The deflation case: caught, gutted, poached and eaten

Re: The deflation case: caught, gutted, poached and eaten

... Jim Rogers - who co-founded the now closed Quantum Fund with George Soros - told 750 global fund managers in Tokyo today that, America is “completely out of control”, there will be a 20-year bull market in commodities and that prices will be in turmoil.

Hear! Hear! Tough to bet against a Jim Rogers macro thesis. He may have made a wrong call or two (e.g. Russia in the 2000's) but he is a wily player. Also worth noting that Ty Andros's description of the near future is in lock-sync with what Jim Rogers describes.

As this plays out at some point Rick Ackerman and Mish are going to be doing some acrobatics - hanging off the chandeliers to continue interpreting this as a global or even US net deflationary outcome. The pundit armchair may not be warm enough yet, but if 'waves of global goods-price deflation' had been my platform for the past four or five years, I'd be quietly looking for some rhetorical exit from that public position by 2010, lest my ability to manoeuver within that argument were reduced to the size of a handkerchief.

_________

Edit: Donalds - I recommend reading some of Mr. Andros' articles to add to, or broaden the picture on commodities inflation - he draws a panoramic, global picture. These commentaries are all brimming with intelligence and astute reads on the macro trend. At least I found it excellent reading. If you are unfamiliar with his comments, you can review a complete set of his articles at the Safehaven website (safehaven.com). Just go to the archives and look up "Ty Andros". The global inflationary bias comes into very sharp focus in his collected letters. Gary Dorsch is also excellent on the same themes. The quality, depth and breadth of their collected comments present a powerful case.

[FRED]

Re: The deflation case: caught, gutted, poached and eaten

Any possibility that the increase in money supply reflects the movement out of Commercial Paper, etc., going into Fed. account that show up as money supply.

As for commodities, any possibility that as economic and financial conditions deteriorate further, speculators will unwind their positions to cover margins, bringing down commodities in a fast dash, greatly filtering out the crowded trades?

Any possibility that the above unwinding mirrors (in a feedback loop) the unwinding of the yen carry trade, further exacerbating the commodities unwinding, and thus further drying up of liquidity?

Any possibility that as the recession deepens and unemployment grows, declining aggregate income results in significantly reduced spending, coming at the same time that the global uncoupling theme loses all steam?

Any possibility that as the shadow finance economy shrinks further and things like the CDO market continue to wither away that lending and borrowing will largely evaporate, leading to less liquidity, less velocity, and consequently less cash in circulation?

Any possibility that as the US deficit grows under strains of declining local, state and fed. tax revenues that the Treasury is forced to push forward an oversupply of treasuries for which Fed monetization can't over compensate for?

Any possibility that as the US plunges deeper into a consumer-driven recession, it is accompanied by a loss of incentive of FCBs to buy US Treasuries, forcing up US interest yields and thus forcing down even more borrowing and lending, exacerbating the credit/debt crunch and rising insolvency?

Any possibility that as goods inflation in China, M. East, etc., goes higher, that pressures to unpeg from the dollar rises as well, further reducing their interest in buying Treasuries backed by a weakening dollar?

Lets say an at least some of the above is true and in combination materializes. Would U.S. inflation still grow and expand at a level that quantifies as debt deflation?

Are any of these events dollar positive? No. Then they are all inflationary.

Quantum's Jim Rogers says US 'out of control'

Leo Lewis, Asia Business Correspondent

Jim Rogers - who co-founded the now closed Quantum Fund with George Soros - told 750 global fund managers in Tokyo today that, America is “completely out of control”, there will be a 20-year bull market in commodities and that prices will be in turmoil.

And he also warned that it “made sense” if global competition for resources ended in armed conflict.

Mr Rogers told delegates to the CLSA investment forum that the prices of all agricultural products would “explode” in coming years and that the price of gold, which hit an all-time high of $964 an ounce yesterday, will continue its surge to as much as $3,500 an ounce.

Gold would continue to rise, the analyst Christopher Wood told fund managers, “because it is the exact opposite of a structured finance product”.

In a blistering attack on US monetary policy and the “helicopter cash drop” responses of the Federal Reserve, Mr Rogers described the American dollar as a “terribly flawed currency”.

He said that the plan by Ben Bernanke, the Fed Chairman, to “crank up the money-printing machines and run them until we run out of trees” had exposed America’s weakest point to her rivals and enemies.

[donalds]

Re: The deflation case: caught, gutted, poached and eaten

Any possibility that the increase in money supply reflects the movement out of Commercial Paper, etc., going into Fed. account that show up as money supply.

As for commodities, any possibility that as economic and financial conditions deteriorate further, speculators will unwind their positions to cover margins, bringing down commodities in a fast dash, greatly filtering out the crowded trades?

