Deflation, Inflation and Housing

Posted by Ray on June 22, 2010 under Main | Be the First to Comment

There is an interesting story from CNBC.com that illustrates that a bond trader is concerned that the bond market will collapse. It is not the fear that the bond market will collapse that caught my eye, it is the fact that he thinks deflation will fuel the collapse. I do not see that happening, exactly, yet at least. Clearly housing is still seeing deflation and we are not at the bottom yet either.

Logic dictates that we should all be gearing up for inflation, now, but the data does not lie and I can pull the most aggressive data I want and it shows ultra low inflation rates which is scary, frankly. With the massive printing and monetization of debt that we have seen over the past 2 years we should see some inflationary pressure, somewhere, but nothing. Not only has the Fed’s balance sheet grown, but it is growing and so is the national debt, at a record breaking rate. Still, inflation is nonexistent which is puzzling to all economists and policy makers, even housing that is given the most generous tax breaks and, recently, a huge tax credit to buy is showing that prices are falling, not rising. This is a severe problem and it is going to get worse.

Deflation will continue to rip through the economy as the deleveraging continues which could be for another 3-4 years, but there are always caveats which I will go over. The primary reason there is no inflation, this isn’t rocket science unless you are an economist, but credit is contracting and people are saving more which means less money is in circulation. Bank balance sheets are enormous right now, but the irony is they are still largely insolvent and even if they could lend why would they with 10% unemployment and initial claims coming in at 470K a week? All of this means prices will drop lower across all categories, except for food which I admit has me perplexed as well.

The primary reason is the fact that everyone is deleveraging and paying down debt. We live in a society that was driven by consumption, but that consumption was not organic, i.e. actual income driven, it was credit driven. Once that credit is gone, and it is long gone, consumption ends as we once knew it. Sure, we will have hot products like the iPad, why, I do not know, but that is not for me to decide and even those products have a certain shelf life meaning their appeal will eventually wear off. Especially when we have initial claims, on a monthly basis, at 1.8M which is twice the population of Montana and the target market, 18-30, is experiencing a high rate of unemployment.

This lack of inflation is not lost on the Federal Reserve and believe me they are worried about it. Tomorrow you will not see any drastic change in their language or actions. They will likely get rid of paying interest on bank deposits, what’s the point if inflation is nil. In fact, I am willing to bet, this will not be in the announcement, that the Fed’s balance sheet will get even bigger and what should concern you is the amount of currency swaps that appear on their balance sheet. Those swaps are for Europe’s banks that “are just fine” so they can settle their trades in the relatively safe reserve currency, the USD. If that number keeps growing the problems in Europe are much larger than we are being told. Europe will also weigh heavily on tomorrow’s decision and that will be a reason that no major action will be taken as well.

It is clear that deflation or disinflation is here at the moment and I am sure it will get worse, but it will also be somewhat quick. As many of you know the U.S. has decided to not pass an official budget this year. This is the first time this has happened in almost 40 years and there is only one reason I can speculate this is not happening, the $1.6T estimated by the President was a little too conservative and the actual number is probably much higher. Why debate that before the midterm elections? It would also bring the U.S. front and center in the whole sovereign debt fiasco that Europe is going through at the moment. Frankly, our balance sheet is much, much worse than what we are so critical about over in Europe and we haven’t even instituted socialized medicine, yet.

Deflation is great for U.S. treasury debt as investors can capture greater real returns and the treasury pays out little interest, but this is not going to last long. Our deficits and our tinkering in China’s affairs is about to bite us in the rear end in a big way. First, we owe too much and can never, ever repay it, there is just no way out of it and we cannot “grow our way out” and the people suggesting that are loony tunes. Second, I suspect the RMB, Yuan, China’s currency, will eventually weaken, I am very sure of it, but it may also strengthen in the meantime which would be humorous only because China would then be running big trade deficits, not surpluses, and would not have to buy our debt. I wonder how well our $40B daily auctions would go then.

I also wonder if Congress will actually pass the much dreaded Currency Manipulator Bill they are threatening China with, I think that is Smoot-Hawley on steroids. If both these things happen, China lets the currency strengthen to get the U.S. off their back, right before they drop it to new lows, and Congress passes their tariff act, that is essentially what it is, what would that do? It would force Americans to pay much more for goods, that is inflationary, and it would force China to either not buy more U.S. debt because there is nothing to hedge against and in all likelihood China would end up being net sellers of treasuries because all of their bubbles would have popped and they would need to get liquid. All thanks to politicians who have no clue how capital works. That would lead to inflation in a big way because all that inflation we exported over the years would wind up right back home where it belongs.  This, of course, is a worst case scenario.

