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Joseph Stuber

 
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  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    Kyle

    Certainly the fractional reserve bank system has more than ample motivation to finance the debt. They just use excess reserves to purchase the debt and then when the Treasury spends the money back into the economy the money comes right back to them. They end up with the same cash position they had at the start plus the added benefit of a government bond that pays them interest.

    When you can create money out of thin air and use it to buy an asset that makes you money you are going to do that. US Treasuries will never go begging for a buyer as long as the fractional reserve bank system is in place.

    JS
    Apr 8, 2014. 02:24 PM | Likes Like |Link to Comment
  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    Kyle

    Those who know how to exploit inflation can do quite well. The way to do that is to leverage one's money. A house for instance can be purchased for 10% down and if inflation is occurring it is because price is rising faster than carry cost.

    If inflation is running at 8% and the cost of money is 5% then a house that cost $300,000 is gaining by $24,000 a year whereas the carry cost is only $13,500 netting $10,500 on an initial cash outlay of $30,000.

    Just saying - it isn't all bad.

    JS
    Apr 8, 2014. 12:25 PM | Likes Like |Link to Comment
  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    Kyle

    "Higher rates in theory would defend the bond market, but not in this case because the world will front-run the Fed and get out of bonds when they realize the Fed is exiting the QE game for real."

    If the world doesn't already know the Fed is exiting for real they just refuse to listen. QE is over and bonds are actually getting a safe haven bid as stocks seem serious this time about coming off.

    The bond markets biggest threat is inflation spurred by a dollar glut. As the dollar falls and inflation heats up the Fed will respond by allowing interest rates to normalize and I think we will see a gradual - perhaps even rapid - spike at the front end of the yield curve and a general flattening of the curve. The middle and long end won't go up near as much as the front end and the curve will look a lot like the 2007 curve reflected in the chart above - at least that is what I think.

    As rates are allowed to spike higher the bond market should attract investors and that is what I think could happen but the impact to the bond market in the short term is a sell off as the Fed allows the rates to climb followed - hopefully - by a stabilization of bonds when the yield curve flattens to perhaps 5% or 6%. That is my opinion anyway.

    I think you are right that the carry cost for the debt will approach $875 billion as this occurs meaning even a $1 trillion deficit is going to be a problem as most of it will go to covering carry cost.

    My own view is that the Fed realizes they are going to have to let inflation spike higher in order to monetize the debt. Inflation will produce a higher M2 velocity and, in addition, we could see M2 climb pretty fast as dollars locked up in foreign held treasuries move back into the banking system. As money supply increases and M2 velocity picks up it will be a driver of GDP and we could actually see a drop in debt to GDP even if we do continue to run $1 trillion deficits.

    I think the best period to compare to is the 70's after closing the gold window. We've never had a situation quite like the one we have now but the dollar did come under attack in the 70's and inflation spiked sharply higher moving GDP roughly 40% higher during that period. A repeat of the same rate of climb on GDP would put GDP at $24 trillion. Compare that to just a 12% overall gain in GDP since the 2009 trough.

    Of course the other thing to consider is that in the 1970's inflation spiked from about 3% to 13% - a little more than a 4 fold increase. From current levels a 4 fold increase would be in the 7% range on inflation and I think we could easily see that 13% inflation rate again at some point in the next several years and that would push GDP even higher.

    As ugly as this sounds it doesn't mean a US default on treasuries and in fact I think TIPS could be a pretty good performer in the next 4 or 5 years.

    JS
    Apr 7, 2014. 07:41 PM | Likes Like |Link to Comment
  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    Kyle

    "Who is going to fund the new issuance of Treasuries to finance the fiscal deficit if the Fed isn't there to monetize? A permanent end to QE would mean a U.S. default."

    Higher rates defend the bond market. The US won't default on treasuries - they will certainly have to allow the rates to normalize though and that isn't a good thing for economic growth.

    There are a lot of fixed income investors that would love to see rates in the 5% to 6% range. And of course the banking system will be there as well to pick up the slack.

    JS
    Apr 7, 2014. 04:10 PM | Likes Like |Link to Comment
  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    Flash

    I may reach out to you. Just curious - are you an energy trader?

    I know a number of energy traders - most now retired - and they do have a very focused knowledge of energy markets. My brother in law worked in the industry for years staring out with Koch and moving from Houston to London. Then moving to Phibro and even Enron for a very short time. He eventually set up his own company in the early 90's dealing in OTC derivatives in the energy markets and did very well there.

    Your bio doesn't help a lot as there isn't one and just curious about your background.

    JS
    Apr 7, 2014. 07:14 AM | Likes Like |Link to Comment
  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    Flash

    Now we are talking. Good input and good analysis.

    As I said there could be many reasons for the spread contracting and I only offered one perspective. You have offered another - and now backed with some good logic - and I can't argue that you may well be correct in your analysis.

