I have previously laid out my thoughts as to what will eventually happen with the whole inflation-deflation debate, but the issue is still raging full speed ahead. It is interesting that it is hard to find 2 experts that actually agree on what will happen or is happening, deflation or inflation. I think it is obvious that we have disinflationary forces here as producers cannot pass along higher prices or they will lose business. In fact, only food, a basic necessity, has any real pricing power right now.
While I am comfortable claiming we have disinflation right now I do not think it will last for a very long period of time. I believe we will see more easing by the Fed via asset purchases, but that will not create immediate inflation. However, over a longer period of time we will see that inflation pick up and not because of money velocity, but because of straight out dollar devaluation. Let me explain.
We did not experience inflation in the 1930’s because no one spent large sums of money on a regular basis. People actually were starving even as food prices declined, sad really. The thing is that since we were on the gold standard, or a form thereof, it was impossible to have true inflation even though FDR was spending like a madman. The Fed was also not in the practice of buying assets because, well, they followed the rules. Because of the gold standard and there were no asset purchases, government bonds or otherwise, inflation remained tame, deflationary in fact. This is a very 30,000 foot view of the situation, but I think you get the gist of what I am saying.
Now we do not have the gold standard, I am not preaching for a gold standard either, just pointing out the obvious, and we have a completely fiat money supply. The Fed has used its “emergency powers” to do what it would not do in the 1930’s, buy assets. It is clear that the asset purchases are doing nothing for the economy other than keeping rates low on loans, which no one wants or are really willing to make unless you have a perfect credit score. It is not even kicking up much inflation, at all, which is because there is simply zero money velocity. Since there is no money velocity the typical economist will say that inflation is impossible and it can never happen, never say never.
What the heads buried in the sand do not realize, because they are using the Depression as their road map (they always do this at the wrong time I might add), is that the dollar is floating now with nothing backing it. That in itself is not bad, as a matter of general opinion, as long as the printing press is used sparingly and every country prints money at relatively the same pace. The problem is that now, after the crisis supposedly ended, countries are printing money at a slower pace or they stopped printing altogether. Many are certainly not doing asset purchases.
Forgetting the fact that QE will do nothing to ease the pain of the economy being bad, sorry, but it will do nothing whatsoever, what it will do is wreak havoc on the dollar. Since the currency is floating more printing and asset purchases will diminish the value of the currency. This has been Ben’s and Obama’s plan all along since Obama wanted to double exports within 5 years, something that can never be accomplished. We are seeing the impact of what more printing will do to the dollar now, unless you think 1.5 cent moves in the Euro/USD pair is normal, as investors move to a currency that is somewhat more sound, not that the Euro is sound, but perception is half the game.
The citizens, us, will not feel the devaluation right off the bat because we consume 87% of what we produce domestically. However, imported products will cost more and we do import a lot of goods, obviously. As domestic supplies are sucked up by foreign countries, as our dollar is worth less thanks to Ben, we will have to import more from elsewhere. This is how our next bout of inflation will begin, dollar devaluation without an increase of money velocity. If you think about it it will make sense, capital flows to the land with the cheapest goods and a weak dollar means China, Europe or whoever, will find more value, cheaper products, from America.
That actually sounds good, more purchases of American goods means higher production as we have to replace what others are buying, but that may not be the case. Why? Simple, prices domestically will be rising and our government, always trying to do the right thing will institute some sort of protectionist legislation to stop prices from rising as incomes are stagnant. It would be a form of capital controls of sorts, but in reverse. Can’t you see it now? Prices are rising and people are not able to get those big screen TV’s or something less important, food, so the government tries to stop it through making new laws. It sounds counterintuitive, but it would happen, look at what Congress wants to do to China in order to get the yuan to appreciate in value? Actually, if we do more QE Congress will not want that to happen because China will literally own us if or when the dollar is devaluated.