What is more than likely to happen is the fact that the U.S. simply continues to spend and the bond market slowly begins to demand a higher risk premiums. Eventually it will end up like Greece where the U.S. cannot borrow at reasonable rates, but long before that the Fed will take matters into its own hands and begin to buy treasuries through quantitative easing programs, they did it once, they can do it again, right? Except this time it will be inflationary, but not from a money velocity point of view, from a dollar depreciation point of view. That is much worse because you actually do not have to increase money velocity to destroy the currency which will crush savers and the middle class.

The beauty of this is it doesn’t happen all at once, it happens over a period of months and the government will tell you this is a good thing. How you say? Oh, it is a perfect plan. Because we consume about 80% of what we produce domestically so we won’t see it right away, but what we will see is our exports increase dramatically, because the dollar is falling on the international markets. More people will become employed, sounds good right? Well, I am not done yet. As people become employed they spend more and prices rise and as prices rise wages will need to increase, but no one is buying our debt still, except the Fed. The money supply will have to keep growing to keep up with inflation so they print, monetize and send out more money to banks to get into circulation. Wages will increase at exponential rates, but it won’t mean anything.

You see, it is all fake, driven by the monetization of our debt and eventually the dollar will simply be worth nothing and no one will want to trade with us or at least do business in our currency which means production stops because you cannot exchange our currency for anything else, it is Zimbabwe. The printing of money is a dangerous thing and the economists who insist that what separates us from Greece is that we do have a printing press are right, but for the wrong reasons. It is much more dangerous that we have a printing press because we can do terrible things to ourselves and what I just laid out above it could happen. It might happen because there is historical precedence. There are 2 well documented cases, the Weimar Republic and Zimbabwe.

It happened, in both cases, quickly, very quickly and in Germany’s case they started out with deflation, much like what we have now. As the government repaid debt and tried to keep the economy going they printed money and they went from deflation to inflation in the blink of an eye. They were so efficient at printing money they eventually only printed money on one side of the paper, to speed up the process. They even used wood tokens so people could at least burn them for some value. It doesn’t take much to start down the path of inflationary cycles because neither the Germans or Zimbabwe wanted to be the poster child for hyperinflation, quite the contrary in fact, they, like Ben, think they can control events, capital. That is where they went wrong, capital has a mind of its own and once a path is determined it is tough to change course or stop it altogether. Some very smart men were in both countries and they failed at stopping the inflationary onslaught. I highly doubt our Fed can stop it since they admit they cannot see things coming anyhow.

As far as the folks who say these things cannot happen here, well, they can and they will. It is inevitable at some point and there is no way a deficit reduction committee can stop it or implement a plan to reduce our debt before it happens. There is no political will left in Washington to stop their spending ways. Especially with some 78M Baby Boomers about to receive the mother of all socialized benefits, how do you say no to the largest voting bloc in history? You don’t.  I believe that the whole deflation/inflation debate is irrelevant as we will have both. Plus, investing for deflation is really no different than normal investing, some bonds and strong dividend paying stocks which should be your core holdings anyhow. Inflationary investing, well, that is a different story and while I prefer toilet paper and gold you may prefer tobacco and food, either way. The point is, it is coming and you will not see it happening until it is here.

Bring on the European Stress Test

Posted by Ray on June 7, 2010 under Main | Be the First to Comment

Look, things in the U.S. are certainly better, even though I am bearish on the economy, but they are just a “less worse” type of better rather than a true recovery or whatever you want to call it. Someone once commented that I would not know a V shaped recovery if it sat on my face, or something to that, as the recession in the early 1980’s saw a lag in initial claims of some 6 months before the recovery in employment happened. Boy, I hope that person is reading this because that comment was made in august or September of last year, almost a full year ago, and initial claims barely broke the 500K mark as we speak, is that the ”V” we are looking for? The fact is in a post credit collapse employment is a leading indicator, I said it a year ago and I am saying it now and the only difference is the unemployment rate is HIGHER today than a year ago.

What changed over the last 12 months?

