Fed Intervention, Market Response Confirm: We're on the Path to Hyperinflation

As most of us who have been watching the financial markets know, last week was quite a week. The Federal Reserve announced they would print money to buy Treasuries and mortgage-backed securities.

The Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

The market promptly responded:

1. Gold shot up and stayed up; it is currently trading at $958 at the time of this writing. Silver is rallying as well, trading at $13.48 per ounce at the time of this writing.
2. The US dollar dropped sharply against all other major currencies.
3. Crude oil rallied above $50 per barrel.
4. Treasuries rallied.

From these events, we can deduce two things:

1. The Fed is clearly aggressively pursuing an inflationary monetary policy. This is further evidence that the Fed can do what it wants; if the Fed is truly determined to inflate, it will be able to do so, regardless of whether or not banks will lend. Monetary policy is a fiat matter.
2. The market is clearly willing to run from the dollar in the face of outright monetization.

As money supply is expanding while demand for US dollars is collapsing, and as dissatisfaction with the political environment in the United States is at a nearly unprecedented level, it is clear the ingredients for hyperinflation are in place. See our previous analysis of hyperinflation for a more detailed explanation.

Moreover, CPI data released yesterday by the Labor Department in the US noted that consumer prices rose for the second consecutive month. Should this trend continue, it sets the stage for a price/wage spiral, whereby higher prices lead to higher wages, which in turn lead to higher prices, and so on. Declines in demand due to higher prices may not be sufficient to stop prices from rising further should the Fed continue an inflationary policy.

The New Trading Environment

As we have discussed before, "playing defense" against monetary policy is crucial to wealth preservation in a centrally planned economy. Based on the signals the market and the monetary authorities have recently given us, here are some trading thoughts for the near future:

1. Gold and silver. I've advocated precious metals many times before, and continue to do so, as they are the conventional inflation hedge, and remain the market's monetary commodities of choice.
2. As the Fed is distorting the free market process in the Treasury market through intervention, Treasuries may be difficult to trade without technical analysis.
3. Watch oil. Should it continue to rise, which seems very likely to me, it would be further evidence of an inflationary spiral, as rising oil prices will lead to rising gas prices, which in turn will lead to rising prices, and a demand for rising wages. With that said, I find oil's behavior a bit perplexing, and thus I personally favor precious metals as an inflation hedge. Those with a larger capital base and a need to diversify, though, may seek solace in oil.
4. The stock market remains a trader's environment, even more so than before. Those who can use technical analysis to understand momentum will be best positioned to find profits in the stock market, in my opinion. Fundamental analysis will be less effective, as the Fed's interventionist behavior will make rational analysis difficult and perhaps fruitless.

Disclosure: Long gold and silver.

Comments

[Ray Lopez:]

S. Patel is talking his book. He does not realize that you cannot predict hyperinflation given the data we have now. We're on the road to inflation though, that's for sure.

I'm long Au as well.

We're on a road to nowhere. Come on inside. Takin' that ride to nowhere. We'll take that ride. HA! - Talking Heads

Mar 21 04:36 PM

[John D:]

More experts??

Mar 21 05:34 PM

[smartmoney123:]

What effect , do you think, will the fed intervention have on the Market financial stocks, :ie, wfc- bac- citicorp etc. on Monday 3/23/09?

Mar 21 05:37 PM

[jockeydog:]

I believe the inflation happened when the IB's/Hedge funds were leveraged 35/1. The housing bubble was the hyperinflation, and it's correcting now. What we're seeing now is temporary inflationary tactics to normalize the deflation.

Mar 21 06:08 PM

[cj51:]

> Should this trend continue, it sets the stage for a price/wage spiral, whereby higher prices lead to higher wages, which in turn lead to higher prices

Which ignores the all to real possibility that unemployment will reach 10% or worse, which implies no higher wages. Some companies are cutting salaries right now. Ford is cutting. On average, the middle class has been treading water for a few decades now.

Mar 21 06:24 PM

[ddtuttle:]

We are currently experiencing deflation on a global level. World net worth has dropped something like 50%, an amount that dwarfs the amounts actually "created" by central banks. We are in a deflationary spiral that show no signs of stopping.
When prices finally stop going down we'll have assets worth a fraction of their former value and many times the corresponding money supply. That will be a recipe for inflation, but from massively deflated values and prices.
Until then cash (and gold) are king. Once the inflation starts, then you'll want to switch to commodities (and gold).

Mar 21 07:35 PM

[Vuke:]

A "price/wage spiral" ?

When so many have lost jobs or live in fear of such? It's a little premature but perhaps you are looking a few years ahead? The specter of deflation still lurks in corners but, either way, gold and silver should do well and, most importantly, hold value.

Mar 21 08:31 PM

[Mad Hedge F...:]

You can count on it. Way to go Ben! If pouring gasoline on the fire doesn’t work, try nitroglycerine! Some $1.2 trillion in new agency and bond purchases, including previously untoucheable long term treasury bonds. Goodbye dollar, hello 4% home mortgage rates. Just tack on another 3% to the 2010 inflation rate. The bond market had its biggest up day in history, gold soared $50, the euro gapped up 4%, and commodity prices roared. Citigroup (C) has quadrupled from $1 to $4 since last week, while General Electric (GE) has doubled from $5 to $10! Just when you think this guy has thrown in the kitchen sink, he shows up another truckload of kitchen sinks. I guess this is what a 1590 SAT score gets you.

Mar 21 08:35 PM

[@TexasER:]

"As money supply is expanding while demand for US dollars is collapsing,"

Demand for USD is not collapsing. It may collapse, but your statement is way ahead of the facts.

