A recent email I sent some friends...
Alon,
There is one thought process that arrives at a crossroads and presents investors, economists, bankers, and, especially, Mr. Ben Bernanke with an enormous dilemma. Essentially, the world is awash in liquidity, especially US dollars, due to the actions of US Federal Reserve and "Easy Al" Greenspan, or as I like to call him "Satan Himself". In order to buoy the quickly falling US economy in 2001 the Fed decided to maintain a monetary policy that was so loose that it allowed for the greatest credit expansion in history. The credit expansion from 2001-2005 has been roughly $12.2 trillion vs. $2.6 trillion in real economic growth, which means that there is now close to $10 trillion extra dollars present in the system that have to go somewhere.
Essentially, the total amount of purchase units has risen significantly. A good way to think of this is as a bath tub that had the water on too long, the water flooding (easy monetary policy and credit expansion) has risen the level of all of the toys in tub (final destinations for cash, which will be discussed in a minute) whereas a normal business cycle is like a wave back and forth that rises and falls like a cosine function. Ultimately, THIS IS THE SOURCE OF INFLATION.
Now, as I mentioned, the new money in the system has to be applied to something such as goods, services, assets, etc. On a macro level there are only three places this new credit can go 1) The prices of goods and services (PPI and CPI measure this), 2) Out of the system to foreign producers (Trade Balance, or should I say trade deficit in our case, measures this), and 3) Asset markets (Financial asset prices measure this).
While it may seem like Alan Greenspan, aka "Satan Himself" and the man who doubled the US money supply in the period from 1997 to 2005, is the only one capable of such monetary irresponsibility, the country has seen this type of behavior before. If you were to plot the YoY change in M3, the broadest measure of money supply of USD, you would see that in the early 1970s and later 1970s there was double digit credit/M3 annual growth going on. THen if you also plotted the YoY change in CPI and PPI on that same chart you would see that about 18 months after the double digit money supply / credit growth that the prices of goods and services, measured by CPI and PPI, grew at double digit rates as well; this is why everyone remembers inflation being so bad in the 1970s and why the price of oil and gold hit all time highs measured in current dollars.
So, you are asking yourself, "Where is the inflation today?", a quote that Wall St. bulls and central bankers seem to keep shouting in the media. Well, my first response to this is that CPI is not the only way to measure inflation; CPI is a relatively new tool that was developed shortly after WWII and only measures the prices of goods and services. Inflation can show up in CPI, and it is starting to as today's report began to show, but it can also show up in the other two places that I outlined above. The reason that we are not seeing CPI inflation is actually due to the record trade deficit that we are seeing. The fact is that, to quote Morgan Stanley Economist Steven Roach, there is a global labor arbitrage in play right now. Evidence of this is that in the same time period of the mentioned credit expansion, 2001-2005, the labor costs per unit of output declined by 18% and the US trade deficit has gone from -$400 million to its current level of -$800 million, 100% growth. Basically, we have bid up cheap labor and goods in China / India / etc. and "Shorted" the expensive GM manufacturer making $35 / hr. I mean if you were an executive at a manufacturing company and you could outsource work that in America you had to pay $280 / day to China and pay that much for like 35 workers instead of one wouldn't you? Given that manufacturing profits have decereased by 46% in the last decade, I think that cost cutting is your main concern if you value your job. So what has happened is that while the PPI has increased by 14%, the price of labor has decreased significantly. THUS, we have imported deflation through cheap Asian goods and services and exported PURE INFLATION, in the sense that its just a keystoke of electronic blips in exchange for real goods and services. Thus, we have a situation where the VERY DUMB American public thinks everything is ok b/c CPI is tame, and I am not even going to go into the fact that pre-clinton calculation of CPI is running closer to 8% (CHECK OUT John WIlliams site www.shadowstatistics.com if you don't believe me), when in reality the inflation is just sitting in other countries' central bank foreign reserves.