Nothing. Wait, I take that back, a lot. The U.S. is now $3T more in debt, we performed a “stress test,” which we are telling the ECB to do, more on that in a minute, and the Fed expanded its balance sheet by how much? What did we get for all of that? A 5.2% GDP print based on inventory a rebuild that was probably premature, if we take away the stimulus would firms have rebuilt their inventories so much? I think not. Unemployment is slightly better thanks to temporary jobs and government hiring, not exactly what I would call “robust” at all. The bottom line is all my criticism of the stimulus was right, it failed.

The banks are better you say, right? Are they? If you think that, well, I just don’t know what to tell you. Did the banks get rid of the “toxic assets?” Did they write all their bad debts off? Did real estate values increase? How about commercial real estate, is that sector flying strong again? No. Are banks loaning money again? Sure, if you have a credit score of 850 or better and don’t need the money they will gladly make a loan to you. However, if you need to refinance your home you better hope you qualify for a government program or you are out of luck. The “stress test” was a joke and meant nothing because we are at the outer limits of the stress test, remember, 10% unemployment, etc., etc.? What saved the banks was one thing and one thing only, the repeal of mark-to-market account, period, end of story.

If we brought back mark-to-market accounting today we would have a handful of big institutions left, I guarantee it. Just look at Wells Fargo’s balance sheet with the “Pick-A-Pay Loans” they inherited, worse, they bought, from Wachovia, the LTV’s, except for Texas, God Bless Texas, are all horrible. I am not saying WFC would fail, I am just saying they would have to realize pretty significant losses is all. It is no coincidence that right after, literally right after, the repeal of mark-to-market accounting rules by the FASB, by Congressional pressure I might add, bank earnings went through the roof. What replaced mark-to-market accounting? Mark-to-model accounting, do you know who made that model famous? Enron, need I say more?

Europe

Now, Timmy Geithner is over in Europe telling the Europeans to do a “stress test” to let the world know all is well. Sorry Tim, I do not think this will work since it is technically not the banks in question, but rather the sovereign debt that they are holding. Why not do a stress test on governments instead, maybe that will solve the problem. This is a banking problem, again, that was brought on by huge deficit spending and countries inability to service their debt loads, this is big, huge actually. While this will impact banks it is not really banks that caused it, but politicians who decided to bribe the people with their own money.

It is likely that one of the PIGS, or whatever we are calling them now, will default given the issues they have and the inability of politicians to say no to spending. It is just odd, it always has been, that the people demand all this gravy from the government in the form of give a ways, tax credits or straight cash in some form. Don’t these people realize that they are only getting back their own money? Actually, if governments spent less and had lower debts that means they would have lower overall taxes which means the people would have more money on their own… they would be better off! However, the people insist on being bribed with their own money and politicians are only too happy to oblige.

The point is that this bigger than the banks as we are talking about the solvency of countries now. Bailouts are much more difficult to do for countries and the implications of a default by any country has widespread ripples that most people have no idea can or would occur. Even if Hungary or Greece defaults it is a huge deal and will impact governments and banks all over the world. I have been saying this for months now, Greece is a big deal and all those people saying it is not are, well, disqualified to render their opinions anymore as the markets have spoken and they have sided with me.

Run a stress test, it doesn’t matter because it really doesn’t matter Tim. The problem is with government spending this time and I do not think mark-to-model accounting can fix this problem.

The real problem

The real problem is I do not know where the sovereign debt problems will end, I know it will get worse. I know that more European countries will succumb to this very same issue as most European countries are socialist by their very nature and their debt levels are very high. As the weaker countries fall they will drag the stronger countries down with them, it is just how it works. I made a call that the Euro will fall to 1.18, we are about there. Do I think it will go lower? Yes, to parity in the near future. I think 1.16 is the next level, but the ECB will have to intervene and China has to intervene as a weak Euro is a major problem, it is, another story for another time. The currency will not survive without a mechanism to eject the weak states, period.

After the carnage in Europe is done, I do not have a timetable for that, it could be tomorrow or 10 years from now, but more than likely it will be sooner rather than later, the debt problems will spread, to the U.S. We have $13T in debt and an economy that is not recovering, I am not happy about that, but those are the facts. We are spending $4.9B a day, 3 times the amount George Bush, not exactly the face of fiscal conservatism I might add, was spending. We are in major trouble and what are our politicians doing? Trying to figure out how to get stimulus 3 out the door, that’s what.