Mar 21 10:08 PM

[Teutonic Kn...:]

As I related elsewhere in SA late last year, the government present courses of action are clearly "hellishly inflationary (after Carl Ichan's remarks on the original $700B Hank Paulson Bailout)".

The much-touted deflationary scenario is looking more like a myth now. Forget about the $4.9M ultimate luxury home in Naples, FL that was, and still is, being listed. You could go in with a 50% discount offer if you have the money. But such deflated jewel would probably be reserved for those bankers who just got their bonuses.

Want an example of inflation for ordinary folks like you and me? Get ready to pay a hefty tuition increase if your kids are heading out to state public university. State education budgets are being cut ruthlessly, and the colleges had no alternatives but resort to raise fees.

See what I mean by inflation coming?

Mar 21 11:03 PM

[davewsail:]

"Moreover, CPI data released yesterday by the Labor Department in the US noted that consumer prices rose for the second consecutive month. Should this trend continue, it sets the stage for a price/wage spiral, whereby higher prices lead to higher wages, which in turn lead to higher prices, and so."

Are you smoking something? Talking about a price/wage spiral is far fetched when unemployment is increasing at an alarming rate and employers are cutting wages for the first time snce the great depression. Don't forget that the labor market is governed by supply and demand just as any market is. Right now there is way too much supply chasing too little demand. Until that flips there will be no wage pressure.

Mar 21 11:26 PM

[Homer II:]

Simit, you said "...as the Fed's interventionist behavior will make rational analysis difficult and perhaps fruitless." and yet you recommend holding precious metals? What do you call the drop in metals prices last August if not "interventionist behavior" by the Fed? The government well know if precious metals are allowed to seek their true level, that the Dollar will fall inexorably as PMs rise. So, they "meddled" to suppress the natural tendency for Gold to rise beyond $1000/oz and forced it down into the $700s to crush the appetite of the wise investors... and prop up the Dollar to buy some more time.

So, do you think now, the government will allow metals prices to float up freely, speaking metaphorically?

Mar 22 12:54 AM

[Vox Rationalis:]

"The Federal Reserve announced they would print money to buy Treasuries and mortgage-backed securities."

Is that what they announced? So currency in circulation is about to increase by more than 100%, right?

"1. Gold shot up and stayed up; it is currently trading at $958 at the time of this writing. Silver is rallying as well, trading at $13.48 per ounce at the time of this writing."

And so they've almost regained what they lost in the last month. But not quite.

"2. The US dollar dropped sharply against all other major currencies."

Which is, by the way, exactly how we should expect the currency markets to react as world economies recover. Based on valuations over the last few years, the dollar should not be expected to remain this valuable on the other end of this recession.

"3. Crude oil rallied above $50 per barrel."

From its close the day before the Fed announcement: $49.04. Wow.

What about "5. Everything else rallied too. The S&P continued a two-week rally, adding 2.1% on the day."

"The market is clearly willing to run from the dollar in the face of outright monetization."

Sigh. Have we seen a "run from the dollar"? As I said, commodities regained most of the ground lost against the dollar in the last month. And for currencies, using the dollar index for simplicity, looks like a 3.5% drop since the Tuesday close. You have to go all the way back to mid-January to find this level.

How does this compare with last year's run TO the dollar? Well, it's early, and certainly this two-day trend could continue. But consider - for the five months ending in July, the dollar index moved sideways between a touch under 72 and 74. Between August 1 and November 20, it went from about 73.4 to 88 - a 20% move. Now THAT's a "run."

Of course, the dollar was historically low last summer. Based on recent history, which has seen the dollar decline pretty steadily from 120 in 2002 to the low 70's last year, my guess is that the current value +/- 5% is about where it "should" be.

"As money supply is expanding while demand for US dollars is collapsing..."

"Collapsing"? The dollar's up a couple of percent for the year, and to you it's collapsing.

"...and as dissatisfaction with the political environment in the United States is at a nearly unprecedented level..."

Are you saying Americans want to replace the American political system? Seriously, what are you going on about here?

"...it is clear the ingredients for hyperinflation are in place."

Such rubbish. You don' t have any idea how hyperinflation might occur. Your second article on the subject, and you've yet to describe any elements of a hyperinflationary scenario that exist or might exist in America. By the way - your threshold definition of 40% per year doesn't seem to be supported by economist/historians - 40% per month is closer.

"See our previous analysis of hyperinflation for a more detailed explanation."

I commented on it at length, including many questions that you chose not to answer. Some are listed at bottom.

"Moreover, CPI data released yesterday by the Labor Department in the US noted that consumer prices rose for the second consecutive month. Should this trend continue, it sets the stage for a price/wage spiral, whereby higher prices lead to higher wages, which in turn lead to higher prices..."

By your over-the-top rhetoric, here's what I guess you mean by "this trend": November-December inflation was -2.5% and January-February inflation was 0.7%. So "this trend" would result in March-April inflation of 3.9%, May-June inflation of 7.1%, July-August inflation of 10.3%, etc. Hey - keep this up for a couple of years and you'll get to Cagan's definition of hyperinflation

Like I said in my last to you - if the temperature keeps dropping like it has the last few hours, we'll all be popsicles next week!

"As we have discussed before, 'playing defense' against monetary policy is crucial to wealth preservation in a centrally planned economy."

A "centrally planned economy." You're not really being serious with any of this stuff, are you? This is just a gag, right?

"Gold and silver. I've advocated precious metals many times before, and continue to do so, as they are the conventional inflation hedge, and remain the market's monetary commodities of choice.

Which is better? Do you think gold's recent high valuation relative to silver makes silver a relatively better investment? Or since you're seeking protection not against inflation but against the total breakdown of society, is gold better because it's more valuable by weight? Do you suggest buying diamonds, too?