    I truly appreciate these kinds of comments as they inform me on areas that I may not have considered and that, after all, is the most important thing. It is not about me being right for the sake of being right. It is about me being right for the sake of my money and my investments and to close my mind to other views puts me at risk of being wrong.

    I intend to investigate a little further based on your comments and appreciate your take on this. Thanks.

    JS
    Apr 6, 2014. 11:52 AM | 1 Like Like |Link to Comment
  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    Flash

    "That is a fundamental oil story. . . "

    No, the idea that it is a fundamental story is nothing more than an opinion based on very limited knowledge just as my premise is an opinion. The difference is I acknowledged that my view was an opinion and you make your statement as a matter of fact.

    My question to you - how the hell do you know? And the answer is you don't know nor do I. As for me, I can only guess but I am willing to look at all the various explanations I can think of and I think the one I set forth makes more sense than any other. You certainly aren't offering me any analysis that suggests it is a "fundamental oil story".

    I did consider the fundamental argument and looked at crude supplies and we are in the upper half of the average inventory levels so it certainly isn't based on a shortage as it relates to WTI. On the other hand there are legitimate reasons to assume that oil stocks using Brent price as the benchmark could be an issue as the tensions in that area could slow or halt flows of crude suggesting that Brent should be pricing in that geopolitical risk and yet that is not what we are seeing.

    Freedom of speech is everyone's right but to be relevant you should at least offer some basis for why you think it is a "fundamental oil story". I certainly offered a basis for why I think it isn't.

    JS
    Apr 5, 2014. 05:58 PM | 2 Likes Like |Link to Comment
  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    samurai

    "I do not believe that real estate will be see a big benefit from inflation returning to the USA. With rising mortgage rates, stricter loan standards, millenials swamped in student loan debt and real incomes falling, the demand will be lacking. SOme areas will do well of course but overall, with the baby boomers past their spending prime, I think that we have seen the highs in real estate for a long time."

    All the points you make are logical as it relates to real estate value appreciation. There are opposing forces at work though in a high inflation environment. The question is one of a significant spike in inflation and not just a modest spike.

    When we closed the gold window inflation spiked from about 3% to 11%. Then, in 1973 we had the oil crisis created by an OPEC embargo pushing crude up by 4 times in a short time window and producing a recession. That pushed inflation lower for a time but even this drop in inflation bottomed out at 6% - a rate that was still 2 times higher than prior to the closing of the gold window.

    Thereafter, inflation again spiked moving from 6% to 13%. Keep in mind this inflation created an era of what was eventually termed "stagflation" but the point is this - inflation did drive real estate much higher during the 70's in spite of the "stagflation".

    Just to put the matter in perspective I will use my own experience. I bought my first house in 1973 for $17,500. I sold it in 1975 for $29,000 and used the equity to leverage into another house that I paid $45,000 for and sold that house in 1977 for $72,000. I put the equity into a c.d. and used it as a form of compensating balance to establish a bank line of credit for the purpose of buying more real estate.

    I bought 3 houses and moved into one of them as I made modest improvements on the other two. I sold the other two for substantial gains over the course of a little over a year and eventually sold the one I lived in. I bought the one I lived in for $29,000 and sold it for $45,000 and had similar gains on the other two.

    I then moved into commercial real estate and started building new houses. Over a 7 year period I built my holdings to roughly $1,400,000 by 1979 and banks were begging me to borrow from them and in fact the smaller banks were advising me on how to overcome their lending limits by forming multiple entities so they could loan me more money. Keep in mind at the end of that period inflation was running at 13% so my appreciation on my asset holdings - even at 10% - was $140,000 a year which was a lot in 1970's dollars and especially for a kid still in his 20's.

    Of course all that came to an abrupt end when rates spiked under Volcker but that is not the point. The point is we had a period of recession, demand destruction created by the oil embargo and just a generally sluggish economy but that didn't stop real estate appreciation.

    Additionally, banks will be forced to expand M2 through credit creation if we see the yield curve flatten. That may not make sense on the surface but here is the point - at the present even conservative banks can make money on the yield curve with no risk. But when the yield curve flattens that opportunity no longer exists and banks must revert to lending again.

    And keep in mind they are creating money when they loan. In other words, they simply make a journal entry that debits their loan account and credits deposits. They have the added incentive to lend in that inflation is an effective hedge against their risk in the sense that each year the asset (real estate) gains in value increasing the value of their collateral.

    Maybe I need to write an article on this as I think it bodes well for bank earnings as well as real estate.

    JS
    Apr 5, 2014. 10:13 AM | 1 Like Like |Link to Comment
  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    Christopher

    I clicked on the link and saw the chart reflecting China's total reserves from Fred. There is no basis for suggesting that China is supporting the dollar based on China's total reserve holdings as only the dollar holdings are relevant as it pertains to supporting the dollar.

    Although the chart is vague on what exactly is included here I assume that euro, yen and SDR's are included along with US Treasuries. In any event the $4 trillion is not the total value of dollar reserves.