I have been saying for months that our debt to GDP level is almost at parity, but it takes the Drudge Report for people to start listening? OK, at least people are listening now. The problem is we have no politicians willing to take the steps to fix out problems. Go ahead, elect the Republicans, look what they did from 2000-2006, they really helped to speed the process up, in my opinion. Of course, out current President and Congress has surely kicked what the Republicans did into hyper drive as they added 30% to our debt load in less than 2 years, that is $3T, an astounding figure. Neither of these parties really want to fix the problems, in my opinion, because they have a vested interest in perpetuating the problems so they can stay in power, it is just how it works.

What this means is we are all in very big trouble. I am not talking about, oh, gee, go buy an ounce of gold and protect yourself from inflation, I am talking about the Weimar Republic, hyperinflation, type of trouble. I see no way out besides inflation and in a big way. As Paul Krugman points out, there is a big difference between Greece and the U.S., we can print our own money. We also know Ben Bernanke has no problem with hitting that print money either. I am also confident that the Fed is, basically, completely incompetent.

If we cannot go to the market to finance our debt, which we have trillions of dollars of that most of it matures in under 10 years, the Fed will monetize it. That is how we will deal with our sovereign debt crisis, we will print our way out of it and it will be the very worst thing we can do. Instead of cutting our government, spending or doing anything else that is logical, because politicians want to get reelected, they will choose to inflate their way out. Will gold protect you? Yes, but so will food and any other useful commodity including toilet paper. It disturbs me to no end that we are where we are and that the President is listening to the likes of Mr. Krugman who thinks deficits don’t matter, they do, and that since we can print money it is OK, printing money is not OK.

In the meantime I am still short the market. We will have a bounce I am sure and I almost took a nice broad long position today, but I passed. While I am sure we will have that bounce I did not think the risk reward was worth it. My target is still 900 on the S&P 500.

The BP Selloff

Posted by Ray on June 1, 2010 under Main | Be the First to Comment

The media is blaming BP for just about everything nowadays including today’s selloff which is absurd to say the least. There is little doubt that BP has had an impact on the oil service sector and sent those shares lower as the government is about to unleash the proverbial Hell on the sector for what amounts to a horrible accident. A word on the spill, it is terrible, awful and I hope it gets taken care of as soon as possible, but BP is doing everything it is supposed to be doing. Even the President admitted that the company cannot make a move without his direct approval, so let’s make sure we spread blame to all who deserve it. However, the leak is not the cause of the market selloff, but only part of the problem.

What I found extremely interesting in Tuesday’s trading was that the Euro made a fresh 4 year low and someone decided to step in and buy the Euro like no tomorrow. It had to have been a central bank because I know of no investor that would be anxious to buy anything that just made a fresh 4 year low on speculation of a rebound, but that is rumor and my own speculation and it does not matter who did it because it happened. The Euro is leading the trading and that is what is important to realize and that in itself is what is interesting because that trend is on again and off again day by day so do not depend on the Euro to always be the guide. To be sure if the Euro is leading the way check the EURO/USD and EURO/JPY pairs and id they are both heading in the same direction with the market the trend is valid, if they are mixed take your own chances trusting the Euro to lead.

What else was extremely interesting today is the fact that the Russell 2000 and the transports had diverged from the Dow 30, S&P 500 and the NASDAQ all day today. It is also important to note that I have mostly thrown my charts away as I feel they are more or less useless at this point, but I do look at them from time to time. Regardless, I always use the RUT, Russell 2000, to gauge the overall movement of the market and where we are ultimately heading for the day, it is fairly accurate as it is a broad based index, and if you are a Dow Theorist you watch the transports anyhow to see where the Dow will go for the day. I guess I am a bit of everything because I watch a lot of things all throughout the day. Of interest was the RUT was down a good 1.7% most of the day as the Dow was positive and the S&P crossed throughout the day and the transports were also down about 1% throughout the day as well.

Having a divergence in itself is not a big deal, it kind of happens all the time and the markets tend to even out at the end of the day, but not today. The RUT and the transports ended down pretty hard, almost 3% and over 2%, respectively, while the Dow ended down 112 and the S&P ended down 18. Typically, when the RUT and transports are down that much the Dow is down about 200+ and the S&P is down about 30 so it was strange trading all day long. It is safe to assume that I merely held my shorts today as I think there is something to this divergence and there is more downside to this market. However, the real catalyst for the selloff was not BP, oh no, it was the EU.

