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.
Was it Greece? Was it a fat finger trade? Was it high frequency trading? Was it quant funds run amok? No one knows for sure, but it was ugly to say the least. I believe the selloff was very, very real and a matter of no one left to buy the dip. We fell within 1.5 points away from all trading being halted and we miraculously reversed course and rebounded some 700 points. Some think it was the Fed or the plunge protection team, I would say that is not farfetched either.
The one thing this was definitely not was a fat finger trade, like originally reported. When trades are entered for equity orders they only use numbers, not letters so the whole “B” versus “M” argument is a bit irrelevant and merely makes a good news story. I believe this whole thing was a perfect storm of a hugely overbought market, yes it is and was overbought, mixed with Greece contagion fears sprinkled with a bit of tight orders by HFT or quant funds and no one left to buy, anything. All liquidity was sucked out of the market and when that happens, well you saw what the results are.
I believe this is only the beginning and things will get much worse. It was also odd to see mining stocks remain in the green along with gold. If this was a trading error these stocks should have tanked as well, but they did not. This tells me that the selloff was more than a bad trade or order imbalance and any other ludicrous reason the media can come up with. It was selling, real live selling from people who know what it is like to lose 40-50% of their money and did not want to repeat that again. Watch fund flows to verify this, I bet we see more bond fund inflows in the very near future.
Even if you were short it was a tough market for you, especially option traders who saw the bid/ask spread widen to levels I have rarely seen before. I am long VIX August and September calls and it took an hour to get pricing back to normal and there was no premium being given for being in the money. It was amazing to see the selloff today as I jokingly went to my wife’s office and said the market is crashing, it was down only 280 at the time, and when I turned it to CNBC to show here it was down 400 and moving fast to the downside. It was breath taking and luckily I was hedged, but the talking heads on TV and perma bulls that you talk to probably told you that hedging was not important and the market now only moves up, it doesn’t, sorry to tell you.
I always find it odd that when the market tank there is talk of manipulation, but if the market goes up for 8 straight weeks that is normal, come on now. I do not believe anything about today was manipulated, except for the massive rebound that “just happened” all of a sudden. No one seems to be really looking for the cause of this, in a serious manner I mean, and are chalking the decline up to a fat finger event, etc. I am a bit more inquisitive though and while I do not have an answer, I have some theories.
I have heard rumors that the overnight repo market in Europe is frozen, I do not know if this is true yet, and if you notice the overnight LIBOR has been creeping up and is close to the 1 and 3 month rate, this might mean the rumor of the repo market is true. On top of that the risk of contagion is extremely real, I wrote about that a week ago in the “Greece Does Matter” post, and the next up is Portugal followed by Spain, Italy and France who owns tons of PIIGS debt, $781B to be exact. After that it is anyone’s guess to who is next, but it is more than likely going to be the UK. What is happening in Europe should be a lesson, in advance, for the US who, ever since Obama has come into office, seems to think the European way of doing things is better than our system, it is not.
The reason for the debt crisis is the massive debt these countries accumulated to give away free health care, massive pensions, paid vacations and other luxury things to their populations. Clearly following the European lead is not a wise move, but that will not stop our politicians who are immune to market downturns because, A) they are all wealthy and B) they are paid very well for what little work they do. We are the next Europe and we will suffer the same issues they have now if we do not get our act together. I am fairly certain that the funding crisis which is a rumor today will be public knowledge in a few days and is one of the main reasons for our selloff today.
If Europe cannot fund itself, other than through the printing press, today will seem like good times moving forward. This is bigger than Greece and it is 10 times bigger than Lehman, we are talking about countries now, not banks. Essentially, we decided to save the banks at our own peril and we are now seeing the results of this action. We should have let them fail, all of them, because we now run the risk of major countries failing. Was Goldman Sachs really worth it? I think not.
What really stood out today was gold, it went up and is on the verge of a tremendous break out. Are gold bugs really that creepy now or is it that we knew something in advance? For those of you wondering, it is the latter. Gold is now the new reserve currency, period. We may suffer from deflation when this funding crisis escalates, but that will quickly turn into inflation, very, very fast. When dollars come into high demand and they are not available we will see this deflation, but remember, we have Helicopter Ben at our disposal. He will literally get into his helicopter and drop dollars all over the country. This will seem like nothing as the dollar stays strong, but that will be very short lived.