"As the Fed is distorting the free market process in the Treasury market through intervention..."

The Fed's been "distorting" the market for Treasurys for years. Did you know that at this time last year, the Fed owned $675 billion of Treasurys, which is more than twice as much as they've recently announced intentions to purchase? I'm guessing not.

"...Treasuries may be difficult to trade without technical analysis."

I should have known. So, have you seen the outline of Barad-d'ur in the recent charts, proving the odds of Armageddon are high?

"Watch oil. Should it continue to rise, which seems very likely to me, it would be further evidence of an inflationary spiral, as rising oil prices will lead to rising gas prices, which in turn will lead to rising prices, and a demand for rising wages."

Yeah. It sure worked out that way last summer, when oil was nearly three times higher than now, didn't it?

"With that said, I find oil's behavior a bit perplexing, and thus I personally favor precious metals as an inflation hedge."

Hilarious. You find OIL's behavior perplexing? Compared to gold? Then I guess you can't possibly figure out silver, which has historically been highly correlated with gold. Until about August, that is, when silver fell (along with every other commodity) and gold didn't.

There's nothing at all perplexing. Gold retained its value during this period, when other commodities were falling, because of fear. When people get scared, they run to gold. And since there's no reason to think that this fear will not subside, there's no reason to think gold's valuation relative to other commodities will fall back in line. Which means gold is by no means the best available inflation hedge.

"4. The stock market remains a trader's environment, even more so than before. Those who can use technical analysis to understand momentum will be best positioned to find profits in the stock market, in my opinion. Fundamental analysis will be less effective, as the Fed's interventionist behavior will make rational analysis difficult and perhaps fruitless."

This is perhaps the most foolish thing you've written. The Fed's actions will have very little impact on the vast majority of listed companies. Of companies with good prospects at good valuations, very few (if any) might be negatively impacted by the government's actions -- especially the Fed's actions. I'd actually say that the government's action is more likely to affect you fortunetellers than fundamentalists, since technical analysts are much more active traders.

This is an incredibly GOOD time to be buying equities. Using Robert Shiller's 10-year P/E valuation metric, the S&P 500 is cheaper than at any time in the last 23 years.

-----
Here are a few things I asked last time (since you brought it up):
Exactly how was the fiat-based monetary system the cause of this crisis? No, better question: how did we avoid crisis for so long with the same monetary system? Or do you think the current crisis took oh, 50 years to build?
Do you really think that, if the US currency broke down, that society would hold together well enough for foreign currencies to be useful?
And how much of people's wealth do you think they should hold physically, risking theft and loss while earning no return?
Why didn't you describe any scenario that might result in hyperinflation?
What are the odds of hyperinflation? Come on, put a number on it.

Mar 22 01:41 AM

[Michael Hoeft:]

He's right though IMO. Long Gold and Silver. And Yen.

Mar 22 06:53 AM

[utilitus:]

Comments above questioning the impact of a price/wage spiral in even the mid-term seem apt. But I don't understand inflationary transmission mechanisms fully. Another key dynamic motivating inflation is its' 'expectation'. Fed chairmen often talk about "anchoring" it - well, now they're fitting it out with hyrofoils, semaphore flags and steam whistles. It's perhaps the cheapest and most flexible tactic to actually engender inflation. ( I personally resent having to orient my well-ordered financial life according to the desperate requirements of late capitalism, where inflationary expectations are functionally propaganda. Makes me want to pop a cap in someones' 'output gap'.)

Mar 22 10:14 AM

[Teutonic Kn...:]

To put it bluntly, I view the CPI as a bit of a joke.

It is meant to serving mainly the government purposes of having some form of a metric to adjusting Social Security, Medicare/Medicaid, and other payments, as well as for updating civil service salaries, and contractual purposes.

It would also give your boss (for those who are employees, myself included) some basis to meter out to you those meager annual merit pay raises.

Look at the so-called Boom Years of 2001-2008 with the Housing Bubble. New college graduates with their freshly-minted diplomas faced buying a single-family home at prices of $800,000 upwards in some hot metro areas. Did the government factor in these exuberant and outrageous price increases in their calculating the annual CPI? Obviously not.

Mar 22 10:48 AM

[Teutonic Kn...:]

One final 2-cent of mine, sorry for being piece-meal, on inflation.

You are, and will be, paying more, for less...for many years to come as a result of the saga...

Mar 22 10:59 AM

[Shelley S:]

Superb work "Vox Rationalis (aka BS Detector)"... you have an impressive insight.


On Mar 22 01:41 AM Vox Rationalis (aka BS Detector) wrote:

> "The Federal Reserve announced they would print money to buy Treasuries
> and mortgage-backed securities."
>
> Is that what they announced? So currency in circulation is about
> to increase by more than 100%, right?
>
> "1. Gold shot up and stayed up; it is currently trading at $958 at
> the time of this writing. Silver is rallying as well, trading at
> $13.48 per ounce at the time of this writing."
>
> And so they've almost regained what they lost in the last month.
> But not quite.
>
> "2. The US dollar dropped sharply against all other major currencies."
>
>
> Which is, by the way, exactly how we should expect the currency markets
> to react as world economies recover. Based on valuations over the
> last few years, the dollar should not be expected to remain this
> valuable on the other end of this recession.
>
> "3. Crude oil rallied above $50 per barrel."
>
> From its close the day before the Fed announcement: $49.04. Wow.
>
>
> What about "5. Everything else rallied too. The S&P continued
> a two-week rally, adding 2.1% on the day."
>
> "The market is clearly willing to run from the dollar in the face
> of outright monetization."
>
> Sigh. Have we seen a "run from the dollar"? As I said, commodities
> regained most of the ground lost against the dollar in the last month.
> And for currencies, using the dollar index for simplicity, looks
> like a 3.5% drop since the Tuesday close. You have to go all the
> way back to mid-January to find this level.
>
> How does this compare with last year's run TO the dollar? Well,
> it's early, and certainly this two-day trend could continue. But
> consider - for the five months ending in July, the dollar index moved
> sideways between a touch under 72 and 74. Between August 1 and November
> 20, it went from about 73.4 to 88 - a 20% move. Now THAT's a "run."
>
>
> Of course, the dollar was historically low last summer. Based on
> recent history, which has seen the dollar decline pretty steadily
> from 120 in 2002 to the low 70's last year, my guess is that the
> current value +/- 5% is about where it "should" be.
>
> "As money supply is expanding while demand for US dollars is collapsing..."
>
>
> "Collapsing"? The dollar's up a couple of percent for the year,
> and to you it's collapsing.
>
> "...and as dissatisfaction with the political environment in the
> United States is at a nearly unprecedented level..."
>
> Are you saying Americans want to replace the American political system?
> Seriously, what are you going on about here?
>
> "...it is clear the ingredients for hyperinflation are in place."
>
>
> Such rubbish. You don' t have any idea how hyperinflation might
> occur. Your second article on the subject, and you've yet to describe
> any elements of a hyperinflationary scenario that exist or might
> exist in America. By the way - your threshold definition of 40%
> per year doesn't seem to be supported by economist/historians - 40%
> per month is closer.
>
> "See our previous analysis of hyperinflation for a more detailed
> explanation."
>
> I commented on it at length, including many questions that you chose
> not to answer. Some are listed at bottom.
>
> "Moreover, CPI data released yesterday by the Labor Department in
> the US noted that consumer prices rose for the second consecutive
> month. Should this trend continue, it sets the stage for a price/wage
> spiral, whereby higher prices lead to higher wages, which in turn
> lead to higher prices..."
>
> By your over-the-top rhetoric, here's what I guess you mean by "this
> trend": November-December inflation was -2.5% and January-February
> inflation was 0.7%. So "this trend" would result in March-April
> inflation of 3.9%, May-June inflation of 7.1%, July-August inflation
> of 10.3%, etc. Hey - keep this up for a couple of years and you'll
> get to Cagan's definition of hyperinflation
>
> Like I said in my last to you - if the temperature keeps dropping
> like it has the last few hours, we'll all be popsicles next week!
>
>
> "As we have discussed before, 'playing defense' against monetary
> policy is crucial to wealth preservation in a centrally planned economy."
>
>
> A "centrally planned economy." You're not really being serious with
> any of this stuff, are you? This is just a gag, right?
>
> "Gold and silver. I've advocated precious metals many times before,
> and continue to do so, as they are the conventional inflation hedge,
> and remain the market's monetary commodities of choice.
>
> Which is better? Do you think gold's recent high valuation relative
> to silver makes silver a relatively better investment? Or since
> you're seeking protection not against inflation but against the total
> breakdown of society, is gold better because it's more valuable by
> weight? Do you suggest buying diamonds, too?
>
> "As the Fed is distorting the free market process in the Treasury
> market through intervention..."
>
> The Fed's been "distorting" the market for Treasurys for years.
> Did you know that at this time last year, the Fed owned $675 billion
> of Treasurys, which is more than twice as much as they've recently
> announced intentions to purchase? I'm guessing not.
>
> "...Treasuries may be difficult to trade without technical analysis."
>
>
> I should have known. So, have you seen the outline of Barad-d'ur
> in the recent charts, proving the odds of Armageddon are high? <br/>
>
> "Watch oil. Should it continue to rise, which seems very likely to
> me, it would be further evidence of an inflationary spiral, as rising
> oil prices will lead to rising gas prices, which in turn will lead
> to rising prices, and a demand for rising wages."
>
> Yeah. It sure worked out that way last summer, when oil was nearly
> three times higher than now, didn't it?
>
> "With that said, I find oil's behavior a bit perplexing, and thus
> I personally favor precious metals as an inflation hedge."
>
> Hilarious. You find OIL's behavior perplexing? Compared to gold?
> Then I guess you can't possibly figure out silver, which has historically
> been highly correlated with gold. Until about August, that is, when
> silver fell (along with every other commodity) and gold didn't.
>
>
> There's nothing at all perplexing. Gold retained its value during
> this period, when other commodities were falling, because of fear.
> When people get scared, they run to gold. And since there's no reason
> to think that this fear will not subside, there's no reason to think
> gold's valuation relative to other commodities will fall back in
> line. Which means gold is by no means the best available inflation
> hedge.
>
> "4. The stock market remains a trader's environment, even more so
> than before. Those who can use technical analysis to understand
> momentum will be best positioned to find profits in the stock market,
> in my opinion. Fundamental analysis will be less effective, as the
> Fed's interventionist behavior will make rational analysis difficult
> and perhaps fruitless."
>
> This is perhaps the most foolish thing you've written. The Fed's
> actions will have very little impact on the vast majority of listed
> companies. Of companies with good prospects at good valuations,
> very few (if any) might be negatively impacted by the government's
> actions -- especially the Fed's actions. I'd actually say that the
> government's action is more likely to affect you fortunetellers than
> fundamentalists, since technical analysts are much more active traders.
>
>
> This is an incredibly GOOD time to be buying equities. Using Robert
> Shiller's 10-year P/E valuation metric, the S&amp;P 500 is cheaper
> than at any time in the last 23 years.
>
> -----
> Here are a few things I asked last time (since you brought it up):
>
> Exactly how was the fiat-based monetary system the cause of this
> crisis? No, better question: how did we avoid crisis for so long
> with the same monetary system? Or do you think the current crisis
> took oh, 50 years to build?
> Do you really think that, if the US currency broke down, that society
> would hold together well enough for foreign currencies to be useful?
>
> And how much of people's wealth do you think they should hold physically,
> risking theft and loss while earning no return?
> Why didn't you describe any scenario that might result in hyperinflation?
>
> What are the odds of hyperinflation? Come on, put a number on it.