About 10 PM EST last night the ECB released a statement saying that EU banks may write down about $290B in debt, that is a problem. When that news hit it drove futures down 50 ticks and they just stayed there all night long. Considering that it was a holiday that is a pretty big move so I was not surprised this morning when I saw the open, but I was surprised on the turn at 10 AM when the markets went positive and I saw the divergence in the different indices. I kept waiting for the reversal to happen again, but it did not come through until 3:30 which is a bit odd, kind of, but it also shows that this market is not a bull market at all anymore, it is a bear market. A bull market would not be trading like this and we would not get such bearish signals at 3:30 PM, sorry to be the bearer of bad news.

I do expect a rally in the short-term, but nothing to write home about, previously I thought a run to 1,200 on the S&P was possible, but not any longer. I believe we may see 1,120 or so, but that is about it unless the news really turns, which I do not see happening. I believe the ISM data we saw today is the beginning of the official rollover in the data series, leading indicators already rolled, and I am not expecting much more strong economic data as the stimulus money is gone, that was a quick trillion, eh.

Everyone is watching for the employment report on Friday, but no one looks beyond the headline number so why bother? With initial claims in at 460K, 2.5 years into this thing(!), we are in negative job growth territory. I expect to see the unemployment rate climb to 10%+ as people get back into the workforce as extended unemployment benefits are running out and people reenter the workforce. I expect a high number of government employment which needs to be discounted and one needs to remove the Birth/Death model tinkering that occurs because those jobs are simply made up, that is why 880K jobs had to be added to the unemployment roles in February as this model underestimates the unemployment rate. If the private sector is adding only temporary workers at this stage we are in big, big trouble and that is NOT a bullish item, it is very bearish. Overall, I expect a number that is going to be in the 300 – 350K area, I hear of some shenanigans in the numbers, more on that is I can confirm, but until then it is rumor only.

I do not believe there is much upside to this market and the risks run very high with the exception of cash and gold. At this point even high paying income stocks are getting hit hard and bonds are, in my opinion, overvalued at this point and I got very lucky with my exit on high yield. I like short treasuries, 2 year durations, but cash is better at this point. I believe deflation is here and it is going to get very tough going forward which means stocks are way overvalued by 20 – 30%, think 10-12 P/E on $75 earnings on the S&P plus much lower growth. Be very nimble or start looking for entry points for a short position, but you should have been doing that 3 weeks ago so don’t go jumping on the bandwagon now without doing your research.

At this point I am holding high yielding stocks, short duration treasuries, country specific ETF’s, equity income ETF’s, 3x bear ETF’s, put options, gold, silver and platinum group metals. Clearly I am thinking much lower equity prices, deflation followed by inflation at some point. Everyone is a genius when the market is going up, but we are about to hit a very rough market and I expect volatility to remain elevated for some time and the VIX might offer some excitement for you, but you must understand it before you do anything with it. In the meantime my price target is 900 on the S&P 500 which has been my target since the beginning of the year, I think it could go much lower if conditions worsen. Good luck.

What a wild ride

Posted by Ray on May 26, 2010 under Main | Be the First to Comment

The past 2 weeks we have seen the markets do things that simply do not seem natural from freefall flash crashes to intraday 300 point turn around rallies. However, there is one thing that is pretty clear, I would not buy this pull back. As David Rosenberg points out and a few other non-perma bull market strategists, not that there are many left, point out is that these wild swings are not normal in a bull market.

Think back to the market of late 1999 to the early 2000 and you will remember such swings, but do you remember how it ended? If you bought on those dips you never made your money back, ever if you bought the NASDAQ and you would have barely broke even in the S&P 500 if you sold at the peak in 2007. I think it is safe to assume that this market action is a sign of a sick overbought market trying to lure you in to buy one more time before it robs you blind, don’t do it. To be clear, I believe the broad market will move lower, I think 900 to 950 is not an unreasonable target, but we could move much lower than that. Before you say it, no the fundamentals are not so strong that we could not see the lows of last March, more on that in a minute.

I am not saying do not buy great individual companies, not at all, I am bearish on the market, but I like some individual names. I am bullish in the biotech area as there are tons of patents expiring in the next few years and you will see big pharma buy many of these names, but I also like big pharma too. Look at the yields and the rock bottom P/E’s, they are dirt cheap and you should look at some of these names, but biotech is not a prisoner to the business cycle, as long as it is well funded and near approval for a drug. I also like consumer staples that pay dividends, boring names, but they pay you to hold them and no matter what the economy is doing you will always need toilet paper and a toothbrush, I hope at least. I also still like high quality bonds and can make a case for treasuries right now, but use your own discretion, I would stay away from high yield, I sold mine a couple months ago.

