Inflation May Be the Solution 24 comments
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I've been rather vocal about being bearish going into Q4, and so far, it seems I've been either much too early or completely mistaken in acting on my instincts - I began my hedges at the beginning of August, and as of now have completed them and even dipped a little into the short side. Furthermore, there seems to be a fresh bevy of evidence suggesting that the green shoots are indeed real, and have somehow grown roots in what I thought was toxic soil:
Tim Iacono analyzes the state of the housing market, with positive Case Schiller data to back it up.
China sees growth in industrial production, signaling that, despite concerns of their own asset bubble, they may be assuming that the worst is already behind us.
Bloomberg sees an earnings boom due to layoffs and productivity increases resulting from them. In my opinion, this is a net positive, as it shows a willingness on the part of corporations to adjust to a 'new normal'. My original concern was that the economic effects of high unemployment would erode corporate profits - but if profits are still healthy throughout this mess, that means that the first and most important consideration for corporations to begin rehiring is already in place - scaleabe, profitable operations. If they are able to hang onto productivity improvements from this recession, then these operations may scale quite well as demand eventually works its way back into the system - even if it takes years for it to do so. In the meantime, we will have to see if bottom lines are actually buoyed by these 'productivity improvements'.
The government has begun to implement the beginning stages of an exit to QE. Of course, the government can easily reverse course and re-start even more emergency measures, but the fact that they're winding down these kind of operations is suggesting that they think the fire in the theater has burnt out. Now, reconstruction can begin.
Don't get me wrong, there are still enormous hurdles to overcome:
From the Fed: Consumer credit decreased at an annual rate of 10-1/2 percent in July 2009.
Retail has dropped accordingly. Even Wal-Mart (WMT) is feeling the effects of decreased consumption.
As always, John Lounsbury is able to make a most compelling case, this time that banking is still a basket-case.
So, at this juncture, with the winter ahead of us, I wanted to see if there were any factors I may have missed a couple months ago that would lead to a benign environment for stocks in general, short and long term. Even after dismissing the somewhat contradictory signals above as being a wash, I still cannot quite dispel the specter of inflation.
Not being a professional economist myself, I will do the best I can to outline an inflationary scenario that may end up culling the bears from the market. I would appreciate any feedback in adjusting base assumptions or in any logical flaws that may arise from my approximations. My concern is that it is quite possible that inflation could become such a dominating force as to not only nominally raise the price of living in the US, but at the same time destroy the main foundation of any bearish argument on the economy - debt overhang and the corresponding consumer retrenchment.
The Fed has seemingly dedicated itself to fighting the beast that is deflation. As a result, policy has been incredibly accomodating towards stimulating economic activity in any shape and form. So far, it seems that what has been stimulated more than anything else is a mini-asset-bubble, as evidenced by oil's resurgence and the S&P's 6 month rally. Gold has also rallied nearly 40% from last winter's lows.
Combine this with Bloomberg's point about productivity improvements. The idea here is that corporations would somehow be able to deliver higher profits even in a slowing spending environment. This would be one sign that besides adjusting to a new normal, higher commodity prices would have been passed to the consumer - the first indication of inflation filtering throughout the economy. The consumer, cognizant of higher corporate profits, may end up demanding higher wages to keep up with the pace of commodity inflation. Once this happens, then it is easy to see that concerns about nominal consumer spending dropping and debt overhangs may become mitigated by the rising tide - the consumer may end up with less overall (the 'new normal'), but they will end up with even less debt.
What this may translate to is that the current rally may be justified as already pricing in future inflation and wage growth.
Signs to look for would be inflation in commodities (check), and a rise in corporate profits (pending). Once profits rise, wage level increases (or at least a fuller employment picture) would follow (pending). Then, the coup de grace would be whether or not the Fed decides to reign in inflationary forces by not only mopping up the QE liquidity, but also by raising rates to counter inflationary forces. I don't think I've relayed anything new here - this (outside of the initial commodity inflation) is a textbook definition of a recovery.
What I think will happen this time around (and is quite possibly already priced into markets), is that the Fed will not act forcefully to reign in inflation. Unlike the 70s, the Fed simply has no reason to - in fact, it has every reason to let the genie out of the bottle and wish our debt away into a distant memory. To put this into my trampoline-speak from earlier this year, instead of getting off the trampoline and doing a proper inspection of the device, the Fed will opt for us to jump as high as we possibly can, hoping that this air-time will be enough to fix any problems they may find in the integrity of the trampoline, and also hoping that such a leap will not itself permanently damage the trampoline. Not too reassuring, but it is not like the public would care that much - all they want is for the party to begin anew, and to feel that rush from the upward surge into the air (just don't look down).