While all of this is happening the treasury market, after an initial huge ramp up in prices, this is what the Fed will be buying, will be in freefall as no one will want to be repaid, without a substantial risk premium, in devalued dollars. This will lead the Fed into more massive buying because even at this stage Americans will not even want to buy our own debt. Also, China will have no need to hold their massive treasury holds so they will be selling like mad. All of this is happening without money velocity picking up. Even if you think I am wrong about the previous paragraph think of it this way, if our production did pick up because of foreign country buying sprees that means we will have the money to buy things, but it will only increase the inflation rate… damned if it does, damned if it doesn’t.
It has nothing to do with actual money velocity anymore, we even have mild inflation with dwindling velocity now, and has everything to do with confidence in the system. More QE will be bad news for global confidence in the USD, it is on shaky ground as is. If we look at today’s market action it proves how the market will react, lower dollar, higher commodity prices and equities stuck because it is good news on one hand and bad news on the other hand. Longer term high inflation is bad news for stocks, in my opinion, and bullish for commodities, obviously. Stocks are horrible inflation hedging instruments, look at the last 10 years for proof, while silver (by far my favorite investment right now), gold and other metals should do very well. Of course, precious metals are not really an inflation hedge, but a currency hedge instead. Since we are looking at a currency issue rather than straight out inflation it makes bullion of any flavor very attractive.
Could anything change my mind about what I think will happen? Sure. If no QE happens it will be great news, but the likelihood of no QE ever happening again are about as long of a shot as you can get. While I am using QE for my defense of my position in this article I believe we can safely assume that budget deficits will not get better so even if no QE happens our spending will accomplish the same thing. I say that knowing that if the deficit does not resolve itself the Fed, to save the US, will still have to do QE eventually on a massive scale no matter what, to keep rates low so the interest doesn’t bust us. However, the Fed cannot suck in all that paper and treasuries will fail eventually.
Outside of no QE I think there is not much that can change my mind about what I think will happen. It is pretty much in stone and will happen either as I laid it out or in a somewhat similar fashion. In the near-term I am still bullish on treasuries, now that we sold off, and on silver, gold too, but I am more partial to silver right now. I am not crazy about stocks and would be very hesitant about committing major capital to any position right now, the market is trading odd to say the least. At this point bullion is your best play, silver looks very promising and a recent Scientific American article points out that there is only 19 years left of easily mined silver, a no brainer to me, buy it.
People always wait to buy metals to “see how it does” and while they are waiting the price goes nuts and then they buy it and wonder why they lost money. Don’t be one of those people, but buy it smart, some every month. Because even if you think the bulk of my argument is wrong, or all of it, we have disinflation and higher bullion prices, what do you think will happen when we do have inflation? Not to mention silver is not only a precious metal, but an industrial metal. So, if you think the world is going to end, buy silver. If you think we are in a real recovery, buy silver.
Today was a bit odd in the markets as they sort through the Greek problem, along with the upcoming PIIGS issues, and a so-so initial claims report. The dollar started out strong and then sold off as anxiety subsided about Greece, but don’t kid yourself as the problems are just getting started. What is interesting is the dollar correlation trade is back after being somewhat broken for the past couple of months. Frankly, the dollar correlation to the markets makes so little sense it is just plain bizarre as the gains of a weak currency are so short-term and on a longer term basis it is simply just bad for everything.
Regardless, you cannot argue with something that is clearly working, but as the EU’s issues expand it is sure to send the dollar higher after it takes a little breather here. Longer term the dollar is going much, much lower, its not political it is simply mathematics that dictate that fact, but President Obama confirmed the dollars fate. During the State of the Union address Obama said he wants to double exports, a feat that can only be accomplished if you actually produce something or you devalue the currency. The US does not produce many real products as compared to China or other Asian countries, our largest exports are financial products, bombs and heavy equipment which is vastly different than producing, say, hammers which is what China makes.
In other words, our exports are for select industries or institutions and not for the average person. I am not saying we don’t produce things for everyone, but we do not produce enough things for people to double our exports over 5 years. If we get our manufacturing sector back, meaning more than 11% of GDP, we may have a chance to boost exports. However, the US is not competitive in manufacturing as our labor costs are through the roof compared to Asia or Mexico which reinforces the idea of a massive dollar devaluation in the future, a weak currency would make our products competitive worldwide. Essentially, we are a service oriented economy and you cannot export services. If we could double exports that would be fantastic as jobs would be much more plentiful, but I digress.
