, which can be found in its entiretyat the link below.

      The combination of an extremely overleveraged
      economy, ineffectual monetary policy
      and misdirected fiscal policy initiatives suggests
      that the U.S. economy faces a long difficult struggle.
      While depleted inventories and the buildup of
      pent-up demand may produce intermittent spurts
      of growth, these brief episodes are not likely to
      be sustained. In several years, real GDP may be
      no higher than its current levels. However, since
      the population will continue to grow, per capita
      GDP will decline; thus, the standard of living will
      diminish as unemployment rises. These conditions
      will produce a deflationary environment similar to
      the Japanese condition.


      Investments in long term Treasury securities
      are motivated by inflationary expectations. If fixed
      income investors believe inflation is headed lower,
      they will invest in long-dated securities, while they
      will invest in Treasury bills, or inflation protected
      securities if they believe inflation is headed higher.
      In the normal recessions since 1950, the low
      in inflation was, on average, 29 months after a
      complete economic recovery was underway, and
      bond yields moved in a similar fashion.
      If this
      recession were normal, then the low in inflation
      would be in late 2011, at which time investors
      would begin to consider shortening the maturity of
      their Treasury portfolios. However, because of our
      highly-indebted circumstances and the movement
      of private sector resources to the public sector, the
      trough in inflation will be moved out, meaning that
      the low in Treasury bond yields is a distant event.

      The path there will be bumpy, as it was in the U.S.
      from 1929 to 1941 and in Japan from 1989 to 2008.
      Presently the 10-year yield in Japan stands at 1.3%.
      Ultimately, our yield level may be similar to that of
      the Japanese.
      Emphasis JN

      http://hoisingtonmgt.com/hoisington_..._overview.html
      Jim 69 y/o

      "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

      Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

      Good judgement comes from experience; experience comes from bad judgement. Unknown.

      Comment


      • #4
        Re: "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

        Then from nine months ago Hoisington and Hunt had this to say.

        The inflation outlook from the monetary
        and fiscal standpoint looks truly deflationary, yet
        some believe that dollar weakness will reverse this
        circumstance and create inflation. This is unlikely.
        First, our imports are about 13% of GDP, and even
        if the dollar were to halve in value, the price of
        imported goods would not only have to compete
        with U.S. producers, but also their price adjustment
        would have to offset the other 87% of factors
        included in the pricing indices. Second, unlike the
        1930's a 50% decline in the dollar would be difficult
        to engineer. Fisher recommended to Roosevelt that
        the U.S. should exit the gold standard, which he did
        in April of 1933. That was a fixed exchange rate
        system, and within three months the dollar lost more
        than 30% against the gold block countries and fell to
        60% of its former value within the next five months.
        This spurred our exports and provided some price
        inflation (2.9% per year, GDP deflator) for the next
        four years. Then, in 1937 the tax increases (the next
        policy mistake) reversed the positive growth rate of
        the economy and drove price levels and economic
        activity downward again. However, even with that
        small period of price increases the overall price
        level never recovered from the 25% decline that
        occurred from 1929 to 1933, and thus deflation
        reigned. Today the declining dollar is a good thing
        in terms of our trade balance, but the modest change
        will be insufficient to offset the negative forces of
        insufficient domestic demand.

        Next year the core GDP deflator will fall
        to zero, with the possibility of negative levels.
        Likewise, long-term interest rates, which are highly
        sensitive to inflation, will continue to move toward
        lower levels. As stated in previous letters, we see no
        reason why longer dated Treasury interest rates will
        not mirror those of Japan, which provides a modern
        signpost for a deflationary environment. Currently
        the Japanese ten-year note stands at 1.3% with their
        thirty-year bond yielding 2.1%.
        Jim 69 y/o

        "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

        Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

        Good judgement comes from experience; experience comes from bad judgement. Unknown.

        Comment


        • #5
          Re: "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

          Hoisington and Hunt from the 4th QTR 2009 report.