The result is that people like myself, looking at the depressing, horrifying spectacle of the grasshopper struggling in the winter, may be over-reacting in the marketplace. It's quite possible that shorts in this environment may get their rear ends handed to them as they correctly predict a 'new normal', except that nominally speaking, this 'new normal' may be accompanied by wage and asset inflation masking the effects. Winners in such a scenario would be holders of base commodities and non-dollar denominated assets (as the dollar gets decimated in the international currency markets due to this permissive debasement scenario from the Fed), and anyone who was mildly to strongly bullish on the US economy (nominally speaking). Losers would be anyone nominally shorting the market, as I have done recently to a small degree.
I'm not sure if I am simply relating common sense, or something more contrarian to common knowlegde, or if I am completely mistaken in my logic and reasoning. I had the urge to at least attempt to solidify a possible scenario that is contrary to the bearish views that I have come to accept, one reason being that the markets are indeed brushing away all bad news for seemingly no good reason. It could be that the nominal rises are simply that - inflation may end up making the waters rise for everyone.
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By my calculations paying back £600million/month means that consumers should be debt free around 2200AD!
None of this takes account of Business and Government debt, including unfunded liabilities.
When debt gets too big to pay back, it isn't.
The choices are inflation or default.
These debts are never going to be paid down.
What do you get when you inflate an inflation (isn't that a song -- 'How do you handle a hungry man'): You get....MASSIVE DEBT, followed by the BIG CRUNCH...which is what happens to the universe after it can expand no longer. The BIG BANG comes only after the BIG CRUNCH, a deflation of the bubble universe, has led to a contraction back to zero. Bernanke-Greenspan want the BIG BANG to be continuous.
The Big Bang is a continuous infusion of energy inflating the universal bubble. The Big Crunch is a continuous abstraction of energy out of the imploded universal bubble. The infusion of energy that inflates the universal bubble in cohesive and builds a sophisticated material structure of the universe. The abstraction of energy OUT OF the universal bubble is chaotic and destructive and de-constructs the sophisticated form that the infusion has constructed.
Everything in the world works according to analogy.
Heat, expansion, melting together of forms. Cold, contraction, fractionation of forms.
On Sep 11 07:36 AM CautiousInvestor wrote:
> Historically, inflation has always been the unspoken goal of central
> bankers and those that sits on the board of the cartel. This time
> will be no different and rates will not rise until willful policy
> inaction leads to looming inflation, a connect established in AD
> 33.
>
> At its onset, rising inflation allows bankers to steepen the yield
> curve by raising longer-term rates and thereby expand lending margins
> for longer dated products. Similarly, manufacturing companies are
> able to increase prices faster than the rate of increase in underlying
> costs, expanding margins. The part ends when either costs get out
> of control or one or more asset bubbles is created.
>
> In the latest crisis, there has been globally coordinated and unprecedented
> increases in fiscal spending, along with extraordinarily expansive
> monetary policies, to prevent the world from falling over the edge
> and falling into financial abyss. In agreeing with recent comments
> made by Alan Greenspan, I am confident these unprecedented actions
> will result in one or more bubbles.
>
> And to the extent there is some relationship between the efforts
> to create a bubble and the financial cost and aftermath of dealing
> with the collapse of a bubble, the oncoming bubble will rank among
> the biggest.
When the rich guys get extra money from the Fed and government bailouts. Then they have no incentive to share it with the rest. And that's why they are speculating with this money in various financial markets without producing much economic growth.
Real economic growth comes from trade and exchange between everyone in the economy. And right now, the common people don't have much to offer to the rich folks in exchange for their money.
The rich folks have no incentive either to lend to the common people who have already reached their borrowing limits or to increase their wages. There is no way for the money the rich guys got from the government to go the common people in some kind of trade and exchange. And without such trade and exchange, the economy can't grow in a sustainable way.
The only thing all this extra money can do is stimulate wild speculative bubbles in various assets, such as oil last year and the stock markets this year. But such speculation can't stimulate economic growth because this is simply gambling where some people gain and others loose and the net sum is zero.
great article link
On Sep 11 07:24 AM Davewmart wrote:
> Inflation is perhaps not as practical an option as it was in the
> 70's.