The US is still losing jobs at a disturbing rate as we are now some 2 years into the recession which should show everyone that this time it was indeed different than past recessions. While we posted high GDP numbers for the last 2 quarters the growth was based on government stimulus and an inventory rebuild that is quickly coming to an end. With some 8 million jobs lost from this recession there is little chance of unemployment coming down for a very long time, unless the BLS continues to take individuals out of the system like they have been. Some estimate that is could take 8 years for the US to regain full employment and that is with a reasonable growth rate, which we are unlikely to actually have.
The employment picture is simply not improving like many pundits claim it is, there are 6 people chasing every job opening. Hiring’s are also not lived up to expectations either as many firms are still laying people off versus rehiring them. It is scary to think that we have 0% interest rates, some trillion dollars in government stimulus and the Fed has a $2T balance sheet with unemployment first time claims still above 440K a week. I will admit that the stimulus probably did help soften the blow with unemployment, nowhere near as much as the administration claims, and the jobs are temporary at best which does nothing to really help the employment picture. We spent a ton of money for well below average results which is really bad news as the annual budget deficit is hitting 10% of GDP and the national debt is just sky high.
I have little hope that any jobs bill will actually work at this stage of the game because there simply is just no end demand for products. Without end demand who is going to hire? Things are better than they could have been, so they say, but I am convinced that if we let things run its course we might be further along than we are now. The depression of 1920-21 was a quick sharp contraction which ended as quickly as it began because the government did not follow the Keynesian method of stimulus. Massive spending is stealing from the future and when you are heavily indebted country it is a recipe for disaster. In other words, I believe that we should have dealt with the blow and let firms fail in 2008 and we might have been closer to the end by now than the middle.
If we look at the effects of the governments intervention we would see that they are making problems worse, not better. The housing market is still declining versus being at the bottom if we did not try and prop up demand. Unemployment may have been much worse if we did nothing, but I am sure that once all the junk was out of the system it would be going up by now versus being stagnant and, in my opinion, on its way to the bottom. Government intervention merely kicks the can down the road and steals from the future. We can see this playing out in the PIIGS now and we can also see what a heavily socialized government, meaning universal health care and liberal social programs, creates huge financial problems and eventually will cause countries to fail. The US is not far behind the PIIGS even though most believe “it can’t happen here,” it can and will as we set the course and it there is no way to stop the insanity of our government. Both parties are to blame.
So, watching Venezuela, with its currency devaluation, and the PIIGS with their fiscal largesse is telling of what will more than likely play out in the US. That statement is not political, it is mathematical as there is no political will to do what needs to be done. Don’t get me wrong, I do not enjoy preaching lower entitlement programs and reduced benefits, but tell me what choice do we really have? Raising taxes would work temporarily, but not permanently as higher taxes drive capital away from countries and people learn that making less may mean more take home pay. The irony is that we all saw this coming and were forewarned by many credible sources, but we did nothing to prevent it. Essentially, we kicked the can down the road for a fix later and it is now later with leadership who has no idea how or what to do about our troubles. This could get very ugly, very fast.
Long-term I am a firm believer that this administration along with Uncle Ben has it out for the US dollar and both have a policy of dollar devaluation. After all, Obama likens himself to FDR, as anyone who actually read a history book would know only prolonged the Depression, and FDR loved a devalued dollar. Uncle Ben realizes that the only way to grow the economy, pay for Obama’s crazy social plans and cover the present and past politicians reckless spending is to inflate our way out. The operative word in that last sentence is ‘inflate’ meaning inflate the monetary supply thereby creating inflation. However, that is on a much longer time frame, but between then and now it is deflation as far as the eye can see.
No matter what report you look at, the Beige book, ISM or any other industry report there is zero pricing power. As a matter of fact I just say Old Navy, known for really cheap prices, advertising more 50% off sales and I am willing to bet, especially given the very weak YoY retail sales comps, the sales go to 60%+ very soon. That is not exactly definitive proof of no pricing power for that you would have to go and see the other hundreds of sales going on in local and national chain stores.
