Prepare Yourself for the Inflation Invasion 43 comments
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Inflation Expectation Eases
The Treasury Department, responding to growing demand from China and other investors, will boost the sale of inflation protected bonds, i.e., TIPS. Chinese officials had indicated they want inflation-protected securities, especially as the U.S. economy starts to recover.
TIPS value fell after the announcement. The spread between TIPS and comparable Treasury Notes ended at around 1.93%, signaling that investors expect annualized inflation of 1.93% over the next decade. However, this is still below both the average 2.8% of the past 10 years, and the 2.1% at the end of last year.
Inflation’s Twin Tale
Most analysts are of two minds about inflation: One group tends to argue that the Fed's printing of new money would lead to explosive inflation or even "hyperinflation.” The other group argues that there is too much "slack" in the economy for prices to rise, i.e., a stagnation scenario, due to high unemployment, falling wages, plunging home values, and damaged 401ks. So far, the latter view seems to have held up better.
Growth of Money supply
At the moment, both inflation and deflation are seemingly off the radar based on the latest consumer and producer prices. Realistically, we can’t ignore the inevitable inflationary effect from the government’s quantitative easing program.
Since the start of this global economic crisis, the U.S. government has been injecting massive amounts of new currency into the financial system to prevent deflation and stimulate economic growth. M2, a measure of money supply that includes checking accounts and money-market mutual funds, has grown about 16% over the last 12 months, or a colossal $1.12 trillion increase. All that money is going to find a home. This phenomenon will eventually devalue the dollar and push price inflation much higher, which is also referred to as reflation.
Betting on Inflation
Warren Buffett said on Aug. 18 that the U.S. must address the massive amount of “monetary medicine” that has been pumped into the financial system and now poses a threat to the economy and the dollar.
In reality, the Fed will likely be slow to act, in part because of the still high unemployment rate, which rose to 9.7% in July, from 7.2% in December. So the U.S. has got a lot of inflation or even hyperinflation issues to worry about in the future.
Meanwhile, Pictet Asset Management, which manages $60 billion in fixed-income assets, reportedly is buying U.S. inflation-protected bonds, betting that the government’s economic-stimulus measures will fuel price growth.
W-Shaped vs. V-Shaped
Prominent Harvard economist Dr. Martin Feldstein indicated that the U.S. economy has improved, but he wondered "if the current recovery is really sustainable" or whether there could be "another slowdown or indeed downturn after the third or fourth quarter".
Judging from the recent commodities rally, we may have inflation, for example, in food and energy, while deflation in the rest of the economy. If this stagflation scenario emerges, we will likely experience a W-shaped recovery instead of a V-shaped one.
Commodities Rock & Rule
A large spike in prices for goods and services is expected once we finally emerge from this global economic crisis, which could be in a year or so. Hard assets such as oil, agricultural products and precious metals will experience substantial price appreciation in this future high inflationary environment. Therefore, commodities are well positioned as a sector with likely strong growth prospects over the next decade.
Investing Strategy
Based on this analysis regarding inflation and a likely W-shaped recovery scenario, here are some ideas of potentially profitable plays to consider:
Precious Metals ETFs: SPDR Gold Trust (GLD) & iShares Silver Trust (SLV)
Hard Assets ETF: Market Vectors RVE Hard Assets Producers ETF (HAP)
Agriculture Commodities ETF: PowerShares DB Agriculture Fund (DBA)
Metals Equity Play: Freeport McMoRan (FCX), BHP Billiton Ltd. (BHP)
Crude Oil Producer: Petroleo Brasileiro SA (PBR), ExxonMobil (XOM)
Disclosure: No Positions
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OK, what happened after every other massive speculative bubble in the history of the country? Deflation, major recession or depression. We already had massive inflation in everything, particularly real estate. The pendulum has got to swing hard the other way, and for a long time! Buffet is screaming inflation because he needs to create it. If it was certain he would not have to promote it!