          Since 1990 Treasury bond yields have
          steadily moved downward in line with a more
          benign inflationary environment (Chart 6). Those
          yearly declines in yields continued last year with
          an average interest rate of 4.07% versus 4.28% in
          2008. Obvious sharp reversals have occurred in
          their downward trend due to shifts in psychology
          reacting to generally transitory factors, as we saw in
          2009. To remain fully invested in long Treasuries
          in this high volatility environment requires a simple
          discipline based on the academic literature which
          demonstrates that over time bond yields move in
          the same direction as inflation (Fisher equation).

          Presently, we view the inflationary
          environment as benign because: 1) the U.S.
          economic system is overleveraged and academic
          research confirms that this circumstance leads to
          deflation; 2) monetary policy is, and will continue
          to be, ineffectual as efforts to spur growth are
          thwarted by declining asset prices, loan destruction,
          and adverse regulatory influences; 3) the federal
          government’s spending spree will necessarily
          cause taxes and borrowings to rise, further stunting
          any economic growth. These factors ensure that
          inflation will be quiescent. Interest rates easily can
          and do rise for short periods, but remaining elevated
          in a dis-inflationary environment is contrary to the
          historical experience. We are owners and buyers
          of long U.S. Treasury debt.
          Jim 69 y/o

          "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

          Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

          Good judgement comes from experience; experience comes from bad judgement. Unknown.

          Comment


          • #6
            Re: "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

            1. Hunt and hoisington go from saying the multiplier on gov’t spending is “considerably less than one and quite possibly close to zero” to then ASSUMING it is in fact exactly zero. Perhaps this is correct, perhaps not.

            2. they properly point to the burden of debt payment on the whole economy.

            3. they discuss why q.e. hasn’t led to much inflation by saying “the monetary base is not money.” In fact, q.e. has been sterilized by paying banks interest on the excess reserves they have parked at the fed. This gives the banks a risk free return.

            4. The fed is already making noises about ceasing to pay interest on excess reserves. This action, in combination with a forthcoming q.e. ii, will move liquidity out of fed deposits and into the real economy, likely into financial assets first as the banks prefer to game the financial markets rather than make loans. The money will then slosh elsewhere.

            Comment


            • #7
              Re: "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

              Hoisington and Hunt from early April 2010 in the first quarter letter.


              ...lower inflation leads to lower interest rates.

              Treasury Bonds

              With excessive levels of debt and
              contractionary monetary and fiscal policies in place,
              inflation will continue to moderate, thereby driving
              long term treasury yields lower. The path to lower
              rates will not be smooth as volatility will arise from
              heavy sales of U.S. government debt and occasional
              transitory improvements in economic activity.
              However, patient investors will be significantly
              rewarded.
              I believe that the thesis that guides these guys with the probable direction of interest rates is that direction of rates are most closely related to inflation. "lower inflation leads to lower interest rates."
              Jim 69 y/o

              "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

              Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

              Good judgement comes from experience; experience comes from bad judgement. Unknown.

              Comment


              • #8
                Re: "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

                "The Rising Threat of Deflation" http://www.aei.org/outlook/100971

                Originally posted by John Makin
                As we enter the second half of 2010--the "postcrisis" year--while markets have been obsessed with Europe's debt crisis, they have failed to notice potentially more ominous developments. The United States and Europe are heading toward--and Japan already suffers from--deflation, a classic prolonger of crises that boosts the real burden of debt and crushes profit margins.


                .

                Many market participants and policymakers have warned that such aggressive easing will lead to inflation. Contrary to those expectations, as noted above, core inflation has steadily moved lower in the United States and Europe and is approaching outright deflation, which Japan is already experiencing. By later this year, persistent excess capacity will probably create actual deflation in the United States and Europe. Moreover, the recent appreciation of the dollar, especially against the euro, exacerbates the U.S. deflation threat.

                .

                The link between volatile financial conditions and the real economy has been powerfully underscored by the events since mid-2007. Growth has suffered and subsequently recovered given powerful monetary and fiscal stimulus. And yet, the damaged financial sector, unable to supply credit; a jump in the precautionary demand for cash; and a persistent overhang of global production capacity have combined to leave deflation pressure intact. The G20's newfound embrace of fiscal stringency only adds to the extant deflation pressure.