Why do I think boring and income is the best model right now? Well, the market is going to correct even more than it already has, kind of a simple explanation. Income strategies, which I have been on the record for supporting since last year, makes sense because we are living in disinflationary, possibly deflationary, times where real yields are much higher than what we think. I am a long-term inflationist, come on look at all the money being printed and Obama wants to double exports in 5 years, you cannot do that with a strong dollar, but right now deflation is the name of the game and income makes sense. Deflation also means stocks need to be trading at much lower multiples than most people think and that is why I think this correction will potentially be much deeper than most people believe. Time will tell who is right about that.

The Fundamentals!

What about the fundamentals? Are they better than a year ago? Sure. Do they support a 20 P/E multiple on the S&P 500? Nope. Do you really think the housing data since the homeowner tax credit implementation was actually real data? No way. How about unemployment, do you believe temporary jobs are going to lead America to the next level of prosperity? Well, all the amazing job growth has been only in the temporary job area, let’s not forget that the actual employment report numbers are tinkered with via the birth/death model which added 188K jobs to last month’s employment report. For those of you who don’t know, the birth/death model are estimates the BLS uses to predict how many new business are started based on how many business died and population growth, it is fantasyland stuff basically.

What about corporate earnings? They have been good, but I do not believe they are sustainable. First, the stimulus is running out, that is a very important thing to remember moving forward. Second, a cool 30% of the S&P 500’s earnings come from Europe and up until lately U.S. companies enjoyed, globally, a weaker dollar which is over since the new sovereign debt issues are driving the value of the dollar higher. In technology a large percentage of earnings came from Asia and I do not believe that will continue much longer because of what is happening in Europe, Greece was a big deal indeed.

You see, Europe represents 20% of the worlds GDP and, believe it or not, China’s top importer is not the U.S. it is the EU. So, if the EU is going to have lower growth because of austerity measures, which they will, it will automatically be a drag on world GDP, but it will specifically hurt China. If China begins to slow down that is very bad news since China is “the recovery story of the world” or some other tag line the media gave it. In other words, China will be buying less from the U.S., exporting less to the EU and the EU will be buying less from the U.S. Also, China will be running, more than likely, trade deficits not surpluses which means they do not need to buy our debt. Can you see the problem now?

Greece is/was a big deal not on its own, but because it was locked in with the other PIIGS which were locked into the EU as a whole. It is all very bad news and no matter what CNBC says we are all still coupled with each other. It is the interlocking of the global economy, especially in the debt markets, that is the problem and there is no escaping it. I am afraid that even when governments guarantee debts that may not be enough anymore because, as the price of gold is proving, people are losing faith in money. Our whole system is based on faith and when that faith is damaged that is when problems get out of control and I believe we are just about at that point. The rumor yesterday was a .50% rate cut, how is that good for the Euro? If anything that would have brought it closer to parity to the USD. Printing another trillion just won’t calm markets because it means nothing. At this point I cannot see much of anything from Europe that will calm the markets.

The only things they can do is let the PIIGS default on their debt and kick them out of the EU, not necessarily in that order. Anything else will just prolong the problem and the printing press is the cause of the problem, not the solution.

Explaining Deflation vs. Deflation

Posted by Ray on May 16, 2010 under Main | Be the First to Comment

I was reading Zero Hedge yesterday, a post in regards to gold where Peter Schiff was part of the topic, and there were some interesting comments. One caught my attention as being somewhat ludicrous which is not unusual, but is was because the author is a contributor to the site. Unfortunately the comment was flagged as junk, I hate it when that happens because counterpoints are always good things to have and I do not mean to rip him apart, but rather correct years of misinformation he probably picked up from school or TV armchair economists.

One comment he made was:
“On gold to the moon: Peter you’ve been talking up your gold positions for years, but once calm is restored, you’re going to take a major haircut on gold.”
Another was:
“On the US economy “not growing”: Has he looked at the ISM, employment (not just payrolls but household survey), industrial production, and the leading indicators over the last ten months?”
And the other one was referencing that as soon as the trillions in bailouts the banks received hits the economy it will calm the economies or something to that effect. He also indicated that as long as confidence remains in the system everything will be fine, which is true, but how much will it take to keep that confidence or instill that confidence? Also, the more money we inject to create confidence the more confidence it actually erodes, it is a zero sum game in the end. Part of the comment was that the EU was trying to avoid a “deflationary death spiral” or something similar, this is why people should not flag things as junk because they are not junk, which is what really bothered me.