OK, lets say all the speculators speculate on inflation, then what, commodities etc spike in price, it kills any momentum in the economy and back to depression! It is simple and inevitable - Period!
OK, what happened after every other massive speculative bubble in the history of the country? Deflation, major recession or depression. We already had massive inflation in everything, particularly real estate. The pendulum has got to swing hard the other way, and for a long time! Buffet is screaming inflation because he needs to create it. If it was certain he would not have to promote it!
OK, lets say all the speculators speculate on inflation, then what, commodities etc spike in price, it kills any momentum in the economy and back to depression! It is simple and inevitable - Period!
Sethbru is the only one so far to get his facts straight.
The size of the Fed's sheet peaked on April 23rd. It has contracted 10% since then, $200 billion. This has coincided with stocked bottoming and the rally. Everyone pretending that the Fed is still inflating is simply not doing their homework by reading the actual balance sheet.
I see pundit after pundit predicting that as soon as the Fed stops expanding the market will tank, when it stopped over 4 months ago and the market took off like a rocket.
$700 billion in the short term loans, 90 days and under, that the Fed made at the peak of the crisis, have run off into cash, repaid to the Fed. If the Fed had just extinguished all of it immediately, it would have been the most rapid deflation in history. As it is, the run-down rate is as fast as the early 30s.
The Fed lent $500 billion to US banks in term auction credit and through the discount window. 45% of that has been repaid already. The Fed lent $250 billion directly to US corporations in its commercial paper and asset backed facilities. 65% of that has been repaid. The Fed lent $250 billion to foreign central banks via swap lines, indirectly supporting the dollar business of European banks especially. 70% of that has been repaid.
The Fed has extinguished a third of the money as it flowed back to them, invested a third in mortgage backed securities, and the remaining third in treasuries (plus actually about 40%, with 10% in agency debt).
In doing so, the Fed has rebuilt the treasury position it had back in 2007, but no more than that. It sold off the bulk of that position between Bear Stearns and Lehman, while it was running up its loans to the banking system. Those loans did not grow the sheet before Lehman, because they were offset dollar for dollar by feeding treasuries into the market. After Lehman they doubled the sheet size. Now they are running off all the extraordinary short term stuff and rebuilding the treasury position they had at the outset.
The only large new item on the sheet is the big position in mortgage backed securities. In case nobody noticed, Fannie and Freddie went broke in the meantime. The home loan banks have run off $250 billion in their sheet while the Fed has expanded. Overall, the Fed has taken over the busted role of the agencies in supplying marginal new mortgage financing, while the agencies concentrate on workout stuff and controlling their credit losses.
It is completely unsurprising that the result has been a decline not an increase in average prices, 2% at the consumer level and 5% at the producer level. The biggest being energy - the swing in the terms of trade there alone comes to several percent of GDP.
Also in case everyone just forgot, the inflationary brainstorm that any real asset would go to infinity in money terms, *was* the bubble and it comprehensively busted. Those so predicting were wrong to the tune of $15 trillion in asset price losses.
But the same crowd are still chirping away their sacred hymnal that inflation must be right around the corner. If they think so, hey, buy up all the mansions and all the half empty new suburbs and all the half occupied strip malls. Oh wait, they tried that already.
Sometimes a debt denominated in nominal dollars is simply worth more than a real asset you can hit with a stick. Value isn't a material thing. And no, central banks that put their economies through the wringer we just went through when necessary to maintain the purchasing power of their currency, do not see that currency repudiated by the people, which is what hyperinflation is. All of the hyperinflation predictions are utter nonsense.
Next to those who think the public debt is so ruinous it must bankrupt everything. They continually confuse debt with negative net worth. Take TARP, which is always presented as "costing" $700 billion. Um, where do they think that money went, to the great money-pit in the sky? Every dollar of it was someone's receipt, so yeah I think it will be available to the private sector. And oh yeah, the government got $700 billion in bank preferred stock for it, at depression prices and terms. All of it entirely profitable already, let alone longer term.