    JS
    Apr 4, 2014. 05:43 PM | 1 Like Like |Link to Comment
  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    Kyle

    I didn't get down to the granular detail on the matter of M2 and GDP growth rate and simply referred readers to the line slopes of the two metrics.

    However, since you raised the question I went back and calculated both GDP and M2 growth rate using the following variable rates: growth rate is measured as percent change for each data value from a year ago; data values are quarterly; and the period was 5 years with the last data value calculation for both metrics being the last quarter of 2013.

    The growth rate for the last quarter was 4.07 for GDP and 4.74 for M2. Of course those values will change based on the way you play with the variables so in my view the granular look lacks useful information as it relates to inflation. However, looking at the line slope on the raw numbers does reflect that M2's slope is flatter than GDP slope and demonstrates that M2 is not outpacing GDP at a rate that creates much inflation.

    JS
    Apr 4, 2014. 04:53 PM | Likes Like |Link to Comment
  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    Ken

    I probably will but feel free to message me if you have questions. I usually write for my own edification and publish those pieces I feel might be on matters other contributors are missing but I am always happy to share my thoughts for those who are interested.

    JS
    Apr 4, 2014. 03:48 PM | 1 Like Like |Link to Comment
  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    TDune

    Example: If China continues to receive dollars as they will, what do they do with those dollars if they are moving away from the US dollar as the currency of choice for settling trade obligations? In the past they have used them to buy US Treasuries but they aren't doing that today.

    So - they have dollars and if they sell dollars to buy yuan they will drive the dollar lower and the yuan higher - a bad move for a country who is dependent on a low relative currency for export advantage.

    It makes better sense to buy - say gold - or perhaps move the money into the US banking system and spend it to buy real estate which is an inflation sensitive asset. When they move the money into the US banking system M2 spikes and so they are creating an inflationary environment in the US and buying an asset that will appreciate in an inflationary environment.

    M2 is roughly $11 trillion in round numbers today and if China - by themselves - disposed of their treasury holdings and moved those dollars into the US banking system we would see an increase in M2 of about 10%.

    JS
    Apr 4, 2014. 12:18 PM | 3 Likes Like |Link to Comment
  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    Christopher

    Where do you see that the PBOC has spent $4 trillion supporting the dollar. Their treasury holdings are closer to $1.2 trillion - not $4 trillion. Just wondering how you came up with that number.

    Also they have sold roughly 8% of those treasuries since the middle of last year and that cannot be construed as supporting the dollar. Bottom line they buy treasuries in lieu of swapping their dollars for yuan as selling dollars and buying yuan would drive the yuan up and that would be counterproductive for a country with a trade surplus that is dependent on exports as China is. That of course is your point and I agree.

    But, and this is a big but - a shift occurred last year in that China stopped holding treasuries and sold over $100 billion. As I pointed out to another reader above the stock and bond market from 2002 through the middle of 2012 had an almost perfect positive correlation and from April of last year through today the two markets have a very high negative correlation.

    Something changed a year ago but if you refuse to search for the answers as to what created that shift and instead, remain comfortable in your assumption that the status quo will continue you will miss the subtle shifts that may be signaling a major trend change.

    JS
    Apr 4, 2014. 12:04 PM | 2 Likes Like |Link to Comment
  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    Andysud

    I think you are wrong on your interpretation. From Aug 2002 through June 2012 both the S&P and TLT were up 55% - an almost perfect postive correlation over a 10 year period. From April 2013 to today stocks are up 22% and bonds down 10% - close to perfect negative correlation over the course of 1 year.

    JS
    Apr 4, 2014. 11:05 AM | 1 Like Like |Link to Comment
  • How The Fed Has Exported Inflation And What Happens To Risk Assets When The Money Flows Reverse [View article]
    Christopher

    The stock market's current valuation is supported by the yield curve which requires high bond prices so I can't really argue that point.

    I also agree that you can't be bullish on stocks and bearish on bonds at the present time and I am not bullish on stocks.

    Your point that bond yields are the discount rate for equity cash flows implies that when stock earnings fall to a certain level one would be well advised to rotate into bonds and therefore the bond market - to some degree - sets the price for equities in the aggregate. No problem with that either.

    Where I think we might disagree though is the idea that were we to cross over that point where stock PE's were so high that the earnings relative to bonds would cause money to flow out of stocks and into bonds and therefore the two markets are always inversely correlated. I think that is what you are saying and if so, I disagree.

    Both bonds and stocks have been positively correlated for a number of years now. And that positive correlation can continue on the bear side as well.

    Part of the reason that is true is that the stock market is supported by credit - as in carry trades - and that means when stocks are sold the money goes to pay off the money fund debts and therefore that money just disappears - it doesn't rotate into bonds.

    Coincidentally the Fed is providing a place for those money funds to park there money when the carry trade unwind begins as they are becoming very aggressive competitors for those funds with their reverse repo operations.

    JS
    Apr 4, 2014. 12:04 AM | 2 Likes Like |Link to Comment
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