People are thoroughly confused by deflation and deflationary death spirals and what that means. Deflation is a problem, we have deflation now, but it is not a huge problem. However, a deflationary death spiral is what we had in the 1930’s and is what keeps Ben Bernanke up at night. We will not, I do not think, have that deflationary death spiral and I think we need to understand what that death spiral was, what caused it and why we will not have it. After that I want to address the rest of the comments he made above.

What we suffered fro in the 1930’s was horrible and something I hope we never see again. To understand more about what it was like in the Depression please Read The Depression: A Diary by Benjamin Roth and stay away from the academic stuff. However, during the depression dollars were scarce because fo the massive bank failures and deposits were frozen or simply lost when the bank closed down. On top of that the stock market wiped out millions of peoples savings which had a domino effect into the real estate market which is what caused the banking crisis, somewhat reversed from today’s crisis I might add.

What this did was literally wipe dollars out of existence, they just disappeared and were not transferred to anyone else. Today one persons loss is likely another’s gain through derivatives or other hedging instruments known as bailouts, but that was not the case in the 1930’s. Since these dollars were gone or frozen and the U.S. was on the gold standard we did not have a Helicopter Ben to get dollars into the system, at first the Fed tightened credit, who knows why, but they later tried to reverse that decision, but it was too little too late. What we had was complete demand destruction and people saving whatever dollars they had, which was strange because people would rather starve than spend their money.

In fact, while people were starving crops were on or at a record pace, prior to the dust bowl fiasco of course. It was a simple fact that the U.S. was tied to the gold standard and could not put more dollars into the system and people just did not want to spend what they had saved because who knew what tomorrow would bring. We also had no safety systems in place such as unemployment insurance, welfare or Social Security, until FDR was elected a few years into the Depression. By not having those safety nets in place it made things much, much worse and that is why we had such massive deflation.

This was not the run of the mill demand deflation, which is what we have now, this was the death spiral lack of dollars in circulation plus no demand deflation. So for people to draw a comparison to 1930’s deflation to todays is a bit ridiculous to say the least. We have those safety programs now so people will not starve instead of spending money, ironically our poor actually have cable TV, go figure, and we have other safety nets in place. This is why we will not see 1930’s deflation and this is also why we can hide the evidence of our current Depression, if we do not have to see the soup lines they are not there, right? Never mind the fact that 1 in 8 Americans receives some form of Food Stamp assistance, if that is not a Depression statistic I am not sure what is.

The banking system is still suffering from after shocks much like we saw in the 1930’s, closures did not stop for years after the crash of 1929 as real estate continued to decline in value, sound familiar? We are still suffering from similar bouts of bank closures today because of declining real estate prices and that is unlikely to change. Many of these banks were bailed out, funny how some “too big too fail” are now failing after they were bailed out. How can, as his comment claimed, the markets be calmed because of trillions in bailouts will build confidence when those banks who were bailed out are still failing? This is very similar to the 1930’s when many banks who received aid under the first Hoover plan still failed. The point being is that it will take a long time for the system to heal itself and with the government propping it up it will take much longer. The Depression lasted some 10 years, 7 with major government help, our current problem got help on day 1, how long will our recovery really take?
With the massive stimulus and government spending in the banking system it is nothing more than inflationary measures. The comment that “when the trillions making it into the economy will only build confidence,” is a bit absurd, in my opinion, as it points out that the issues were very bad for a very longtime. Also, when the trillions, a bigger and more accurate statement would had been if the trillions, make it into the economy it will create inflation, period. There is really no doubt that the measures taken by all the central banks were to stem the tide of the aforementioned deflationary spiral and it did work, but the central banks cannot stem the tide of the inflation that they created. After all, central banker’s primary mandate is to inflate the currency at about a 3% annual rate to begin with so they have no real mechanism to dis-inflate a currency anyhow. Sure, they can raise rates and do reverse repos, but serious, that will do little.