However, there is an even bigger sponge that has absorbed all of that new capital in the system, a sponge that most people aren't trained enough to understand how to properly value its prices. The sponge I am talking about is the global financial markets, especially the US residential real estate market. I mean look at a 5 yr chart of the S&P 500, the CRB, Corporate Credit Spreads, Emerging Market SPreads, Real Estate prices, Real Estate volume, the Russell 2000 Growth, the Nasdaq, etc. and you will see that every single one of these markets has been and continues to be in a bull market. THis is strange b/c in my opinion the only one of these with a really compelling fundamental argument is commodities, as the supply and demand equations are all out of whack currently and take along time to correct. I contend that it is the asset markets that are hiding the majority of the massive inflation that is present in the system, and it makes sense that the "average joe" doesn't see it as he/she isn't trained to see or doesn't look at closely enough the aggregate prices of the various markets. Most people tend to concentrate on micro valuations of the individual area / security of interest to them and fail to see the bigger macro picture. What you see is overbought markets that lack risk premiums and proper valuations.
So where are we now? We are starting to see REAL assets bid up, financial assets bid down, the dollar correct, etc. However, without mentioning some very key idiosyncratic issues (i.e. the Iran Oil Bourse, the very expensive Iraq War, the current Administration's propensity to spend recklessly and put the country deeper in debt, we are currently around $51 trillion in the hole, which will be made up by higher taxes and a weaker dollar in the future, and the return of the true money GOLD) I would say that the US dollar is on one way path - downwards. I mean the G-7 and IMF recently publicly stated that a dollar devaluation is imminent. However, there is a question at hand: whether the central bank can manage a steady slow decline and run the risk of a dollar collapse or should the bankers do what the Fed did at the end of the 1920s and vacuum up the excess liquidity?
Either way we go results in a very bad outcome. If the Fed allows for a devaluation, which would be implied by a pause or stopping of rate raising, then I would beg you, as I have with all of my friends, to buy as much PHYSICAL gold as possible b/c we could very easily see a Hyperinflationary scenario like Germany saw in the 1920s. In contrast, if Bernanke takes responsibility for SATAN, and cleans up the system, like Paul Volcker did in the late 1970s/early 1980s, we will see much higher rates than anyone is talking about right now, which will cause a global deflation and major asset price contractions in every market, including the ever so-"precious" metals that have been doing so well lately. In addition, we will probably end up with a depression, not a recession a depression, like we saw in the 1930s as people will literally drown in their own debt and be forced to rebuild the ever so-needed infrastructure in the US, like what happened with the New Deal and the Tennessee Valley Authority.
Most of the stuff I read is calling for rate pause and easements as the authors don't believe the US can survive a deflationary rate hike like we saw 25 years ago. I am skeptical of this view b/c throughout history things move in a periodic manner with booms and busts; the thing is that in a time series that exhibits mean reversion, like Business Cycles, it usually holds that the reaction always resembles the magnitude of the action. In the 1920s in the US and in the 1980s in Japan, there were egregious credit expansions / asset bubbles that lead to massive excess and ultimately depressionary recessions. I fear that is what is coming in the US, but I could very well be wrong. If I am wrong you should own gold; if I am right you should probably also own gold and short eurodollars.
In regards to your question about Covered Interest Rate parity between the Euro and Dollar, I would say that you are correct in thinking that if the rate differential strucurally changes in favor of the Euro that the dollar descent should probably accelerate. But other things to make you more confident on the short USD / long Euro pair trade is that Soros, Buffet, Gates, and Russia are all on public record calling for the devaluation of the Ol' dollar. In addition, I strongly believe that the long anticipated Iranian Oil Bourse, which, imo, is the reason for all of the public heat on Iran and the absence of the M3 statistic in the weekly money supply reports from the privately own corporation known as the Federal Reserve, is now in operation. I would point you to look at the market action last week when the dollar decreased significantly vs. the euro and the price of oil went up $5 - the first time the dollar and oil have made significant moves in opposite directions - which is also very bullish for the Euro. Overall, I would say to take out as much debt as possible in US dollars and put it in canadian bonds, euro bonds, gold, silver, sugar, unleaded fuel, oil, etc. Even if the rates increase significantly you have access to capital at cheaper than market prices.
BB OUT.
