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Erwan Mahe is an asset allocation and options strategies adviser for the largest European Asset Management firms. Publishing macro-economic research, he has been managing leading European financial brokers since 1987, and sold his company, Paresco Futures, to the OTCexgroup in 2005. He is now... More
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  • Fisher Price Deflation!  0 comments
    Sep 4, 2009 12:47 PM | about stocks: SPX, TLT, EZU, IAU, IGOV

             We have all seen yesterday’s and this morning’s comments by Mr T and his German  friends at the ECB, Stark et Weber.

          It is just worth noting that the first thing he did was to confirm the continuation of a LTRO without premium in September, a measure whose impact we just saw in short-term rates, which is a good sign.
          And we are looking for the same scenario for the LTRO in December.
     
          What interested us the most last night were the comments by Mr Fisher, of the Dallas Fed, which we reproduce below:
     
    ·        CEOs are struggling to cope with excess capacity and slack.
    ·        They have an abundance of almost every input and output and no pricing power.
    ·        To maintain sales volumes and clear inventories in the face of weakened demand, they are cutting prices."
    ·        He noted that nearly half of the items contained in the PCE price basket fell in July.
    ·        for the immediate future, the risk to price stability is a deflationary risk, not an inflationary one.
    ·        They will continue to focus on cost control, most painfully by shedding workers and driving those who remain on the payroll to higher levels of productivity.
    ·        The net result is that we are likely to see a prolonged period of sluggish economic performance and uncomfortably high unemployment as businesses reallocate capital and labor to fit the new economic landscape.
    ·        the needed reallocation of labor and capital has been, and will continue to be, impeded by financial markets.
    ·        Although substantially improved from last fall...markets are still a long way from having normalized,
    ·        We know from our own experience and from the experience of other countries that financial headwinds like these take years to abate.
    ·        it will be a long time before we see growth strong enough and sustained enough to make an appreciable dent in excess capacity
     
          You can’t be any clearer, which reinforces our preferences for government fixed rate instruments.
     
     
          We see the same thing in Japan, where the pace of the fall in activity has slackened (I love these PC formulations), although I doubt those affected by non-financial capital investment think it is so cute, given the 21.7% contraction in combined capital investment by Japanese
    non-financial companies in Q209 y-o-y, as opposed to the expected -23% (great deal!).
          These investments effectively declined by Y7,811.1bn, i.e. below the low point of the Q2 2002 recession.
          This amount to a 50% contraction in investments, since the highs of 2007, which brings us 22 years backwards to June 1987.
          And this is in current yens, which surprises no one in that it is characteristic of an economy, which has fallen into a deflationist trap.
          All of a sudden, the profits of Japanese businesses have declined 53% in one year.
     
          But we are so lucky in Europe to have Iron Man Stark explain to us with a straight face that deflationary risks, which he assures us did not exist before, have more or less disappeared today, without seeing the contraction in his argument …
     
     
          There is just one thing about which we can be sure
         
          As long as China continues to manipulate the yuan’s exchange rate to prevent its appreciation, and its manufacturing overcapacity and overabundance of manual labour, it will continue to play the role the world’s export deflation workshop.
          It is a sort of entropic black hole dragging the rest of the world into a spiral of declining prices.
     
          The economic sector which is suffering the most from the decline in investments in Japan is manufacturing, which contracted 32% y-o-y in Q2, following -21.2% in Q1.
     
     
          In the meantime, the debt deflation process continues, the best example today being RBS.
     
          The bank engaged in debt deflation via debt destruction, with its decision not to call certain subordinated securities, under justifiable pressure of the European Commission, which ruled on 19 August that government-funded banks should no longer pay yields on the subordinated securities part of their capital when they are posting losses.
          RBS and Lloyds are also seeking to deflate their debt via the debt to equity swap process, by taking capital stakes in real estate companies in loan payment default.
         
           Disclosure : Long 20 years OAT 0% Coupons, EDF Corp 5 Years 4.5%.
             Thaler's Corner.
    Themes: market, economy, bonds Stocks: SPX, TLT, EZU, IAU, IGOV
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