Any possibility that the above unwinding mirrors (in a feedback loop) the unwinding of the yen carry trade, further exacerbating the commodities unwinding, and thus further drying up of liquidity?

Any possibility that as the recession deepens and unemployment grows, declining aggregate income results in significantly reduced spending, coming at the same time that the global uncoupling theme loses all steam?

Any possibility that as the shadow finance economy shrinks further and things like the CDO market continue to wither away that lending and borrowing will largely evaporate, leading to less liquidity, less velocity, and consequently less cash in circulation?

Any possibility that as the US deficit grows under strains of declining local, state and fed. tax revenues that the Treasury is forced to push forward an oversupply of treasuries for which Fed monetization can't over compensate for?

Any possibility that as the US plunges deeper into a consumer-driven recession, it is accompanied by a loss of incentive of FCBs to buy US Treasuries, forcing up US interest yields and thus forcing down even more borrowing and lending, exacerbating the credit/debt crunch and rising insolvency?

Any possibility that as goods inflation in China, M. East, etc., goes higher, that pressures to unpeg from the dollar rises as well, further reducing their interest in buying Treasuries backed by a weakening dollar?

Lets say an at least some of the above is true and in combination materializes. Would U.S. inflation still grow and expand at a level that quantifies as debt deflation?

[c1ue]

Re: The deflation case: caught, gutted, poached and eaten

GRG,

Your investment philosophy is quite sound - merely different than mine.

We're all in a world where there is no single right answer.

As for Bernanke drawing a line in the sand - I would posit that it is more likely he gets fired and Volcker II comes in.

Burns did not get much chance to fix his 'errors'.

But of course, it is not clear to me that Volcker II could do what Volcker original got away with.

[GRG55]

Re: The Deflation Case: Caught, Gutted, Poached and Eaten

GRG,

The bond market's buying into commodities may be logical given the dramatic lowering of rates, but this does not automatically mean that increasing commodity prices are driven by fundamentals.

Commodities are not being driven by pixie dust. However, the primary fundamentals driving commodities today are not the same as the fundamentals that started this cycle in the aftermath of the 2001 recession.

The question which I still do not considered settled is whether the increases in commodity prices are truly representative of underlying economics rather than sector rotation.

Sector rotation? Well if that is what you think then we have had the longest period of multi-year sector rotation into an asset class that I can ever recall - and although I am not the age of Buffett or Russell, I have been around a few years...

This is not to say there is not money to be made in the oil/gold run up, but knowing what true 'sea level' is makes exit decisions much more accurate once the money tide abates.

After all, even the massive Internet money flows eventually abated - and only those firms with real businesses retained much of their previous value. Even for these, few of them have come close to their salad Y2K prices.

Oil is thus better in many respects than gold as it is a fungible commodity - gold is driven far too much by 'investment demand'..

Well as far as I know gold is a fungible commodity also. But I accept your point that oil has useful purposes other than solely as a financial speculation or store of value. And I've held oil for much longer than precious metals, perhaps because of the same reasoning. Please note that my comment was not restricted to just oil and gold, but all catagories of capital intensive commodities and the producers.

One item which I do not see studied much is the dynamics of capital destruction..

Well we may get our chance to watch this up close and soon, if my expectation that Bernanke will draw a line in the sand on inflation comes about.

It is because of this study that I am not so eager to jump on the gold/oil bandwagon, but have preferred to choose investments in areas where underlying economic growth is higher and in businesses with structural monopolies thus pricing power - but also with flexibility engendered by having labor as the highest single cost.

Cannot disagree with your general philosophy in this regard C1ue. My experience is the best investment returns I ever made (in every respect, not just financial) were those times I invested in myself.

[FRED]

Re: The Deflation Case: Caught, Gutted, Poached and Eaten

I would expect that many of the institutional fixed income and pension fund managers are required to maintain investments in the bond/fixed-income universe. In that respect moving to sovereign debt is understandable.

And hedge funds that actually hedge something would be a welcome development...:rolleyes:

Did we say "Hedge Fund"? We meant Unregulated Speculative Investment Pool (USIP).

[GRG55]

Re: The Deflation Case: Caught, Gutted, Poached and Eaten

This is a hot topic of debate within the hedge fund community. The general consensus is that managers bailing out of non-AAA rated corporates are not moving money from corporates into commodities but rather to the "safety" of government bonds, staying within the fixed income asset class. The perception of relative low default risk is creating a premium over inflation risk, so bond prices on the long end are rising and yields falling. How are commodity prices related? One theory I like is that hedge funds are buying into commodities to hedge the inflation risk in their bond positions.

I would expect that many of the institutional fixed income and pension fund managers are required to maintain investments in the bond/fixed-income universe. In that respect moving to sovereign debt is understandable.