There is one thought process that arrives at a crossroads and presents investors, economists, bankers, and, especially, Mr. Ben Bernanke with an enormous dilemma. Essentially, the world is awash in liquidity, especially US dollars, due to the actions of US Federal Reserve and "Easy Al" Greenspan, or as I like to call him "Satan Himself". In order to buoy the quickly falling US economy in 2001 the Fed decided to maintain a monetary policy that was so loose that it allowed for the greatest credit expansion in history. The credit expansion from 2001-2005 has been roughly $12.2 trillion vs. $2.6 trillion in real economic growth, which means that there is now close to $10 trillion extra dollars present in the system that have to go somewhere.
Essentially, the total amount of purchase units has risen significantly. A good way to think of this is as a bath tub that had the water on too long, the water flooding (easy monetary policy and credit expansion) has risen the level of all of the toys in tub (final destinations for cash, which will be discussed in a minute) whereas a normal business cycle is like a wave back and forth that rises and falls like a cosine function. Ultimately, THIS IS THE SOURCE OF INFLATION.
Now, as I mentioned, the new money in the system has to be applied to something such as goods, services, assets, etc. On a macro level there are only three places this new credit can go 1) The prices of goods and services (PPI and CPI measure this), 2) Out of the system to foreign producers (Trade Balance, or should I say trade deficit in our case, measures this), and 3) Asset markets (Financial asset prices measure this).
While it may seem like Alan Greenspan, aka "Satan Himself" and the man who doubled the US money supply in the period from 1997 to 2005, is the only one capable of such monetary irresponsibility, the country has seen this type of behavior before. If you were to plot the YoY change in M3, the broadest measure of money supply of USD, you would see that in the early 1970s and later 1970s there was double digit credit/M3 annual growth going on. THen if you also plotted the YoY change in CPI and PPI on that same chart you would see that about 18 months after the double digit money supply / credit growth that the prices of goods and services, measured by CPI and PPI, grew at double digit rates as well; this is why everyone remembers inflation being so bad in the 1970s and why the price of oil and gold hit all time highs measured in current dollars.
So, you are asking yourself, "Where is the inflation today?", a quote that Wall St. bulls and central bankers seem to keep shouting in the media. Well, my first response to this is that CPI is not the only way to measure inflation; CPI is a relatively new tool that was developed shortly after WWII and only measures the prices of goods and services. Inflation can show up in CPI, and it is starting to as today's report began to show, but it can also show up in the other two places that I outlined above. The reason that we are not seeing CPI inflation is actually due to the record trade deficit that we are seeing. The fact is that, to quote Morgan Stanley Economist Steven Roach, there is a global labor arbitrage in play right now. Evidence of this is that in the same time period of the mentioned credit expansion, 2001-2005, the labor costs per unit of output declined by 18% and the US trade deficit has gone from -$400 million to its current level of -$800 million, 100% growth. Basically, we have bid up cheap labor and goods in China / India / etc. and "Shorted" the expensive GM manufacturer making $35 / hr. I mean if you were an executive at a manufacturing company and you could outsource work that in America you had to pay $280 / day to China and pay that much for like 35 workers instead of one wouldn't you? Given that manufacturing profits have decereased by 46% in the last decade, I think that cost cutting is your main concern if you value your job. So what has happened is that while the PPI has increased by 14%, the price of labor has decreased significantly. THUS, we have imported deflation through cheap Asian goods and services and exported PURE INFLATION, in the sense that its just a keystoke of electronic blips in exchange for real goods and services. Thus, we have a situation where the VERY DUMB American public thinks everything is ok b/c CPI is tame, and I am not even going to go into the fact that pre-clinton calculation of CPI is running closer to 8% (CHECK OUT John WIlliams site www.shadowstatistics.com if you don't believe me), when in reality the inflation is just sitting in other countries' central bank foreign reserves.