In fact, for all the money spent on bailouts and stimulus measures I would argue we have received a very poor return on our investment. We had a sharp mini-V of a +5% GDP print, but that appears to be it. We had spend far less in the past and had averaged far higher GDP prints, about a 7% print after major interventions, so, sure, you got a V, but it is one side of a W, sorry Charlie. People had been bragging about the ISM Survey’s for some time until the Ism survey’s failed to support their claims, but they fail to support my claims as well. In fact, they are neutral, but well below what we would call normal expansion averages. Not to mention, these are survey’s and should be calculated as survey’s, as in this is how people feel at this point in time, not as this is what will happen in the future.

My main point is that we do have growth and things are better, but no where near where the bulls think they are and we are not heading to where they think we are going. The comment also pointed to the leading economic indicators as a “bright spot.” Funny, Kudlow and company have not brought up the LEI for sometime now because, well, the number rolled over a couple months ago now and has been heading lower, funny what happens when Uncle Sam cuts off the money. So, I am not sure what LEI the commenter is looking at, but the one everyone else is looking at is pointing to the South, not the North, good luck if you think down is up and up is down because you got Vertigo my friend.

The global economy is about to end its amazing recovery, sorry folks. Europe is 20% of the global economy and they are instituting massive austerity measures right now and these are only the start, more is needed. If 20% of the world’s buyers have less money you will see economists start lowering forecasts very soon, trust me on that one. You know how the U.S. is pestering China to revalue its RMB? Well, it is pegged to the U.S. dollar, right? Do you know who China’s largest trading partner is? Hint, it is not the U.S., it is the EU. That means Chinas products are now more expensive in the EU than they were just 2 months ago. Wasn’t China credited for the global recovery? Isn’t China in the middle of a liquidity bubble? Won’t not selling products hurt their exports causing an artificial popping of their bubble which could cause more problems for the world than originally thought? I think so, but we are still pressuring them to revalue and spreading the falsehood that we are their largest trading partners, what baloney.

It is kind of funny to see people dismiss all this information and keep economic events locally when this is a global economy, I mean, there is a reason why when the U.S. market tanks foreign markets go down as well and why when we go into a recession so do other countries. Decoupling will happen, but not until the rest of Asia emerges like China did, but until that happens China is dependent upon the U.S. and the EU. However, let us mak sure we are clear, the EU is, for sure, China’s biggest trading partner and a falling Euro is a big problem for China as well. Keep an eye on that, I am.

On to the topic of the day, gold. Peter Schiff has been bullish on gold since, well, forever now and has taken much heat for it since it climbed from $250 to $1,240, yes, taking heat for something that quadrupled. The commenter stated that gold will take a haircut, a major one, when markets calm down, maybe he is right, but let’s take a look so far. Trillions have been spent on the banks, that has not calmed the markets and now you have governments in trouble, what is going to calm the markets even if small governments start defaulting? Even beyond that, look at 2003, 2004, 2005, 2006, 2006, 2007, 2008, 2009, 2010. During most of those years the markets were considered “calm” and in a “goldilocks” period upon a new wave of global liquidity never before seen, what happened to the price of gold? Oh, yeah, it quadrupled.

The one big down year gold had was in 2008, when it first hit $1,000 I might add, when everything was in liquidation because of a global margin call. If the Fed did not start dropping money from helicopters we would have had our 1930’s deflationary spiral on our hands, but that is not what happened. What happened was things were supported by the government and long before the markets shot back up 70% gold was on its way back up to it’s previous $1,000 high. So, Peter Schiff can hold on to his gold trade all he wants, it worked for him as he lost little during the collapse by holding it and it returned more than the S&P, from January 1, 2009 to December 31st, 2009, than the S&P 500 did without the volatility. Comments like the ones made by the person in question show that they do not look at the facts and simply do not like the asset class, or do not understand it, and end up looking silly at the end of the day.

Do I think gold will go down? Yes. Why wouldn’t it? Everything rises and falls, but I think it will be much high 10 years from now than today. We know that central banks inflate the currency, that is a fact. We know, especially right now, that sovereign default risk is real and confidence in currencies is really a fleeting thing, we have merely been lucky for 38 years since the gold standard was eliminated, we know that turmoil will always exist and we know gold, silver or other commodities are a finite resource that has much higher demand that supply could ever meet. In my opinion, only a fool would not want to own gold, just look at APMEX.com, all their smaller American Eagle coins are sold out for crying out loud, is that the confidence in the global system we are looking for? Is that the sign of a growing global economy? Nope.