Up until the last few days the only industry that had real pricing power was the energy industry and that is going away very fast. Commodities have been hit hard because of a rising dollar which is driving speculators, finally, out of the space. Oil is getting pounded which will mean lower gas prices which is great news for Fedex, UPS and you at the gas pump. Unfortunately matural gas is still holding its own and your state is sure to raise its taxes on your utility bill to cover its budget shortfall so your power bill will likely remain the same or go up, sorry. I should say tech did maintain some pricing power, but not for much longer as the consumer is not returning.
This is all evidence of deflation or lack of overall demand. Frankly, with oil especially, there was never any real demand anyhow as the economy is in worse shape than advertised, see the continually revised down GDP figures. It is unfortunate that this is the case because this lack of demand, deflation, will mean big trouble for the economy in the next few months. All those wishing, dreaming, or smoking those green shoots will be rudely awakened to the fact that deflation will lead to more jobs being trimmed and sales not meeting expectations. As I have stated many times before, we were on deaths door a year ago and earnings expectations have been lowered to levels not seen in years and many companies cannot even beat those figures.
If you cannot beat EPS or revenue estimates that were what your firm easily beat 5 years ago, there are major problems out there. However, let’s not let the facts get in the way of a great recovery story. Well, actually, there is never really a recovery until demand comes back and with deflation in full swing it is painfully obvious that demand is dead. Just because there has been a huge melt up in stocks does not mean there is a meaningful recovery in the economy, the data disproves that theory. The market is and always has been a horrible forward looking instrument, if it was truly a forward looking oracle like people claim there would never be a correction and we certainly would not have seen 14,000 in the fall of 2007.
Regardless, until Uncle Ben and Obama can create inflation, believe me they will do whatever they can to create it, we will not have a meaningful recovery. Ironically, what I guessed they would do, set up a quasi-government banking institution with the TARP funds or a public term lending facility, is coming to fruition. I do not know what this will do to money velocity, but it will certainly distort it and either devalue the USD or inflate it to levels we have not seen before. Whether this has the desired reaction or not is also unknown, but we will find out. We need controlled inflation from competent public officials, but this government and this Federal Reserve are not competent.
I have been a vocal critic of the Federal Reserve over the past decade as they have created this current mess and now demand credit for cleaning it up. I liken their current demand for praise to the following: Ben spilled a glass of cherry Kool-Aid on his white carpet then quickly ran over to my house finding my most expensive white cashmere sweater, taking back to his house and cleaning up his carpet. Those of us understanding the staining reaction of Kool-Aid know that his carpet is destroyed and my very expensive sweater is also destroyed, but this guy wants praise for fixing the problem even though the issues are still right there in front of us.
Ben deserves absolutely no credit for fixing anything and deserves to be fired along with having history branding him, and Greenspan, branding them as the two who destroyed the financial system. Of course there are a whole slew of Congresspersons and economists who deserve to go down with them, they are too numerous to name, but I am sure you can guess the top 10 or 20 off the top of your head as they are still wildly popular and in office today. None of this changes the fact that I know exactly what Ben is trying to do and, this will be a shocker to most of you, I do support what he needs to do, but I have so little faith in the man that I know he will fail. My knowing he will fail is why I criticize him so.
We can all agree that the efforts of the government over the previous 12 months have benefits one group of Americans, bankers. Thinking that any of the actions have benefited anyone else is ridiculous to say the least. Your credit card rates have increased, your banking fees went up, people lost their jobs, credit is contracting, income for workers is down, taxes are heading up and banks are making record profits and bonuses that is a rather lopsided list. Ben is not oblivious to this fact, but what he was and is trying to do is create inflation. However, the Fed can create money at the stroke of a few keys on the computer keyboard, but what the government cannot do, ever, is create credit.
Without credit or credit demand, which there is very little of, there cannot be inflation. Another term for this is money velocity and, again, we can all agree that there is no money velocity happening as bank balance sheets are swelling at the Fed right now. This is why I firm believed that the government will open term lending facilities directly to the public or small business in the near future, which will be a huge mistake, in my opinion, because we will go from massive deflation to massive inflation overnight, but that is for another article and let’s focus on what Ben is trying to do.
