Looking For Deals: Credit Inflation 2013

by: John M. Mason

We talked about this subject at lunch today. Then I got back to work and saw the following article: "Hedge Funds Increase Bullish Bets Most Since August: Commodities".

The point? Given the credit inflation that is underway, there are going to be a lot of places for one to put their money over the next three to five years, but it is not going to be the middle class or below that are going to be able to take advantage of them.

The above article contains the following: "Speculators and money managers increased net-long positions across 18 U.S. futures and options by 9.8 percent to 929,588 contracts in the week ended Nov. 27, the biggest gain since Aug. 21, U.S. Commodity Futures Trading Commission data show. Gold holdings reached a six-week high, and wagers on a wheat rally jumped the most since June. Cattle bets more than doubled. The Standard & Poor's GSCI Spot Index of 24 raw materials rose 1.9 percent in November, the first monthly gain since August."

The specific reason given for this is that the economy of China seems to be accelerating, and China is the biggest consumer in the world of everything from cotton to copper to coal.

And there is plenty of money around to borrow to speculate with… at absurdly low interest rates!

Housing seems to be picking up. A reason for this is the fact that the Federal Reserve believes that it is necessary to buy $40 billion in mortgage-backed securities every month to get the housing industry moving even faster.

Who seems to be benefiting from it so far? Well Fargo and JPMorgan Chase.

But guess what? The damn commercial banks are keeping the Fed's policy from working as fully as it could.

William Dudley, President of the Federal Reserve Bank of New York, states: "a wider gap between yields on mortgage-backed securities and home loans is reducing the potency of the central bank's monetary stimulus."

Dudley continues that while there is "solid evidence" the Fed's monthly purchases of $40 billion in housing debt have been effective in lowering yields, "the impact of monetary easing on the economy through housing and mortgage finance has been impeded to some degree."

But there is a lot of interest in housing and another bubble arising out of the frantic efforts of the Federal Reserve to pump more and more money into this sector.

And what else? Oh, the possibilities that the "fiscal cliff" might actually be averted with tax changes that would fall more on the top 5 percent of income earners have been met with special dividends and stock buybacks.

In addition, guess who is getting a lot of business connected with the settlement of the "fiscal cliff"? Consultants. Wealth advisors. Financial experts. And so on and so forth.

Why? People want to know where they can put their money and not be subject to the new rules and regulations they might be subject to.

Economists seem to ignore the fact that people can and will change behavior if the tax code or whatever is changed to fall on them. (This is even though they believe that they should pay their "fair share." And they don't like to be singled out as the solution to the problems being faced by the middle classes.) The models of the economist assume "ceteris paribus" …everything else stays the same, including the willingness of taxpayers to shelter their income from new taxes.

When the government takes measures to set up incentives to help certain people, or when the government tries to stimulate the economy to create jobs and to help businesses expand operations or to help particular industries or areas of the country, opportunities are created to make money.

In these cases, usually the people that benefit the most are not the middle classes… or below. They just don't have the wealth or the knowledge to take advantage of the opportunities that develop. This is why the credit inflation that began in the early 1960s helped to create a skew in the income/wealth distribution heavily in favor of the top 5 percent.

My guess is that if the policies of the federal government, both monetary and fiscal, don't change from where they now are, we will see further skewing of the income/wealth distribution over the next 10 years.

Credit inflation creates price inflation in some way, whether it is in consumer prices or it is in asset prices.

Can this happen if there is only 2.0 percent growth in real GDP? Can this happen when there is so much under-utilized manufacturing capacity and so much under-employment of labor?

The answer to this is yes. The reason: the under-utilized capacity and the under-employment of labor are, to a large extent, structural. Not all existing plants and equipment can be utilized in the present era with more productive mechanical technology and more inclusive information technology. Likewise with the under-employment of labor. The capabilities of a good portion of the labor force are just not consistent with the needs of industry today.

The reason why the economy is growing so slowly is a structural problem. This means that there is even more money floating around chasing fewer goods and services now than there was in the latter half of the twentieth century.

So, there are going to be opportunities around to make a lot of money. However, this money will not be earned in a steady flow of profits from good, stable, sustainable businesses. We are past that.

Why did General Motors (NYSE:GM) and General Electric (NYSE:GE) start up financial institutions? Well, for quite a few years, their financial institutions earned more than their manufacturing divisions. In a period of credit inflation, financial innovation pays off!

A lot of other banks were started up during this time period. Many of these banks are now being acquired to build scale and achieve geographic expansion. Who is buying and who is selling?

Who is going to service small- and medium-sized business loan needs? I believe that "shadow banking" is going to move out here. With the improvement and spread of information technology, I believe that this "space" will become commoditized. How do we get the money the Fed has "forced" into the financial system into this channel?

What about the money market area? Controversies exist concerning the operating techniques that will become standard here. There is going to be further innovation in this area because people need a 21st century "non-bank" place to manage their short-term assets.

But the rule that needs to be applied in these cases is the one that can be taken from the leveraged-buyout boom of the 1970s and 1980s. In order to really make money, you need to be in on the early end of the bubble, and not at the end. In the early stages, substantial economic profits can be made. At the end, however, everybody is "chasing their tail" trying to earn the extra buck, and all the economic profits have been competed away.

Another rule: don't get into the action too soon. You may find an opportunity to make a lot of money, but if no one else realizes what you do, you may be holding the opportunity for a long time before anything is realized… if it ever is. So get in when others seem to be acting, but don't enter the arena at the end of the bubble.

The federal government is going to be creating a lot of opportunities for you to make money in the next three- to 10-year period. Unfortunately for the middle classes and the under-employed, the major opportunities will not be available to them.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.