Inflation: It's a Crowded Trade

It seems that the most popular analysis out there anymore is that the dollar is doomed, the Fed is printing and inflation/hyperinflation is around the corner. It seems that every guru that gets a chance to be heard, to remind everyone that we will be the second coming of Zimbabwe anytime now.

The funny thing is, they never tell us when that will occur.

I also believe that the dollar will fall and inflation will rear its ugly head but I just don't see it in the numbers short term.

Everyone and their grandmother knows that the Fed is printing multiple trillions of dollars. Therefore they conclude that it's time to buy gold and ammo. I'm saying that we will get there, but that it's just not yet that time.

Take a look at a chart of the SP500 compared to the price of gold. Gold has been relatively flat for sometime now while stocks have ramped up in what most are saying is due to printing and liquidity. Inflation, if it were here, would be reflected in most asset classes, gold especially. Wouldn't the perfect storm of economic collapse and the printing of trillions mean that gold should already be at $3000? But that hasn't happened yet.

If the Fed is printing trillions and inflation is not here, then where is all of this money going? It sure isn't making it into the economy yet. One has to remember that a trillion in bank equity was wiped out from bad loans. Unless the Fed prints trillions of dollars and allows the banks to hold that cash in order to stay in business another day, here is a theory about what happened:

1. Banks lose $2 trillion in equity and are about to be shut down because their tier 1 capital ratios are destroyed;
2. The Fed prints $2 trillion and gives it to the banks, who replenish their capital and are allowed to stay in business;
3. Inflation is not created because that money does not make it into the economy yet via new loans to consumers and businesses.

Don't believe it? Take a look at this report from Martin Weiss analyzing the Z1 Fed Funds Flow. You will see on page 11 that government borrowing in the first quarter was up about a trillion and a half dollars. That was dwarfed though from the massive contraction in private sector credit of nearly $1.8 trillion dollars.

All in all, after all this printing, lending contracted $255 billion in the first quarter. Not the makings of hyperinflation.

We can see money not making it into the economy again in the chart below from the St. Louis Fed. I have plotted M2 Money stock (blue line) against Personal Income (green line) and Total Loans and Leases at Commercial Banks (red line). One can observe that money supply during this de-cession has increased quite a bit, yet for the first time since these numbers have been tracked, personal income is dropping substantially, as well as loan and leases outstanding.

What does this mean? All this printed money is not making it to you or me in the form of wages that we use to spend on items. So much for the theory of more and more dollars chasing goods.

Those lease drops mean businesses aren't taking on more equipment to meet more demand needs. This is probably due to the fact that they have PLENTY of ability and capacity to meet current demand and any increase in demand that may come from printing money:

We have a long way to go before factories are at full throttle and needing to increase prices in order to meet the demand.

This only scratches the surface , but it is evident to me that, although inflation will be here and be here strongly, we are still a long way from inflation actually being here.

My bet is the Fed sees the deflation getting ready to spiral and are scared to death, but until the banks start lending and consumers start spending again, it won't arrive. They say the recovery is here and things are better, but until they start raising the Fed funds rate, their actions are stronger than their words.

Disclosure: Napa Wealth Management clients are short a small position of the SP- 500 by being long SH

Comments

[Donald Ingram:]

Deflation is what is occuring now. Inflation later, then years of disinflation. It will be a Japanese style "stagflation" while the deleveraging process continues, which will take years to wash through the system at present levels. This is if we don't experience another shock wave. Another big shock could push the whole mess over the cliff edge! Look out below!

Aug 24 02:04 PM

[Michael Clark:]

Deflation. Protectionism. Possibly world war. Certainly civil war in Europe (the reinvigorated right wing against Islam). There are all sorts of dark things that still need to happen before we start inflating again.

Inflating DOES NOT WORK during Night-Cycles. The actual Day-Cycle of bubble inflation runs from 1992 - 2010. In 2010 the forces of inflation will be absolutely defeated -- and the forces of deflation will run wild, unopposed, from 2010 to 2019. Then the inflation forces will begin to gain strength again, slowly, regaining power in 2028.