However, there is an even bigger sponge that has absorbed all of that new capital in the system, a sponge that most people aren't trained enough to understand how to properly value its prices. The sponge I am talking about is the global financial markets, especially the US residential real estate market. I mean look at a 5 yr chart of the S&P 500, the CRB, Corporate Credit Spreads, Emerging Market SPreads, Real Estate prices, Real Estate volume, the Russell 2000 Growth, the Nasdaq, etc. and you will see that every single one of these markets has been and continues to be in a bull market. THis is strange b/c in my opinion the only one of these with a really compelling fundamental argument is commodities, as the supply and demand equations are all out of whack currently and take along time to correct. I contend that it is the asset markets that are hiding the majority of the massive inflation that is present in the system, and it makes sense that the "average joe" doesn't see it as he/she isn't trained to see or doesn't look at closely enough the aggregate prices of the various markets. Most people tend to concentrate on micro valuations of the individual area / security of interest to them and fail to see the bigger macro picture. What you see is overbought markets that lack risk premiums and proper valuations.
So where are we now? We are starting to see REAL assets bid up, financial assets bid down, the dollar correct, etc. However, without mentioning some very key idiosyncratic issues (i.e. the Iran Oil Bourse, the very expensive Iraq War, the current Administration's propensity to spend recklessly and put the country deeper in debt, we are currently around $51 trillion in the hole, which will be made up by higher taxes and a weaker dollar in the future, and the return of the true money GOLD) I would say that the US dollar is on one way path - downwards. I mean the G-7 and IMF recently publicly stated that a dollar devaluation is imminent. However, there is a question at hand: whether the central bank can manage a steady slow decline and run the risk of a dollar collapse or should the bankers do what the Fed did at the end of the 1920s and vacuum up the excess liquidity?
Either way we go results in a very bad outcome. If the Fed allows for a devaluation, which would be implied by a pause or stopping of rate raising, then I would beg you, as I have with all of my friends, to buy as much PHYSICAL gold as possible b/c we could very easily see a Hyperinflationary scenario like Germany saw in the 1920s. In contrast, if Bernanke takes responsibility for SATAN, and cleans up the system, like Paul Volcker did in the late 1970s/early 1980s, we will see much higher rates than anyone is talking about right now, which will cause a global deflation and major asset price contractions in every market, including the ever so-"precious" metals that have been doing so well lately. In addition, we will probably end up with a depression, not a recession a depression, like we saw in the 1930s as people will literally drown in their own debt and be forced to rebuild the ever so-needed infrastructure in the US, like what happened with the New Deal and the Tennessee Valley Authority.
Most of the stuff I read is calling for rate pause and easements as the authors don't believe the US can survive a deflationary rate hike like we saw 25 years ago. I am skeptical of this view b/c throughout history things move in a periodic manner with booms and busts; the thing is that in a time series that exhibits mean reversion, like Business Cycles, it usually holds that the reaction always resembles the magnitude of the action. In the 1920s in the US and in the 1980s in Japan, there were egregious credit expansions / asset bubbles that lead to massive excess and ultimately depressionary recessions. I fear that is what is coming in the US, but I could very well be wrong. If I am wrong you should own gold; if I am right you should probably also own gold and short eurodollars.
In regards to your question about Covered Interest Rate parity between the Euro and Dollar, I would say that you are correct in thinking that if the rate differential strucurally changes in favor of the Euro that the dollar descent should probably accelerate. But other things to make you more confident on the short USD / long Euro pair trade is that Soros, Buffet, Gates, and Russia are all on public record calling for the devaluation of the Ol' dollar. In addition, I strongly believe that the long anticipated Iranian Oil Bourse, which, imo, is the reason for all of the public heat on Iran and the absence of the M3 statistic in the weekly money supply reports from the privately own corporation known as the Federal Reserve, is now in operation. I would point you to look at the market action last week when the dollar decreased significantly vs. the euro and the price of oil went up $5 - the first time the dollar and oil have made significant moves in opposite directions - which is also very bullish for the Euro. Overall, I would say to take out as much debt as possible in US dollars and put it in canadian bonds, euro bonds, gold, silver, sugar, unleaded fuel, oil, etc. Even if the rates increase significantly you have access to capital at cheaper than market prices.
BB OUT.
posted by Not Sure if Al Gore or Global Warming is a Bigger Joke at
9:49 PM
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