Mar 22 11:50 AM

[MarkitWacha:]

Talk of both inflation and deflation is premature.

There is truth that we're riding along several points of inflection, ones that go both ways. In the following year or two, we'll find out how clever and skilled the Fed is at doing their job -- full employment and price stability.

Remember that to the Fed the market is just a tool, kind of how we think the politicians are tools. The board of governors can't keep their fat paychecks and rich political influence if they don't do their jobs. In the real world, economists aren't terribly productive. They're like physicists that work for hedge funds.

full disclosure: long commodities (and gold) via GSG.

Mar 22 12:32 PM

[prudentinve...:]

World net worth went up through an artificial asset bubble, not through real value created by labor producing goods and services. The bubble burst because it was artificial and unnatural, and now the fed is re-creating it. The money the fed is printing will cause high inflation that will be impossible to rein in, in addition to further distorting the economy in favor of artificial asset values, and away from productive labor producing useful goods and services.


On Mar 21 07:35 PM ddtuttle wrote:

> We are currently experiencing deflation on a global level. World
> net worth has dropped something like 50%, an amount that dwarfs the
> amounts actually "created" by central banks. We are in a deflationary
> spiral that show no signs of stopping.
> When prices finally stop going down we'll have assets worth a fraction
> of their former value and many times the corresponding money supply.
> That will be a recipe for inflation, but from massively deflated
> values and prices.
> Until then cash (and gold) are king. Once the inflation starts, then
> you'll want to switch to commodities (and gold).

Mar 22 02:29 PM

[Amitabha Mu...:]

No hyperinflation will occur. As I was suggesting from the very beginning that fed should print money. If it was done before the fall of Lehman Brothers for supplying the ailing bank the required liquidity then this huge phenomenon could be averted. Since seeing the Lehman Brothers other sick U.S.banks would approach the fed.
Because of the multiplier effect of the money any amount of money locked in so called toxic assets would create a dearth of money supply ten times the locked money. So America is now moving in the right direction and very soon the economy will start its upward journey.
,

Mar 22 02:57 PM

[8financial:]

Hey Stupit,

You get no points based on the quantity of words on a page. But nice try at stating the obvious. If nobody has told you, then let me break it to you. Deflation is a bitch! And it continues for a long time. Helicopter Ben should bring a bigger helicopter because he's short by about 3 Trillion dollars.

Mar 22 03:32 PM

[H. E. Canada:]

For those who follow Robert Shiller and believe that "Using Robert Shiller's 10-year P/E valuation metric, the S&P 500 is cheaper than at any time in the last 23 years" - you may want to take note of this article from Bloomberg, March 11, 2009, link at www.bloomberg.com/apps...

I draw your attention to this excerpt:

"The Bloomberg confidence index for U.S. equities posted the biggest decline among the 10 countries, dropping 14 percent to 29.5. A reading below 50 indicates investors expect stocks to retreat in the next six months, while readings above 50 mean they anticipate a rally.

The S&P 500 may still be expensive even after its slump to a 12-year low this week. The index is valued at 13.9 times earnings, according to data compiled by Yale University Professor Robert Shiller that measure equities against a decade of profits. At the bottom of the three recessions since 1929 that lasted as long as the current one, the average ratio fell to 8.74."

If one accepts that confidence in the markets is low and believes we are in a recession similar to the three extended ones cited in the Bloomberg article, and that comparable valuations can be expected, one can reasonably conclude that we will see a much lower S&P 500 in the near term (unless one is predicting much higher earnings).

To be sure, the Shiller P/E at current valuations is near a level that in the past has been a good entry point for long-term investors into the stock market. Having acknowledged that, there is a huge difference between entry at 13.9 and one at 8.74, and the implied levels of the S&P 500.

A New York Times article, 10/10/2008, cited the Shiller P/E as well:

"There are two things to keep in mind, in the event that you consider these ratios to be a sign that now is the time to buy. First, the p-e ratio typically falls well below its long-run average during a bust. It fell to about 6 in both the 1930s and early 1980s.

Second, remember that there are two components to the p-e ratio: the ‘p’ and the ‘e.’ Based on the kind of recession we may now be entering, it’s entirely reasonable to think that corporate earnings will fall, maybe significantly. That would mean that stocks would also have to fall just to keep the p-e ratio in its current place."
See link at economix.blogs.nytimes...

How many more points must the S&P 500 average lose to get us near 8.74 P/E? What loss does this indicate for those already in or still in the market?

Mar 22 04:47 PM

[zermux:]

The Fed is acting to try to make you think that inflation is on the way. unfortunately the Deflation train is to big to stop. They will continue to act irresponsibly and make things much worse than they would have been otherwise.

Its over. Buy a gun and some rosary beads.

Mar 22 05:26 PM

[Dirk McCoy:]

If we make use of broadband to improve diagnoses, houses to nucleate small businesses, and foreign trade links to increase labor capacity, there's no reason the economy can't absorb this new money, even if/when asset values recover and monetary velocity increases.