> 'Many predict that, instead, the government will inflate its way
> out of this future bind, using Federal Reserve monetary expansion
> to fill the shortfall between outlays and receipts. But I believe,
> in contrast, that it is far more likely that the United States will
> be driven to an outright default on Treasury securities, openly reneging
> on the interest due on its formal debt and probably repudiating part
> of the principal. '
>
> www.econlib.org/librar...;br/>
>
> IOW, the Government would love to but can't get away with it.
Regardless of whether it is or it is not the right thing to do short term, what is the cost long-term of willful betrayl of its part of the contract by the government? Inflation is stealing from the common man to pay for the government's excesses.
Why do people quietly accept stealing as a viable solution in the financial markets while put people in jail for stealing of goods and services?
If companies can add to profits despite a weak consumer and rising commodity prices, it would point to a most adept conforming to the 'new normal'. More than likely the cost cuts linked to the productivity enhancements would remain even after employment picks up. Inflation-based wage increases would follow, and voila - we have a recovery with the 'new normal' priced at a higher nominal level.
Stocks may indeed lose 'real value' over the next decade, but nominally, you wouldn't see any of it. This is my fear as I ponder whether or not to add shorts going into this winter.
On Sep 11 12:24 PM Socialism cannot compete! wrote:
> Scaleable, profitable operations? Growing demand, even if it takes
> years? How can this happen with 15 million unemployed...10% of the
> workforce? This downturn is only getting started....
You've addressed my main concern. I still think retail will be hit hard, given that even with adept inventory management and shrewd cost-cutting, top line erosion during the all-important Christmas season may end up raising fixed costs to such a high percentage of sales that they bleed red ink anyway.
The surprise to me would be that other corporations would actually fare quite well in this environment. I find that hard to believe given the state of the consumer - any real 'green shoots' would be predicated first on corporate profits rising enough to compensate for a still-weak financial sector and IMHO weak retail. That's a tall order, but Bloomberg's point seems to be that corporations may have already adjusted their cost structures to reflect the 'new normal'. Exactly what a good aggregate earnings number would be to reflect 'new normal' is beyond my experience to compute, although a significant increase from today's levels (say, 20%) would IMHO justify a slightly higher valuation of the S&P 500.
If the Fed then becomes accomodative even in the face of inflationary pressures, it's easily possible to see an eventual nominal resumption in 2007 asset price levels, even with much higher costs (hopefully reflected in the CPI). This would then destroy bearish arguments predicated upon aggregate debt-to-asset levels, as we would have successfully inflated our debt down to a more manageable number.
Bottom line, shorting in any degree in such an environment would be foolhardy.
On Sep 11 07:25 AM Tom Armistead wrote:
> Ricard, on corporate profits it is possible after all the restructuring
> that companies will have very strong operating leverage and will
> be extremely profitable as revenues increase from a low base point.
>
>
> A lot of companies cut 20%, if revenues return to 90% of what they
> were these companies will make very good money. This would generate
> some hiring which would be helpful on the employment front.
>
> On debt, the government is propping up banks while they write off
> the debt that cannot be repaid. That leaves the government with
> additional debt incurred to finance the bailouts. But homeowner
> and credit card debt is being reduces pretty steadily by writeoffs
> and bankruptcy.
>
> All of this money created to stimulate the economy has to go somewhere.
> It is to be wished that it leads to a pervasivive increase in the
> cost of all goods and services, rather than more asset bubbles.
> But with gold going over 1,000 maybe asset bubbles will be the order
> of the day.
great article, and I agree with the conclusions. Inflation is the most likely path that the federal government will take in the short term. It's one of the reasons why I have most of my portfolio in precious metals and commodities.
That said, I think there's one thing you fail to mention, and that is that full-blast inflation, while the most probable solution, is not inevitable. I see hints of the Fed pulling back some QE (lip service yes, but better than nothing). Inflation would defeat the credibility of the dollar, and indeed, the US as a sovereign nation, if it's allowed to be used as a tool to repudiate our debts. That damage, along with the fact that I see a high probability of increased taxes with this administration, makes for a more moderate inflation scenario (more taxes = more balanced budget).
Maybe it's just naive thinking, but I hope we don't go towards the inflation road for another reason. We have increased our standard of living on the backs of poor and destitute Chinese workers for the past 20+ years now. In return for their labor, we promised to pay them a certain amount of dollars. It just doesn't sit right with me morally, that one of the richest and most powerful nations in the West, would in effect, steal from a developing nation with hundreds of millions still in poverty. Communist or not, these are real people, and real lives. Add that to the fact that inflation would destroy the savings of millions of honest and hard-working, but perhaps not financially savvy Americans who've tried to do the right thing and save for a rainy day... That just inflames me to no end. Am I the only person that feels that Fairness still has a place in the world? That we should, perhaps, live up to the promises we made, no matter how painful it is? Sometimes it certainly feels that way.