Anybody here think you can go broke borrowing at 2 to lend at 5 with a nice double on the capital after converting? Anyone think if the amount so deployed is really big, it means you are that much moer broke? It was merely a good trade, better than half the people here can boast of recently.
In the last 2 years and a quarter, the treasury has placed over $3 trillion in net new debt at rates under 4%, with a blended cost more like 2%. How have you done, in comparison? Oh and the Fed took a net zero of that, while US private investors took 65%. The vaunted Chinese buyer mentioned in every single breathless news report took 11%. The rise in the US savings rate since last summer replaces everything the Chinese invest here 3 times over and to spare.
Why does no one do their homework on this stuff, even here?
On Aug 24 12:53 AM lance sjogren wrote:
> Inthemoney: I agree the stock market rise the last several months
> is probably largely due to monetary expansion.
>
> In my view, stocks have become severely overvalued due to too much
> money sloshing around looking for a home.
>
> What I wonder is when will that stop. Stocks represent companies
> that operate in the REAL economy (aside from fiancials, of course).
> The REAL economy sucks.
>
> Stocks are way overvalued considering the horrendous state of the
> real economy.
>
> But still, the money printing goes on, and all that new money has
> to go somewhere.
>
> The smart investor is one that can figure out where people are going
> to shift all that money once they realize that stocks are overvalued
> and due for a major correction.
>
> I wish I knew.
>
> I think at some point it will be commodities, especially precious
> metals, but that may still be 2-3 years down the road.
Capacity underutilization is at a historical high, the velocity of money has fallen off a cliff and the traditional money multiplier mechanism is temporarily impaired because of banks either parking their excess capital back with the Fed to earn 0.25%, using Fed money to bid in treasury auctions, or to patch the gaping holes in their balance sheets.
Banks are reluctant to lend and are holding on to the low-cost capital provided by the Fed to brace themselves for the impending wave of Alt-A, optionARM and prime real estate losses.
If the historical correlation between monetary profligacy and inflation has been compromised by the above, then how exactly will monetary-based inflation manifest itself within the next few years?
Good points, but not the whole story. Inflation has been masked by declining energy and real estate. Inflation for nearly all other raw materials is very present - I know because that's where I live, in the world of metal and component parts. Moreover, the approx. $4T of excess dollars floating around the world is looking for places to hide from *expected* inflation, and in this case, perception can create reality.
On Aug 23 02:30 PM sethbru wrote:
> Fundamentally, I think many of us misunderstand what the Fed has
> really done. They have not added any new liabilities to their balance
> sheet since the last bank bailouts 6 months ago - actually, they
> are starting to get paid back now. Also, they did not really print
> physical paper dollars that are now circulating in our economy. Rather,
> they just placed billions of electronic dollars in the reserves of
> the major banks. If the banks just hold the reserves (which they
> must do while waiting for their toxic assets to settle), that money
> never goes into circulation, we do not get too many dollars chasing
> limited goods (actually, we have resource gluts now), and we do not
> get wage inflation (actually, we see hours worked shrinking). Rather,
> we have excess capacity and a glut of most goods. Furthermore, much
> of the enormous debt on balance sheets across the world will never
> get paid, resulting in a destruction of wealth and dollars, leading
> to deflation since we have fewer real available dollars chasing after
> an excess supply of over-produced goods. Recent declines in CPI and
> PPI are evidence of this. Finally, history teaches that the investment
> public is usually fooled, and we currently see 97% of currency investors
> expecting the US$ to decline further, and many of them predicting
> outright hyperinflation. Inflation is a myth - the Fed knows it,
> as they are desperately trying to inflate away this potential depression.
Dian-check out my article on the dollar bottoming where I explain things more and let me know what you think.
Um, default is a ridiculous concern. TIPS are a better bet long term than nominal notes at 3.5% certainly, that just isn't saying much. I can get intermediate and long corporates at 7% and change - first tier names.