If we return to demand-side economics so that these investments of the past 30 years are used to babysit welfare babies while we yield our trade connections to the Chinese and others, then inflation could become a problem, though hyperinflation is very unlikely under about any scenario.

And 8financial, how do you come up with an additional $3 Trillion? I'd be interested to know how you calculated that. I don't disagree, by the way.

Mar 22 05:28 PM

[fg144331:]

I would like to hear Paul Volker interviewed to get his thoughts on
this mess.

Mar 22 05:45 PM

[ManAboutDallas:]

Instead of interviewing Paul Volcker, how about a grass-roots effort to have him installed as Treasury Secretary instead of the pixilated leprechaun we have now. We MIGHT have a fighting chance then.


On Mar 22 05:45 PM fg144331 wrote:

> I would like to hear Paul Volker interviewed to get his thoughts
> on
> this mess.

Mar 22 06:21 PM

[Ken - Break...:]

Stop trying to scare people. We are not on the path to hyperinflation. The market even says so. The best indicator of inflation is to compare the yield on the 10yr Tbond with the 10yr TIP yield. Right now that spread is about 1.3% which means 1.3%/yr annual inflation for the next 10yrs. Focus on the data, not your emotions.

Mar 22 07:07 PM

[Philman:]

Hmmm...deflation? Unfortunately, other than in government reports, and the price of gasoline, housing, and a few other basic commodities, I'm not seeing any. I just went out to eat, today. Less diners. Much higher prices. Last week, same thing. Went to Macy's two nights ago for their 1 day sale. They raised all the jewelry prices by about double, only to claim that they were taking 50% off.

No, I'm afraid there is NO deflation on the horizon, and none happening now. What I am seeing, in my everyday life, is INFLATION, with capital letters. I am also seeing stores and restaurants closing. But, the ones still open, are charging me higher prices. I don't know where the government gets its numbers on the CPI. I think they invent them...


On Mar 21 07:35 PM ddtuttle wrote:

> We are currently experiencing deflation on a global level. World
> net worth has dropped something like 50%, an amount that dwarfs the
> amounts actually "created" by central banks. We are in a deflationary
> spiral that show no signs of stopping.
> When prices finally stop going down we'll have assets worth a fraction
> of their former value and many times the corresponding money supply.
> That will be a recipe for inflation, but from massively deflated
> values and prices.
> Until then cash (and gold) are king. Once the inflation starts, then
> you'll want to switch to commodities (and gold).

Mar 22 07:12 PM

[Philman:]

Ken, you say "We are not on the path to hyperinflation. The market even says so.

Can you possibly be so naive? The market was also telling us, in October, 2007, that boom times were ahead, with a DOW of over 14,000. Let's see...where is the DOW now? People like you are cheerleading when it goes above 7,000!

We are not only about to see hyperinflation. More accurately, we are going to see a hyperinflationary depression of the same type and kind that was seen in Weimar Germany from 1919-23. But, it is good that we still have some foolish people, like you, out there. It allows me to load up on gold and silver, without paying $2,000 per ounce, quite yet...

Buy stocks, Ken! I need someone to sell mine to!

Mar 22 07:18 PM

[Philman:]

Homer,

The Fed has no choice. The momentum building in gold and silver will soon be unstoppable. They will probably crash it a few more times, but, in the long run, the manipulation is doomed. A critical point will come in their dollar manipulation, when the production of dollars gets to the critical point that a chain reaction will come about, imploding the dollar, and breaking gold and silver free from the constraints the fed would like to impose.


On Mar 22 12:54 AM Homer II wrote:

> Simit, you said "...as the Fed's interventionist behavior will make
> rational analysis difficult and perhaps fruitless." and yet you
> recommend holding precious metals? What do you call the drop in
> metals prices last August if not "interventionist behavior" by the
> Fed? The government well know if precious metals are allowed to
> seek their true level, that the Dollar will fall inexorably as PMs
> rise. So, they "meddled" to suppress the natural tendency for Gold
> to rise beyond $1000/oz and forced it down into the $700s to crush
> the appetite of the wise investors... and prop up the Dollar to buy
> some more time.
>
> So, do you think now, the government will allow metals prices to
> float up freely, speaking metaphorically?

Mar 22 07:24 PM

[Conan the B...:]

Philman: you want to hold gold. Hold it forever.

To live in a hyperinflationary environment you will have to sell some since your wages will never catch up to prices, what will you get? USDs and you will never be able to repurchase it at the prices you sold it for.

See how long that lasts you depends on your lifestyle, I won't have Your problem.

I won't have to sell my gold because I'm buying Stocks which will benefit from an Inflationary environment, they will go through the roof in a hyperinflationary environment and they will start paying hefty dividends.

So you go ahead and buy Physical Gold and Ignore what you will need to actually live in your Hyperinflationary environment. To my knowledge, Physical Gold is not Marginable.

Mar 23 03:40 AM

[AlphaDude:]

Well, I don't see Weimar style hyperinflation, but I feel sure there is gonna be pretty high inflation in foodstuffs and other essentials, while at the same time, luxuries and discretionary will be dropping in price.

The gov't will be able to change the CPI basket to show an inflation rate of just about anything they like but if food and fuel are costing us dearly it won't matter what you call it, people will be suffering.

Mar 23 06:33 PM

[Vox Rationalis:]

H. E. Canada wrote:
> "The Bloomberg confidence index for U.S. equities posted the biggest
> decline among the 10 countries, dropping 14 percent to 29.5. A reading
> below 50 indicates investors expect stocks to retreat in the next
> six months, while readings above 50 mean they anticipate a rally.

Do you have any information on the correlation between this index and market performance?