No, you are not. I feel the same way. But it seems most people onloy think about numbers, not about the hard and cold reality behind the numbers.
Just like how the leaders in Wall Street have let us down and is one of the key players in causing our poverty rate to increase, so the CCP risks letting the Chinese down whenever they make similarly bad investment decisions.
On Sep 11 09:03 PM inthemoney wrote:
> > Am I the only person that feels that Fairness still has a place
> in the world? That we should, perhaps, live up to the promises we
> made, no matter how painful it is?
>
> No, you are not. I feel the same way. But it seems most people onloy
> think about numbers, not about the hard and cold reality behind the
> numbers.
On Sep 11 12:24 PM Socialism cannot compete! wrote:
> Scaleable, profitable operations? Growing demand, even if it takes
> years? How can this happen with 15 million unemployed...10% of the
> workforce? This downturn is only getting started....
Latin American Exports Sink to 70-year Low
A 29% drop in international prices of raw materials plus a drop in demand caused decline.
By . Agence France-Presse
Aug. 26, 2009
Latin American exports fell 30.9% in value in the first quarter of 2009, in the lowest figures for the region since the 1930s, according to a UN-backed study published on August 24.
Exports will plummet 25% in value in 2009, and by 11% in volume compared with the previous year, predicted the study by the Economic Commission for Latin America and the Caribbean (ECLAC).
"The fall in regional commerce has no equivalent in recent history," the regional study center, which is based in Chile, said in the report. "The external shock suffered by the region is above that provoked by the Asian crisis (in the 1990s) and the debt crisis (in the 1980s)."
A 29% drop in international prices of raw materials, and a generalized drop in external demand from most countries, apart from China, contributed to the fall, the study said.
"Only China has maintained a sustained demand for raw materials, which gave a counterweight to this adverse situation for regional commerce," it added.
Regional mining, oil and manufactured goods sectors were worst hit, while agricultural products were less affected, the study said.
Copyright Agence France-Presse, 2009
One big reason why we have such a huge trade deficit is because the labor forces of countries with which we have deficits make do with a lot less consumption than ours. In order for us to become more competitive, we will have to produce more while making do with less.
Such a correction in US spending habits and its toll on future real growth can be masked by inflation, i.e., nominal growth.
On Sep 12 01:36 AM Student of History wrote:
> All of the people I know who are gainfully employed (Including myself)
> are grateful to have jobs even though our real wages are probably
> slowly decreasing as I type this. When I read about the alleged
> productivity increases that firms are experiencing, I'm beginning
> to see that it's just a euphenism for forcing the reamaining workers
> who haven't been laid off to do more with less (or else)... These
> alleged productivity increases aren't coming from innovation and
> they are definitely not coming from investment. I wouldn't count
> on this as a long term engine for earnings growth either.
People don't accept it. It just has ever thus been so.
It is much easier for dependent authorities to jail little people for crimes. They don't have $$$lawyers, lobbyists, and organizations (media,bloggers, and host of non-profits) and powerful business/political allies, to lead their defense and claims of innocence. Occasionally, a biggie will fall, when one of the allies has been burnt by their behavior, or if there is absolutely no other political way out. The penalty will be light. The well connected Madoff expected only 12 years! He must have harmed quite a number of the elite to get the sentence he so justly deserves, even thought it isn't over yet (appeals).
I gave you thumbs up...surely goodness and justice have some place in this world, or so I too would like to believe.
On Sep 11 10:01 AM inthemoney wrote:
> Inflation is the same as abandoining a contract, only the contract
> is not between the private parties but between the government and
> the people.
> Regardless of whether it is or it is not the right thing to do short
> term, what is the cost long-term of willful betrayl of its part of
> the contract by the government? Inflation is stealing from the common
> man to pay for the government's excesses.
> Why do people quietly accept stealing as a viable solution in the
> financial markets while put people in jail for stealing of goods
> and services?
On Sep 11 07:24 AM Davewmart wrote:
> in contrast, that it is far more likely that the United States will
> be driven to an outright default on Treasury securities, openly reneging
> on the interest due on its formal debt and probably repudiating part
> of the principal. '
>