And hedge funds that actually hedge something would be a welcome development...:rolleyes:

[EJ]

Re: The Deflation Case: Caught, Gutted, Poached and Eaten

Where I disagree with EJ (or at least do not understand the logic) is this part...

...because it seems to me that as long as real rates are negative, and money is exiting the bond market due to rising inflation expectations, long bond rates will be under upward pressure, and won't fall. Liquidity across the credit sector is drying up. Even the infamous "recycling" of US$ by Asian Central Banks into US debt instruments, which was so much a part of keeping longer rates suppressed, is now being replaced by the SWF search for equity in assets instead.

If long rates indeed continue to fall, isn't there much less incentive for bond investors to sell their bonds and buy commodities? :confused:

This is a hot topic of debate within the hedge fund community. The general consensus is that managers bailing out of non-AAA rated corporates are not moving money from corporates into commodities but rather to the "safety" of government bonds, staying within the fixed income asset class. The perception of relative low default risk is creating a premium over inflation risk, so bond prices on the long end are rising and yields falling. How are commodity prices related? One theory I like is that hedge funds are buying into commodities to hedge the inflation risk in their bond positions.

[akrowne]

Re: The Deflation Case: Caught, Gutted, Poached and Eaten

Maybe not. Remember when commodities (mostly energy) crashed in late 2006 and stayed down till late 2007?

Yeah, I think that was "ka". Blink and you might have missed it.

[metalman]

Re: The Deflation Case: Caught, Gutted, Poached and Eaten

Editing error. My bad. Changed the tense back.

wishful thinking? the uk was an economic basket case when she joined up, no? many credit north sea oil and other luck.

[FRED]

Re: The Deflation Case: Caught, Gutted, Poached and Eaten

Eric, Margaret Thatcher isn't dead.

Editing error. My bad. Changed the tense back.

[dcarrigg]

Re: The Deflation Case: Caught, Gutted, Poached and Eaten

Eric, Margaret Thatcher isn't dead.

Ha!...I was about to go look this up, because I didn't remember an obituary. Thanks Chris.

Here's another great Thatcher quote by the way:

"No one would remember the Good Samaritan if he'd only had good intentions; he had money as well."

Please, noble lady, while I'm crossing the British country side with this house upon my back, might I have a little of that trickle from the top?

No? Oh well, just keep trudging along.

[c1ue]

Re: The Deflation Case: Caught, Gutted, Poached and Eaten

Quote:

Originally Posted by herbkarajan when credit is destroyed, real money supply *may* contract (CPI deflation) this is because people can no longer convert assets into real cash. The nasdaq crash of '01 was highly deflationary because people had less money in their brokerage accounts and less money to spend. Similarly, right now, people have less real money because their accounts containing junk bonds are marked down and home equity lines are reduced. Preventing asset price deflation from spreading into 'real' economy is the Fed's job. They do this by devaluing the dollar and thus proping up asset prices. Stock market benefits from lower currency, the run up in gold and oil is purely speculative and may or may not continue even if the dollar keeps heading lower. The key is the lower dollar it will continue to fall as long as the assets prices are in danger.

I could not disagree more. The run up in capital-intensive commodities and resource extraction companies is a deliberate and rational response to the Fed being forced to cut rates in an already inflationary environment.

GRG,

The bond market's buying into commodities may be logical given the dramatic lowering of rates, but this does not automatically mean that increasing commodity prices are driven by fundamentals.

The question which I still do not considered settled is whether the increases in commodity prices are truly representative of underlying economics rather than sector rotation.

This is not to say there is not money to be made in the oil/gold run up, but knowing what true 'sea level' is makes exit decisions much more accurate once the money tide abates.

After all, even the massive Internet money flows eventually abated - and only those firms with real businesses retained much of their previous value. Even for these, few of them have come close to their salad Y2K prices.

Oil is thus better in many respects than gold as it is a fungible commodity - gold is driven far too much by 'investment demand'.

One item which I do not see studied much is the dynamics of capital destruction.

As the Economist noted quite some time ago, a single cent invested at the time of Christ's birth would yield a ball of gold larger than the Earth by now, but the reason this has not happened is that there are periodic episodes of wealth destruction.

Inflation is only one of these methods; I have been studying the various historical analogs to understand both the methods and dynamics of how wealth destruction can occur.

It is because of this study that I am not so eager to jump on the gold/oil bandwagon, but have preferred to choose investments in areas where underlying economic growth is higher and in businesses with structural monopolies thus pricing power - but also with flexibility engendered by having labor as the highest single cost.