On TIPS and any difficulty paying them, again not a serious concern, there simply aren't enough of them outstanding to be material. The Fed would frankly like a larger and more liquid demand for them to assess inflation expectations more reliably, but they are complex enough that demand for them has been punk since inception.
When they are over 3% real yield they are good long term value though...
Trade what is happening not what 'should be' happening.
On Aug 25 02:52 PM Jordan Lindsey wrote:
> If you are betting on inflation now while we are experiencing minor
> deflation will you be able to remain solvent enough to take advantage
> of the inflationary opportunity when it arrives?
>
> Trade what is happening not what 'should be' happening.
Yes, investment banks are not lending, because they are pushing money into hard assets and quities with superior returns vs. lending to consumers and businesses. Noticed that $GS let its macro bulls out? www.bloomberg.com/apps...
Also, the QE is not limited to the U.S. Just like the current recession is the most globally synchorinized in history, so are the global central banks QE's. Imagine the amount of money pumped into the system globally when we finally come out of this recession. If that does not spell inflation, then I don't know what does.
Thanks for your comment.
On Aug 25 08:36 AM Marli wrote:
> I pose a question.
>
> Capacity underutilization is at a historical high, the velocity of
> money has fallen off a cliff and the traditional money multiplier
> mechanism is temporarily impaired because of banks either parking
> their excess capital back with the Fed to earn 0.25%, using Fed money
> to bid in treasury auctions, or to patch the gaping holes in their
> balance sheets.
>
> Banks are reluctant to lend and are holding on to the low-cost capital
> provided by the Fed to brace themselves for the impending wave of
> Alt-A, optionARM and prime real estate losses.
>
> If the historical correlation between monetary profligacy and inflation
> has been compromised by the above, then how exactly will monetary-based
> inflation manifest itself within the next few years?
On Aug 25 08:36 AM Marli wrote:
> I pose a question.
>
> Capacity underutilization is at a historical high, the velocity of
> money has fallen off a cliff and the traditional money multiplier
> mechanism is temporarily impaired because of banks either parking
> their excess capital back with the Fed to earn 0.25%, using Fed money
> to bid in treasury auctions, or to patch the gaping holes in their
> balance sheets.
>
> Banks are reluctant to lend and are holding on to the low-cost capital
> provided by the Fed to brace themselves for the impending wave of
> Alt-A, optionARM and prime real estate losses.
>
> If the historical correlation between monetary profligacy and inflation
> has been compromised by the above, then how exactly will monetary-based
> inflation manifest itself within the next few years?
On Aug 25 07:35 PM Dian L. Chu wrote:
> Just take a look at the stock and commodities markets, whose performance
> has diverged from and contradited to almost all economic indicators.
>
>
> Yes, investment banks are not lending, because they are pushing money
> into hard assets and quities with superior returns vs. lending to
> consumers and businesses. Noticed that $GS let its macro bulls
> out? www.bloomberg.com/apps...;sid=a0sLU2hOmYZ0
>
>
> Also, the QE is not limited to the U.S. Just like the current recession
> is the most globally synchorinized in history, so are the global
> central banks QE's. Imagine the amount of money pumped into the
> system globally when we finally come out of this recession. If
> that does not spell inflation, then I don't know what does.
> Thanks for your comment.
If everyone in your neighborhood is financially strapped and you offer to increase their debt, they are going to tell you to take a hike! If you hand them money, they are either going to pay down debt or save it, not go out on a massive buying spree and run up prices! The US is your neighborhood! Oh, and the rest of the world is doing the same thing! They are trying to keep their ship afloat, not going on binge spending sprees!
Name your poison.
On Aug 25 02:55 PM Disa Anja wrote:
> Yes! Like Greenspan said markets can remain irrational longer than
> traders can remain solvent!
On Aug 25 02:52 PM Jordan Lindsey wrote:
> If you are betting on inflation now while we are experiencing minor
> deflation will you be able to remain solvent enough to take advantage
> of the inflationary opportunity when it arrives?
>
> Trade what is happening not what 'should be' happening.