> "The S&amp;P 500 may still be expensive even after its slump to a
> 12-year low this week. The index is valued at 13.9 times earnings...
> At the bottom
> of the three recessions since 1929 that lasted as long as the current
> one, the average ratio fell to 8.74."

1. I think this is a poorly chosen metric. Since the S&P level tends to be a leading indicator, taking the Shiller reading at the recession's low doesn't seem as good as taking the cycle’s low. Near the bottom of each of the referenced recessions (1930-193x, 1973-1974, 1980-1983), the Shiller index bottomed lower than 8.74, in two cases significantly lower.

2. Using Shiller's 10-year P/E data back to 1930 (so that I'm including the Great Depression data that's the most damaging to my assertion of good value), the S&P 500 is (at 800) at a lower Shiller 10-year earnings-based price than during 61.3% of previous months. Does this indicate that we're at the bottom? No. Is it a better indicator of whether or not stocks are "expensive"? Obviously, yes.

> If one accepts that confidence in the markets is low and...

...believes that this is significantly predictive, and...

> believes we are in a recession similar to the three extended ones
> cited in the Bloomberg article...

Grouping the recession(s) of the 1930s with those of the 1970s and 1980s is unreasonable, as the Great Depression was worse by quite a large factor (I would also argue that the 80-83 recessions were meaningfully worse than the 73-4 recession). So you may have it one of three ways: the current recession is like (a) the Great Depression, (b) the 1970s-80s recessions, or (c) neither.

> ...and that comparable valuations can be expected,
> one can reasonably conclude that we will see a much lower S&amp;P
> 500 in the near term (unless one is predicting much higher earnings).

The behavior of the market during each of the three recessions you cite was very different, and the circumstances of this recession are very different from any of them. So how can we reasonably conclude anything about market levels in the next year or two based on a simple “averaging” of three very different prior recessions?

> To be sure, the Shiller P/E at current valuations is near a level
> that in the past has been a good entry point for long-term investors
> into the stock market. Having acknowledged that, there is a huge
> difference between entry at 13.9 and one at 8.74, and the implied
> levels of the S&amp;P 500.

Great argument against market timing. What if it doesn’t get to 8.74?

>A New York Times article, 10/10/2008, cited the Shiller P/E as well:

Nit: not a printed article, but a blog entry.

> "There are two things to keep in mind, in the event that you consider
> these ratios to be a sign that now is the time to buy. First, the
> p-e ratio typically falls well below its long-run average during
> a bust. It fell to about 6 in both the 1930s and early 1980s.

There are big problems with this tidbit of analysis. The most critical is that S&P earnings have falling faster than at any time in history. I can't find the data right now, but I believe Q42008 earnings were negative. Additionally, though I haven't done the work, I believe the losses are far more concentrated than previously - the weakest performers in the index never dragged P/E down as as they have this time. What this means is that while market earnings are far lower, the median company (in fact, most companies in the top 475 performers) is not even close to as bad off as the market average might make one think.

Consider the following. Related to the 1980-3 recessions, inflation-adjusted earnings fell 35.6% from peak-to-trough over 5 years 8 months. During the Great Depression, the earnings peak-to-trough was a staggering 66.6% loss over 3 years. In the recent downturn, it's taken less than 2 years for earnings to fall from 86.45 to Shiller's December estimate of 26.5 - a 69% loss. During the worst of the Depression, the most earnings fell in any 12-month period was 35.6%; during 2008, earnings fell 60%.

Does this mean our economy is worse than the 1932 economy? Not remotely. It's far more likely that our metrics are simply inadequate to the task. P/E analysis fails, as the earnings of a handful have fallen dramatically, pushing the market P/E up. A good read on this is here: seekingalpha.com/artic....

So where will the Shiller bottom? Shiller 11 is about S&P 630 right now. Shiller 10 is about S&P 575. We’d have to go to 500 to see Shiller 8.74.

Mar 23 09:49 PM

[H. E. Canada:]

Thoughtful reply, Vox, and the article you referenced is appreciated. Further study of it is worthwhile. In the meantime short puts and high-probability short vertical put spreads are celebrating the market action Monday. And a protective put on GLD keeps one safe on the downside in that position. Indeed, a good day it was.

Questions obviously arise regarding your observation about the differences in recessions: "The behavior of the market during each of the three recessions you cite was very different, and the circumstances of this recession are very different from any of them." and regarding your declaration about the unprecedented drop in earnings: "Does this mean our economy is worse than the 1932 economy? Not remotely. It's far more likely that our metrics are simply inadequate to the task."

What metrics do you propose, if p/e and historical comparisons do not apply to our current situation? How are you measuring the market to justify your statement that the values we see in the market are actually inexpensive?

The macro earnings estimates cited by Denis Ouellet reaches into the toughs of the 70s and 80s for development of "a reasonably conservative assumption given previous cycles experience." Sounds like the use historical data from unlike recessions for comparison purposes to me. Please clarify.

Regarding the issue of timing the market and "... where will the Shiller bottom?" - It's not so much a matter of trying to pick a bottom to optimize entry or maximize gains; I make no claim on that ability. In fact I have, unintentionally, averaged down in some positions believing (hoping?) that lower entry prices represented good value at the time. My additional position in SPY, as an example, is still down about 10% from EOY 2008 even with the last two weeks positive action.

You ask: "What if it [the Shiller p/e] doesn’t get to 8.74?" I was asking a similar question about valuations when the market in early Jan09 recovered from Nov08 lows, and bought in, again. And thus my unintentional averaging down.

We are at a similar inflection point now. Anticipating the possible continuation of the recent uptrend, many are buying in, again. Some, thrice bitten and wary of buying into a mere bearish bounce, choose to remain more or less on the sidelines, perhaps making short-term plays or nibbling at a few "attractive" issues while the dust settles a bit, but basically waiting for the equity horizon to become more distinguishable.

Again, citing the referenced article by Ouellet:

S&P 500 INDEX VALUATION
* Valuation using the Rule of 20 method give “trough” valuation of 791-923 for the S&P Index using current trailing earnings, 3% to 20% above current levels.
* Using 2009 operating earnings estimates, “trough” valuation would be 720-840.
* The worst case scenario, using the $43 estimate would bring trough valuation of 516-602.

May one infer from the Rule of 20 valuation that we have already seen the bottom, that equities are indeed relatively "inexpensive" and not likely to get less expensive? Is this your valuation metric?

The 2009 operating earnings estimates valuation appears to allow at it's lower range a potential retest of the market lows, or perhaps the hint of a trading range we have entered. Is either a correct judgement?

The worst case scenario results in a much lower market than we have yet seen. Is this valuation less valid than the other two?

Ouellet says: "Deflation is even worse [than inflation] because once consumers become convinced that prices will be lower next month, they naturally and logically stop buying (like the housing market currently). The collapse in demand forces prices further downward which results in an economic death spiral that is virtually immune from policy actions. "

My sense is that many investors have a like view of the equities market, with that same expectation of lower prices in the future, because they have recently experienced the results of deflation in their holdings, not the "normal" up and down gyrations of market prices. One might argue that this is a misperception, but what would you call a 30% to 40% loss of equity values in the broad market? Until those perceptions change, trust in the equities market will languish, as many investors expect lower prices.

Indeed, Denis Ouellet cites as remaining risks: 1. "The economic and financial environment deteriorates much further and 2009 earnings are materially below current estimates of $40 (reported) and $60 (operating)." and 2. "Deflation, which would adversely impact both earnings and PE multiples."

And these ramaining risks, as you well know, is what we all should be gauging whenever we choose our entries and exits.

Mar 24 03:14 AM

[Ken - Break...:]

Philman, do you even know what a 10yr Tbond or a 10yr TIP represents? Its the market estimation of what those yields will be for the next 10yrs (duh?). The Dow or any other stock index represents whats happening now. Its not called the 10yr or the 5yr Dow for a reason. Seriously, if you don't understant these basic concepts you should not even be trading.

If you want to buy gold go ahead and enjoy your 3% ave annual return like it has for the past 25yrs. The fact that you're still holding your stocks that have dropped 50% instead of selling everything in 2007 like I did is further proof that you simply don't understand the markets at all.

Mar 24 06:28 PM

[Ken - Break...:]

Philman, do you even know what a 10yr Tbond or a 10yr TIP represents? Its the market estimation of what those yields will be for the next 10yrs (duh?). The Dow or any other stock index represents whats happening now. Its not called the 10yr or the 5yr Dow for a reason. Seriously, if you don't understant these basic concepts you should not even be trading.

If you want to buy gold go ahead and enjoy your 3% ave annual return like it has for the past 25yrs. The fact that you're still holding your stocks that have dropped 50% instead of selling everything in 2007 like I did is further proof that you simply don't understand the markets at all.


On Mar 22 07:18 PM Philman wrote:

> Ken, you say "We are not on the path to hyperinflation. The market
> even says so.
>
> Can you possibly be so naive? The market was also telling us, in
> October, 2007, that boom times were ahead, with a DOW of over 14,000.
> Let's see...where is the DOW now? People like you are cheerleading
> when it goes above 7,000!
>
> We are not only about to see hyperinflation. More accurately, we
> are going to see a hyperinflationary depression of the same type
> and kind that was seen in Weimar Germany from 1919-23. But, it is
> good that we still have some foolish people, like you, out there.
> It allows me to load up on gold and silver, without paying $2,000
> per ounce, quite yet...
>
> Buy stocks, Ken! I need someone to sell mine to!

Mar 24 06:29 PM

[Rock Johny:]

inflation or no, imo, we're witnessing the closing chapters of the Great Raping of America by multi-national players...even so much of the bail-out money is being diverted overseas under the guise of CDS.

Why do you think Bush's first bailout proposal wanted all that money with no oversight at all.
Cuomo said "CDS contracts were at the heart of AIG's meltdown. The question is whether the contracts are being wound down properly and efficiently or whether they have become a vehicle for funneling billions in taxpayer dollars to capitalize banks all over the world."
this comment says it all:
"funneling billions in taxpayer dollars to capitalize banks all over the world."

The end result of this won't be pretty whatever label you want to put on it.

Just like the markets have been massively shorted the last 10 years, the best way to cover would be to break the entire American financial system. I have a feeling that the top of the top players justify their deeds based on concerns of over-population and the perceived need to chop America off at the knees in order to quell it's self-indulgent polluting lifestyles and recompense for fomenting war all over the world and meddling in so many sovereign governments' affairs.

Does anyone ever get the sense that the old guard English bankers & royalty has a desire to punish the upstart America and reassert it's authority?

Even culturally, you have these Brits on TV judging and telling us 'ugly Americans' how pathetic we are, i.e.; Simon Cowell & Gordon Ramsay or how to act: Sharon Osbourne. Thank goodness Anne Robinson didn't last. Does anyone see a link?

Are there any American hosts on British TV telling them how to act? They'd be laughed off the air, no doubt.

Did i get off subject?

Mar 27 08:00 AM

[Ken - Break...:]

Cuomo also said that the markets were dropping due to rumor-mongering by the short sellers a year ago. He implied the banks were fine. Cuomo is clueless.

Mar 27 04:59 PM