We know that Ben knows what he and Congress have done is wildly unfair to the public and his inflation creation is his gift to you. What he is trying to do, through devaluing our currency, is raise your pay by weakening the currency through the printing press. By doing this your pay will increase, but your debts will remain the same and as long as he leaves interest rates at 0-.25% your debt servicing costs will also not spiral out of control. This was also taken care of for unsecured debt with the credit card reform act passed earlier this year, is this all making sense yet?
Now, this is not all for you, don’t be silly, this is also for Uncle Sam as well. We have $12T in total US debt, $7T in US treasuries with $2.8T maturing next year. We will also have to spend between $1-1.6T in deficit spending next year as well which means we, the US, will have to raise some $3.8-$4.4T in treasury sales next year, that has never been done before. The US has also restructured most of our debt to mature in <10 years on a rolling basis, I have no idea why other than creditors demand shorter maturities, which is scary. Regardless, the US cannot raise interest rates to a meaningful level ever again. Let me repeat that, the US cannot ever raise interest rates to a meaningful level ever again.
I can hear you saying that I am nuts or do not know what I am talking about. Maybe, but guess again. At the current rate of spending, not including health care, within 10 years at the current interest rate levels the debt servicing costs will be so great that we will not be able to spend money on anything else. It is not me saying this, it is mathematics based on demographics, projected unemployment rate and a bunch of other major issues. What I am getting to is the only way out for the US is to inflate our money supply, exactly what Ben is trying to do now. Who cares that we are the reserve currency, it doesn’t matter as everyone has accepted that this is our only solution or accept a US default on our debt. That is the truth and there is no strong dollar policy, that exists in media sound bites to make people like me happy, that is it.
Back to Ben and you. If Ben is successful, which is doubtful, then he will inflate our way out of this mess. You will earn more money and your debt will remain flat which means you will be able to pay it off in no time at all. However, new debt will be hard to obtain and terms will be very unfriendly as the administration has made rate increases for lenders difficult. Here is the real catch, while the Fed will not be able to raise interest rates, the market will demand much higher rates on government debt so kiss that 30 year bull market in treasuries goodbye. This will translate into higher rates on other debt across the spectrum. Basically, credit will continue to contract at a continued record pace for consumers and, in my opinion, high yield debt defaults will be through the roof.
With all of that said, you want Ben to succeed, as strange as that sounds. You want him to implement this plan and then pull it in on a timely basis because that means banks will be made whole and the consumer, yes, something for the consumer, will also be made whole. Not only that, but it will allow the government to continue down its reckless path of spending and funding its idiotic projects without directly taxing you to death. Notice I said directly taxing you to death? Because you have to remember if Ben pulls this off your energy bill, on top of and cap and trade BS, will go through the roof, your food bill will go through the roof and any other commodity based purchases will be sky high which is a hidden tax. All of those purchases have a hidden tax that you are unaware of, they are always buried in the small print, but nevertheless they are there and fund the government especially on the state and local levels. In this case, the higher the prices, the higher the tax revenue which will fund the local, state and federal governments without taxing you directly. Don’t blame me, you all voted for these people.
Never fear though, this plan by Ben is failing and will fail. As I said earlier, the Fed can print all the money it wants, but it cannot create credit no matter what it does. That is our issue right now, not only do banks not want to extend credit, but no one wants credit. Without extending credit we do not get the important inflationary impact of money velocity which makes Ben’s plan useless. Never fear though, President Obama and Tiny Tim is here to mess everything up as I bet they will announce a public lending facility very soon to “initiate job creation” with leftover TARP funds. This will not only create some perverted unforeseen form of inflation that no one has ever seen before, but it will skew all sorts of numbers as well. I cannot wait to see how the employment report looks after these new programs are announced!