[GRG55]

Re: The Deflation Case: Caught, Gutted, Poached and Eaten

when credit is destroyed, real money supply *may* contract (CPI deflation) this is because people can no longer convert assets into real cash. The nasdaq crash of '01 was highly deflationary because people had less money in their brokerage accounts and less money to spend. Similarly, right now, people have less real money because their accounts containing junk bonds are marked down and home equity lines are reduced. Preventing asset price deflation from spreading into 'real' economy is the Fed's job. They do this by devaluing the dollar and thus proping up asset prices. Stock market benefits from lower currency, the run up in gold and oil is purely speculative and may or may not continue even if the dollar keeps heading lower. The key is the lower dollar it will continue to fall as long as the assets prices are in danger.

I could not disagree more. The run up in capital-intensive commodities and resource extraction companies is a deliberate and rational response to the Fed being forced to cut rates in an already inflationary environment.

[GRG55]

Re: The Deflation Case: Caught, Gutted, Poached and Eaten

The Deflation Case: Caught, Gutted, Poached and Eaten

Oh, no! Not the Inflation vs Deflation debate again!

by Eric Janszen

The Fed’s greatest challenge is that the need to create an inflationary firebreak between crashing asset prices and the real economy has become so obvious that Wall Street money managers are starting to pile into the inflation bet en mass...

On Rick's part this seems inconsistent:

On the one hand he says Uncle Ben has avoided excessive use of the printing press (perhaps he's bought into Mish's argument that money supply has not been growing)...

"Are there any $100 bills wafting your way? We didn’t think so. So much for the theory that “Helicopter Ben” would shower America with printing press money if something ever went seriously wrong with the economy"

...but then he goes on to say (emphasis mine)...

"So, what Helicopter Ben appears to have achieved using measures that even we would concede are hyperinflationary is: nothing."

If Rick thinks what the Fed has done so far is hyper-inflationary that would suggest he's having some serious trouble with his definitions.



On EJ's part the first and last excerpts below seem, to me, to be in conflict:

On the one hand EJ says (emphasis mine)...

There you have the impetus for the commodity price increases: you’re losing money on bonds earning 5% when true CPI inflation, versus the phony numbers, is over 5%. This is why so much money is flowing into commodities.

...with which I completely agree. For the first time in more than 2 decades bond investors are faced with a Federal Reserve Board that is cutting rates not into a dis-inflationary environment, but in a clearly inflationary one. This is a key difference between the Greenspan era rate cuts and the situation today.

Which could be why this happened...as Ka-Poom more accurately models the Greenspan era case history (?)...

The surprise that I did not anticipate is that the “Ka” disinflation and “Poom” inflation are happening simultaneously.

Bond investors are now confronted with the rather unfamiliar situation of having to seek capital-intensive inflation hedges, at the same time the Fed is cutting rates :eek:; capital-intensive because of the gargantuan size of global bond markets (compared to equity markets), and the enormous amount of money that is trying to be redeployed. This is also why those who still expect commodities to collapse as the recession progresses will find they are wrong. They have not figured out that the "rules" from the Greenspan era rate cut cycles have changed. I agree with EJ that until the bond market anticipates that the Fed will reverse policy, and start to fight inflation, flows out of the bond market and into capital-intensive inflation hedges will continue. This is why I remained way long, and continued to add (on the dips) to oil, natural gas, coal, uranium, precious metals, selected base metals, other "stuff", and the companies gobbling tons of capital to produce more of this "stuff", in spite of looming recession concerns (however, stupid me, I completely overlooked the ag sector).

[Just as an aside, I am going to make a prediction here that, although Bernanke is no Paul Volker, he is going to surprise the hell out of a lot of people by becoming more of an inflation hawk, for a period of time, than most of us are expecting. Rates won't go to zero in a straight line, and that is how he is going to clobber the commodity inflation trade, at least temporarily, at his first opportunity.]

[Edit added: And when Ben puts on that black mask and mugs the commodity and gold markets, the uninformed pundits will explain it was just stupid speculators in an overdue reaction to the recession. In fact it will need to be a shallow recession with minimal increase in official unemployment to give Captain Inflation the opening he needs to pause the rate cuts, threaten a resumption of rate increases, cut the legs out from under the inflation hedge trade, and temporarily restore some inflation-fighting credibility and breathing room for the Fed. Only if the recession morphs into something very serious, very quickly, will the Fed be stuck]

Where I disagree with EJ (or at least do not understand the logic) is this part...

Short rates are going to zero and long rates, driven by liquidity, will continue to fall. As long as they do inflation and commodity prices will continue to rise.

...because it seems to me that as long as real rates are negative, and money is exiting the bond market due to rising inflation expectations, long bond rates will be under upward pressure, and won't fall. Liquidity across the credit sector is drying up. Even the infamous "recycling" of US$ by Asian Central Banks into US debt instruments, which was so much a part of keeping longer rates suppressed, is now being replaced by the SWF search for equity in assets instead.

If long rates indeed continue to fall, isn't there much less incentive for bond investors to sell their bonds and buy commodities? :confused: