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Let's kick around some thoughts about QE2 and money supply. 127 comments
http://seekingalpha.com/article/235809-understanding-the-mechanics-of-a-qe-transaction
HTL asked if there were any flaws in the author's logic and if not whether we should protect ourselves from too much enthusiasm about QE2 or the assumptions about what it will do in the market.
After reading the article, I responded with my thoughts, which are reproduced here. The author was clearly on a logical path and appears to know his stuff, yet some of his conclusions and suggestions for the implications of QE2 (or more precisely lack of implications) baffled me.
Here is my original response to HTL, which he suggested we bring to an insta in order to explore more fully (hopefully with help from others!):
...This is the part that makes no sense to me,
"They are merely changing the composition of the bank balance sheet. The logical question that most people ask is: “where did the Fed get the money to buy the bonds?” They didn’t get it from anywhere. It truly is ex nihilo."
As at least one commenter pointed out, this sounds a lot like where the money is being printed.
And even if it is not being created... well let's look at my analogy.
Let's say I take a HELOC out on my house for $100,000. I haven't printed any money, I've only "changed my balance sheet." In the author's words, I have exchanged one less liquid asset for a more liquid asset with an interest penalty (the author was talking about losing out on interest income and in my example one loses via interest payments).
But you tell me, just because this is a "balance sheet adjustment" does that mean it is not inflationary? Of course not. I will spend the $100,000 and increase the velocity of the money, which is inflationary.
Swapping bonds for cash doesn't seem like the non-event the author describes. And furthermore when the cash for these purchases is not "created" but "just comes from out of nowhere", that doesn't even pass the sniff test.
I think folks arguing along these lines may be technically correct about the composition of the bark, but they are unaware they are lost in the forest. (I think that's how that saying goes...)
Attempts to spur lending have failed in the past. Why? Because all the extra liquidity always seems to get sucked up by a quicker and easier place to make money -- the stock market. So regardless of what this stunt will do to spur economic activity and regardless of whether saying it increases the money supply will get you a failing grade on a senior level economics exam, it seems clear to me that it is increasing liquidity (even the author agrees with this) and that this liquidity will be pumped into the market as dollars seek return. This is only more certain if the stated goal of QE2 succeeds and interest rates are kept low. Dollars chasing return will have no place to go but the currency, equities, and commodities markets. This will help inflate, or at least prop up these markets.
And I think Ben is okay with that. Inflating a stock bubble is -- I think by his way of thinking -- a little like giving a weak and starving person a sugary drink. He wants to get the economy moving even if the boost has no nutritional value and the crash will only make matter worse. He is afraid if we fall asleep we will die. He is hoping by inflating a bubble (the sugar rush) we will get up and find our own food. There are obvious political components of pointing to the malnourished patient on the sugar rush saying "see everything is okay". But I think the policy is quite deliberate and if he were honest he'd admit it was out of desperation.
The author implies there is a nothing to see here component of QE2. If this were the case, they would not be bothering to try this at this late hour and with all traditional ammunition spent. You can say that my $100,000 HELOC has only changed my balance sheet, but if you think it won't affect my economic activity as a result, you are sadly mistaken.
(My HELOC example is intentionally chosen for its implicit cautionary elements.)
My conclusion, therefore, is that QE2 does suggest artificial inflows into the stock market. And an equity bubble is inflationary. Even Ben hopes it is inflationary. So I disagree with the author that counting on QE2 to help push up equities is mistaken.
Disclosure: Long PM and mining stocks
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This post has 127 comments:
HardToLove
You are talking about some of the QE questions that are important. I'll add my understanding and await correction from others:
1. QE is basically printing money, plain and simple.
2. QE is monetizing debt.
3. QE is not inflationary until it is inflationary. Recognizing that boundary is virtually impossible until well after the fact.
4. QE may help push stocks up, but asset bubbles in a lot of other areas, especially commodities, are a bigger affect.
5. The bubbles produced by QE in the U.S. are also in other parts of the world as well as the U.S., sometimes more elsewhere, because our trade deficit continues to push dollars overseas.
6. All that being said, QE may be useful and far from the worst way to go. Deflation because of the failure to monetize can be devastating.
Steve Hansen has been writing some good stuff on QE leakage into the rest of the world: econintersect.com/word...
Two other good articles are "Did France Cause the Great Depression" by Doug Irwin econintersect.com/word... and "The Myth of Expansionary Fiscal Austerity" by Dean Baker econintersect.com/word...
There is no road map to the future, and in the current situation there isn't even compass. We are bushwacking with no map and no compass, just a bunch of economic theories all of which have been found wanting in one way or another.
QE caps the yield on US government bonds. When government bond yields go up, more money moves into bonds, particularly if they are rated safe. If those yields are kept low, more money should flow to other investing opportunities with a higher return. So theoretically, QE should reduce capital in-flows into US bonds. Why would you want to do that?
After each QE bond purchase, increased capital should flow into other investing opportunities… this should have the effect of artificially inflating the stock prices of those investments. I assume the idea here is that the higher the stock price, the more likely a company will attempt to grow its business, hire new workers, make new investments in their business, and so on… So QE could be seen as an attempt to jump start business growth by changing the flow of investment capital away from bonds.
One big issue I see is that the resultant flow of investment capital is not controlled. So QE related capital investments are likely to flow into other countries such as China where investment opportunities might be seen as more favorable. This could result in an overheating of emerging market economies where over heating is defined as increased inflationary pressures, which appears to be happening in China. This is likely the reason why China is upset about QE2.
After this, I get even more confused… For example, I don't understand the effect of QE and its interaction with the FED. It seems that QE increases the US Debt. If you buy your own bonds, you are putting the purchase price of those bonds onto the debt side of your ledger. So does QE basically increase the US debt profile in exchange for channeling investment capital out of the US bond market into other investments?? If so, it sounds like QE is basically giving away money while hoping and praying that the resultant change in capital flows will somehow jump start the global economy… and who pays the price for that jump start?
Where am I right, and where am I totally missing the boat here?
The bond market players pay *something* for their money. Even with ZIRP and carry trade, they have a cost. Further, they have (access to) a finite quantity of U.S. dollars.
Because the Fed has, effectively, a negative cost of money (i.e. they buy a yield with money that cost $0.00) and an infinite supply of these dollars, the normal bond market cannot compete with the Fed.
Ditto for any other U.S. market that the Fed chooses to influence. Hence, "Don't fight the Fed".
Some money will be diverted to the stock market. But the instability implied by the current state of the U.S. economy, the unpredictable machinations of the Fed, the congress, the U.S. Treasury, and uncertain tax policy makes me think that the money will look for both a higher yield and a more stable environment.
So foreign markets seem to offer that right now. But there's a catch.
Since the dollar is the reserve currency and is widely held, the effects of QE2 leak into those foreign markets as well. Currency wars result (note several countries have already instituted measures to force reduced inflows of U.S. dollars) as they try and protect their currency from excessive appreciation, relative to the U.S. dollar so that they can maintain their export advantage and keep their export-oriented economies humming along.
So, "You can run, but you can't hide" becomes the problem.
Do you think Bernanke knew this would happen? I do. Many think he's clueless, but I don't think so.
Anyway, I think that's where part 2 comes in - commodities. Although they might be volatile, they always have an intrinsic value - a minimal level of demand, finite supply and retained, at some level, value IN TERMS OF PURCHASING POWER. Fiat currency does not have such a trait. So even if one feels that commodities are overpriced right now, you know that over the long haul they are safer and they can not be debased through inflation. They can only suffer deflationary pressures. The worst that can happen is a bubble and then collapse of price. And if you believe that severe inflation is the unavoidable outcome of QE2, then you run to hard assets and countries that are rich in them.
I think that is why we see the cost spikes in commodities of all types. And why gold is now accepted as margin for certain futures contracts overseas (oil?).
Now, all of what I'm speaking to above has nothing to do with whether there really *is* inflation, which is always and everywhere a monetary phenomenon, supposedly. Price increases alone are not signs of inflation. They may result from demand and supply imbalances caused by many factors not directly related to the amount of money in circulation or a general change in the perceived value of a particular monetary instrument.
All of this has only to do with the *expectation* of inflation and, IMO, the excessive concentration of money in few hands that are quite adept at putting capital to work in the most efficient manner and location.
*If* at some point the markets observe that there really is nothing inflationary about QE2 WITHIN THE U.S. (my assumption and emphasis), as Cullen claims, then all the markets suddenly change. This was my concern and why I first posted the link in the Q.C.
Right now, the herd, including all of us I guess, are trading on the common market expectation that QE2 will cause *massive* inflation. Also influencing trading is the *expectation* (certainly to be realized) that yields on certain traditional *safe* investments, like government bonds, will be going substantially lower as the Fed forces prices up. So it becomes important to ascertain if this inflation expectation is correct or if Cullen is correct.
That is what I hope we can examine here, with DM's permission.
I'll post some thoughts on that primary topic tomorrow after I do some more review. It will take me a while I suspect since I'm a tyro at this stuff.
Keep in mind that what Cullen posits apparently comes from a Modern Monetary Theory (not really a theory, but a description of what MMTers believe to be the actual operation of our monetary system) POV, and is, in *many* major ways, in conflict with various "classical" theories of money.
HardToLove
As we go forward, when I say inflation, I will usually mean the measurable phenomenon of reduced purchasing power of money, whatever the cause.
To take a specific example, people. If more people get a college education and are capable of producing more, wages naturally rise *if* there is a demand for those services to provide goods. Your cost of people has gone up, but there has been no inflation if that increased cost has produced goods of equivalent increased value - either the goods have gotten less expensive or satisfied an increased (or new) demand.
So we can see why it is important to have a more precise meaning of "inflation" that just "increased prices" or "reduced purchasing power".
And "people" may be the best measure, on several levels, as all money is a payment for labor (no product of any kind is delivered without some level of labor).
HardToLove
But HTL, I can't agree. Saying that 1 out of 100 things increasing in price does not denote inflation is very close to how the government says there is no inflation if only food prices are rising. By my definition, there _IS_ inflation if 1 out of 100 things increase in price, but if the items were selected to be equally weighted, this one thing would need to DOUBLE in price to suggest 1% inflation. And if you think about it this makes sense. If the 100 things you speak of were chosen because they are things I need or want to buy, then my inability to buy them for the same price denotes reduced purchasing power, and hence inflation. A modest increase in just one or two items, BTW, would properly indicate near zero inflation.
Take an old west mining town as an example. There are some basic necessities of life and there are some luxuries. If the price of an egg rises, do you have inflation? What about if the price of a mining pick doubles? How about if the price of a mining pick, the price of an egg and the price of a shot of whiskey all double. Now do you have inflation? There answer is that inflation is not an on-off switch. It is always (like a fever) a matter of degree. Most doctors say a temperature of 99, while higher than normal is not rightly called a fever. I would say some decline in purchasing power that is very small (like say one item out of 100 increases in price a little) is not really measurable inflation. But by the time you see several things increasing in price, it suggests that you have less purchasing power and hence inflation.
One could try to measure inflation only in terms of money supply, but one would go far astray in my opinion. Because the velocity of money is an important factor in inflation. Money supply in and of itself says nothing about its velocity. You can in fact have inflation in closed systems with a stable money supply. Money simply has to circulate faster and faster. We don't have a good measurement for the circulation of money as far as I know that doesn't involve prices. Hence, watching price action is like watching the mercury in a thermometer to measure temperature.
'So we can see why it is important to have a more precise meaning of "inflation" that just "increased prices" or "reduced purchasing power".'
If you can precisely define inflation in a sensible way, I would like to read that definition.
If you want to define monetary inflation on the one hand and price inflation on the other, we certainly do that. It seems to be in vogue. My problem is that money supply needs to encompass velocity and that is often ignored. For example, if one defines inflation as dependent on money supply and then says "we have no increase in money supply so we have no inflation)" then the resulting truism is useless, especially if price inflation meanwhile is going through the roof.
That is why we need to take a second and kick around what we mean by inflation or we will not be able to talk about the real impact of QE2.
What do you mean by inflation?
I still have to re-read Cullen's stuff as a starting point to get back on topic.
@ DM: "1 out of 100 things increasing in price does not denote inflation is very close to how the government says there is no inflation if only food prices are rising"
LoL! Should I be offended that you ascribe to me behavior ascribed to the government? ;-))
I said “...your purchasing power has been reduced, *if* you still include that one good in your calculations, but you will acknowledge I think that there has been no inflation”.
There was no suggestion that you should exclude that item. In fact, my words clearly require that the item be included to reach the conclusion that “your purchasing power has been reduced”. My intent was to demonstrate that as folks focus on a select number of items (as does the government), a case could be made for general inflation when there was none, in fact. The government inverts its use, trying to demonstrate that inflation is low by focusing on a select few items.
That is exactly why we need to nail down a common understanding of what “inflation” is. Then it can be discussed in a frame of reference commonly accepted and understood.
Here would be a good place to include a commonly accepted understanding of what is inflation.
From Wiktionary:
(economics) An increase in the general level of prices or in the cost of living.
(economics) A decline in the value of money.
(economics) An increase in the quantity of money, leading to a devaluation of existing money.
Now, since we are heavily into semantics, I suggest that a common starting point for further discussion be based on the above, rather than the POV of an individual. And if that is acceptable, we can proceed later on to topics more closely related to Cullen's article.
Moving on …
“By my definition, there _IS_ inflation if 1 out of 100 things increase in price “
I assert the “1 out of 100” can not, in isolation, be used to determine inflation.
Later, you seem to agree ...
“view inflation as a loss in purchasing power of money”
“A modest increase in just one or two items, BTW, would properly indicate near zero inflation.“
I can agree, mostly. But a price increase of 1 item, in isolation, certainly can't meet these two tests, nor the three conditions from Wiktionary above. Further, modest price increases in just one or two items are no indicator at all of any inflation either.
“items were selected to be equally weighted,“
What these words suggest is not workable. If I buy 100 boxes of crackers a year, do you suggest that to construct an inflation gauge we have to include 100 rib-eye steaks that are really only purchased a few times a year? A 1-to-1 relationship? How many cars? Houses? If the selected item had a value equal to ten times the value of all the other 99 (say the other 99 had an value aggregate of $99 and the selected item had a value of $999) and it's price changed by +10%, indicated inflation would appear to be ~ 9%. Further, if we assume that item 100 is only bought once every ten years, (so we assign its annuual cost to be only $99.90) the 10% increase over ten years would work out to something significantly less than 1% per year.
A proportional weighting of some kind that is much more representative of peoples consumption profiles would be better. Further, an apportioned cost-basis method would more accurately reflect reality. We buy crackers weekly, monthly, … but we buy cars (in my case) every 10 to 15 years. It would be rational to include the total yearly cost of crackers in the annual calculation, but only, say, 1/10 the price of a car bought only once every 10 years.
HardToLove
Secondly by equal weighting I meant weighted in such a way as to be of equal impact. I should have said "properly weighted" or as you have rightly suggested "proportionally weighted". But we really don't need to argue about how to build a thermometer to talk about a fever, and we don't need to talk about a designing a real world measurement of inflation to agree on what inflation is.
Only your third definition has anything to do with money supply, and then it seems to be in relation to its effects on prices.
If you go to wikipedia you will find this:
"Inflation is a rise in the general level of prices of goods and services in an economy over a period of time.[1] When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation is also an erosion in the purchasing power of money."
So I think we've done a pretty good job exploring the nuances of this nondescript term. I would argue that we don't need to care how it is measured in the real world to talk about the fact that it COULD be measured, and we both seem comfortable with the idea that inflation must involve higher prices.
For what it's worth, I have heard inflation broken out even more than price inflation and monetary inflation to include "asset inflation". We may want to choose to talk about types of inflation since asset inflation is usually associated with bubbles and inflation across different sectors rarely keeps lock step. Or we could scrap the idea of inflation altogether and simply talk about what things might go up in price.
I think you and John have rightly suggested that commodities are among those things poised to go up in price as a result of several of the features of QE2.
Thanks for your articulate and thought provoking responses :)
(There seems to be some confusion about what we are both saying about the 1 in 100 example, but it doesn't seem critical to the general concept of inflation, so I'll leave it there.)
HardToLove
Does it make sense for the government to pay out more than it takes in? Is this so all the ARMS reset lower and avoid additional foreclosures?
<"This is fascinating," said Michael Shaoul, chief executive at brokerage firm Oscar Gruss, who spotlighted the screwball market action in one of his intraday market notes. "You have, in theory, an impossible event, which is that the man in the street is paying less interest than the government is." >
Here's the link:
online.wsj.com/article...
Hat tip to the 5 Minute Forecast, for writing about this today!
I think we need to look at two things (which I won't necessarily get to now). What happens if QE2 meets its stated goal of suppressing interest rates and what happens if it fails. There is a good article by Calafia Beach Pundit (who I usually disagree with) about how QE2 may be powerless to control bonds if long term inflation expectations are high:
seekingalpha.com/artic...
The gist of the argument I think is fairly sound and it suggests that if the bond market sees inflation coming, prices wil drop and yields will rise. This would be a failure of QE2 and its implications are worth considering. One obvious idea worth exploring is whether fear of inflation could burst the bond bubble and chase all that supposedly safe money into either higher risk (stocks) or more safe places (PM and perhaps other commodities).
I still have to read the articles John linked, which I want to do before I get too far astray...
seekingalpha.com/insta...
A cute ~7 minute animation.
www.creditwritedowns.c...
HardToLove
You have caused a change to the bank's balance sheet and you have caused the creation of money even though you did not print it.
You had a zero balance HELOC. So the bank had no asset or liability for your HELOC on its balance sheet and had reserves sufficient (@ 9:1, $111.11K) to make a loan of $100K. When the loan is made the bank adds $100K to both its liability side and the asset side. At that moment, of course, its net position is not changed. Only mandatory and excess reserves are affected..
This is one difference between what happens when Bernanke does what he does and you take $100K against your HELOC. Regardless of whether or not you spend the money, $100K of new money has been injected into the system. The measure(s) of money (M1 or M2, IIRC) will reflect this activity as an increase. If you do spend the money, some velocity is added and it adds to any inflationary effect.
How did you cause the creation of money? It was created by the bank when it placed 100K in your checking or savings account. Money creation is an effect of credit extension by the banks.
The bank did not have this money prior to making the loan. It had "reserves" against which it can loan out 90% (fractional reserve banking). When the loan is made, required reserves increase and excess reserves reduce and new money is now in the banking system and available to begin flowing in the economy.
“But you tell me, just because this is a "balance sheet adjustment" does that mean it is not inflationary? Of course not. I will spend the $100,000 and increase the velocity of the money, which is inflationary”.
However, the bank will not spend it's reserves. It will loan out against them. As the article quoted Bernanke, “What’s happening is that banks are holding more and more reserves with the Fed “. And also, “If the government removes t notes then all they’re doing is altering the term structure of their liabilities”. This second point seems to be important later on.
Where I think Cullen's article falls short is in stopping at the technical analysis of net accounting effects and ignoring some behavioral changes, which you have directly illuminated.
I think that behavioral changes will occur that make me agree that it will be inflationary, given the following considerations.
1. The banks lose profit giving up higher yielding treasuries for lower-yielding reserves.
2. They will be looking for ways to increase these yields to increase profitability.
3. They can buy treasuries again, or other somewhat similar, but riskier, instruments, I guess.
4. They can originate more loans to generate additional interest income.
In short, QE2 seems to be the same old playbook – cure problems resulting from a credit bubble which produced a potentially deflationary spiral by re-inflating the credit bubble once again. Since inflation is the stated objective, there is no reason to believe that Bernanke would do something he sees as *not* inflationary. If his goal is inflation and this action is not inflationary, why would he do it? To achieve something which is not his objective? I don't think so.
There is the possibility that he has some objective he's not detailed. But what I think his statements and actions indicate, is that the goals are still inflation but he's trying a slightly different strategy. Remember that a 2% inflation rate is deemed the target to promote all the good things we get in our economy.
Cullen also states “Therefore, you’ll often hear that banks have new money to put to work. That’s not true. They had a 0.2% piece of paper that was already put to work and can be exchanged in markets for whatever they please”.
I may be wrong here, so someone please correct me if so. The 0.2% piece of paper in the form of some short term paper is not the same as reserves is it? If so, they could lend using that as reserves and there would be no purpose that I can see in converting from that to “cash reserves”. To me this implies Bernanke is trying to stimulate increased credit and economic activity which would be inflationary, meeting his stated goal.
Further, if my above assumption is correct, although the aggregate “money” in the system has not changed and so there is no “new money”, each individual banking institution sees “new” reserves from its perspective which it can lend against. Since (I assume) they will be chasing enhanced yield and increased profitability they will have incentive to lend against the additional reserves.
My thoughts about banks' behavioral changes may be supported by this quote from Cullen's article.
“We know the Fed turned over ~$50B to the U.S. Treasury (its “profits”) from QE1. What did the banks get in return? They got a checking account at the Fed earning 0.25% or roughly $2.5B over the course of QE1. So the private sector LOST ~$47.5B in interest income it would have otherwise earned”.
When he says “private sector”, I presume that most of that is the banks. Although $47.5B in reduced income may not seem much in today's trillions of dollars environment, I suspect there's many banks that would notice if a substantial portion of that were formerly coming to them and it no longer did. They would likely adjust their behavior to try and recoup some of that lost revenue stream. QE1 was, IIRC, !$2T, so this one is much less, ~$600B. Missed earnings may be only a bout 1/3 of the above number, but still a significant amount.
Cullen says “So, now you must be asking yourself why the heck they’re even doing this to begin with. Well, QE supposedly changes the term structure of the bond market. Fewer 5 year notes should lower interest rates and entice borrowing, generate lending, make other assets more attractive, etc. If you sell your bonds to the Fed and receive low interest bearing cash you might want to re-balance your portfolio. Mr. Bernanke is hoping you will reach out on the risk curve and buy equities or corporate debt”.
From what Cullen states, the net desired effect seems to me to be similar to the effects of the “easy money” and “easy credit” policies that led us into this mess in the first place. Lowering interest rates means cheap money, again. Each loan made creates more money. Risk taking is again encouraged by low interest rates.
He adds “But the price you purchase those securities at will depend entirely on their fundamentals and the price that you and the seller agree upon. If you run out and bid up risk assets just because you think the Fed is “printing money” then you’re making a mistake. If you run out and buy stocks even though their fundamentals have not changed you are making a mistake“.
Is he implying that there is no risk/reward assessment done? If credit is cheaper, money is easily obtained, does this not lower the calculated risk? Does this not in turn become part of the “fundamental analysis” of the buyers? The fundamentals of the purchased assets may not have changed, but the environment in which they are analyzed has changed. A fundamentally weaker asset may be more attractive in an environment such as is being created.
The part that seems to be most uncertain to me is this last statement by Cullen.
“The Fed has caused this mass hysteria over a minor interest rate decline. In short, there is not more cash in the system following QE. There is not more “firepower” with which to purchase equities. Hopefully, the above description makes that very clear. This was most obvious in Japan where QE caused a brief 17% rally in equities as speculators leveraged up, jammed prices and then later realized that the slightly lower yields hadn’t really changed anything”.
So far, this part seems to be playing out as he predicts.
“What happened next? Their equity market fell 40%+ over the next two years. QE was a great big “non-event”. All it did was manipulate markets temporarily and cause a huge amount of confusion”.
Is this what we are seeing? Is there something different between Japan and us that make the outcome Cullen suggests less likely? Do any of the following affect the potential longer-term outcome?
1. Most Japanese bonds are owned by its citizens, not so here.
2. Japanese have had a much higher long-term saving rate.
3. The Japanese economy was a much more export dependent one.
4. Their currency is not a reserve currency.
5. Their aging demographics are ahead of ours?
6. Other?
HardToLove
I'll be quiet now.
HardToLove
Inflation occurs when a unit of currency at time One buys less product/ services at time Two. The opposite occurs with deflation. So time has to enter into any operational definition of inflation.
Stealth Inflation:
American's are already feeling the effects of significant inflation. However, sometimes manufacturers hide real price increases. For example Kleenex has sneakily reduced the size of each Kleenex tissue. The package looks the same and contains the same number of individual pieces, but the pieces are smaller…. You don't buy Kleenex by the ounce, so this represents a stealth price increase.
I am seeing more and more examples of this… for example, the number of pieces of sausage in a package has been reduced from 12 to 10. The package price remains the same, but the consumer is actually eating a 16.67 % price increase…. A good number of shoppers do not look at price per oz, and the manufacturers know this. So instead of being up-front about the need to increase prices, they try to sneak it by you…. I don't like it when companies lie or are sneaky.
Politicizing the Measurement of Inflation:
The measurement of inflation by the government has become politiczed to the point that the inflation measures they are using are incapable of measuring real inflation in key areas of our economy. Yet these are the metrics they are using to make and evaluate their policies/ decisions….. So the government acts under the rule that its better to say there is little to no inflation then to have metrics that represent the truth….
If you can't accurately measure something how can you manage it? You can't…
The whole series is very well done. But I wanted to lead you to Chapter 16, "Fuzzy Numbers" and beyond. Chapter 16 touches on what you have said, but is even more ... "flabbergasting". It turns out the same item, through "Hedonistic Adjustment" is adjusted downward to make inflation look better and adjusted upward to make GDP look better.
SFAmazing!
www.chrismartenson.com/
I recommend everyone view this and THANKS DG!
Enjoy,
HardToLove
HTL, I think you did great work discussing fractional reserve banking. But you took my analogy too literally. I was intending my "balance sheet" to stand in for the Fed's balance sheet. And my point was similar to your conclusion -- that moving money from an illiquid asset (bonds or in my case my house) to a liquid asset (cash in both cases) is inflationary. I did not mean to consider my relation to banking when I used a personal balance sheet as a stand in for the Fed's. But your point is well taken and worth the description of fractional reserve banking.
This paragraph is excellent:
"Is he implying that there is no risk/reward assessment done? If credit is cheaper, money is easily obtained, does this not lower the calculated risk? Does this not in turn become part of the “fundamental analysis” of the buyers? The fundamentals of the purchased assets may not have changed, but the environment in which they are analyzed has changed. A fundamentally weaker asset may be more attractive in an environment such as is being created."
And you are exactly right I think. That is the point of making money cheaper for the banks -- to allow them to put it to work in ways which they would not if the cost of money were higher.
The part, therefore, where Cullen claims there is not more firepower in the system as a result of QE is just wrong. He makes dire predictions about those who get ahead of themselves for expectations about the market, and he cites Japan. But one could easily look at the overall market since the last QE and produce a counter argument. Hey if the point is that all this cheap money doesn't magically fix the economy, I agree entirely. But of the point is that QE has no impact on equities, I don't think the evidence supports this notion.
The US is not Japan, and most or all of the differences you list are very relevant to this discussion.
As we attempt to use the impact of QE2 to improve our own positions, I think it is valid to note that it will not fix the economy -- it may not have an impact on it or it may even hurt it. But if we look at where it may have an impact, so far we have identified (I think) that
1) It may help blow bubbles in foreign markets as excess liquidity in the US chases return
2) It may start or exacerbate currency wars
3) It may blow commodity bubbles as liquidity seeks return AND folks look for safe harbor against global instability and inflation
4) It may continue to have some impact on US equities and to the extent that it helps banks keep making money (even if they are not lending as must as the Fed claims it would like them to) it may help the financial sector perform well.
5) It may impact inflation in the long term as it is hard to spot inflationary bubbles until the mark has been overshot. Here one needs to accept that certain asset bubbles might rightly be called inflationary. This would certainly apply I think if the price of oil is driven up again, since oil impacts the cost of so many other things. And of course the implication here is that PM and miners should do okay if these effects of QE2 come to pass.
One thing we seem not to expect from QE2 is strength in the market resulting from underlying stability and recovery in the economy. In this sense I would agree with Cullen that one needs to be careful not to get ahead of themselves in stocks.
Later I will explore what I think might be the impact of QE2 if it fails to move the needle. In other words, I think QE2 will have an impact on investing even if it fails to have the impact the Fed is hoping for.
That means so far our expectations of price rises should be holding even excluding debasement of the dollar.
Where before we could assume that longer-term rates had predominately some expected reasonable inflation rate risk as the primary cause for the need for higher yield, I think it now includes that *and* fear of what the exit strategy will be and what the results of that will be *and* another component.
Supposedly the is Fed trying to drive bond prices *up*, reducing interest expense to the government and other beloveds and assuring exorbitant profits to his banker cronies as he buys treasuries from them only, rather than directly from treasury, at a higher price. If he is failing to raise prices sufficiently to accomplish this, even with the trillions already expended and the new amount, what does it say?
seekingalpha.com/artic...
To me, two things. One is that the primary dealers and others (foreign banks, sovereign wealth funds, ...) are low-balling the auctions, giving a higher reported yield. Why?
They can dump useless dollars held that carry a lot of risk and get something that yields a current value + some interest, which offsets some of the loss of purchasing power of held dollars over time. And being relatively liquid, they can be converted at face value, less a small amount, as needed to dollars for transactions. So, instead of holding dollars losing x% over time, they hold treasuries holding a value of (face value + time premium earned) - (time value of x%).
And they paid *less* than face for them, of course.
Second, they know Uncle Bennie is buying back at face, essentially, so they can choose to sell back for a nice fast turn around profit less some small costs.
And, of course, this all benefits main street, until you look at Doug's charts.
Anyway, factoring this in, I think it might change the critical aspects of how we might play all this out. Two things: what's going to happen to various things we invest in or trade and what is the exit strategy likely to be and how do we identify it earlier than others?
With my level of inexpertness, I'm hoping you and others, in aggregate, can come with a plan later on.
HardToLove
My simple answer: go short those businesses that will falter.
Commodities should get cheaper ( at least for awhile).
It seems to me that is the key for surviving a deflation, buying puts or going short, a directional play.
en.wikipedia.org/wiki/...
Of course, plan ole cash does okay in a deflationary environment, and precious metals don't do as bad as you might think. During rapid deflation, the race to store value helps keep them afloat.
Personally I think our deflationary days are behind us. Come hell or high water, the Fed will pump as much liquidity as it needs to to keep the dollar worth less (or worthless). There might be bouts of deflation, but I think the rush to combat this will only guarantee even more inflation down the road. Growing companies with low debt load and PM seem the safest bets for all kinds of scenarios to me. And of course companies operating in better economies (like TTM) make sense too.
A more clever person than me could certainly do well by betting against companies who are going to struggle in a deflationary environment (assuming we get one), but I am happy to try and find fairy solid plays that will do well under a bunch of different assumptions.
Do not forget to read the notes at the bottom especailly note #8 hillarious and # 11 which I think is going to happen, rate pegging is going to collapse because QE2 is creating inflationary pressure. DM this goes to your comment above about bond pop.
www.federalreserve.gov...
"For this reason, as I have emphasized, prevention of deflation is preferable to cure"
Did he do this? Does it depend on what you measure? Housing, down. Labor cost (labor *is* an asset), down. Stock markets, *still* down. Dollar, down. Financial assets, down. Etc.
What he *never* mentioned in that speech was the *HUGE* credit bubble the Fed, in conjunction with our congress, encouraged by keeping rates too low for too long and encouraging malinvestment by that action *and* such things as Community Reinvestment Act, reducing leverage restrictions on our major banking institutions (Bear, Lehman, ... ) for whom they are the regulators (boy they did great on that front, no?) ...
As Mises said, once credit deflation starts it can't be prevented. It can be extended in duration, but it can't be stopped.
Did BB not consider credit money? Did he not see the pressures it would and was causing? Or the risk it presented as leverage ratios were relaxed and certain market segments were already overheating as he spoke?
HardToLove
Ben should pull away from the poker table here after he's "read 'em and weep"!
stockcharts.com/h-sc/u...
HardToLove
stockcharts.com/h-sc/u...
HardToLove
1) Future purchases may be terminated or sharply curtailed. This could have a souring effect on equities to the extent that some of their pricing was propped up by QE2 expectations and by actual money finding its way into the market from QE2.
2) The failure to control long bond prices would result from buyers building in expectations of higher inflation (demanding higher yield). This would not harm those who are already making inflation plays, I don't think. In other words successful QE2 could result in inflation but failure of QE2 may be because folks already expect higher inflation. It seems the only winning play here is inflation (hence precious metals look safe).
The dollar may get stronger in the short run, and that can mess with one's mind, but inflation seems the safe bet to me. Gutsy people might play with short term deflation, but I'll catch the next bus, I think.
mises.org/daily/4807
Sorry its a little off the mark but Austrian econ and Paul Krugman kinda fit here.
I think that is an interesting notion. How do you measure failure when something hasn't been enacted? Is it a case of buy the rumor sell the news?
Have you ever seen a party that failed before it was thrown? It is technically not possible, and yet there it is. Sometimes you just know no one will show. If the bond market is already making plans not to attend while Ben is still licking the invitations, things are not off to a great start.
Of course there is a little hype about any anticipated Fed action. Even interest rates (when they were not pinned on 'E' I mean) would always get a lot of hype. So some of what we are seeing is a correction from the QE2 hype, I think.
By and large I think QE2 will have a small but noticeable impact in the direction expected. But as your delightful video pointed out, what's another 600 B compared to 2 T? One is a weekend getaway and the other is just dinner and a movie. Hard not to be a little underwhelmed.
Similarly, the current attempt is to force money to the long end of the yield curve by "anchoring" expectations that short and medium term "safe" instruments will have little to no yield because the Fed will be buying "tons" of them with "free" money and driving their prices up and yield down. Then "market" money should go into riskier assets and longer-term bonds, which still offer some kind of yield. As an adjunct, stock markets should run up as the money the bankers receive for the bonds is put to work (assuming they don't again go into some hoarding vault again, like "excess reserves", to sit there and mildew while the economy continues to struggle).
Since this has not happened completely the way it was hoped - long-term bond prices continue to erode driving yield up - I see this as a "Failure to Launch".
Premature? Maybe. But consider. Markets always try to "front run" what it believes will happen. In this case, buy bonds now before everybody gets into them and drives the prices higher. This gives two benefits, - higher yields, if the bonds are held, and capital returns if they are later sold at a higher price when the crowd rushes in.
The pricing shown on the chart indicates this has not happened. This says the "smart" and "big" money is not cooperating.
I believe that this is because in the eyes of the players the likelihood of inflation is seen as much greater than Bernanke anticipated.
Ergo, failure before the event even happens ... *unless* you consider the "anchoring" of expectations as part of the event.
HardToLove
P.S. This has one other interesting twist to it. It has to make Bernanke, and others, wonder if he has "lost control", as many predicted would be the case. If he can no longer bring about the desired results by "jawboning", the Fed's tool box is a little emptier and forces it to the "riskier" tools in its toolbox.
BTW, as one article I read pointed out, QE2 is not really new, its a continuation, in more massive form, of what the Fed normally does anyway. And the program is indeed underway.
www.newyorkfed.org/mar...
Thanks to the provider of the link - DG? I'm unsure now.
Kudlow just commented how the dealers front-ran the Fed and are now selling eveything they hold to the Fed and yields are running up as prices fall.
I'm not sure the Fed realizes just how smart, relative to the Fed at least, these players are!
HardToLove
It's called disinflation- inflation slowing down...
John M. Mason's "Interventionists Are Setting Up One-Way Bets for Traders"
seekingalpha.com/artic...
To me it says *if* the Fed is successful, we should look for an appropriate time to trade on falling longer-term bond prices, initially, and then shorter-term ones.
And as the carry-trade on the dollar begins to unwind (already happening?), we should position to gain from a market drop, possibly with some inverse ETFs.
Clear signs of inflation have already began to show up in the official reports, IIRC, and that would be another side of the trade.
Specifics are beyond me right now, but I'm sure between all of us, some good ideas will arise.
For right now, I think a positioning in various precious metals is a good start, when the opportunities and pricing looks right.
HardToLove
It is in an article by Mercenary Trader, "This Market Has No Safe Places" here.
seekingalpha.com/artic...
HardToLove
"Market Sell-Off: The Realization That QE Is Not Inflationary".
seekingalpha.com/artic...
HardToLove
Logical Thought called him the bearish version of Calafia Beach Pundit. LOL.
The focus is primarily on the contraction of the credit bubble, which is real and addressed by Mises as being unstoppable, as the cause of this deflation. He discounts many of the recent price rises seen as speculative action.
Both the article and comments are worth reading, IMO.
seekingalpha.com/artic...
HardToLove
Surely the housing market is a deflationary force -- all popping bubbles always are -- but the market is not actually terrible in the mid-west (as was cited by a commenter) and in the Northeast (where I live). Folks are still doing a lot of re-fi and homes sales are still happening. The idea that most people who have equity in their home couldn't sell it if they want to is simply an exagerration. As for folks with no equity in their home, well of course they have no wealth in their home, but that wasn't the target of his example.
Price increases are speculative? This seems to suggest the idea that speculation is not real inflation. This is simply wrong. It may be dangerous, it may be volatile, but if speculative bubbles in commodities expand, we can have inflation that is very real in the rest of the economy. Anyone remember the oil bubble? Weren't gas prices higher as a result, and didn't this drive up other prices. Isn't this inflationary? Clearly arguing something is a speculative bubble does not in and of itself discount the possibility of inflation.
Food and energy prices will be falling? Okay, sure, I'll believe it when I see it.
If we were to get across the board deflation -- not just the asset deflation we saw most noticeabley in housing -- we would see the value of a dollar rise dramatically (according to this argument). This would punish existing debt holders, but reward savers. And it would make the value of every new dollar borrowed (every new credit dollar) increase. This would lure in more credit, not less, as the value of borrowed money is relatively high. Yes it would be more painful for folks to carry debt and bad for folks who are still carrying old debt, but very enticing for folks to add new debt. Not in the "it is smart to do this" way but simply in the "look at all the money I can get" way. Again this goes back to a difference of opinion about why ccredit is contracting right now. The lion's share of credit contraction right now is due to default. Of those who are being sensible and spending down debt, only a small portion of them will remain disciplined when the next punch bowl gets carried into the room.
So maybe its semantics. Yes, we are battling defaltion right now. The author says that we will have inflation "later". I think it may boil down to who means what in terms of now and later. If I bet on inflation and it doesn't really take hold till 2012, that is not a dumb bet to me, that is betting and winning on the arrival of inflation. If inflation in the future means 2018, well that's another matter entirely.
I honestly think what we are headed for is stagflation. This is the 1970's again -- problematically high unemployment and previously unheard of simultaneous inflation. It shouldn't happen according to classical models, and yet there it was. And we are headed right back for more, I think. Unemployment will remain stubbornly high and prices will still increase.
As long as the FED and govt keep manipulation going nothing is certain. We don't know how badly they are going to screw up and exactly what that screw up will be.
This we can say. They will screw it up..... because they are batting 1000 on that as evidenced by everything financial they have ever touched.
So here we sit with an unopened box of chocolates not knowing what we are going to get.
Snif...snif...shake..s... shake....I'm betting on stagflation.
I really hope I am wrong.
"The evidence of a stock market wealth effect is weak; the common presumption that there is strong evidence for the wealth effect is not supported in our results. However, we do find strong evidence that variations in housing market wealth have important effects upon consumption".
And there's this little nugget: "On the conference call Robert Niblock, CEO of Lowe’s confirmed that housing is indeed double dipping and that prices are likely to continue falling “at least” through the middle of 2011. Niblock says prices will only fall 4-8% further. Zillow and Clear Capital are both reporting declines of -4.3% and -6.8% in the latest quarter. S&P predicts prices will decline 7-10% in 2011".
This is contained in Cullen's recent "Lowe's Q3 Earnings Provide Insight on Housing Double Dip" here.
seekingalpha.com/artic...
Worth a read.
HardToLove
Short form: deflation for the asset-related (housing, certain financial and credit related - shorter form - "the rich folks") and inflation for necessities (food, gas, clothing, healthcare, - "the poor folks").
With income disparity being what it is, the ones that get the headlines are the assets because they affect the ones that have the assets and is what MSM, Wall Street, the Fed, ... are all about.
The "poor", who have relatively few assets, are not concerns of those in the media and cohorts. So, no inflation discussed much.
If you consider that "making money" is about "assets" and not "necessities", you can see why the bias is the way it is. Add in that the government has a vested interest in making CPI as small as they think they can get away with ... (I'm sure they would shutdown shadowstats and their ilk if they could find an excuse).
There will be deflation as long as the credit contraction continues I think. There will be inflation as long as the Fed exists and it will be exacerbated as long as our fiscal and monetary authorities view the "fix" for where we are to be doing the same thing that got us in this mess (easy money, low rates, easy credit, ...) to be the cure, rather than viewing the structural changes needed as being the fix.
BTW, I can make a case for deflation for the "less well-off" too by saying take a look as "wage deflation" (a.k.a "efficiency gains"). If this stays in place, deflation will become more widespread. With the current fiscal and monetary policy it may be that "wage deflation" will reverse someday. I don't know, of course.
HardToLove
bpp.mit.edu/daily-pric.../
Thank you for posting it here!
Since *true* inflation relates to purchasing power, you don't happen to know of a site that gives wage (in the form of take-home pay) do you?
Related directly to this blog's topic, using the interactive feature, we can see that from 10/12-11/16 we saw the BPP rise 0.6828%.
Hm, I wonder what came along around that time? Seems to me it was talk of something starting with "Q". Something the Fed was going to do?
Regardless, let's annualize that percentage. We'll just call it a month (a little rounding never hurt anybody).
IIRC, "=(1+0.006828)^12" is the formula? Correct me if I'm wrong.
WOW! =>8-O
8.51% per annum!
Of course, "one xxx" does not a trend make. We'll have to check back frequently.
Now to be fair, I do need to use just a month - don't want to make BB look bad, right? So 10/12 - 11/12 change was +0.625%. Plugging that into the formula gives annual inflation of 7.76% - not nearly as bad, huh? >:-\
OOPS! Big problem. It says it includes "Supermarkets, electronics, apparel, furniture, real estate, and more". Now we can't have that - makes the government look bad for being so lazy (Oh! That's not why the government does it the way *they* do?).
But it's not all bad. The index is just now back to where it was on 9/15/2008 (100.4983), from whence it had plunged to a low of 96.4911 on 12/20/2008 (continued for a year, it would have been a 15% deflation rate per year, ~1.347% per month). So we've moved up, as of 11/20/2010 by 4.17% in 23 months.
HardToLove
I'm pretty sure that once QE2 gets into full swing, purchasing power should be lost *if* it really does cause some inflation.
That's why I wondered if you happened to know some place that tracked wages.
Thanks,
HardToLove
A little OT.
Interesting factoid: "Adjusted for inflation, the median income in 2009 was $167 less than it was in 2001".
inteltrends.wordpress..../
HardToLove
www.irs.gov/pub/irs-so...
It's only through 2008.
Take a look at lines 22-24, which includes number of returns filed, adjusted gross. Unfortunately, all figures are estimates based on sampling. I guess they don't have computers that can crank out accurate statistics 2 years after the fact. I think the oldest and weakest PC I have in my house (dating from 198x) might be able to handle the chore for the IRS (IRS, call me - I'll do it for a reasonable fee).
The mean adjusted gross per return in 1999 was $38,198.64 and in 2008 it was $50,184.69. For this to hold even with inflation, the inflation rate would have to average ~2.767%. Since I seem to recall a couple of "pullbacks" over that period, this might be reasonable.
If we used the official BLS numbers, the chart looks reasonably close. But if the SGS Alternate CPI is more truthful, way off.
www.shadowstats.com/al...
HardToLove
data.bls.gov/cgi-bin/s...
Don't know how much to trust the data there, we know all sorts of adjustments get made in certain areas. But there are several cost-related data sets available that are a lot more current than what the IRS delivers to the public.
I selected several wage and salary data sets and the rate of increase in wages seems to be dropping pretty dramatically recently, in percentage terms, even as we've already seen that the prices are climbing substantially in both the link you provided and the shadowstats.com SGS-Alternate CPI.
Out of time for today, but I'm hoping something useful comes from all of us knocking all this around.
HardToLove
P.S. A story detailing some of the painful adjustments over time.
www.marketwatch.com/st...
Let's see, target = 2% and we are +3.4% over that, short-term. I guess the Fed is about to bat 1000 again - all wrong!
Of course, I might be premature in my speculation.
HardToLove
Thanks for reading through and giving your thoughts. I have comments and questions, but don't have time today. Wanted to make sure you knew your perspective was welcome and appreciated, however.
Yes. That is exactly why DM put up this blog - so we could discuss what constitutes inflation, determine what was going on and try to arrive at an investing strategy that was appropriate for what was really happening and *likely* to happen down the road.
DM and I basically disagree on what is "inflation", but to further the main purpose - determine what's happening, going to happen and plan a strategy, we accepted a simple definition of "inflation" and moved on.
Whether or not QE II is *causing* it, whether or not it is inflation in "classical" terms has become irrelevant to the main goals: what's happening, what will happen and how do we plan for the consequences.
No offense, but I don't think any of us want to revisit that question right now. Others may disagree, certainly.
The major thrust now has gravitated to understanding the "mechanics" of what is going on, what will happen, what will be the consequences and how we might position ourselves for it.
But please contribute as you see fit - all reasonable arguments are welcome and it is in that way we all help each other!
HardToLove
We *need* a deflationary event to correct the distortions and imbalances that have built up over the decades through inappropriate use of credit in "non-productive" ways.
The attempts to correct the problem by a dose of the same “medicine” that caused the problem, more non-productive credit use, is totally irrational. Einstein said that doing the same thing over and over and expecting different results was the definition of insanity.
He was a smart man.
The folks in charge are not so smart and may qualify as “insane” by the above definition.
People who have to survive in this environment will do the best things for themselves. Right now, that is de-leveraging by reducing debt obligations, whether by pay-down or default. The Fed and government is neither smart enough nor big enough to prevent this. Corporations are also doing this by retiring older higher-interest bonds and and issuing new lower-interest bonds and sitting on the cash – not investing it in any productive way, other than maybe buying treasuries or other “highly liquid” assets.
As noted in some other links that I and others have posted, GDP seems to have a strong correlation with credit expansion and contraction. Yes, there are other influences, but while both consumer and corporate credit use is falling, Mises' statement that a credit contraction can not be stopped will hold.
From “Into the Abyss: The Cycle of Debt Deflation“ here
seekingalpha.com/artic...
“One of the most famous quotations of Austrian economist Ludwig von Mises is that “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later, as a final and total catastrophe of the currency involved.” In fact, the US economy is in a downward spiral of debt deflation, despite the bold actions of the federal government and of the US Federal Reserve taken in response to the financial crisis that began in 2008 and the associated recession. Although the vicious circle of debt deflation is not widely recognized, precisely what von Mises described is happening before our eyes.”
I agree with this sentiment.
All of the things you state seem correct to me.
HardToLove
seekingalpha.com/artic...
The author tries to promote QE2 with the "it's not printing money" argument and then explains in her comments why it is a good thing that the government is printing money and how it is not inflationary. This would not be so offensive if not for the claim that if you think QE2 is inflationary, you don't understand monetary mechanics.
I still think this article and comments are worth it for the picture they give of just how few people have any inkling what they are talking about. Opinion is one thing, but many folks joining in the talk just clearly don't know what's going on. The reasons for this, and its implications to investing and our economy, could be its own instablog.
I came away from my reading with a renewed desire to plan for the day of reckoning. We are on a rollercoaster that will run out of track at some point down the line, and we're all chatting and arguing about whether it looks like rain.
I'm not sure what to make of it all. There were some parts that seemed a good thing and other parts not.
Since I'm so new at all this, I don't have the confidence to call "BS" either way. But it is more grist for my mill.
Another POV (opinion) on the *reason* for qE2 is provided by John M. Mason here.
seekingalpha.com/artic...?
HardToLove
Get through the China part, he nails thepart on the USA, and it is very pertinent to this topic.
www.europac.net/media/...
Chris Martenson's "Interview With Steve Keen: It's All About the Debt" is a little long, but is a *fabulous* discussion of the credit issues that are intimately intertwined with our current difficulties and, beyond that, with how our economy responds with and without credit actions.
It disparages various classical economic theories.
I'll be reading this one several times.
seekingalpha.com/artic...
HardToLove
To use his own words against him, Steve himself says, "I don’t think it’s possible to stop banks wanting to lend too much money." And this is kind of my point. He says elsewhere that we have too much debt and unsustainably high debt. But how do we know what level of debt is too much? I agree with the obvious idea that debt can not exponentially increase forever. But if you assume for a moment that much of current de-leveraging is via default and you further assume that these defaulters will be back on the debt wheel as soon as they can (and we take Steve's own point that banks will always lend more), I think one can easily project that debt will be expanding by 2012. To use his own models, if the RATE of new debt increases, we have job growth. We may very well see this bubble re-inflating in late 2011 and early 2012 and job growth may start to come back. When it does, the long suffering credit junkies will have the green light to binge and we will be shopping and speculating again in no time. This is highly inflationary, and is why I am positioning my portfolio for inflation.
Sure it's possible that we have a long depression, but credit functions differently now than in the 1930's and there are many many people and institutions that are ready to leverage up as soon as the system will allow it. I think those interested in blowing new bubbles will try to allow it post haste. Thus, inflation.
But this is more an argument that he underestimates the power of stupidity than an argument against his excellent and cogent analysis.
I don't know, but I do have some considerations about the points you raise.
Unless you are willing to assume that the banks no longer face insolvency, which folks smarter than I assert they are facing, due to the bad assets that they have refused to mark to their proper value, I don't see a desire to lend in the near future. As Robert points out below, why move away from 0% borrow and ~4% lend to the government? *If* we are in a deflationary environment, as many fear, what could be better than *holding* cash with *no* risk and a *high* *real* yield (say, -1% inflation +4% yield = 5% and compound that for a couple of years).
In this environment, with GDP projections moving downward as we speak, unemployment being stubbornly high and showing no substantive signs of improvement (other than people falling out of the governments flawed counting mechanism), worries about another down leg in housing and real estate values, CRE defaults coming over the horizon, FinReg impact expected to reduce profitability for consumer loans – especially the fees that were so profitable – making them much less desirable, wage deflation already evident (reducing consumer's ability to pay), then why would banks want to lend at substantial risk rather than take a guaranteed nominal yield? Yes they want to lend, but at reasonable risk (hence, tightened creditworthiness standards). It's most likely the banks will be “late to the party” by waiting until the environmental risks of loans abates substantially, making the expected aggregate yield better than the “free money” yields they are now making.
As to debt defaulters being back on the wheel ASAP, yes. But in what time frame? If they defaulted, what was the cause? Loss of job? Likely a high percentage of those will remain unemployed a long time. Strategic default? Not likely to jump on again until economy indicates it's “all good” again.
And both of these take hits to their credit score and availability.
So I can't see substantial credit increase as early as you surmise, considering that GDP growth estimates have been getting reduced and unemployment is expected to remain high, taking substantial consumer spending out of the equation. Of course, it is a chicken and egg issue.
How much debt is too much or too little? I think Steve's studies are likely the only path to a good answer. For me, it would be the amount needed to support productive investment and a much smaller percentage allocated to consumption. I don't have a clue. But I can see that all debt that is financially well engineered to ensure productive increases and returns (including assessment of near, medium and long term risk factors) could be theoretically unlimited.
Banks would be sometimes less interested in this due to the lower returns, as compared to consumer loans. However, maybe they've learned and will prefer productive loans that may have a much lower risk profile.
You remember how it used to be? Banks made good loans to good risks.
I do believe that inflation will come, but not substantial in 2011. Maybe 2012. Per folks smarter than I am, it will take many years for banks to unwind their bad assets and return from the brink of insolvency.
Further, much depends on on both fiscal and monetary policy and economic responses.
And the responses should be gauged as “uncertain”. I mean, who would have thought that POMO buying tons of intermediate to longer term treasuries would have increased yields, even if it is only short term?
HardToLove
P.S. Personal spending +0.4%, income +0.5%, Oct durable goods down 3.3%, jobless claims down 34K to 407K. But CNBC guest states orders have been slowing.
Breaking News
FOMC minutes reveal Fed divisions
The Federal Reserve considered whether to target a long-term interest rate at a special videoconference meeting in mid-October, in what would have been a radical change to its monetary policy, according to the minutes of its November meeting.
Although the Fed rejected this policy, it suggests that targeting a long-term rate - such as the yield on 10-year Treasury securities - might be an option if inflation continues to fall in spite of the new $600bn round of quantitative easing, nicknamed QE2.
link.ft.com/r/0QSDPP/0...
Can you provide a link supporting this assertion?
Go to stockcharts.com and pull up a weekly chart of any of the longer-dated bonds. Tell what you see.
I happen to have my trading platform up right now and using (TLT) as a proxy, the long-bonds have dropped from an intra-week high of $109.34 the week of Aug 23 to an intra-week low of $93.81 the week of Nov. 15, -14.2% in a bit less than three months. The fact that the last weeks had a small rise is more likely a result of the Euro bailout "crises" and the Korean situation, combined with cessation of POMO operations by the Fed until November 30th.
Further, it has been widely reported, IIRC, that indirect buying (e.g. Chinese) has been dramatically reduced over the last several months. Maybe I remember incorrectly?
A link supporting your assertion will correct my misunderstanding.
HardToLove
I don't disagree with you about how and why banks are making a safe 5% on free money. But they are also continuing to take risks with some of the money in order to get a better yield. This is good for those of us who are into equities and commodities, at least in the short run.
Regarding your many good points, HTL, I can only say that I see unworthy credit being extended all the time all around me. The old practices may have abated somewhat but they have not ceased. And anyone who thinks that the consumer has now found religion and will only spend what he earns doesn't understand what it means to have grown up in the 80's and 90's in America. There will obviously be an impact from the decreasing amount home ATM cash -- at least for a while -- but I think many folks underestimate how many people who are buying homes today (especially foreclosures) will be at the re-fi window in a few years.
I sound like I am trying to argue that nothing has changed and that we are going to bounce back just fine. I don't believe this. But there is a strong counter-force to the changes we have seen the last couple years. There are still many folks who crave shopping and spending and will do so as soon as they can, no matter where the money comes from. And there are many institutions that got used to charging 24% interest and they are still out there trolling for customers. If any of you know folks with bad credit or a lot of debt, and you know them well enough to talk about this kind of thing, ask them if they have received any credit card offers in the past two months. Ask them if they have received special "low interest balance transfer checks (with 4% transfer fee and a teaser rate that expires next year). Ask them if they are spending down their debt and resisting the urge to shop. The reality is that credit card debt is alive and well. There are defaults which give the appearance of de-leveraging, and there was a brief period of sobriety where folks thought it was a good idea to pay more than the minimum, but these are not the same thing as systemic de-leveraging.
There is no doubt that the collapse of the housing market has affected the credit cycle. HELOC's and the like were responsible for a tremendous amount of consumer cash flow. I would not argue for a second that those days are right around the corner. But all that needs to happen for inflation to spark is an expansion of credit from its previous lows while GDP holds steady or expands a smidge. And I think beginning this holiday season we will see that the consumer is tired of not consuming.
Unemployment is obviously a problem for the economy right now, but fear of the high unemployment is probably an equal if not greater inhibitor of spending. Obviously households without income are spending less. But households with disposable income (and there are more of these than the those without) are getting responsibility fatigue and are looking for any kind of signal that it is okay to saunter back up to the punch bowl.
The folks I talk to who are young adults with credit problems are not talking about the need to be responsible and how they plan to get their finances in order. They are talking about how much it sucks not to have any money. Their plans for future spending have everything to do with the funds available to them this instant and nothing to do with what makes for wise financial strategy. This means if they get more credit, they will spend it.
So what I think we will start to see in the next 12 months (barring an obvious game changer like war in Korea) will be a gradual uptick in consumer spending and gradual optimism that we have weathered the storm. With an increase in consumer activity, a general increase in debt load will follow. This will heat things up just enough to bring the economy to a simmer, which many folks will interpret as good news.
But the important part of this prediction is that we are still playing in the same house of cards we always have been, and I think the next shock will be even bigger than the last.
So I think there is a strong case for deflation and credit collapse right now, but I don't buy it yet. I think we will see the economy re-inflate just enough to get almost everyone thinking the worst is over. Banks will believe they have pretty much covered their bets. Some businesses will have no choice but to hire folks to meet the increasing demand in order not to fall behind their competitors, who appear to be rising from the ashes. This will bring strong and rapid inflation. The impact of this inflation will be de-stabilizing. At some point in the future, we will experience a shock and old wounds will be exposed. Economists will post charts that show we never did cure our addiction to credit and despite a brief downward blip in 2009-2010, we continued to expand rapidly past previous levels. There will be no place to hide because we never took the time to actually heal and instead hid our bruises with makeup. Then will come our prolonged bought with deflation.
Sounds like just another silly prediction that you read about all the time on SA and elsewhere, but it is truly how I see this playing out. And it is why I remain short term bullish on stocks and inflation.
www.youtube.com/watch?...
"ECRI's WLI Surges to a Six-Month High; GDP Revised Higher"
seekingalpha.com/artic...
Do keep in mind that the stock market is one of the compo0nents iof the ECRI model, so it is influenced by the market. And the market is influenced by ECRI readings. Anybody see a self-reinforcing feedback here?
And don't forget that the market is also being influenced by "Uncle Ben" (no, not the rice) QE2 activities.
OTOH, I just posted a link in the rare earth concentrator wherein the guest states we are in a deflationary environment.
My view on which way were headed in the economy has a decided influence on whether we'll see generalized inflation or not.
HardToLove
There are bound to be lots of head fakes in a weak recovery and I always was a sucker for head fakes when I used to play recreational basketball. (Of course, the absence of referee to call travel when the pivot foot was dragged made the head fakes even more effective.)
So, anyway, I think the head fakes are so strong right now that the pivot foot may moving more than just a little slip. Rick Davis discusses how the consumer durable goods contribution to GDP is extraordinarily weak econintersect.com/word... and Steve Hansen is seeing early indication of possible deflation in consumer services econintersect.com/word.... We just won't know for a couple of more months whether Rick and/or Steve are onto the start of real trends or just looking at more head fakes.
At least they are looking at the fine print details which many fail to do. Now all we need is a referee to watch the pivot foot.
From my so far limited learning, I'm in the deflationary camp, believing that the larger and longer the bubble, the faster the drop (and boy was this one fast!) and the longer the recovery time.
With the apparent change in the employment recovery profile we're watching, I think the situation will be worse than most anticipate.
The open question is still the net effects of QE2 I guess. Can it overcome the headwinds it is designed to overcome? I'm betting not.
HardToLove
Has nice little compilation of some 12/3/1 month price change in commodities.
seekingalpha.com/artic...?
Also, the comment by Abegaz is worth considering if he is right that "stockpiling" (i.e inventory build) may occur, boosting GDP again.
I'm thinking that if Cullen wants to insist that QE2 is not causing inflation he may need to offer a plausible scenario for what is causing these price increases.
HardToLove
=============
... yesterday's publication of Core PCE yesterday (minus food and energy items).
At 0% on the month, like the previous month and +0.9% on the year, this indicator is at its lowest level since it came into existence in the United States, as you can see in the graph below.
===============
Can we assume the PCE lies less than the rest of the statistics we are spoon fed? It's not a rhetorical question, I really don't know the source of and manipulations of the data used.
Also included in the article is an iteration of what has been stated before, and parroted by me in some comments long ago, that the Fed's policies are in fact deflationary in nature.
==============
"If we consider that these interventions by the Fed (QEs) are taking income (interest) from the pockets of private-sector economic agents (in reality, the Fed's profits and losses), they are basically reducing aggregate private-sector demand.
And the end result is quite the opposite of inflationist".
===============
A short read, worthwhile adding to the pile of continuously conflicting views we get.
The primary focus is ostensibly an emphasis on the meanings of some statements included in the released transcript of the non-public meeting the Fed held. But there are some other items addressed too.
seekingalpha.com/artic...
Maybe we should throw up our hands in disgust as one article shows huge commodity price increases and discusses the need to pass on price increases to end users, ergo inflation has already beset us, and the other shows that we are in fact deflating and have results so extreme that they challenge historic ranges.
HardToLove
So I, being curious by nature, want an explanation from these "experts" as to what is really happening if QE2 is *not* inflationary on the one hand, or why it is inflationary on the other hand.
My current suspicions is that we get a story from each side biased by their predisposition(s). I guess MMTers look at "simple asset exchanges" and fail to see some other effect that is in play. So now we have to seriously doubt the validity of their thought process. The other side sees real numbers (always a better foundation IMO) and says we have inflation but doesn't "connect the dots" that would allow us to see what is the cause? QE II? The world CBs all engaging in "money printing"? Something else, like price of gold? Who the hell knows in this environment.
It's no wonder the average citizen gets raped so often - no one seems to really have a handle on how this works in such a manner that a common understanding of the forces at play can be used to manage them.
OTOH <conspiracy theory> maybe that's intentional. See this video that AlbertaRocks posted in one of the articles I mention earlier.
www.youtube.com/watch?...
</conspiracy theory>
HardToLove
In other words, the effects of QE2 may in fact be deflationary in some respects and inflationary in others. And we may get nothing real out of it except the risk that one force will override the other, and we will either grind to a halt or go racing off down the road. In the meantime smoke starts billowing out of the engine and the tread is starting to burn from the tires spinning in place.
To the extent that QE2 supports equity and commodity bubbles, it is clearly inflationary. OTOH, I am becoming more convinced that the impact of credit deleveraging has removed so much money from the economy that we may have some room to run before we spot actual inflation in the wild (and not just the garden variety domesticated inflation that is always hanging around in the alley near the grocery store...)
That would resolve, for me, why we have the apparent conflict of inflationistas and deflationists.
The resolution occurs through the following logic mechanism.
1. Cullen is right - it's an exchange of assets, no new money flows.
2. Money always seeks yield. If yield is not available here, it leaves.
3. The best way for this to happen is to leverage by borrowing at *very* low rates to buy something that is appreciating at a much higher rate.
4. Since there is a *lot* of "free money" available to certain institutions that have *very* sophisticated trading desks, they all lever up and compete with each other for those assets that promise higher yields.
5. The assets return not only what they would "naturally" yield, but also the additional yield that is a result of increased competition for "scarce" resources - high yielding assets.
If what I guess is true, we can draw some conclusions.
1. The assets that have seen such huge run-ups are in a "bubble", or nearly so.
2. They will continue to grow a larger bubble until something pops them.
3. The most likely cause of a pop is related to changing currency strength.
4. A strengthening $US will cause an unwinding of carry trade in $US and force it back to another currency, like the yen.
5. During the adjustment, the asset prices will deflate, likely overshoot, and then return to some semblance of normalcy.
Regardless, the inflationary effects of the speculative bubbles formed by a "weak dollar policy" as implemented by BB and TG, regardless of intention or nomenclature, will be (is already being) passed through to the economy and the citizenry, to our great detriment.
So although QE II may not be inflationary in its mechanical aspects, the mindset, policies and implementation of surrounding policies set up an inflationary scenario even though QE II itself, and its predecessors, are deflationary in nature and mechanical effect.
In other words, we've properly identified the crime committed but arrested the wrong alleged "perp". With so many ingredients in the stew, it's hard to identify the meat.
Thoughts? And *if* all this is true, then a strategy based on inflation expectations solely would be a poor stance to take. We would need one that accounts for what I envisioned or its offspring. Remember that this was the intent here - get a strategy that is useful to us. And we can't be certain of that *unless* we can fathom what is *really* happening.
MHO,
HardToLove
Just one thought on your scenario, however. #4 A strengthening $US will.... There is no guarantee that the USD will strengthen over time. Yes, it will have pops and it will do well if there is sabre rattling or worse war breaking out. But as the US position deteriorates, it is not impossible to see continuing weakness in the dollar, especially since that is the goal of fiscal policy at this point in time. Sooner or later, the dollar will gain strength, but if this is later, the inflationary side effects you describe may have taken root for a long time and the bubble in commodities may have grown very large. This suggests to me the Silver Play (for example) may still be a wise one going forward.
But lets assume for a moment that it all plays out in the near term the way you describe. It is not clear to me what that says about investing. I can see that bond yields would rise, and this could do a number to the bond bubble. This would drive up interest rates which would encourage savings and even give strength to the bond market (not for all the old high priced bonds but in terms of money flow). This would drive up credit card and mortgage rates, which would very powerfully fuel the credit de-leveraging problem that you describe. Housing would have to fall further since homes are really bought on the basis of the monthly payment and not anything else, so reduced capacity to buy would bring prices down. So I know where I don't want to go, but still not sure about the right play here.
I should say I don't do options and I don't like shorts. There is always something to go long on in every market, so I would be looking at what these items might be. It is easy to say "short the world" but that is not an answer I will stop at.
Have you just painted the picture of how we get to the deflationary post-inflation wasteland that I referred to a while back? If so, do you see a play?
I have been following your discussion with great interest.
If you will allow me to interject some thoughts: If inflation (commodities, energy, food or whatever) is in fact just another bubble, then the final deflation will be draconian and all the "liquidity" provided to the banks by QE and MBS transfer to Fannie, Freddie and the Fed will disappear into a black hole that swallows up the "liquidity" without unwinding a fraction of the excess debt.
The debt of the world is probably well over $100 trillion and that of the U.S. somewhere around $50 trillion. The total efforts in the U.S. to provide liquidity for handling the debt is of the order of $2+ trillion (heading toward $3 trillion with QE2). All this can do is provide the lubricant to keep moving the debt around. It does little to help reduce the debt. The strategy is to let the banks "earn" their way out of the hole. But if their earnings are actually derived from creating more debt (private or government), they never make much progress. Wonder why it's called extend and pretend? Kind of obvious I think.
The last over-leverage crisis was the S&L debacle mid-80's into the 90's. Most would agree the banking system was on the ropes then and that was a very small fraction of the size of the current crisis. Most banks were actually insolvent then (even with that much smaller problem) and took nearly a decade to earn enough to (sort of) get back on their feet. What did it take? A tech boom, which of course bubbled, but without a deep impact on the banks.
So we have a much bigger pit now. Where is the 10X boom (compared to the tech boom) going to come from in the next 10 years to address a crisis which is much more than 10x the S&L crisis?
Hope I didn't overstay my welcome with this long winded comment.
BTW, Dirk Bezemer has a very interesting article which discusses how the Babylonians handled debt crises: econintersect.com/word.... Ancient Babylonia dealt with debt crisis in a process akin to bankruptcy for speculators and support mechanisms for producers. Today we are doing just the opposite.
My gut take on everything is that is never as big as we think it is. So I understand that we are headed for doom -- this simply can not end well and anyone even sort of paying attention has to see this. And yet the movie keeps playing and we somehow always kick the can down the road. My instinct is that this is not yet "the big one".
But you're not wrong about the scope of the problem. It is like those old serials they used to show in the theater (or so my Mommy tells me). Our heroes are tied up in the back of a truck with no brakes that is barreling down toward the cliff. How will they ever get out of this? And yet every following episode they somehow survive, only to get into even more trouble next time. The provider of forced plot twists in this case would of course be the Fed and other market makers.
On a slightly different topic, but related... what concerns me even more than the incredible amounts of debt in the world, which appear are about to unravel and be unwound (one way or the other), is the exposure to derivatives. Perhaps 18 months ago I'd read that the total exposure to derivatives, mostly by the banks, was over 600 trillion. Recently I read that the total exposure to derivatives is closer to 1 quadrillion (sorry, I wish I'd kept track of which article that was). Of that, 90 trillion is attributable to JPM alone.
I realize these exposures are not official 'debt', but they are of such mind boggling magnitude that it would take very little to go worng and suddenly those who are on the wrong side of these trades are flat out bankrupt. Overnight! These outrageous and blatantly irresponsible adventures into the bizarre world of greed, manipulation and gambling with the futures of our descendants for generations to come can only add to the likelihood of further troubles ahead. The amount of 1 quadrillion is something along the lines of 10 times the GDP of the entire planet. (I just threw that number out there, it could be 100 times. I'm not sure, but you get my point.) JPM are monsters. IMHO they are very likely going to lose control and in doing so, cause such panic the likes of which the world has not yet experienced . J. P. Morgan himself once said: "I don't get migraines, I give 'em". That arrogance is still alive and well within the firm. In fact, it's a prerequisite for employment. It is this type of arrogance that is displayed by the exposure they're willing to take on.
I think the 'carry trade' plays a lot into the equation and into the interesting discussions going on here. The US dollar is very likely to explode higher and the Aussie dollar/yen cross is likely to implode just as quickly. I believe it's going to happen much, much quicker than most believe possible. That Aussie/yen cross is such a good measure of "risk on" and "risk off" that it deserves watching closely. Recently it has turned sharply lower, indicating a sudden risk aversion could be at play here.
In any event, even though the Ben Bernank is trying to expand the money supply and create inflation, it's quite apparent that his plan is failing. If his plan were succeeding, bond yields would have continued lower... his very goal. They are rising. The action of the Fed have been thoroughly trumped by China's hiking of rates, plus their increase in the reserve requirements for their banks... twice in one month. China is clearly making a statement here and her actions are clearly targeted at neutering the Ben Bernank's goal of re-inflating the world at any cost. Destroying the dollar is of little concern to him. I think China's efforts, along with the outrage by many leaders from all over the world, combined with the sovereign default issues are going to result in a total failure in the efforts of the Fed. I believe the world 'must' go through a period of severe deflation before any inflation can get underway. I honestly believe we're looking at two years of deflation, minimum... for as long as it takes to address every single sovereign credit crisis in existence. I believe they 'must' be addressed and resolved. The recent bail out of Ireland was not a solution. It was a band-aid. The Dubai issue is re-emerging. Portugal and Italy are teetering. This is really serious stuff. Spain will likely be the final straw, the straw that really sets the deflation mode into high gear.
Having gone overtime here, I guess I just have to wrap it up by clarifying that when I refer to deflation, I'm talking about the global money supply, not prices. There is a huge difference. IMO people are likely going to see huge deflation in most things discretionary... real estate, stock markets, commodities, wages, vehicles, trips abroad and ladies of the evening. But nasty increases in everyday staples, like some foods, medical costs, any and all government fees, and worst of all taxes. Deflation is such a nasty thing that in a way I don't blame Bernanke for trying this insane experiment to delay the inevitable for another decade because the alternative is just so awful. But they're (we are) in such a pickle here that I don't think there's any getting out of it now.
On a happier note, it's much warmer here now. We've already had a two week spell of record cold temps and tonight it's downright balmy at 15F.
.
1) $SPX
2) $TNX (rates on 10 yr. treasuries)
3) the ratio between the two (in candlesticks)
stockcharts.com/h-sc/u...
What this chart is displaying is the greatest extremes ever seen between rates on the 10 yr. and the S&P. It's one of those 'the elastic band is stretched to the limit' charts. Something just has to give. In order for this chart to 'revert back to the mean' so to speak, it would require either that equities have to fall sharply, or that rates have to rise sharply (meaning the 10 yr. treasury would fall sharply), or any combination of both. That combination 'could' also include equities falling sharply with rates also falling but to a lesser extent. In any of the possible scenarios, it appears that the most likely outcome would be that equities fall. The alternative is that if equities were to continue to rise, then the rise in rates would have to be alarmingly fast. And in that scenario... equities do not rise. So the only conclusion I can draw is that the stock markets are likely headed lower at least until this chart shows some form of resolution of this extreme.
So to answer your question, since the direction of bonds is still not convincingly clear to me, it appears that to sell equities is the ticket no matter how this resolves.
===================
"I wouldn't bother asking if I didn't think you could be right."
I appreciate your open mindedness DM. I don't pretend to be right although I think I am. I'm just not arrogant enough nor confident enough to get all aggressive and jump up and down that I've got it all figured out. Peter Schiff (who I admire greatly) would argue that I'm wrong. Mish (who I also admire) would argue that I'm right. I think Mish will be proven right first and that Peter will be proven right two (or more) years from now. How's that for diplomacy on my part? It's the best I can do, lol.
TA is all about putting the odds in our favor to the highest degree possible and at the present, every indicator in my arsenal is pointing towards a correction in the equities markets at the very least. The shape, speed and form of the next leg down will go a long way to helping me (and my friends on a different site) figure out whether we're in for a real beating or just a correction of some form. There is no more important level right now than 1130 on the S&P. If that level gets breached, the odds of new highs becomes very remote and perhaps for a very long time. Obviously, that opinion is very clearly expecting the deflationary scenario. I'm fully willing to admit that I could be dead wrong in that expectation, but we're going to find out soon enough.
.
Correct. But it may be very likely to take a *long* time to weaken appreciably since the majority of trades it balances against are in Euros. ISTR something like a 3:1 Euro:Dollar ratio being quoted? If I'm in the ballpark, I believe we can count on it generally strengthening until the final rounds of the European Union debt crises plays out and the Euro can begin to acquire some of its former strength. A couple years at least?
Of course, other currencies could come to the fore, interest rates elsewhere might be hiked, and we've already seen capital inflows to foreign nations being staunched via various measures, … that could potentially derail this scenario. But someone smarter than I would need to propose that scenario.
I think the silver play has a lot going for it, especially if JPM et al are trying to unwind their short positions. With the margin increases from the CFTC, and other possible measures of which I'm ignorant, to help out these 4 gigantic short banks, we might see a substantial pullback in silver. If there is a typical overshoot to the downside, some very attractive prices may be seen. My only reservation would be if we enter a deflationary period. What is silver then? A commodity or money? In the first case it theoretically drops in price. In the second, it does all the things money is supposed to do.
It could be both. But if so, a different paradigm is exposed. Regardless of deflation, it gains in value because the supply as commodity is reduced as large amounts are diverted for use as money.
“I can see that bond yields would rise, and this could do a number to the bond bubble“.
“Pop” on over to your favorite charting tool and look at the 30 year. Since the last week in August prices have been trending down – yield up. It's already doing that number.
Completely the opposite effect “The Bernanke” was targeting. And it seems to be getting the “longer maturity” issues, as indicated by (TLT), which I recall being $107+, $105+ (lots of assertions it was in a bubble then – maybe we are too late and its popped already?), … now sits in the mid-$97 range. It's now being supported by its 200 day SMA ($88.15 and rising), but will soon bump up against its 50 day ($94.64 and falling). With the 50 day moving down, and 200 day moving up, there's going to be a break as the range gets squeezed. Maybe earlier than that. Looking at the weekly for TLT, it seems most likely that when it encounters the 50 day (est. $95-$96 level by time of intersection). That same range will likely act as support from October 2009. It should diddle around there a bit, make a couple head-fakes up and then continue down, barring unforeseen events.
Why do I think this? I see no way, again sans exogenous events, that a perception of a continuously weakening dollar (which seem the most likely outcome of the Fed's actions, and I emphasize “perception” here) can sustain rising bond prices and falling yields. For that reason, I've revised my “be alert” target on TLT from $98 to $96-$95 for a potential entry into (TMV), a triple short, guided by charts and actions at that point for a short-term play.
Caveat: POMO actions start up again on 11/30, so we'll need to be alert to behavioral changes.
“Housing would have to fall further since homes are really bought on the basis of the monthly payment and not anything else, so reduced capacity to buy would bring prices down. So I know where I don't want to go, but still not sure about the right play here “
“Have you just painted the picture of how we get to the deflationary post-inflation wasteland that I referred to a while back? If so, do you see a play”?
If we had mark-to-market rather than “mark-to-fantasy”, I'd go long an short financials ETF, maybe (SEF) or (SKF), an ultra short. This still might be a good play given the issues in consumer credit, Finreg reducing profits on “outrageous” fees, CRE defaults still looming, IIRC, all the liquidity piling up in “excess reserves” and their mainstay, treasuries, falling in yield. The unknown is how will the banks respond? They have to do something to make money. What will it be?
And let us not forget – if we do have deflation for some reasonable period, “cash” is a good investment, although I wish I was a Forex trader and could get exposure to something else besides the USD.
As always, these are the musings of a tyro here and should be used only for the stimulative benefits that lead to the correct answers.
MHO,
HardToLove
John, I know I echo all our sentiments when I say you're always welcome to add your thoughts.
The “draconian” nature you mention is deemed by some to be a certainty. The claim is that the “extend and pretend” just makes the end-point more severe. Since I tend to view delayed inevitability as a coiled spring with a constantly-increasing tension, I have trouble envisioning a less harsh outcome.
Here's a pdf from McKinsey Global Institute from mid-2009 that talks of some of the issues.
www.mckinsey.com/mgi/r...
As you mention later in your comment, I have trouble seeing how banks earn their way out of trouble, considering the items I mention in my reply to DM about falling yields, Finreg, …, and the McKinsey document. And I know you are on-board with the troubled bank list, which just keeps on growing and growing and … an “Energizer Bunny” effect. I think that, all things considered, re-structuring of some debt becomes inevitable.
“The debt of the world is probably well over $100 trillion and that of the U.S. somewhere around $50 trillion“.
There seems to be no easy source of confirmation for any of the numbers we hear thrown around. But it looks like a little “sleight of hand” on the numbers in these links might let us get a good “ballpark” estimate. Caveat” the CIA numbers are from mid-2009, so not reflective of today's reality. A “fudge factor” can probably be applied without introducing too much distortion.
This is an interactive map of world “public debt”. Tabs at the top let you look at different things too. And it is overall debt. So if we know GDP, we can get a rough estimate of overall debt.
www.economist.com/blog...
Here's a couple of CIA data sheets from mid-2009. One is public debt and the other is external debt. I can't figure for sure how these might help in determination of our current situation.
But what I do like about these two is the little hyperlink at the top labeled “Country Comparison to the World”. A click on that makes it more interesting.
www.cia.gov/library/pu...=!
www.cia.gov/library/pu...
And last, something the least useful for us probably, is this total public debt page from the Economist. But it is interactive, allows selection of different metrics and country comparisons and lets us look at what 2011 as well.
www.economist.com/cont...
But, there's a bigger bogeyman in the house. As reported in The Times on September 15, 2008, the "Worldwide credit derivatives market is valued at $62 trillion".
en.wikipedia.org/wiki/...
Hm, 26 months later, has it grown or shrank?
Here's a BIS document from EOY 2009. At the bottom, hover and the graph expands to where we can see US $24T in notional CDS outstanding.
www.bis.org/publ/qtrpd...
Other factors may be in various markets that are OTC, such as can be found by looking at various links on this page.
www.bis.org/search/?q=...
I like this one, www.bis.org/press/p101... which contains “Positions in the OTC derivatives market went up in the three years since the last Triennial survey (+15%, or 5% annualized) to $583 trillion”.
Granted, there are many derivatives that will not have the same impact as pure debt. But we can count on some of the parties involved in these instruments to be affected by the deleveraging that might be seen, causing the effects to ripple through certain segments of the economic and financial environment. A notable clause discusses the growth in the interest rate segment, now 82% of total market notional value.
“So we have a much bigger pit now. Where is the 10X boom (compared to the tech boom) going to come from in the next 10 years to address a crisis which is much more than 10x the S&L crisis? “
I suspect the term used by many others is appropriate here: black hole. A possible answer to the question may reside in Chris Martenson's stuff: energy. www.chrismartenson.com/
ISTM that fiscal and monetary policy notwithstanding, the long-term issue is going to be a structural change in use, source and allocation of energy. As this becomes recognized by various governments, great resources will be brought to bear and will provide equivalent of the dot.com bubble. The problem, as in that bubble, will be mal-investment (already being seen) as the governments dip their sticky fat fingers into every aspect of the pie production, rather than just providing some reasonable policy, guidance and short-term incentive funding and then get out of the way.
“Hope I didn't overstay my welcome with this long winded comment “
PIKER!
HardToLove
www.globalresearch.ca/...
socioecohistory.wordpr.../
english.pravda.ru/busi.../
A ggogle result offers many more.
www.google.com/search?...
I happen to agree with all you suggest. See my reply earlier to John's comment.
HardToLove
Just one observation. Charts are terrific at showing what has happened to sentiment and, therefore, pps actions. But they are not terribly great at factoring in the as-yet not fully implemented changes of such as QE II. Even as we discuss this, there is still a lot of uncertainty about what it actually is, its actual effects.
And here is where I think your judgment (or that of any hOOmOn) needs to be applied.
As example, quite a while before QE II was being seriously considered, on one-minute charts, I watched (SPY) and (TLT) carry on a directional inverse relationship intra-day as well as inter-day. This latter is well reflected in any chart.
Then as QE II became more widely known and guessed at, the intra-day behavior changed. At times they were directionally strongly correlated. Other times they diverged and still other times the predominately directionally inverse correlation kicked in and pretty much held. Then, POMO operations ceased until 11/30 (they start again tomorrow) and the original behavior was seen... sometimes. Other times, SPY was flat and bonds went their own merry way. If you make a 15 minute 10 day, or longer, chart you'll also observe a lot of gap opens in the bond (as reflected in TLT).
My best guess as to the variance from the traditional behavior is that the primary dealers are front-running the POMO activities on behalf of themselves and their clients.
Anyway, my point is that we may be in the midst of some (short-term?) structural change, likely due to the perceptions about QE II and the mechanics of it, that means we have to discount some of the tells the charts normally deliver. I'm certainly not sure of this, but I suspect it is so.
Because I'm so new at all this, I'm not able to correlate what I see happening on the charts with the underlying cause(s). That is, I've been learning and using charting on the basis that certain patterns and technical indicators would appear in charts as indicating a certain underlying sentiment (and therefore behavior) of a large, and possibly diverse, group of investor and traders. ISTM that now, regarding these two asset classes, we no longer have a large and diverse group and we no longer have the same linkages – i.e. the patterns and indicators on the charts are now reflecting something different. Yes, it still reflects money movement, prices, volumes, … but the underlying causes of these “symptoms” have changed and I feel that casts doubt on continuing to interpret them in *precisely* the same way when trying to lay in a future path.
Although maybe OT here, I'm very interested in understanding such changes and how they influence our near-term technical analysis.
I would appreciate any thoughts on this. Of course, if your like me - befuddled, bewildered and bedazzled - I'll understand.
HardToLove
According to Dirk Bezemer econintersect.com/word... the BIS calculated that the nominal value of derivatives world wide was $1.14 trillion in 2009.
Valuable links.
The problem for debt levels is just as you say:
<<<There seems to be no easy source of confirmation for any of the numbers we hear thrown around.>>>
Here is an example:
The CIA reference says for Ireland that the total debt (public and private) held external to the country is $2.3 trillion. A post today by Prieur du Plessus seekingalpha.com/artic... shows total bank exposure to Irish debt as $832 billion (524.4 pound sterling).
Does that mean that sovereign exposure to Irish debt is ~$1.5 trillion?
What if the relationship between the S&P and bond yields just continues downward forever? What would happen if this elastic band, which seems stretched to the limit, is in fact not even close to its limit? What if the ratio goes infinitesimally close to zero? Just because we have never before seen this ratio stretched to the current limit does not mean it can't go further. I have to accept that as a possibility, as illogical as it is. From my point of view, I'm using the chart in anticipation that it will at some point give us signs that it's turning. No chart goes in the same direction forever. Those signs seem to be in place now, but that's not to say this respite is permanent. Could the ratio stretch even further, and the action on the chart continue lower? I don't know. But what would have to happen in order for that to occur?
If the candlesticks on this chart (the ratio) is to continue lower, it would mean that equities, relative to bond yields, would continue higher and vice versa... yields on the 10 yr. treasury would continue towards zero. We're talking about something approaching infinity on the S&P and infinitesimal on bond yields. An explosion upward in equities and bonds at the same time. The conflict with that notion is that an explosion in the price of equities is a sign of inflation if there ever was one.
But an upward explosion in the value of bonds has always been caused by deflationary forces, where lower and lower yields become acceptable. Indeed, the weapon of choice for fighting inflation has always been an increase in rates. That's logical, since an investor, whether it be an individual, a hedge fund, or a government, is losing money on bonds paying 4% if the rate of inflation is 6%. So they demand more return for the rental of their assets... rates rise as an effect of sheer market forces. The Fed ultimately has no control over these longer rates. At least until they went insane. Whether the Fed is indeed insane or perhaps supremely brilliant is a moot point when discussing the possibility that an upward explosion in equities and bonds can happen at the same time. In the long run, it defies logic.
"Anyway, my point is that we may be in the midst of some (short-term?) structural change, likely due to the perceptions about QE II and the mechanics of it, that means we have to discount some of the tells the charts normally deliver. I'm certainly not sure of this, but I suspect it is so."
There is no question that we are in such uncharted waters, perhaps some structural change as you suggest, that perhaps none of us can even fathom what's coming. But In all due respect, the notion that "that means we have to discount some of the tells the charts normally deliver" is something that I just can not agree with. The charts, whether they be current ones, or charts looking at the 1920's and '30's, or charts looking at the era of the South Seas bubble all have meaning. The indications they provide, such as gaining or waning momentum, are absolutely valid and very 'telling', whether we want to agree with them or not. So I wouldn't throw charts out the window as providing helpful guidance just yet.
Having said that, I'm fully prepared to accept the possibility that this elastic band could be stretched further. At this present time though the chart is making a turn, suggesting that "possibly" the limit has indeed been reached. But this change of direction does not imply that the limit "definitely" has been reached. Perhaps this is just a correction in a secular downward path on this chart? But logically, the notion of stocks continuing to rise in an inflationary explosion while the bond market is refusing to buy that as a possibility, makes me think the limit 'has' been reached.
Considering that the bond markets absolutely dwarf the equities markets, they are in the driver's seat. Of that there is little doubt. Equities don't drive the bond markets. Inflation and deflation drive both, with bonds and their accompanying rates reacting to inflation (or deflation) and equities reacting to bonds. But ultimately, direction in both markets is a function of money supply as well as expansion or contraction 'of it', and therefore an expanding or contracting economy. As long as we're seeing rate hikes in Europe that are downright scary, in my humble opinion the writing seems to be on the wall. The big difference this time is "why are rates on foreign bonds rising so sharply?". Unfortunately it's not due to any inflation caused by booming economies, as is usually the case. It's due to credit crises... expansion has apparently reached it's limit and the resolution of 3 decades of wild expansion appears to be upon us. At least that's what all the sovereign credit crises are telling us. I fear we've only seen the tip of the iceberg.
Mr. Love, you once read something I wrote about "know it all dolts". Although I wrote that piece as an attempt at humor, there was a lot of underlying truth in it. I am the first to recognize that I don't know the answer with any certainty. I don't pretend to. I'm just putting forth my views and hopefully they're reasonable enough that they're worthy of discussion. I'm not a "know it all". Nor am I the "dolt", but I could possibly be confused :-)
A little glimpse back at better days:
seekingalpha.com/insta...
Wishing you the best as always...
.
========================
The effects of POMO summarized on a chart. 8 straight POMO days starting at the open on Nov. 12 and ending at the close on Nov. 23. Net result of 8 straight POMO days was a loss of 32.81 S&P points or -2.70%.
Almost every pundit out there attributes the entire run-up from the August 27 low as anticipation that the Bernank would announce QE2. They say that by time the announcement was made official, it was already built in. Since the initial 2 day euphoria following the Nov. 3 announcement, every index on the planet is lower, some by a wide margin. At the close of this week, the S&P is lower by 37.68 points off the high, or -3.07%:
stockcharts.com/h-sc/u...
Perhaps the pundits were right. At least this evidence appears to support their claims. I show this data just to present a clear picture of what has happened. I have no idea what it means going forward except that I have suggested in the past that eventually the POMO funds would not necessarily equate to green days, but to days that prevented a melt down or perhaps provided a bounce in an overall declining market. We'll just have to see what happens going forward.
.
As I mentioned in my comment, since they are 2009 data, we might need a "fudge factor" to approximate today's numbers.
HardToLove
But I did comment recently that I thought the Fed did not realize how smart the folks that he was playing against are.
I mean, if guys like me and DM (no, that is not a slam!:-)) can immediately recognize that there is some kind of trouble ahead and start working on a plan to benefit from it, the "big players" out in the wild must have had it all worked out in a matter of hours.
For me, seeing this effect on both the equities and bonds says that we are on the right track in trying to prepare for whatever it is that is on the way.
HardToLove.
P.S. "Mr. Love"? Knock it off before I smack you one! ;-))
Falling back on comments about the (TLT) and (SPY) correlation, in the past I might have seen the bond move up and then could know that equities would generally move down. In the unknown new scenario, I might have to discount that. Along the same lines, on the chart you linked, we might have to discount the traditional 10 year treasury to equities ratio.
Things like that. Of course we could be in the middle of a "new normal" being formed and the ratio might still be valid but at a different ration.
It was things like that I felt might be getting altered, along with what it implies about "what comes next".
My thoughts are very ill-informed at this time about that and I can only wonder if these types of things might suffer effects that cause their meaning to be altered in subtle ways so the we need to evaluate them slightly differently.
But I do realize this OT for this blog, so we probably ought not to go much further than a few sentences about it. And your comment may have covered it already - essentially numbers are still numbers and generally will continue to carry the same meanings as before.
Thanks for the thoughts!
HardToLove
There was no "moral hazard" associated with the Jubilee year.
It's a very interesting notion, with no "bubbles"!
I hope you didn't miss Dirk Bezemer's article discussing how ancient Babylon handled debt crisis. It is a kind of "Jubilee" year process you describe. They called it the "Clean Slate" process and it was something like bankruptcy for all speculators and protection for all productive people. It looks just like the opposite of how we are dealing with debt overload today.
What is curious is that such a process would actually work now, but the oligarchy has overruled bankruptcy for themselves and removed protections for others over recent years. As I said, sounds just like the opposite of ancient practices.
I have provided links to Bezemer's article above, but here it is again: econintersect.com/word...
seekingalpha.com/insta...
I'm specifically interested in ongoing signs of inflation/deflation and investment ideas if deflation is going to be crashing on our couch for a while.
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