Even if I am wrong about Obama and Tim the Fed will fail at what it is trying to do, I am sure f it. The organization has failed at everything it has tried to do previously and no one should have faith that it can succeed in doing what it is trying to do. Ben tried to talk the Japanese into monetizing their debt in 2003, that made sense. Ben applauded Greenspan’s cheap money policy in 2003 and said he should keep it longer, what? He did not see the asset bubble building when you could get a $500K no document, nothing down mortgage, are you kidding me? I am sorry, but if you did not see this coming with that type of garbage out there you are an idiot, but this guy is running the Fed and says no one can see bubbles coming. The irony is the market is the next big bubble to pop because of his cheap money policy, for the love of God, it trades with the USD/EURO pair, that is the sign of a bubble!
If we look at the Fed’s balance sheet it is impossible for them to drain the liquidity in an orderly fashion. Banks are basically refusing to reverse repo out the liquidity, why would they want to? I wouldn’t when I am making riskless money by borrowing at .13% and loaning it to the government at 1% for a year. Not to mention that the banking system itself, because they will have to bring their SIV’s on balance sheets, are very insolvent in reality so the Fed cannot bring in the liquidity for only God knows how long. Frankly, with the current US debt load and projected debt load, combined with the Fed’s balance sheet we are not getting the inflationary impact Ben wants. We are getting the worst part of it, a falling dollar (Just a note here, the dollar was much worse under Bush before the crisis than under Obama, so cut the guy some slack there) without wage inflation. That means you pay more for gas and food while earning less, not a good thing.
In my opinion, Ben has failed as Fed Chairman and should go back to teaching and that is even questionable. There is no way his plan will work because there is simply no demand for credit out there. Americans are in the middle of a secular shift to frugality and not willing to expand their balance sheets. This is especially true with unemployment ballooning up to where it is and sure to get worse, unless you believe the last employment report (if you did believe the report than please contact me for some excellent investment opportunities in Pakistan and Afghanistan). I hope his plan does work because the consumer could use the wage inflation to pay down their debt, but given the last reports about consumer credit, fat chance. Companies desperately need credit, but they are closing shop so fast that banks do not want the risk. Basically, if you are IBM, you got credit, but if you are Ma and Pa Kettle, sorry, too risky.
The worst part of it all is that while Ben is trying to devalue the dollar to create inflation, which is dumb without any money velocity, he will lose control of the process. When FDR did this in the past, which is what Obama likens himself to, he had one very important thing going in his favor, the gold standard which allowed him to set the devaluation amount. Obama and Ben do not have that luxury. This time there are 100,000 trades around the world that will pile onto a short sale of the USD driving the value down to nothing. This is the primary issue that has me concerned, they ultimately have zero control over the devaluation process. What can they do to stop the devaluation process, print more money? That makes the problem worse, not better. Luckily, for now, we have deflation in the US with an international problem of devaluation so we simply exported our problem, thanks China.
Deflation is here to stay, get used to it. High unemployment is here to stay, get used to it. The federal government will continually interfere and make things worse, get used to it. We will see some funky things happen from some very self important, politically motivated individuals that will create problems we have never seen before, so be prepared. The Fed will fail in its attempt to fix what is created, but you knew that. Wait for gold to come down in price a little more and buy a ton of it because while we will not get inflation like Ben wants, we will get massive dollar devaluation that will eventually come home to roost and it will not be pretty when it comes home.
A new low was made on the DXY today, which should make you very concerned about the stability of our currency as we enter a new paradigm of inflation. While we do not have actual money velocity inflation we do have devaluation of our currency which is unsettling to say the least. What is perplexing is the fact that the dollar is way off today, stocks are up and gold is flat to down, what gives?
Here is an honest answer, I don’t know. I could give into the conspiracy theories which makes sense on such days when we have such a steep decline in the greenback and no movement in gold. On the other hand I could accept the esteemed economists view that gold moved too far too fast with no inflation, but why would that explanation of too far too fast work for gold, but not stocks? So, I give in to no one and accept the fact that someone is just shorting gold today and running into buyers causing a flat market.
However, deep down inside I have a sneaking suspicion that the conspiracy folks are probably right. The only reason I would ever concede this is because the inflation aspect of gold is one part of the argument to own it, the other part is currency devaluation. Plus, who doesn’t like a good conspiracy theory? Gold should be up $20 today, but I digress.
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