                No wonder no country wants a strong currency any- more, as attested to by Europe's easy acceptance of a weaker euro. The acute phase of the financial crisis is over, but the chronic trend toward deflation that has followed it is not.
                Jim 69 y/o

                "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

                Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

                Good judgement comes from experience; experience comes from bad judgement. Unknown.

                Comment


                • #9
                  Re: "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

                  Originally posted by Jim Nickerson View Post
                  "The Rising Threat of Deflation" http://www.aei.org/outlook/100971
                  makin, like hoisington and hunt, assumes the fed is powerless. as uncle ben pointed out in his famous "making sure 'it' won't happen here" speech, the fed has this technology, called a printing press.... we'll see if deflation persists once the fed stops paying interest on excess reserves and then launches q.e. ii, purchasing longer dated treasuries, maybe even munis, and heaven knows what else.

                  Comment


                  • #10
                    Re: "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

                    http://thetechnicaltakedotcom.blogsp...ury-bonds.html

                    The Case for Treasury Bonds. 7/8/2010

                    The last reason to remain bullish on bonds is that no one loves them. It was only 3 short months ago that I made "the call" to go long bonds, and at that time, others were calling higher Treasury yields the sure bet of the decade. Wrong! Since early April, long term Treasury bonds have risen some 12% while equities have fallen 12%. Despite this out performance, bonds still get no respect as we can see by this headline taken from MarketWatch last week: "Bond rally reflects gloom - but don't bet on it lasting".

                    In summary, I believe the dynamics are in place for a secular run in bonds.
                    In line with the above "no one loves them" comment is a piece in this weekend's Barron's Break Free of Your Bonds! By TOM SULLIVAN

                    Investors have piled into fixed-income funds for two years. Now they should be preparing for a rise in rates.
                    http://online.barrons.com/article/SB...el_article%3D1

                    Originally posted by Sullivan
                    NERVOUS INVESTORS SEEKING TO preserve their wealth and pick up yield have swarmed into fixed-income funds in the past two years. U.S. taxable bond funds saw estimated net inflows of $152 billion year-to-date through July 7, according to Lipper FMI. In 2009, the full-year total hit $384 billion (see chart, Taxable Bond Fund Flows). To put those figures into perspective, U.S. equity funds saw just $24 billion of inflows through July 7 and only $5 billion for all of last year.

                    "I think there is a bond-fund bubble," says Marilyn Cohen, president and portfolio manager of Los Angeles-based Envision Capital Management, which runs separately managed fixed-income accounts. "I've seen the flows."
                    http://www.scribd.com/doc/34068095/R...gn-Debt-Crisis

                    And from the GMO group. Edward Chancellor

                    Originally posted by Chancellor
                    These are interesting but intractable questions. Nobody knows their answers. Current yields on government bonds in most advanced economies (PIGS excepted) are at very low levels. Under only one condition – that the world follows Japan’s experience of prolonged deflation – do they offer any chance of a reasonable return. But this is not the only possible future. For other outcomes, long-dated government bonds offer a limited upside with a potentially uncapped downside. As investors, such asymmetric pay-off profiles don’t appeal to us. Caveat (sovereign) creditor!
                    Jim 69 y/o

                    "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

                    Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

                    Good judgement comes from experience; experience comes from bad judgement. Unknown.

                    Comment


                    • #11
                      Re: "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

                      i think bonds will look good and perform well right up to the [inevitable imho] crisis which makes them blow up.

                      Comment


                      • #12
                        Re: "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

                        Originally posted by jk View Post
                        makin, like hoisington and hunt, assumes the fed is powerless. as uncle ben pointed out in his famous "making sure 'it' won't happen here" speech, the fed has this technology, called a printing press.... we'll see if deflation persists once the fed stops paying interest on excess reserves and then launches q.e. ii, purchasing longer dated treasuries, maybe even munis, and heaven knows what else.
                        jk, don't you think that if the Fed has power (this is, it is not "powerless"), that there would be some indications these days and in past months that inflation would be manifested in whatever surveys used to measure inflation?

                        I think it is going to be very interesting to see how the next 4-5 years turn out. Assuming we are alive in 4-5 years, the only thing sure is we will be older.
                        Jim 69 y/o

                        "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

                        Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

                        Good judgement comes from experience; experience comes from bad judgement. Unknown.

                        Comment


                        • #13
                          Re: "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

                          Originally posted by jk View Post
                          makin, like hoisington and hunt, assumes the fed is powerless. as uncle ben pointed out in his famous "making sure 'it' won't happen here" speech, the fed has this technology, called a printing press.... we'll see if deflation persists once the fed stops paying interest on excess reserves and then launches q.e. ii, purchasing longer dated treasuries, maybe even munis, and heaven knows what else.
                          Here's a link to a discussion of what may be available to the Fed as the economic slowdown continues. http://www.washingtonpost.com/wp-dyn...l?hpid=topnews

                          Fed officials do not rule out launching a major new asset-purchase program. Rather, they say they would consider one only if their basic forecast -- of continued steady expansion in the economy -- proves to be wrong. A key factor that would build support for new asset purchases would be a rise in the risk of deflation, or a dangerous cycle of falling prices -- which has become more of a concern as the world economy slows.
                          Jim 69 y/o

                          "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

                          Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

                          Good judgement comes from experience; experience comes from bad judgement. Unknown.

                          Comment


                          • #14
                            Re: "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

                            "Where to invest under austerity?" 7/11/10 http://blogs.wsj.com/source/2010/07/...der-austerity/

                            Originally posted by Alen Mattich
                            As governments tighten fiscal policy, central banks are almost certain to indulge in another round of monetary easing.

                            With interest rates at zero, this means yet more quantitative easing. The question is therefore how do you invest?

                            The immediate bull case has to be for government bonds. Quantitative easing is designed to push down yields along the curve and if that takes central bank buying of long dated government debt, that’s exactly what’ll happen.

                            Sovereign debt will also be helped by the accompanying deflation story. Government austerity raises the risk of declining aggregate demand, which, in turn, is highly deflationary.

                            Ultimately, all monetization of government debt in all but name will be inflationary. But over the near to medium term, deflation remains the key story.
                            .
                            .
                            Some economists, like David Rosenberg at Gluskin Sheff and Albert Edwards at Societe Generale, are out and out equity bears. But within that, they and other bears favor shares with strong dividends–with bond yields being pushed down, anything that produces income will be attractive.
                            .
                            .

                            Industrial commodities are likely to fare badly. Though they’ve done well during the past couple of years, much of this has been down to Chinese stockpiling. With China’s warehouses and storage tanks stuffed full of aluminum, iron ore, copper, oil, zinc and just about any other mineral you can name, demand has already started to wane. If, as seems likely, the Chinese economy cracks under the pressure of its huge domestic and international imbalances, these commodities will fall, and fall hard.

                            Food and other soft commodities could well remain bid, particularly as third world consumption of meat grows. But that’s another story.
                            JN emphasis
                            Jim 69 y/o

                            "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

                            Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

                            Good judgement comes from experience; experience comes from bad judgement. Unknown.

                            Comment


                            • #15
                              Re: "The risk, if not the probability, is that deflation lies ahead." 7/10/2010

                              Originally posted by Jim Nickerson View Post
                              jk, don't you think that if the Fed has power (this is, it is not "powerless"), that there would be some indications these days and in past months that inflation would be manifested in whatever surveys used to measure inflation?

                              I think it is going to be very interesting to see how the next 4-5 years turn out. Assuming we are alive in 4-5 years, the only thing sure is we will be older.
                              first problem: how do you measure inflation? are you accepting the bls's bs at face value? yoy, the bls number shows inflation a little over 2%. john williams' shadowstats number is a little under 6%. and that's with the sgs alternate unemployment rate over 20%

                              right now, as i mentioned above, the fed is doing its best to sterilize its money injections via incentivizing the banks to leave their excess reserves on deposit [at the fed]. at some point, when deflationary forces become too scary, they will cease paying interest on excess reserves. and soon thereafter, when that is insufficient, they will find new paper assets to monetize. THAT's when exciting things will start to happen.

                              Comment

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