After the dollars are dropped inflation will be swift and unlike anything we have seen before. You see, even though Ben flooded the banks with dollars over the last 3 years none of those dollars made it to us, the people who spend them. Instead the banks bought treasuries, also a good option for investors right now, and this time the dollars will bypass the banks and hit us directly, think Bush stimulus instead of green energy stimulus from Obama. Putting that money in our pockets will mean people will spend, that is what Americans do, don’t ask me why. There is where inflation begins and that is only the start. I am not sure what they will do after that, but I am confident it will involve more spending and giving us money, thanks china!
There is where the problems will really begin because there will be a global funding crisis at that point. This means that no one will buy our debt so we can buy iPods. Ben will have to print it, literally print it to get it into our hands. Inflation is a funny thing and very misunderstood, but I assure you that we will not enjoy it, we will at first though if we pay off our personal debts. In the end we will merely be left with tons of worthless paper and sky high prices. What happens next is a mystery to even me and I am a doom and gloom guy, but it is not going to end well. This is why you must own gold, in your possession, because it will get that bad. The worst case scenario is the value of said gold drops, but it will still be better than holding only USD’s. I think the biggest risk is not owning it versus owning it at this point.
Perhaps this was a one day event though, I doubt it, and everything will be fine. Tomorrow we will receive news that the government hired tons of people and private companies hired more temporary workers, we know the number will be good because Obama already scheduled an 11 AM press conference to go over the jobs report. However, those who continue to think temporary jobs and government jobs are a good thing will be very disappointed to learn it is not. I believe that we will open up much lower, working off unclosed sell orders, and we will rebound some tomorrow, who wants to be short into the weekend.
The real show might be next week, depending what happens over the weekend. I am not sure of the near-term outcome or what will happen, I am holding my shorts and VIX calls though, but we did get a glimpse of what will happen longer term today. I do not know about you, but I did not think it looked pretty. As far as believing some trader pushed the wrong button, come on we can do better with our excuses than that.
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.
He actually said that gold is going up in all currencies not just in US dollars. He makes me want to smack my head against the wall and why someone would pay him $1,000 a year for “advice” I will never understand. However, look at gold in CAD or Euro’s or other currencies and you will see it is not going up, its pretty simple to see that actually. It is going up the Sterling, because they are going down the same path we are with quantitative easing and perhaps this is the only currency Ron is looking at, but in most other currencies gold is relatively flat.
I am certainly no rocket scientist, but man, this guy…
This seems to be a continuing theme for whoever is driving the markets to the moon, sell the dollar and buy equities. If you were watching today you would have noticed that oil, gold and stocks were trading down to relatively flat. Right about 12:00 the dollar started to decline which drove stocks and commodities higher.
This is a continuing trend within the markets and the primary reason why we have had such a dramatic rally. However, the reduction in buying power is not worth the trade off, in my opinion. If you are watching the news channels they attribute the markets turn on higher oil prices and virtually ignore the dollars plight, even though it is a weak dollar that moves oil. Why are they ignoring a declining dollar, I do not know, but they are.
There is really no reason for the market to be positive today as unemployment numbers were not very good, but, I guess, no revision in 2Q09 GDP was somewhat good news. Either way, we are seeing continuations of a very tired bull market were the likes of AIG, Citi, Fannie and Freddie are the market leaders. While the talking heads applaud this move I am reducing my equity position to 7%, down from 25%, most of which is international holdings.
Frankly, we are setting ourselves up for a most painful selloff which I am choosing to not participate in. I do not know when it is coming, but it will come and I am sure it will be brutal. The likes of Mark Haines seem to think that my view is very bullish for stocks, maybe it is, but I consider my view to be balanced with the data on hand. The data I see is horrible, frankly, and when AIG and Citi, both of which heavily owned by the government, are the market leaders then we have a serious speculation bubble building.
Examine the chart below, the data at hand and make your own call. I am sticking with the call I made 3 weeks ago, which we are barely 2% higher than now, of a market top. Of all the people I have spoken to, no one understands why we have not sold off yet and, perhaps, we will not. Until earnings catch up with valuations or valuations trade down to earnings I am very bearish on equities.
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