For the foreseeable future, we will have deflation in prices of almost everything. The economy will return to its roots, to its seed-bed.

Aug 24 02:30 PM

[PseudonymName:]

My bet is the Fed sees the deflation getting ready to spiral and are scared to death... they say the recovery is here and things are better, but until they start raising the Fed funds rate, their actions are stronger than their words.

Well said.

Aug 24 02:59 PM

[pungent:]

Outstanding article and analysis -- thanks!

Aug 24 03:19 PM

[mlonz:]

I agree, I had the big inflation play going, and it did great, but it hasnt done anything in the last 2+ months. PPI was down big, inflation is just not there, and it doesnt look like its right around the corner either.

Aug 24 06:09 PM

[TinyTim:]

Good analysis.
The Fed can print the money, but if it's not used, there's little effect.
Velocity is everything, especially when considering inflation.

Aug 24 08:41 PM

[The Geoffster:]

I disagree that inflation isn't showing up anywhere. Have you taken a look at the S&P lately?

Aug 24 09:13 PM

[conceptwizard:]

Bang on the money on this one.

Here's an excerpt from a speech given by San Francisco Fed Janet Yellen drawing the same conclusion:

"I don’t like taking the wind out of the sails of our economic expansion, but a few cautionary points should be considered... a massive shift in consumer behavior is under way.. American households entered this recession stretched to the limit with mortgage and other debt. The personal saving rate fell from around 8 percent of disposable income two decades ago to almost zero. Households financed their lifestyles by drawing on increasing stock market and housing wealth, and taking on higher levels of debt. But falling house and stock prices have destroyed trillions of dollars in wealth, cutting off those ready sources of cash. What’s more, the stark realities of this recession have scared many households straight, convincing them that they need to save larger fractions of their incomes.... a rediscovery of thrift means fewer sales at the mall, and fewer jobs on assembly lines and store counters....

This very weak economy is, if anything, putting downward pressure on wages and prices. We have already seen a noticeable slowdown in wage growth and reports of wage cuts have become increasingly prevalent—a sign of the sacrifices that some workers are making to keep their employers afloat and preserve their jobs. Businesses are also cutting prices and profit margins to boost sales..... With unemployment already substantial and likely to rise further, the downward pressure on wages and prices should continue and could intensify....

If the economy fails to recover soon, it is conceivable that this very low inflation could turn into outright deflation. Worse still, if deflation were to intensify, we could find ourselves in a devastating spiral in which prices fall at an ever-faster pace and economic activity sinks more and more."

"Falling prices." "Deflation." "Devastating spiral." That's not the kind of honesty that one expects from a Fed chief. Yellen must not be drinking the lemonade.

Aug 24 09:48 PM

[LilBob:]

ConceptWizard is right. A lot of people out of work means more competition for fewer jobs and someone's always more desperate than you are... As far as I can tell it appears to me that the stock market is actually being held up by the last of the bailout funds.

At the end of every business transaction you have to have a consumer. You can only prop up markets through mental masturbation for so long. A "jobless recovery" is an oxymoron. American business is not a perpetual motion machine. Eventually you have to have people working to create new goods and transactions to support economic growth or else the whole thing falls apart.

Aug 25 03:56 AM

[Tony Daltorio:]

The article completely ignores the most dangerous type of inflation - asset inflation.

Right now we are seeing the US stock market bubble being re-inflated and the biggest bubble in history - the Treasury market continuing to be inflated.

When these bubbles burst, it will be pain,blues, and agony.

Aug 25 02:48 PM

[Jakester:]

Tony, a strong treasury market is not indicative of asset inflation. It is indicative of deflation.

Aug 30 10:00 AM

[Sicall:]

Good article but it is very easy to see where the printed money is going........straight into the equity market.

If this bubble bursts we are back to square one but the debt is now with governments.

Could be a good time to have some gold.

Sep 07 05:07 PM